Tina: I am preparing to sell my small family business. Do I need an appraisal or is that just for big businesses?
Marcus: Performing a business valuation prior to selling your business is always recommended. Whether your company is a large private corporation or a small family business, knowing the fair market value allows you to identify what are the key value drivers, make strategic decisions that maximize value and mitigate potential risks. In fact, I always advice clients to conduct a business valuation at least once a year as part of a strategic plan, set goals and work towards increasing the enterprise value over time. Once you have had time to optimize the value drivers of your business, it is recommended you start preparation at least 3 months early so that potential issues that may arise during the transaction are addressed prior conducting due diligence. This not only increases the chances of selling the business faster, but it also may increase the investment value perceived by the buyer.
Tina: How can I get a premium value for my business?
Marcus: There are different ways of getting a premium value for your business. Although it may vary depending on the type of industry, market and macroeconomic environment the business operates in, most buyers usually pay a premium when they see investment value as a result of the following:
- The business is scalable and well diversified in its product line.
- The business has consistently generated attractive margins and healthy, steady cash flow.
- There are potential synergies to be achieved in the event of a merger/sale which considerably increases the investment value.
- There are significant barriers to entry and limited competition.
- Management is composed of skilled, experienced and committed professionals.
- The business has a solid revenue model with recurring revenues.
- The business has presence in key markets with strong growth forecasts.
Buying a business is a significant investment decision for most buyers.
Tina: What are the three most important factors that improve the value of a business?
Marcus: In my opinion, the three most critical factors that improve the value of a business is the ability to generate free cash flow, the cost of capital and the business intangibles. Free cash flow represents the main value driver of any business no matter what industry it is in. The first aspect that any buyer or investor considers when buying a business is the cash it generates and returns to the buyer. Secondly, the cost of capital represents the required rate of return any investor would ask when investing in a similar business. As the business uses its capital more effectively and achieves an adequate capital structure, the cost of capital decreases and as a result, the enterprise value increases. And third, businesses in a growing industry with proprietary technology or intellectual property enjoy a differentiation factor with respect to competitors which makes the investment attractive and appealing for the potential buyer.
Tina: From a valuation perspective, why and how is every business unique?
Marcus: Each business operates within a unique macroeconomic environment under its own financial set of circumstances that affect the way its people manage the business and market its products and services, competing in an industry with its own set of regulations selling to clients in different markets. As a result, to adequately value a business there must be a thorough understanding of every aspect of it, including its financial situation, competitive advantages, value proposition, product offering and macroeconomic environment, among other things. From a valuation standpoint, each business is different in that it has its own strengths, weaknesses, opportunities and threats and competes under different scenarios which may eventually impact the enterprise value.
By starting early with due diligence, it will help the owner identify critical issues that can force the buyer to lower the offer or even walk away from the deal.
Tina: Do buyers of businesses place any weight on a business appraisal?
Marcus: Indeed, and based on my experience, most buyers perform a business valuation prior to engaging in an M&A transaction. Since buyers are probably not familiar with the target, it is always recommended that a certified valuation professional conducts a thorough assessment of the business to identify and understand the key value drivers in an effort to mitigate potential risks. Thus, it allows the buyer to have a credible opinion and objective review of the subject company to ensure the investment is appropriate and meets the buyer’s expectations. So, although the buyer is ultimately the one who decides whether to invest in the business and how much risk he/she is willing to assume, a business valuation guides the buyer towards understating the fair market value and making the right decision.
Tina: I am thinking about buying a business. Should I consider a valuation, or at least some advanced due diligence, for the company that I am considering purchasing?
Marcus: Buying a business is a significant investment decision for most buyers. So it is always a good idea to conduct an adequate assessment to ensure the investment meets your expectations and that no unwanted surprises arise after the deal is closed. At least, we recommend conducting a valuation analysis and performing enough due diligence to ensure that the most critical factors relevant to the business such as financial, operational and legal, are all sound and squared away. The potential risks and consequences of making a bad investment, especially in these days, are just too high compared to the cost of engaging a business valuation professional and M&A advisor.
I always recommend business owners to perform a valuation at least once a year to work on key strategies that can add value to the business.
Tina: Can I use online software to appraise my business? What are the risks/benefits?
Marcus: There is business software available online that can be helpful however, it definitively has its limitations. The hands-on approach of a valuation expert when conducting the appraisal such as meeting with key management and employees on-site, visiting the facilities, meeting with suppliers, checking out competitors and networking with industry professionals is extremely helpful towards selecting the right methodology and making adequate assumptions which are immensely important. It is largely understood that most of the value in successful companies lies in the intangible assets; therefore the business judgment of the valuation expert plays a key role and is of significant importance when making adequate assumptions and conclusions of value. Since valuation is more art than science, I believe that no business software can ever substitute the work of an expert.
Tina: Can you appraise my business if it is located outside of the United States?
Marcus: Although business valuations are not limited to the United States only, it is critical that financial statements comply with the Generally Accepted Accounting Principles (GAAP) established by the American Institute of Certified Public Accountants (AICPA). This is done to ensure financial statements meet AICPA’s standards and are consistent when used for business valuation purposes. We have performed several business valuations for non-US companies and we recommend having financial statements adjusted to GAAP standards so that values are in range with industry peers. That way we are capable of analyzing the business and giving an opinion of value which is consistent under US valuation standards and guidelines.
When valuing intellectual property, it is necessary to estimate the incremental earnings that the intangible asset can create for the buyer.
Tina: Do I need a separate appraisal for my intellectual property?
Marcus: Usually it is recommended to have intellectual property valued separately as long as it can be considered a stand-alone asset with revenue-generating capabilities and not entirely dependable on the enterprise. Normally, IP valuations are driven by the earnings capability of the intangible asset and are based on the projected royalties which can be generated. So, when valuing intellectual property, it is necessary to estimate the incremental earnings that the intangible asset can create for the buyer. As a result, it is recommended to have a certified valuation analyst or business appraiser with extensive intellectual property knowledge and experience to calculate the fair market value of the intangible asset on a stand-alone basis.
Tina: Do you have any other tips or advice for anyone buying, selling or appraising a business?
Marcus: As part of their strategic plan, I always recommend business owners to perform a valuation at least once a year to work on key strategies that can add the value to the business. Knowing the enterprise value can help you identify the main value drivers that can contribute to better manage the business going forward. You should not wait to have an offer from an interested buyer to perform a business valuation because the owner may lose upside potential that cannot be capitalized since there is not enough time to optimize value. Also, if the owner is interested in selling the business, engage a valuation/M&A advisor work with him/her on developing an exit plan to adequately address business as well as personal factors that are critical to prepare for the deal. By starting early with due diligence, it will help the owner identify critical issues that can force the buyer to lower the offer or even walk away from the deal.