As a business owner, one of the most important questions you will face is: What is my business worth?
To answer this question, most business owners pay a professional to value their business. Before you do the same, be sure you understand the following:
- What is a valuation?
- How much does a business valuation or appraisal cost?
- Should I have an appraiser, a broker, or my CPA value my business?
- Do I really need a valuation for my business?
- What is the process of determining the value of my business?
When obtaining a valuation, you generally have three options:
- Verbal opinion of value
- Written report, not complying with appraisal standards
- Formal appraisal (self-contained)
Which type of valuation is right for you? The appropriate type of appraisal depends on your specific purpose for obtaining a valuation. Most appraisals are performed for legal purposes, so receiving an appraisal in this format of valuation may be of limited use to you if your goal is to sell your business.
Which standard of value is the right one to use when appraising your business? Most business appraisals use fair market value (FMV) as the standard of value. FMV does not take into account the strategic value to the buyer. Therefore, any business appraisal using FMV as the standard of value for a middle-market company is unlikely to represent what the business may actually sell for.
Finally, who should you hire to value your business, and how much do they charge? Your options include business brokers, M&A firms, CPAs, and business appraisers. Who is right for your situation? And how much does a valuation cost? Do you need to pay $10,000 for an appraisal, or should you trust a free valuation from a broker?
In this article, we answer all these questions and offer specific advice for hiring an appraiser. We also share our research regarding the average cost for a valuation based on our survey of 45 firms.
Table of Contents
- Choosing the Right Type of Business Appraisal
- Verbal Opinion of Value
- Written Report, Not Complying with Appraisal Standards
- Formal Appraisal (Self-Contained)
- Choosing the Right Type of Business Valuation Based on Your Purpose
- Choosing the Right Standard of Value: Fair Market Value Vs. Strategic Value
- Choosing the Right Person to Value Your Business
- Business Broker
- M&A Firms
- Business Appraisers
- Third-Party Appraisers
- Choosing the Right Business Appraiser Based on Your Purpose
- The Best Appraiser for Legal Purposes
- The Best Appraiser for Selling Your Business
- Choosing the Right Methods Based on Your Business & Purpose
- Methods for Small vs. Mid-Market Businesses
- How Buyer Types Affect Your Valuation
- Other Considerations When Valuing Your Business
- The Downsides to Business Valuation Software
- The Third-Party Valuation Myth
- A Valuation is One Person’s Opinion
- The Marketplace is Inefficient
- Do Buyers Follow Valuations?
- Process for Valuing a Business
- Data Gathering
- Analyze & Normalize Financials
- Additional Questions
- Compile the Report
- Average Price of a Valuation – Our Research Based on 45 Companies
- Business Brokers
- M&A Firms
- Investment Bankers
- Business Appraisers
- CPA & Accounting Firms
- Financial Advisory Companies
Choosing the Right Type of Business Appraisal
When considering whether you should have your business appraised, you have several options. The various types of business valuations do not have standard definitions, but most reports fall into one of three main categories:
- A verbal opinion
- A written report for non-legal purposes (such as a business sale)
- A written report for legal purposes
Verbal Opinion of Value
A verbal (technically “oral”) opinion of value is suitable for any business owner who doesn’t need a written report. This type of valuation usually involves the appraiser, broker, or CPA reviewing the owner’s financial statements, and offering a verbal estimate of value. Some business brokers and M&A intermediaries will offer this service for free, while most experienced experts will charge a fee for this service. These types of reports are useful if you are in the exploratory stages of selling a business and would like a ballpark idea of what your business is worth before committing more time, money, and effort to the process. It’s common for us to provide a verbal opinion of value to a client without preparing a formal report. We typically have a 30-60 minute conversation with a client before advising them on what type of report we believe is necessary. A formal report is not necessary for most small businesses.
Written Report, Not Complying with Appraisal Standards
Restricted Appraisal Report Written reports can range from a couple of pages in length to 50 or more pages. These reports do not comply with appraisal standards and cannot be used for legal purposes. We generally refer to these reports as a “business valuation, not for legal purposes.” The format of these reports varies considerably. Some are simple and straightforward, and others are long, formal, and full of technical jargon that has no application outside of the legal world. A “calculation of value” is the industry’s attempt to offer a simplified report for business owners. Pricing can range from free to tens of thousands of dollars. These reports are useful for business owners looking to sell a business. Because these reports do not comply with appraisal standards, the format of these reports varies. Categorizing the types of reports found in this category is nearly impossible.
Formal Appraisal (Self-Contained)
This type of report is required for any legal purpose, such as a divorce, tax matter, or bankruptcy. These reports are often hundreds of pages in length and are of little use for a business owner looking to sell a business. The format of these reports is more consistent than a restricted appraisal report because they comply with the appraisal standards. These reports typically cost $5,000 or more. You do not need this type of appraisal unless the appraisal is being used for legal purposes.
Choosing the Right Type of Valuation Based on Your Purpose
Business valuations are used for many purposes.
The value of a business is often needed in divorce proceedings, tax planning, bankruptcy proceedings, litigation, buy-sell agreements, and strategic planning. Valuations are also needed when arranging financing and assessing economic damages for litigation.
Most appraisals are performed for legal purposes, so receiving an appraisal in this format may be of limited use if your goal is to sell your business. That is because the appraisal may not reflect the actual value of your business if you were to sell your business in an open market.
Most valuations use complex language that is difficult to understand and include formulas that are of little use to a business owner who is looking to sell their company.
For example, most appraisals contain an in-depth analysis of national and local economic and industry factors that affect the value of a business, which is required for appraisals intended for legal proceedings. However, most owners are familiar with the economic and industry factors that affect the value of their business and do not want to pay an expert to prepare a report to discuss these factors.
Appraisals prepared for legal purposes must follow numerous legal guidelines and standards.
For example, an appraisal for a divorce may require a strict definition of value, such as “Fair Market Value,” while an appraisal for another purpose may require the standard of “Fair Value.” Using different standards of value can result in significant differences in the value of the business. While such a distinction might be important for a legal proceeding, it may be meaningless in the real world.
Appraisals prepared for legal purposes must follow a number of strict legal standards. As the business valuation industry has progressed, these standards have become more complicated, and as a result, the standard business valuation report has lengthened over the years.
Following these standards results in an increased amount of time to prepare a report and an increased price for the appraisal. The outcome is that most business valuations are of little use to an owner looking to sell because they are too esoteric and confusing and therefore are of little practical value in the real world.
Many business brokers and M&A intermediaries are confused by these standards, and as a result, decide not to offer business valuations as a service. At the same time, most of the people offering business valuations are business appraisers and CPAs, many of whom have never sold a business. Most have only a rudimentary understanding of the process of buying and selling a business, and few understand the M&A marketplace, which raises the question:
Would you pay an appraiser thousands of dollars to determine the value of your business if that person had never sold a business personally?
Choosing the Right Standard of Value: Fair Market Value Vs. Strategic Value
Most business appraisals use fair market value (FMV) as the standard of value. Fair market value can be defined as follows:
The amount at which a property would change hands between a willing buyer and a willing seller, neither being under any compulsion to buy or to sell, and both having reasonable knowledge of relevant facts.
FMV does not take into account the strategic value to the buyer. Therefore, any business appraisal using FMV as the standard of value for a middle-market company is unlikely to represent what the business may actually sell for.
Strategic value, also called investment value, is the value of a business to a specific buyer. It can represent the added value to a specific buyer of a business. Businesses similar to the buyer’s that offer potential synergies will have a higher strategic value to that buyer. The downside is that you can’t measure the strategic value of your business to a buyer if you are the seller. To measure strategic value, you must fully understand the buyer’s company and have access to their financial statements. The only way to determine strategic value is through a competitive auction process in which multiple buyers compete with one another to acquire your business.
Most businesses priced at less than $5 million will sell based on fair market value (FMV) whereas many businesses priced over $5 million will sell in excess of fair market value.
If your EBITDA is less than $1 million: It makes sense to perform an appraisal of your company if your cash flow (EBITDA ) is less than $1 million annually.
If your EBITDA is greater than $1 million: For companies with EBITDA in excess of $1 million per year, a valuation will only serve to establish a floor (or minimum price) at which the company will sell. Many lower middle-market companies sell in excess of their fair market value if they are sold to a strategic buyer.
Choosing the Right Person to Value Your Business
Many business brokers offer to prepare a business valuation for prospective clients. Some business brokers offer a free report as a lure to induce prospective clients, but most experienced brokers charge a fee for a valuation. If the broker is working strictly on a commission basis, a conflict of interest may exist because the broker may be tempted to provide an inflated opinion of value as an inducement to hire them. The downside is that few business brokers have more than a rudimentary understanding of business valuation. Therefore, finding a qualified business broker to value your business may prove to be difficult.
Many Mergers & Acquisitions firms and intermediaries also offer valuation services to their clients. Many of these firms will provide a simplified valuation report and focus on the value of your business solely in the context of a sale. These firms have experience assisting their clients with buying and selling companies and are well qualified to advise you on the value of your business, especially if the buyer of your business is likely to be a strategic buyer. Additionally, the value of most middle-market companies is established through an auction process and M&A advisors are intimately familiar with this process. They can advise you on the relationship between the price you may achieve through an organized auction process and the baseline value shown in a valuation report.
Accountants and CPAs sometimes offer valuation services to their clients. Some CPAs are also licensed business appraisers. While accountants have a strong grasp of the numbers, few have sold a business before and are not an ideal choice if the purpose of your valuation is to sell your business. On the other hand, larger accounting firms have dedicated M&A professionals on staff and may be more qualified to prepare a valuation.
Business appraisers are the most qualified to value a business for legal purposes. However, if they lack real-world experience selling companies, they shouldn’t be used to value your business if your goal is to sell.
Several appraisers offer their appraisals through a network of business brokers. These networks actively market their services to business brokers, charging as little as a few hundred dollars, while the brokers mark up the cost as high as 1,000%. Many franchised business broker networks actively convince all of their franchisees to market their third-party appraisal services. We generally don’t recommend third-party appraisers.
Choosing the Right Appraiser Based on Your Purpose
The Best Appraiser for Legal Purposes
CPAs and business appraisers are ideal when obtaining a valuation for legal purposes.
When obtaining an appraisal for legal purposes, you should select a business appraiser or a licensed CPA.
The Best Appraiser for Selling Your Business
Business brokers and M&A intermediaries are ideal when the purpose of your valuation is to sell your business or weigh your exit options.
When selling your company, you don’t need an appraisal that can be used in court. As a result, the advisor can produce a shorter report that is limited to the valuation methods that buyers actually use in the real world, which will save you money. The advisor should also have real-world experience selling companies.
Choosing the Right Methods Based on Your Business & Purpose
Methods for Small vs. Mid-Market Businesses
The methods used to value a small business (less than $5 million in revenue) are different from those used to value a middle-market business ($5+ million in revenue). Unfortunately, most valuation software does not make this distinction, and you sometimes end up with a report that is not suitable for your business. When obtaining a business appraisal, ask the appraiser the industry and size of businesses they sell and value on a regular basis.
How Buyer Types Affect Your Valuation
The task of valuing your business is complicated by the fact that there are different types of buyers. Some buyers are looking to buy a business as an investment to be run by a manager. Others may consider your business as a strategic addition to a similar business they already own, in which case they may be able to reap synergistic benefits.
Accounting expenses, for example, may increase only slightly when the buyer adds a second location. The size and type of business you have will determine the type of buyer most likely to buy your business, which will, in turn, determine the multiple the buyer is likely to pay. It stands to reason that whoever appraises your business should be intimately familiar with who is likely to buy your business.
The Downsides to Business Valuation Software
As a result of these complicated legal standards, most business valuation report software is designed specifically to produce valuations for legal purposes.
Nearly all appraisers use commercial business appraisal software when preparing a valuation, while some have produced their own software.
If your goal is to sell your business, you will have a difficult time finding an appraiser that uses valuation software designed for that purpose.
Unfortunately, the reports produced by most valuation software are highly technical and not of much use to business owners who are looking to sell.
Before retaining a business appraiser, we recommend asking to see a sample report. Read it, and see if you can understand it. If you can’t, don’t hire the appraiser unless you need the appraisal strictly for legal purposes.
The Third-Party Valuation Myth
Many business brokers (but generally not M&A intermediaries) recommend obtaining a valuation from a third party. Brokers make this recommendation because they can sell the valuation at a large markup and don’t need the technical expertise required to appraise a company.
Most franchised business broker offices push their franchisees to sell third-party appraisals, often at a 200% to 500% markup. The drawback with a third-party appraisal is that you rarely interact directly with the appraiser. We generally don’t recommend third-party appraisals.
A Valuation is One Person’s Opinion
When obtaining a business valuation, you are simply paying for a professional’s opinion. This opinion is always subject to change.
That means that the value they give you is not the definitive value of your business, but rather is their opinion of value at a specific point in time and current market conditions. It’s based on their limited knowledge of your business, and based on a hypothetical buyer.
The Marketplace is Inefficient
The sale of small and mid-sized businesses is inefficient, unlike markets for other assets, such as real estate and stocks. Pricing in efficient markets tends to fall along a narrower band than that of inefficient markets.
As a result, values vary considerably over time. Therefore, the market and the process used to sell your business can greatly affect the final selling price.
Do Buyers Follow Valuations?
Buyers don’t always follow valuations. An appraisal is an attempt to estimate what a hypothetical third party is likely to pay for your business based on the current state of the economy and your business, and based on the appraiser’s subjective interpretation of your business’s risk and growth potential.
That task is difficult, especially if the potential buyers for your business are unsophisticated, whose opinions tend to be less uniform than sophisticated buyers. While it’s much more difficult to predict how sophisticated people will behave than unsophisticated people, the opinions of buyers are not uniform — therefore there is no typical buyer.
Process for Valuing a Business
Most appraisals start with an analysis of three to five years of your profit and loss statements and balance sheets, and a company questionnaire. This data-gathering process is the time-consuming part of the process for you (although it’s likely the most exciting part for CPAs) because it involves gathering a large amount of financial and operating information on your company.
Analyze & Normalize Financials
Once the appraiser has this information, they will then normalize or adjust your financial statements. This step involves making adjustments to your financial statements to calculate SDE or EBITDA, so your business can be compared with others within your industry.
The appraiser will need to communicate with you during this process and your involvement is key to the accuracy of the appraisal. Don’t be afraid to ask questions during this process.
Compile the Report
Once this step is complete, the appraiser will compile the report based on the information you have given, as well as information the appraiser has already obtained about the industry.
Average Price of a Valuation – Our Research Based on 44 Companies
We surveyed a random sample of 44 business brokers, M&A intermediaries, investment bankers, business appraisers, and CPAs to ask them what their fee would be for appraising a small manufacturing company with $5 million to $10 million dollars in annual revenue.
Here are the results:
Company #1 – Business Broker & Appraiser: They recommended a “Broker Opinion of Value” and did not provide a price.
Company #2 – Business Broker, M&A Intermediary: $10,000 for a valuation.
Company #3 – Business Broker, M&A Intermediary: Recommended a third-party valuation for $4,000.
Company #4 – Business Broker, M&A Intermediary: $2,500 for a business valuation.
Company #5 – Business Broker, M&A Intermediary: $3,000 to $5,000 for an appraisal.
Company #6 – Business Broker, M&A Intermediary: Written opinion for $950 or formal appraisal for $2,500.
Company #7 – Business Broker, M&A Intermediary: $950 to $2,500 for a valuation.
Company #8 – Business Broker, M&A Intermediary: Recommended a third-party valuation for $5,000.
Range = $950 to $10,000
Average = $3,771 to $4,500
Company #9 – M&A Advisor: They said an appraisal was not necessary and recommended we sell the company through an auction process.
Company #10 – M&A Advisor: $5,000 to $10,000 for a valuation, or $350/hour.
Company #11 – M&A Advisor: 5% retainer on the estimated amount of the appraisal. Also includes other services.
Company #12 – M&A Advisor: Offered a free valuation for prospective clients.
Company #13 – M&A Advisor: Did not recommend an appraisal.
Company #14 – M&A Advisor: Recommended a third-party appraisal.
Company #15 – M&A Advisor: Did not recommend an appraisal.
Company #16 – M&A Advisor: Did not recommend an appraisal.
Company #17 – M&A Advisor: Did not recommend an appraisal. Does not offer appraisals. This advisor prefers an auction-based process to achieve the highest price.
Company #18 – M&A Advisor: Did not recommend an appraisal.
Company #19 – M&A Advisor: $1,500 to $2,500 for a limited report. $5,000 to $10,000 for a business appraisal.
Company #20 – M&A Advisor: Required a proprietary report costing $9,500.
Company #21 – M&A Advisor: Did not recommend an appraisal.
Company #22 – M&A Advisor: Did not recommend an appraisal.
Company #23 – M&A Advisor: $6,500 for a business valuation.
Company #24 – M&A Advisor: Recommended a third-party appraisal costing $10,000 to $15,000.
Range = $1,500 to $15,000
Average = $6,250 to $8,917
Company #25 – Full-Service Investment Banking Firm: $12,000 to $17,000. The process takes four to five weeks. They did not recommend setting a price for the company, as they recommended an auction process with no price. They wanted us to pursue the strategic value rather than the fair market value.
Company #26 – Investment Banker: They did not provide pricing. They said pricing varies based on several factors. They also mentioned attempting to achieve strategic value.
Range = $12,000 to $17,000
Average = $14,500
Company #27 – Business Appraiser: $15,000 to $18,000.
Company #28 – Business Appraiser: They had multiple fee structures, starting from a simple report and expanding to a more thorough report, if necessary.
Company #29 – Business Appraiser: $3,000 to $5,000 for a verbal opinion of value; $10,000+ for a written report.
Company #30 – Business Appraiser: $12,000 to $20,000. They discussed different standards of value based on the purpose of the valuation. They said the reporting requirements for appraisals for legal purposes, such as estate planning, are more rigorous and mentioned strategies for maximizing cash flow and value.
Company #31 – Business Appraiser: $2,000 to $3,000 for a calculation of valuation (a very short report). $5,000 to $20,000 for a full business appraisal.
Company #32 – Business Appraiser: $12,000 to $30,000. They can start with a basic report and then upgrade to a more comprehensive report.
Company #33 – Business Appraiser: $7,500 to $10,000 for consulting to determine the value to sell the company. $12,000 to $15,000 to prepare a report for legal purposes.
Company #34 – Solo Practitioner Business Appraiser: $12,500 yo $15,000.
Company #35 – Solo Practitioner Business Appraiser: $6,000 to $10,000.
Company #36 – Business Appraiser: $3,500 to $6,000.
Company #37 – Appraiser, MBA, Economist: $5,000 to $10,000 for a limited report.
Company #38 – Appraiser: $7,500 for a limited appraisal.
Range = $2,000 to $30,000
Average = $7,885 to $13,038
CPA & Accounting Firms
Company #39 – Publicly Traded Full-Service Accounting Firm: $10,000 to $15,000. The reports are 80-100 pages in length, meant for tax and other compliance purposes.
Company #40 – CPA, Business Appraiser: Verbal opinion of value for $2,000 to $3,000. Calculation report for $5,000. Formal report for $8,000 to $10,000.
Company #41 – CPA & Business Appraiser: Charges $15,000 for a business valuation.
Company #42 – CPA & Business Appraiser: Charges $5,000 to $7,000 for a business valuation.
Range = $2,000 to $15,000
Average = $7,500 to $9,167
Financial Advisory Companies
Company #43 – Financial Advisory Group that offers business appraisals: Provides valuations for business sales on an hourly basis. Appraisals for legal purposes are $10,000 or more.
Company #44 – International Financial Advisory Firm: $30,000 to $40,000.
Range = $10,000 to $40,000
Average = $20,000 to $25,000