Is there a difference between a business appraisal for legal purposes and a valuation for a business sale? If my goal is to sell my company, should I have a business appraiser or a broker value my business?
A “legal appraisal” is for legal purposes, such as a divorce, bankruptcy, estate or gift taxes, shareholder disputes, litigation, or some forms of taxation. If you are planning the sale of your business, you should hire someone who has real-world experience buying and selling businesses, such as a business broker, M&A advisor, or investment banker.
Regardless of how much appraisal experience they have, they should also have real-world experience selling businesses. Many business appraisals employ methods that a buyer would never use in the real world, and the knowledge used by appraisers when preparing a legal appraisal is irrelevant for owners who are considering selling their business.
Why do business appraisers use irrelevant methods for business owners who are considering selling? There are three primary reasons:
- Specific methods that are irrelevant in the real world are required when preparing an appraisal for legal purposes.
- Most appraisers use third-party software that includes many default settings. Appraisers may not be able to customize their reports, or it may be time-consuming to set multiple default settings on the appraisal software. Nearly all appraisal software is designed for legal purposes.
- Most of a business appraiser’s clients are business owners who need an appraisal for legal purposes. For an appraiser, it would be inefficient to customize the report for owners preparing to sell since they rarely encounter that situation.
Does this mean that business appraisers don’t provide any value to those considering the sale of their business? Not at all. Experienced business appraisers have access to expensive databases, tools, and resources, and there is value in much of this. But if you are obtaining a valuation solely for purposes of planning the sale of your company, you will be far better served if you retain an expert who has real-world experience buying and selling businesses. This expert will be familiar with the methods buyers may use to value your business. They’ll also consider the salability of your business and any changes that can be made to improve its value. Valuing a business is much more than simply arriving at a number.
The art of valuation is anticipating how a buyer will behave. Who better to perform this task than an expert who has real-world experience working directly with the people whose behaviors you are trying to anticipate?
Have a seat on my couch…
Table of Contents
- Using the Right Method to Value Your Business
- That Time I Almost Became an Appraiser
- Real-World Business Valuation
- Look at What’s Behind the Numbers
- Do What Works in the Real World
Using the Right Method to Value Your Business
Here is a real-life example of how the information may be used — or not. When I worked for another brokerage firm, I sold third-party appraisals to clients (which I no longer recommend, by the way).
One time, I sold a report to an owner of a small manufacturing company. We prepared the documents and other information to be sent to the third-party appraisal firm. We received the report back about two weeks later. The report looked beautiful and official — it was hard-bound in leather with a gold stamp on the cover. The numbers inside were precise and exact. I drove to the client’s office to deliver the report. The client opened it, flipped the pages to the back of the report to look at the “final number,” and then shut the report. That was it — he didn’t bother to look at the rest of the report. He didn’t ask another question regarding the contents of the report.
If all you want is a number, you don’t need an appraisal — you can get a verbal opinion of value. If, on the other hand, you want to understand the logic behind the numbers, a detailed report won’t help you, either. Most reports are 99% boilerplate copy.
In this article, I use the term “appraisal” to refer to an appraisal for legal purposes and the term “valuation” to refer to a valuation for purposes of estimating the value of a business for a potential sale. You should note that these are not necessarily universal terms. Professionals in other industries may use alternate terms or may define these terms differently.
That Time I Almost Became an Appraiser
Eventually, I stopped selling these third-party appraisals. Few clients actually read them, and even if they did, I wasn’t qualified to answer their questions. Then, I picked up a couple of dozen books on business appraisals so I could have the knowledge to explain the reports to clients. My understanding progressed, I gained experience, and I even began preparing some appraisals myself. At one point, I was narrowing down my choice of what appraisal certification to obtain.
That’s when I caught myself.
After a couple of years of learning the craft, I realized that so little of the knowledge I acquired had any relevance in the real world.
I paid for and learned how to use a half-dozen pieces of appraisal software. I became frustrated every time I explored a new piece of software because about 80% to 90% of what was in the software was useless for our clients’ purposes — selling their business.
Real-World Business Valuation
Buyers in the real world generally use one method of valuing a business — a multiple of earnings. When I looked at the appraisal certification curriculum, I realized that not much was practical knowledge, at least as far as what my clients needed. Don’t get me wrong — the knowledge is absolutely essential if you are preparing an appraisal for legal purposes. However, most of it simply was not applicable in the real world when selling a business.
If you are planning to sell your company, you need someone who has real-world experience with selling companies to real-world buyers. Access to the databases alone isn’t sufficient, even if they contain data on actual transactions.
Look at What’s Behind the Numbers
Most business-for-sale databases only tell a portion of the story. As a business owner, what should matter to you is the information behind the numbers. Ask yourself three questions:
- What multiple is used to value your business and why?
- What could you do to increase its value?
- What is the possible range of values for your company?
We have seen appraisals in which the value was $1,434,918. Don’t be fooled by exact numbers. A more realistic range might be $1.2 million to $1.6 million, depending on several factors.
Appraising a business is highly idiosyncratic. If an appraiser uses a particular software, it may limit the perspective on your business that is presented to buyers.
For example, at Morgan & Westfield, we often perform an assessment for clients, and during the process, we may discover that our client’s business has three groups of potential buyers. The values for each group of buyers may be substantially different.
If the business were sold to an insider, an upper cap on the value might be $1.5 million. If the business were sold to a private individual, it might be worth $1.6 million to $1.8 million. On the other hand, if the business was sold to a competitor, it could be worth as little as $800,000 or as much as $2 million, depending on the competitor.
Attempting to capture these ranges and nuances in a report is extremely time-consuming. Businesses are complex, and it’s difficult to narrow down a multitude of interdependent factors to a fixed formula before squeezing them into an efficiently produced report. I know. I’ve tried dozens of times, and I have never found a piece of software that can consistently give clients what they need.
Do What Works in the Real World
At Morgan & Westfield, we have found that what works best is a combination of an abbreviated spreadsheet calculation of value, combined with a written exit plan and an in-depth one- to two-hour conversation.
- The spreadsheet contains adjusted income statements (P&Ls) and a range of multiples applied to the company’s earnings.
- The exit plan addresses all of the qualitative factors, such as potential buyers, deal-killers, value enhancements, deal structure, and so on.
- The most interesting part of the process is the conversation. In hundreds of conversations, no two have been even remotely alike. Every business has its unique issues. By not limiting ourselves to the fixed format of a software program, we are free to focus on the key issues that can impact the sale of a business or its value, whether these issues are qualitative or quantitative. Often, there are several interdependent issues at play, and we thoroughly explore each issue independently before tying them into a cohesive strategy. This is a process of exploration for both the business owner and ourselves.
As our understanding of your business grows, we develop a fuller appreciation for the business and develop a more appropriate strategy to value and sell it. This process is too difficult to reduce to a set of formulas and just isn’t possible with off-the-shelf software.
So, to answer the original question again, yes, there is a difference between an appraisal and a valuation, and which one you have done should depend on your ultimate purpose. If you need an appraisal for legal purposes, by all means, hire a business appraiser. If you plan to sell your company, stick with someone who has real-world experience who can help you truly value your business and maximize your selling price.