The Right Buyer, The Right Seller, The Right Price.
Business valuation should be considered a starting point for buyers and sellers. The more informed the parties in a transaction are, the better the likelihood of a good deal. Of course, each party has different motivations, but fair market value is the price a seller will accept and a buyer will pay. Only the right buyer will pay the right price.
Understanding Business Valuation
Selling a business is far different from selling a house or other tangible asset where there exists comparable sales information sufficient to support a value. Unlike real estate, it is not unusual for 50% or more of an operating business’s value to be based on intangible assets such as goodwill, intellectual property, licenses, location, etc. Business valuation is a complex process. Part art and part science, it relies on elaborate business metrics and intangible factors that only come with experience. At George & Company we have that experience – and we can put it to work for you.
There are several reasons for valuing a business. As well as the buying and selling process, business valuation is an important tool for estate and tax purposes, divorce settlements, and for raising capital. We can help with all of these situations. Our company offers a variety different professional business appraisal services. Our appraisal services can cost from $1000 to $10,000 and more, depending on the size and complexity of the business to be valued.
Read more below about the different kinds of valuations that can be performed on your business, and when a business valuation needs to be done.
Fair Market Value
Fair market value is an estimate of what a willing buyer would pay to a willing seller in a free market (both having equal knowledge of the business and transaction variables), for an asset or piece of property under conditions where neither party feels pressured or obligated to buy or sell. If a transaction occurs within the aforementioned conditions, the transaction price is usually the fair market value. This is not the same as intrinsic value which an individual may place on an asset, meaning what he or she feels the selling/purchasing price should be based on personal preference.
Common methods we use to determine the value of a business
We have found that the businesses we have taken through a formal business valuation process sell closer to asking price than those without valuations. Through the valuation process both sellers and buyers become better informed – making the entire process easier – from start to finish.
Asset valuation is used when a company is asset-intensive. Retail businesses and manufacturing companies fall into this category. This process takes into account the following figures, the sum of which determines the market value:
- Fair market value of fixed assets and equipment (FMV/FA) – This is the price you would pay on the open market to purchase the assets or equipment.
- Leasehold improvements (LI) – These are the changes to the physical plant that would be considered part of the property if you were to sell it or not renew a lease.
- Owner benefit (OB) – This is the seller’s discretionary cash for one year; you can get this from the adjusted income statement.
- Inventory (I) – Wholesale value of inventory, including raw materials, work-in-progress, and finished goods or products.
What does Asset Valuation mean?
Asset Valuation is the process of determining the current worth of a portfolio, company, investment, or balance sheet item.
How can I prepare for an asset valuation consultation?
Business appraisers, business valuators, and brokers start off requesting a copy of the past three years of tax returns and financial statements in order to prepare an overall view of your company’s asset valuation. Other key pieces of information include all the salaries and “perks” that are directly paid to the client and his/her family members. From there, we will examine other relevant analyses in order to conduct a detailed asset valuation. Initial consultations allow us to get an understanding of your goals and make you feel confident that we can help you obtain these goals.
How are assets and earnings best demonstrated?
Most valuations require readjustments to tax returns and financial statements in order to appeal to the buyer. This is not to say we convey a false image of your company. It simply means we examine personal versus operating expenses, for example, and exclude personal expenses from the balance sheet and retain only those that are relevant to a potential buyer.
What if I have a SBA Loan?
Small Business loans are common amongst small to medium sized businesses. Note that if you have a small business loan exceeding $250,000 then you are required to have an accredited business appraisal expert perform a business valuation in order to establish the value of your business with the existing loan. Furthermore, if you are looking to take out a loan, you must have a business/asset valuation in place in order to be approved for that loan.
Capitalization of Income Valuation
Capitalization of income valuation method places no value on fixed assets such as equipment, and takes into account a greater number of intangibles. This valuation method is best used for non-asset intensive businesses such as service companies. “Cap Rates” can be derived from various methodology. One such valuation method is the build-up method where statistical data are used from publicly traded companies. Other cap rates are derived from Industry Rules of Thumb and market sales.
Capitalization of Income Factors
In his book “The Complete Guide to Buying a Business” (Amazon, 1994), Richard Snowden cites a dozen factors that should be considered when using Capitalization of Income Valuation. He recommends giving each factor a rating of 0-5, with 5 being the most positive score. The average of these factors will be the “capitalization rate” which is multiplied by the Seller’s discretionary cash to determine the market value of the business.
The factors are:
- Owner’s reason for selling
- Length of time the company has been in business
- Length of time current owner has owned the business
- Degree of risk
- Growth history
- Entry barriers
- Future potential for the industry
- Customer base
Owner Benefit Valuation
This formula focuses on the seller’s discretionary cash flow, and is used most often for business valuation in which value comes from their ability to generate cash flow and profit. Owner benefit valuation uses a fairly simple formula: multiply the owner benefit times a multiple consistent with the industry to get the market value. George and Company will carefully examine the Seller’s income statement to identify non-recurring and discretionary expenses.
If the expenses are non-requisite to the operation of the company, then they are added to cash flow. Certain non-cash expenses like depreciation and amortization may also be added to cash flow. The total of the owner benefit is usually multiplied by an industry specific number to arrive at market value.
Commonly used by real estate professionals, the market approach determines the value of a business by using an “industry average” multiplier. This industry average is based on the price at which comparable businesses have sold for. As a result, an industry-specific formula is devised, usually based on a multiple of gross sales. These formulas, often called Rules of Thumb, can be troublesome because they may not focus on the bottom line; profits, earnings, EBIT or EBITDA. If an industry Rule of Thumb says company XYZ is selling for 50% of its annual gross sales, would you pay 50% for those sales if the company was not profitable? In most cases, business people want to invest in something that is profitable, sustainable and stable enough to produce growth in the future. The market approach is key to opening the door to opportunities which allow you to make the best business choices.
The appraiser therefore tries to focus on industry formulae where they are applied to a multiple of earnings. This market approach is similar to analyzing a publicly traded company by its P/E (price to earnings) ratio .The approach, if enough empirical data is available, can very often be the most reliable valuation methodology for many industries. George & Company, because of their status as an appraisal and brokerage/intermediary firm, has an extensive data base of actual sales to draw upon. In addition, by means of membership, we also have access to many of the world’s largest data bases of done deals.
Here are a few Industry Multiplier examples:
- Retail (Family) 1/3 of annual sales
- Service Companies (General) 1.7 X annual net profit + inventory + equipment
- Manufacturing (Job Shop) 3-5 times EBITDA plus WIP – with patent, 4-6 times EBITDA
Strategic Options Analysis
A prudent step in deciding if now is the right time to sell your business is to have a Strategic Options Analysis (SOA) performed by George & Company. An SOA, a proprietary tool of the George & Company team, combines the elements of a business appraisal, a financing template to determine the amount of cash a lender will give, trends of the business, economy and the industry you are in. The SOA starts with a recast of your financial statements, adding back non-recurring and prerequisite expenses. This is a critical exercise in selling a business because buyers and lenders expect that the tax returns be prepared to minimize taxes. SOA’s also examine the company’s history, management makeup, working capital needs, business selling market, past sales of similar companies, client concentrations, vendor relationships, and countless other critical factors that will comprise your business’s value.
Having an SOA prepared allows business sellers and other decision makers to make an informed judgment. Maybe the market is red hot for selling your business or maybe the SOA will highlight things that if done will enhance the company’s value down the road. When we say, “Trust the Experts” we are proud that George & Company and its affiliates have appraised and sold thousands of businesses for over thirty years. Our team is as long tenured as any you’ll find in New England or around the US. We find it’s valuable to have knowledge of what it feels like to be sitting on both sides of the closing table. Selling your business can cause emotions to run high. It’s not just about the money. Read more about it here.
When do you need to have a valuation?
A valuation may be used to buy a company, sell a company, mergers and acquisitions of two existing companies, to sell shares of the company to key employees, for divorce estate settlements, to settle estate and tax issues, for insurance issues or to stay current, organized and congruent with the rapid growth of your business. Regardless of the reason, everyone should know the value of their business.
Different Valuations for Different Companies
Two businesses both netting $250,000 can have considerably different market values due to such comparative considerations as revenue growth rate, equipment condition, customer concentration, intellectual property, barriers to entry, competitive situation, owner’s role, administration systems, labor and capital intensity, etc. One business may be operating below capacity and the other might require significant capital investment in order to grow. One may have an absentee owner with strong operating management while the other could be highly owner dependent. There can be myriad business valuation variances for companies that on the surface are quite alike. Attempting to value a business based strictly on market comparables results in an average business valuation that is insensitive to distinguishing characteristics and hidden aspects of the business.
The business valuation of intangible assets relies on income-based methods. Accurate discernment of earnings and seller’s discretionary cash flow (SDCF) is essential if the value is to be true. The business valuation process begins with a detailed examination of the company’s revenue and expenses to accurately determine the true earnings performance of the business. Is the brother-in-law earning $50,000 really needed? Is a Porsche Cabriolet necessary for delivery purposes? If the seller owns the building, is the rent at market rate? How much business is being conducted in the addition to the owner’s house that the company’s maintenance crew built? What about stockholder compensation mystique in S versus C corporations? Inventory pricing creativity? Such typifies the discovery challenge of the appraiser and the rationale for a formal business valuation if a business is to be fully valued.
Valuations as a Share Holder
Stockholder Actions represent many different situations. For example, a minority shareholder in a company may bring action against the majority shareholder. The board of directors may have voted to buy his or her interest in the company at a price that he or she does not feel represents the true value of the shares. In a situation such as this, the minority shareholder may hire us to value the interest of that one person, conducting an independent appraisal for his or her interest in the action.
Another common time for litigation is divorce. In many instances the husband may own the business and the wife, under common law, will be entitled to half the value of that business. In this situation we would be engaged, either by the estate or by an attorney representing one of the parties, to tell the court what the business is worth.
Estate/ Tax Valuation or Gifting a Business to Related Party
Business estate valuations may be requested for a number of different matters related to estate planning. The owner of the estate may want to know the value of his or her assets and business today, as well as what they may be worth in the future. Other uses for estate valuations include planning for a Will or when looking towards retirement.
Avoid Surprises in Due Diligence
Another major reason for a business valuation is to avoid surprises in the due diligence process, which can quickly kill a deal. Full financial disclosure upfront to a buyer is extremely important. Bad news is fully disclosed might have an impact on price but at least the deal is far more likely to survive with upfront disclosure.
With precise earnings information in hand, the appraiser employs several business valuation methodologies and weights the various results according to their pertinence to the business in question. For a business with significant tangible assets, the appraiser incorporates those asset values with the intangibles through methods such as Capitalization of Excess Earnings to arrive at a fully integrated value.
Finally, the appraiser subjects the business valuation to an extensive set of qualification criteria from over 100 SBA lenders for further validation of the value. If the value withstands the SBA’s requirements standards, there is an added basis for its validity.
Every business has a range of fair market value – the business valuation process is not totally scientific. The challenge of the business valuation process is to determine a business’s true earnings, to assign fair value to its intangible assets and to uncover the hidden value drivers of the business that reside below the radar of superficial business valuation techniques.
Legal Aspects of Business Valuation
Whether you are a seasoned practitioner or just starting, the rules of engagement relative to business valuation are constantly evolving. The courts are setting more and more precedents, the experts are getting better and there are more online valuation sources that “seem” to make economic sense. The Uniform Standards of Professional Appraisal Practice as promulgated by the Appraisal Institute of Washington, DC are changing dramatically and the experts need to stay current. It seems everyone has suddenly become an expert in the field. Consider a few things before you chose a professional business appraiser:
- Will your expert be easily qualified by the court?
- Will the trier(s) of fact have confidence in your expert’s opinion of value?
- Is that expert known to the courts?
- Is he or she credible in their report writing?
- Can they back it up with professional direct and cross examination?
- Do they have empirical statistics to back up their valuations?
- Do they advocate for their opinion or their client?
- How many times have both sides stipulated to mutually use your expert?
- Does your expert stay current with state law?
- Can you rely on your appraiser to coach you on key issues prior to hearings and trials?
- Does the expert have a reputation for prevailing in his or her opinion of value?
Picking the Right Legal Experts
We’re sure we don’t have to remind you that the people on your team are a direct reflection of you. The New England legal scene is provincial and it seems everyone knows everyone. Cases get settled to the satisfaction of the parties when credible valuation work is performed.
At George and Company we possess the expertise, qualifications, credentials and knowledge of the legal system to custom tailor reports to your needs. Our staff of qualified appraisers is large enough to get the work done quickly and done right. Our central location in Worcester, MA makes us convenient to all New England states, but we have done plenty of appraisal work outside the area as well.
Business Appraisal for Divorce Purposes
In Massachusetts, the rules for performing a professional business appraisal during divorce proceedings have changed. If you need an expert to provide business valuation and/or expert testimony for dissolution of marriage, the 2007 landmark Mass. SJC case of Bernier v. Bernier may have far reaching implications. This interesting case sets forth the court’s opinions regarding many factors that may not be used in a business valuation or appraisal that’s intended use is other than divorce. While this dissertation is intended to touch upon the main issues of Bernier, caution must be applied, as it may not be applicable in all cases.
George & Company consists of veterans who have provided hundreds of divorce appraisals. Many times, counsel for both sides will stipulate to our expert opinion to save time and money. That said, counsel still has a fiduciary responsibility to advocate the interests of their own client. Our George & Company valuation experts of Massachusetts pay careful attention to their professional ethics, not the interests of either party. After over 30 years of providing certified business appraisals and valuations to Massachusetts and New Hampshire courts, it is interesting to note that we have represented husbands and wives on a nearly equal basis. No one law firm accounts for more than 2% of our annual income. We are known to advocate our opinion of value, not the opinion of the client or their attorneys. In short, we will never be a “hired gun.”
Other benefits from hiring George & Company:
- Life member of The Institute of Business Appraisers, Inc.
- Qualified and testified in many family court cases
- Provided hundreds of divorce business appraisals for settlement or mediation purposes
- Excellent presentation on the witness stand
- In possession of thousands of empirical “sold business” statistics
- Practicing business valuation for divorce cases since 1986
There are many different issues related to Buy/Sell Agreements. Most of the time, when we’re engaged to do that kind of an appraisal, it would have something to do with cross purchase agreement or an insurance funding agreement within the corporation.
In other situations, if one of the partners or shareholders were to die we would be charged with establishing the value of their part of the company. This is also done to make sure a business has enough insurance. Often referred as Keyman Insurance, it makes sure that if that person wasn’t able to complete his or her duties in full or if he or she were to pass away, the corporation would be paid by the insurance company based on the set value. The insurance company will require a professional or a certified appraisal in order to write this type of insurance policy.
A Buy/Sell Agreement can also be as simple as calling us up and saying “I found what I feel is a great business that I’d like to buy and I’d like to have you help me establish a value for it.” In this situation, we will represent the interest of the buyer by preparing an evaluation, in addition to generating an Offer to Purchase and/or a Buy/Sell Agreement.
What to Expect
When you come to George and Company for business appraisals, we start by asking you to provide us with a number of items that will aid us in developing a value for your company. The most important information we will request are financial records and documentation.
In most instances we will ask you for a minimum of three years of tax returns and/or financial statements. Due to the fact that financial statements are typically a more accurate picture of your company’s financial position, emphasis may be placed on these documents.
Other important information includes the history and description of the company, the competition, and the local economic conditions surrounding your business’ location, or the global economic conditions if your business trades on a global scale.
All those things will have an influence on where your company is, the direction your company is going, and what the overall value of your organization is. We strongly believe that complete business appraisals and valuations lead to the successful closing of a deal.
Any financial documents and information forwarded to us remains confidential.