Business Valuation

When buying or selling a business, the business valuation becomes of utmost importance. There are also other reasons to have a business valuation completed. How is a fair price for a business formulated and who makes this determination? Are there recognized guidelines for coming up with a price?

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Business Valuation Overview
What is a business valuation or business worth to the owner, to the market, to an appraiser, to a divorce attorney and to a potential buyer? All of these interested parties may come up with a far different value when asked this question or forced to give an answer. Why is there a difference in value of a private business between these various people? Is there a source that has a formula that will come up with a value for company that is not publicly owned and traded?

The problem with coming up with a business value is there are many sources that can come up with a price. Some use simple rules of thumb and some use very sophisticated financial formulas. Is one better than another or are there valid reasons for each valuation system? The answer to this question is rules of thumb are simple to use and therefore can give quick answers. Is this the true value of the company under inspection? It may be if the company is similar to many companies in the same industry and with very close profit margins and expense ratios. The problem arises when trying to evaluate a company that is unique or does not fit the mold of say the typical printing company or any other service provider. What if their product line is one of a kind or the service they offer is unique to them and does not exist elsewhere. A valuation is still needed and this is where some of the national valuation certifications come into play.

Appraisal certifications qualify the appraiser as one that has passed an exam which has been determined to meet nation wide standards for business valuations. There are several organizations that offer this recognized certification. A search on the Internet will show the associations that offer these certifications and the difficulty in receiving the certification. Using a certified appraiser for business valuation is a step in getting a handle on businesses current worth.

What A Business Should Sell For
Businesses for sale have value to the owner, but that value could be high or low, in terms of FMV (fair market value). A CPA’s value of the business may be accurate and it may be off the mark depending on the CPA’s experience in evaluating companies. A business real estate professional may have the experience to come up with the value, but is this an unbiased opinion. One of the fairest ways to determine a FMV of businesses for sale is to hire a certified business valuation appraiser. This third party opinion can be used for a starting point in the determination of a business and its potential sales value. Further, for multiple businesses, multiple valuations may be necessary to determine the worth of all property.

Coming up with a sales price that is attractive and fair is complex and not easy to do: you should keep this in mind when you are buying a business. Sellers and buyers can have drastic differences of opinion of what a business is currently worth. If this dilemma is not resolved the potential sale may never be consummated. This is a good time to bring in an uninterested third party to value the company as it is currently. The good or bad aspects of the future could be mentioned, but it is the value of the business as currently constituted that is the determining factor.

What A Business Could Be Bought For
A business buyer’s opinion of a purchase price can be biased either way depending on how badly the sale is wanted. The real estate agent that is trying to sell the business may also influence it. As with the seller, getting a FMV from a certified business valuation appraiser may help in coming up with a potential price.

Paying a professional to value a company that the buyer is interested in buying makes a lot of sense. Money spent in this way may save on the purchase price or validate the asking price is acceptable or better yet a bargain. In any event it would give the buyer peace of mind. This professional opinion could save the buyer from making a bad financial decision. Money paid to the professional could be cheap at half the price.

Fair market value is determined by what a willing buyer and a willing seller are willing to accept as the selling price. This is the opinion of the IRS. Ok that is what FMV is but who determines that number and how do they arrive at this price?

How To Determine Fair Market Value
Again we go back to the certified business valuation professional to get an answer that would stand up to IRS scrutiny or for a potential sale. There are many factors that determine this number. They include the nature of the business, its history and the general economic outlook for its business segment. Other pertinent elements are its current financial condition and the potential for future earnings. Another factor is whether or not it is a business leader in the community.

As can be seen these are not easy elements to consider without some experience and standards to go by. A certified appraiser at least has met the qualifications of the certifying body. This opinion has merit for this reason.

A certification means the appraiser has passed an exam and had his appraisal looked at by other professionals. There are reasons behind the elements of the appraisal that have valid thinking behind the conclusion.

Guidelines For Determining a Businesses Valuation
There are guidelines for coming up with a current value of a business. Is the business the owner, the product or the service? The answer to this question is important. Is the owner’s reputation the reason the business is successful? Or are the products and service the reason for success? This can be a critical determination of future earnings and viability.

What are the current earnings and liabilities and what are the prospects for the future? Again this is a question that needs to be answered. The list of questions should be thorough and comprehensive if a fair value is to be assessed. Are there obvious improvements that can be made and what will the cost be to make them happen? All some businesses need is an infusion of capital to make it blossom and thrive. If this is the case, and the funds are available, then the value needs to be raised.

Management of a company is another factor that can make or break a company’s value and its future prospects. If the current management is solid and likely to stay with the company this is a plus. If there is going to be a major change this could severely effect the business. Good to excellent management is hard to find and keep. Quality always attracts attention and good people can make the difference in the company’s future.

Business Valuation and Contingencies
If a business is to be sold, there are questions that need to be answered about possible contingencies that may come up. Is there any litigation pending? Is the employee staff stable and likely to stay? Will the employees that are there now be able to stay when the new owner takes over? These areas need to be looked at and decisions made and told to the staff if the sale is to be made. Surprises are welcome and can also be harmful to a successful company that is sold. Let the people with the company know what is happening and how it will affect them.

Informed employees make better employees and it shows respect for them which is an important consideration in keeping good employees. Almost every business complains about how hard it is to get good people. Paying well is important, but respect is high on the list too. A new owner should have an information meeting as soon as possible after taking over. This will stop rumors and dispel worry about being let go.

After Sale Obligations and Contractual Agreements
Many business sales are contingent on the old owners staying for a specific period to help the new owner and make the transition more seamless. If this is thought to be necessary, then it should be part of the contract of sale. Is the old owner to be paid for his time or is his time value part of the sale price. What obligations does the new owner have and the old owners have with respect to each other? If the new owner is new to the business, will the old owner be able to train and help with the learning of the business. These questions should be part of the negotiations for the business. A bad new owner can quickly ruin a successful business with mistakes in judgment and lack of knowledge. This could be prevented if the old owner is around for a time to help.

If the facility did not come with the purchase, make sure that the rental agreement can be transferred and when it will have to be renegotiated. Are there any zoning restrictions on any new operations the new owner may want to get into?
This could be a stumbling block to for growth if this is part of the game plan for future growth.

Disclosure Requirements In Selling A Business
Disclosure requirements when selling a business are many and varied. They may be relatively unimportant and they could also be vital to the business surviving. If the freeway is to bypass a business area, this should be disclosed if the business depends on drive by traffic. The same would be true if a large store was moving out of a shopping center that drew a good amount of foot traffic. If the business in question depended on the walk bys, then this could be devastating to the business.

If a competitive product was ravaging the businesses sales to existing customers, then this should be disclosed. Knowing of impending problems that are not obvious could be grounds for a nasty lawsuit. Fair disclosure should be exercised in the sale of a business.

Other Reasons For Getting A Business Evaluation
There are many other reasons for needing to know the business valuation of an existing business. If a partner were being brought in and a percentage of the business was being sold, then some value would need to be placed on the new partner’s purchase. A divorce settlement may require that the business value be known in order to divide the jointly owned assets.

Another group of reasons is for estate planning and partner buyout insurance. If the owners want to gift a percentage of the business to their offspring, it would be necessary to come up with a value of such a gift. It is the same thing if it is a charitable donation.

The banker that works with the business may want a current value for determining the current asset picture of the owners. This may be necessary to qualify for a loan. Since the business is likely to be privately owned, this may require the assistance of a professional business appraiser who has been certified.

As one can readily see, business valuation is not easy, nor can it be done well by just anyone. Most owners, buyers and sellers would be wise to hire professional help in this complex area of business. Using rules of thumb and myth-perpetuated multipliers of financial information may miss the mark substantially.

There is a need for quality analysis and thought, not fly by the seat of the pants answers or guesses. This could have serious consequences when dealing with the IRS, estate probation, and partner buyouts or buying or selling the business. Experienced people in this area of business are the obvious answer and should be used to derive the value. Guess work should be left out of the picture.


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