Business Valuation & Appraisal FAQs
The following are frequently asked questions about business valuations:
I'm confused. What is the difference between a business valuation, business evaluation and a business appraisal?
For the most part, the terms business valuation and business appraisal are synonymous. Over the past ten years or so, business valuation has become the more accepted term which connotes placing a reasonable market value on a present going business; or the value of a planned start-up business. A business evaluation is more involved with the management consulting genre. It has to do with assessing the entire business organization and its relative operating effectiveness.
When is the best time to have my business appraised?
Today we live in a world often characterized by gigabytes and hyperlinks. If your newly formed business has been in continuous and successful operation for two years or more, its a good idea to have it valued. Why? Our clients tell us again and again about calls they have received from larger parent firms who are on an acquisition fast track and are interested in "them". And when it comes to negotiating the mechanics of the deal, if you don't have a solid business valuation number "in your pocket" produced by an independent valuation firm, you could be leaving tens, or even hundreds of thousands of dollars on the table. Remember the axiom... "its always easy to lower the price, but ever so hard to raise it". Another "best time" to have your business valued is when it is 20 years old or older and you're thinking of getting a business appraisal because retirement or burnout.
In practical non-financial terms, what is the "real world" value of my business?
In the context of turning the business over to new or different owners, "real world" value amounts to a reasonable price for the business that will reward the present owner fairly for his/her development of a profit producing entity with continuing cash flow potential. The price must also, however, treat the purchaser fairly in that the final price paid is one which can be justified by the income stream of the business in a reasonable period of time and provide an attractive return on investment.
As a business owner, what are the benefits I receive by having my business appraised?
To begin with, when you know what your business is worth you have a more realistic perspective from which to plan the future direction of the business, i.e. let's say your business was worth $750,000 ... would your thinking about it's future change if it was worth $2,000,000? Also, do you plan on working until the "final day"? Is the business to be turned over to your children or to your employees? Or will you sell to a competitor or an outside buyer? All these alternatives become easier to deal with when the business value is known. Estate and tax planning also require a business valuation. And finally, there is one benefit that some owners refer to as "breathability". Without a valuation you guess about the value of your business. With a valuation, you know. And knowing your business value allows you to "breathe" a whole lot easier.
What kinds of records will be required for my valuation?
Typically, tax returns and year end financial statements including balance sheets and income statements. (Cash flow statements also, if they're available) This plus copious conversation with the owner(s) and/or the accountant who is responsible for the firm's records and or tax returns. If additional statements are available which go back as far as five or six years, they can also be included to provide a more balanced view of the operation and its financial history.
If I'm thinking about exiting the business what are my options?
There are several. They would include; 1) an outright sale of the business, 2) turnover of the business to relatives or employees, 3) merger with a friendly competitor who has the knowledge, insight and capital to drive the business forward, 4) retain absentee ownership of the business and hire an administrative manager to continue its operation, 5) terminate the business and liquidate its assets. A professional business valuation is necessary (if not vital) when considering options 1, 2 or 3.
Are earnings multiples a good approach to setting a value on my business?
Probably not. While various public companies may be trading at multiples of 10, 20 or even higher, a closely held firm usually doesn't have the resources to justify higher multiples. For the typical public company, these would include size, the ability to raise capital, a well structured, integrated management team and last but not least the availability of buyers. Determining how a firm correlates to one in the public market is complex, requires considerable professional analysis and is probably not cost effective for most small and mid-size firms.
Why should I have my business appraised if I'm planning to turn it over to my son or daughter?
Because when the "turning over" takes place, it amounts to a gift that you are providing to your child or children and may also include shares they will be purchasing. (If they are purchasing shares... at what price?) And when the IRS audits the gift, the burden of supporting the value of the property "given" is upon the taxpayer. A well documented appraisal of the business will help establish the gift value and indicate to the IRS that a valuation was performed properly. Minority and/or lack of marketability discounts may also become involved and your appraisal firm should also be able to provide this important service and supply the necessary analysis and documentation.
If I'm only going to sell a minority portion of my business do I need a valuation?
In most cases yes and for good reason. When you sell a less than controlling position of your firm, that "portion" is no doubt worth more now than when you formed the company. And if you sell another "portion" in say two years from now, it may well be worth more than the portion you sold this year. In business, things and value, change. And the best way to keep in touch with your business value is with a professional business valuation. It's also a good idea to have your valuation up-dated regularly.
What about my CPA firm, can't they appraise my business?
We live in a world of specialization, whether we like it or not. CPAs do an excellent job in their specialty of tax and audit work, and occasionally offer bookkeeping services to their clients as well. But very few CPAs offer the expertise to value a business because it is not their specialty. We often work with CPAs on valuation projects because of the excellence they represent in the record keeping required to produce financial statements as well as their overall familiarity with the client's business. Your CPA is no doubt a trusted advisor and is often an important participant in the project. But your valuation assignment is best handled by a firm which specializes in nothing but business valuation/appraisal and whose track record embraces many, many years of valuation experience.