Value Blog

Simply, yes.  When you create systems that will allow your business operations to be transferable with minimal interruption , you create value.  A business has value only when the ability to keep generating cash flow can be transferred.  Read more about business plans from Julia Aquino of The HOW Factor, Inc. (www.howfactor.com) below.

Julia writes:

The “Hit By a Bus” Plan

No one plans to be hit by a bus, of course, but what if a sudden, unexpected event occurred in your life? Accidents do happen, as do other significant events that require a business owner to be away from the business for a lengthy period of time. If this happens to you, who will be running your business bright and early the next morning?

If the answer to that question is that the doors would close, maybe not the next day, but soon, then it is time for you to have a plan. In this tightening economy, most businesses could not afford to shut down for even a short time without losing customers and suffering devastating financial consequences.

Whether it is just you running your business or you have a team of loyal employees, someone is depending on your business to continue to operate should the unthinkable happen. What would happen to your family and the families of your employees if no one else were able to run your business in your absence?

The key to business continuation is having a detailed Operations Manual with instructions for “how things are done.” It should cover all of the different systems you have in place and descriptions of the different positions employees hold in your company. If someone can step in and have a written guide to how the business is run, even if they are unfamiliar with the day-to-day processes, then your business has a chance of surviving, and thriving.

An Operations Manual is the master plan for how your business operates, and should cover all of the “steps” you keep in your head. The content of a manual will vary from business to business because the systems that each business uses are different, but the basic structure of an Operations Manual should be consistent. Even the simplest things should be included, like passwords to access the computers and accounts.

If you have no employees, it is just as critical to have a manual so that your family, friends, or other designated individual can step in and answer clients’ questions, retrieve their projects and information, and keep the bills paid until you are able to return to the helm. In fact, having an Operations Manual can be a selling point for solo practitioners when pitching the company to clients. They may wonder who will handle their work or their concerns if you are temporarily away from the business.

An Operations Manual means the difference between a business that can run while you are out of the office, and one that cannot. It will alleviate the stress of wondering what will happen to your company if you are “hit by a bus.”

© 2010 Florida Business Valuation Group

I get so involved in dealing with valuation issues that I forget to write about them. I have had the same issue come up a number of times in the past few months: Clients want to know if they can use a valuation for a number of different things. The answer is generally no, because Valuation reports are date specific and purpose specific.

So what does that mean? Date specific is easier to explain. A valuation is a snapshot of a particular type of value as of a specific date. Most people can understand that they would not necessarily buy or sell publicly traded stock based on a price from three months ago. They would make their decision based on today’s price. While the value of a private company may not change significantly over time, it also could change. The value is determined based on the known or knowable facts as of the valuation date. It does not take into consideration changes in the economic climate after the valuation date, or increases or decreases in revenue. Either of these factors could result in a change in value from one date to another.

Valuations are also purpose specific. Some different purposes could be gifting an interest, the value of a business for a divorce or the value for a dispute with a shareholder. Since different types of value may be used for different purposes, the resulting values may be different. For example, a gift of a 10% interest (minority and non-marketable) could not be used to estimate the value of 55% interest of the company (control and non-marketable) for purposes of a shareholder. The minority interest may have been reduced by discounts for lack of control, whereas a 55% interest would usually not have a minority discount applied. The discount for lack of marketability for a 10% interest could be different than for a 55% interest, and in some shareholder disputes, state statutes may dictate that no adjustment be applied. This example also indicates that two interests, a minority and a controlling interest could have different per share values based on other factors as well. Appraisal reports state that they are for a specific valuation date, valuating a specific identified interest and for a specific purpose. This is so that an uniformed user would not mistakenly misuse the valuation report and reach an inappropriate conclusion.

© 2010 Florida Business Valuation Group

The straight answer is you may not.  Unless the transaction is between family members or will be financed with an SBA loan, a valuation is usually not required.

The advantage to a business valuation is it provides the user with the value of a business or interest in that business.  The advantage to a business valuation is also the major limitation.  The business appraiser will usually provide a single value, based either on fair market value or investment value.  (See blog post here)

Value is a range, though, and there are many different types of value within that range.  As a buyer, you are only concerned with the lowest value within that range that you can pay.  If you can negotiate a lower price than fair market value, you will.

Valuations can be expensive.  If one is not necessary for you to negotiate a deal, you should not pay for one.

The seller has established a starting price for your negotiation.  What you need to determine is whether the cash flow from the business can support that price.

Each buyer has different criteria for whether a deal will work for him or her and there is no right answer.  The things that buyers should consider include:

• What is your risk tolerance?
• What is your required rate of return?
• How long are you willing to wait to get your investment back?
• Will cash flow from the business be sufficient to pay off any debt used to buy the business?
• Will cash flow from the business be sufficient to pay your salary if you are working in the business?

These questions will provide you will the information to determine if the asking price meets your criteria as a buyer.  A business may be worth $100,000, but a particular buyer may not be able to afford the asking price.

Price is the negotiated amount for a particular transaction.  While you need information to make an informed decision, a valuation will not necessarily give you that information.  Your financial professional should be able to assist you in determining whether the asking price of a business meets your criteria.

© 2009 Florida Business Valuation Group

A recent article in the Journal of Accountancy, “Four Options for Measuring Value Creation”, brought up some very good points regarding why the financial statements of a company are flawed as measures of value. The article lists a number of reasons, but top on the list is that value is future oriented, whereas most of the measures on financial statements are historically based. Value is based on anticipated future benefits.

So what does a balance sheet tell you about a business? A balance sheet typically has the historical net cost of the assets a business has acquired over time. The balance sheet does not tell you the type of assets, their age or condition. Older assets may be depreciated and have a very low book value, but still be fully functional in the business. The balance sheet does not indicate what future capital expenses will be to either replace old equipment or to support future growth. Intangible assets, including intellectual property and goodwill, are usually not reflected on the balance sheet even though they may have substantial value.

A balance sheet reports the liabilities of a company. Unless you are reading footnotes to the financial statement (assuming the financial statements have footnotes), the balance sheet usually does not tell you the terms of the liabilities or when they mature. It also does not reflect how old the payables are or whether the company has unused lines of credit. Understanding the obligations of a company is necessary in understanding its value.

Is value better reflected on the income statement of a company? Many people think that profitability, which is reflected on the income statement, the primary element contributing to value. There are two potential problems with this assumption. First profitability is not the same as cash flow. For example, necessary investments in capital expenses for new equipment can impact cash flow while having a minimal impact on profitability. The other issue is the assumption that the level of profitability reported will be sustainable. A business can have increasing sales over a prior year, but if its receivables are increasing at a faster pace, there could either be a problem with collections or the growth may not be sustainable.

Financial statements provide important, but limited information about a company.  Understanding the financial statements is only the beginning in the process of determining the value of a company.

©2009 Florida Business Valuation Group

The conceptual background behind the market approach is to use the behavior of buyers and sellers to arrive at a multiple which reflects the market.  Market methods can be divided into two basic groups: guideline public companies and private company transactions.

There are some major distinctions between the underlying data used for each method.  The public guideline company method uses information from publicly traded companies that are most similar to the company being valued.  The appraiser’s analysis of comparability may include factors such as type of business, size, geographic operations, growth prospects, past historical operating performance and any other factors which may be appropriate.  The appraiser identifies the most comparable companies and then derives valuation multiples based on the trading prices of the guideline companies’ stock as of the valuation date.  This data is based on marketable, minority interests in the guideline companies.

Private company transaction methodology is generally based on the theory that a sufficient number of private transactions will emulate the market for that type of company.  There are a number of databases which track private transactions of companies.  The information is collected from business brokers and intermediaries involved in the transactions, who report the information to the database services.  Each database contains different amounts of information regarding the companies.  The information about these companies represents a non-marketable, control interest in the transaction companies.

So what is the difference?  The public company transactions are evidence of the market value based on a large number of transactions which have been completed between buyers and sellers.  That is the reason that a large number of public companies is not required in order to use the methodology to arrive at valuation multiples.  Each company alone is evidence of the market.

Private company transactions may or may not take place at market value. Buyers and sellers have their own motivations for entering into transactions.   There is only one transaction for each company, unlike with public companies where you could have anywhere from under one million to over 250 million trades in a single day.  The concept behind private company transaction methodology is that with a sufficient number of transactions, the average or mid-point will represent what the market looks like.  That is why more transactions are necessary under the private company transaction methodology.  A few transactions may not be sufficient to represent the market.

What is important to understand is that each valuation is different. Applying any methodology is based on the facts and circumstances particular to the company being valued and the valuation date.

©2009 Florida Business Valuation Group

One of the approaches to valuing a business is the market approach.  This approach looks to either private transactions or publicly traded stock to develop an indicator of value, usually in the form of a multiple.   Is a single transaction representative of the value in the market?

With public companies, the marketplace allows for buyers and sellers to negotiate each transaction by using bidding system.  A buyer will indicate what he wants to pay for a stock and a seller will indicate what he wants to sell the stock for.  When buyers and sellers are matched, there is a sale.  The public stock exchanges provide an efficient system for trades.

When a public guideline company method is used to value a business, comparable companies are identified and the information from the market is used to develop a market value.  Because the data captures the prices paid in the market, it is considered to be a good proxy of fair market value.  Since there are many transactions for each company, it is not necessary that an appraiser use a large number of comparable publicly traded companies in applying this methodology.  (The IRS heavily favors using publicly traded companies as a basis for value in developing opinions of value.)

When comparable publicly traded companies are not available, we look to private markets.  Private markets are no where near as efficient as publicly traded markets.  Often, limited information is available about the sale and the company operations.  Private companies are not require to report information and most information available is from database services that collect the information from brokers and intermediaries.

Since private markets are not efficient, the sales prices usually reflect an investment value rather than fair market value.

With all these challenges, how do we use these private transactions to develop indicators of fair market value?  Using private transactions is based on the concept that when transactions for similar companies are looked at together, these values represent the market as a whole.  The values for companies sold at distressed prices offset the values for companies sold at premiums, resulting in a market value.

Since the private transaction methodology relies upon a group of transactions to extrapolate multiples representative of the entire market, it is necessary to have a sufficient number of transactions to achieve this.  The problem is there is no absolute number.  We know that you need more than five transactions to get a statistically valid multiple.  Most agree that you need more than ten transactions.  The obvious answer is the more the better. With more transactions, an appraiser is better able to analyze the data into groups and arrive at a multiple based on factors that are similar to the company being valued.

While a single transaction price may be representative of fair market value, it is not sufficient to prove fair market value.  Remember price does not necessary equal value.  Price is the negotiated amount at which a transaction takes place and can be influenced by non-market factors.

For more information on the market approach, click here.

©2009 Florida Business Valuation Group

There is no way to shortcut a valuation.  If you are on a budget, you can make choices that will keep your fee down.  However, if you budget it too small, you may be better off with not spending money on a low cost appraisal.

Clients decide to have appraisals done to meet a need.  Usually it is to have documentation to provide that they made a transfer at fair market value.  The appraisal could be required by the IRS or the courts depending upon the purpose.  If an appraiser knows that you will be relying on his or her opinion to provide proof, the appraisal should be done to meet that purpose in compliance with appropriate appraisal standards.

Valuations done in compliance with appraisal standards take time.  So what do you do when your budget is not large enough for an appraisal?

You may be able to reduce your fee by asking for a summary report.  Shorter reports take less time to write.  However, just because you are getting a shorter report does not mean the appraiser will do less work to reach his or her opinion.

Another option is to get a calculation of value rather than a conclusion (or opinion) of value.  The disadvantage to a calculation of value is you will not get the same level of assurance that the number is accurate.  A calculation of value is a limited scope appraisal, where the appraiser and the client agree to limit the amount of work done with the understanding that if all the work was done, the resulting value could be different.  This type of report will not necessarily satisfy the requirements of the IRS or courts, but may work for negotiations.

The bottom line is that appraisals are not inexpensive.  There are some online “valuation calculators”, but the resulting information will usually not constitute an appraisal.  If your budget is too small for an appraisal, you may want to see if you can do without one rather than spending money on something that will not satisfy your requirements.  In any case, make sure to ask questions so that you understand that the report you are getting will meet your needs.

© 2009 Florida Business Valuation Group

Different appraisal organizations’ standards refer to reports that express conclusions (opinions) of value by different terms.

The American Institute of CPAs (AICPA) and the National Association of Certified Valuation Analysts  both provide for Detailed or Summary Reports.  The American Society of Appraisers provides for Comprehensive Reports.  The Institute of Business Appraisers Standards allow for Formal  Reports.   Uniform Standards of Professional Appraisal Practice (USPAP) provides for an Appraisal Report.  While the standards for each organization is slightly different for the different types of reports, they basically require the same minimum information in reports.

The AICPA standards  provide for the following minimum disclosures in a Detailed Report:

• Identity of the client
• Purpose and intended use of the valuation
• Intended users of the valuation
• Identity of the subject entity
• Description of the subject interest
• The business interest’s ownership control characteristics, if any and its degree of marketability
• The valuation date (effective date)
• The date of the report
• The type of report
• The premise of value used in the report
• The standard of value used in the report
• The sources of information that are the basis for the conclusion of value reached in the report
• Assumptions and limiting conditions applicable to the report
• The scope of work or data available for analysis including any restrictions or limitations
• Any hypothetical conditions used in the report and the basis for their use
• If the work of a specialist was used in the valuation, a description of how the specialist’s work was used, and the level of responsibility, if any, the business appraiser is assuming for the specialist’s work
• The valuation approaches and methods used (other standards require disclosure of valuation approaches and methods rejected)
• Disclosure of subsequent events in certain circumstances
• Any application of jurisdictional exception
• Representation (also referred to as Certification) of the business appraiser
• Signature of the business appraiser or the appraiser’s firm (some standards require the business appraiser to sign the representation)
• A section summarizing the reconciliation of the estimates of value and the conclusion of value
• A statement that business appraiser has not obligation to update the report for information that comes to his or her attention after the date of the report.

The USPAP includes most of the items is the AICPA standards and also require that business appraisals must:

• clearly and accurately set forth the appraisal in a manner that will not be misleading;
• contain sufficient information to enable the intended user(s) to understand the report; and
• clearly and accurately disclose all the assumptions, extraordinary assumptions, hypothetical conditions and limiting conditions used in the assignment.

While the different appraisal organizations have slightly different requirement as to what must be included in a report, the above list is a general list of what should be in a report.

Whatever the case, the appraiser is required to follow the standard for the organization to which he or she belongs.   Standards can be viewed online at the organizations’ websites. Links to those standards are also available in my previous post.

© 2009 Florida Business Valuation Group

Each appraisal organization has business valuation standards that apply to its members.  Standards can generally be classified as related to the developmental and reporting.   The different standards are posted online at:

• American Institute of Certified Public Accountants, Statement on Standards for Valuation Services No. 1:  AICPA Standards
• American Society of Appraisers,  ASA  Business Valuation Standards
• Institute of Business Appraisers, Business Appraisal Standards
• National Association of Certified Valuation Analysts, NACVA Professional Standards
• Appraisal Society, Uniform Standards of Professional Appraisal Practice  Standards 9 and 10

The standards are not uniform.   The appraisal oranizations did agree to uniform defiinitions of certain terms, the International Glossary of Business Valuation Terms.   When the AIPCA published its valuation standards in 2008, it added additional definitions.  While the details in the standards are different, the objectives are the same:  to ensure that appraisers do sufficient work to support their work, and that the work be reported in a manner that provides the user with enough information to understand.

© 2009 Florida Business Valuation Group

A rule of thumb is defined in the International Glossary of Business Valuation Terms as “a mathematical formula developed from the relationship between price and certain variables based on experience, observation, hearsay, or a combination of these; usually industry specific.”  Typically they are representative of the average price paid in an industry.  So, it would appear that using a rule of thumb would provide a good estimate of the value of a company. Should Company B still be worth twice as much as Company A?

It is the appraiser’s job to look at the facts and circumstances of a particular business operation in arriving at a value.  This includes establishing how the business compares to others within its industry.  Rules of thumb are not a recognized valuation method because often there is insufficient information available about how the multiples were developed.  Some rules of thumb are supported by market data, and others are not.

If you are interested in researching rules of thumb for a particular industry there are a number of sources:

• 2009 Business Reference Guide, published by Business Brokers Press (www.bbpinc.com)
• Handbook of Small Business Valuation Formulas and Rules of Thumb/Third Edition by Glenn Desmond, published by Valuation Press, 1994.
• How to Value over 100 Closely Held Businesses, Fourth Edition, by Stephen M. Zamucen, MBA, CPA, CVA, ABV, CFE, published by The National Alliance of Consultants, Valuers and Analysts, 2002.
• Handbook of Business Valuation, Second Edition, edited by Thomas L. West and Jeffrey D. Jones, published by John Wiley & Sons, 1999.

Additional information is sometimes available from industry trade groups.

Use caution when using rules of thumb as some of them are dated and may not reflect current industry or economic conditions.

© 2009 Florida Business Valuation Group