Value Blog

It has been a long time since the last post.  You could say that doing valuation work has gotten in the way of writing about valuation work.  I have been doing valuations for over twenty years now.   Things have changed a lot since the early days of valuation.

I should clarify, when I talk about valuation, I am referring to the valuation of privately held businesses.  (Public companies are valued in the marketplace all the time.)  Privately held businesses are a different story.  Their prices have been negotiated for transactions.   Formal valuations of private companies mostly arose out of the need to establish value for estate taxes.  The modern estate tax in the U.S.  dates back to the Revenue Act of 1916.  It took until 1959 for the Treasury to issue Revenue Ruling 59-60, which actually explains the foundation for the valuation of privately held companies.  Revenue Ruling 59-60 remains one of the most concise and thorough resources for business valuation.

When I first started doing valuation work in the early 1990s, the internet did not exist as we know it today.  Many of the resources that were used in business valuation came from books and periodicals at the library.  We actually had to drive there and copy the relevant information.

So fast forward to 2013, we have more information available at our fingertips.  Sometimes I think it is too much information.  However, information without the business valuation experience to interpret it and apply it is useless.

The field of business valuation has grown.  Both the body of knowledge and the number of practitioners.  So what is the point of these thoughts?  It is just as important to have an understanding of how to do a valuation as it is to have the information to do a valuation.  Having the data from the transactions does no good if you don’t know how to properly analyze them and determine if the resulting multiple is appropriate.

It is easy to pick a multiple, the hard part is knowing if you picked the right one.

If you have questions about this or other valuation matters, please contact me.

©2013 Florida Business Valuation Group

The questions was posed to me recently whether a business would sell for more if the owner sold it before he moved away. The owner plays an active role in the business.

The answer, which seemed obvious to me, may not be so obvious: Yes, the owner should sell it while he is still active and available to ensure an orderly and smooth transition to the buyer.

An orderly transition is usually worth something to a buyer. A buyer will be taking over the business with the expectation of being able to continue operating (and generating income) from the business. To the extent that the seller can transfer his/her knowledge to the buyer, the more likely it is that the business operations will transfer smoothly.

If the business is sold without the owner (or a competent manager) in place, the new owner will have to figure things out. Information about key vendor relationships may not be documented. Nuances about customer preferences may not be written down. Even information about employee policies may not be documented adequately.  If the business “operations” are not transferred, the buyer is merely buying the assets of the business.

How a business runs is what enables it to produced cash flow – and cash flow translates to value (and selling price).  Usually, the better the quality of operational information that transfers, the smoother the transition.  Bottom line: successions plans, which include an orderly transition in a sale, add value to a business.  If you know you will be retiring, relocating or otherwise leaving the business, consider making sure that you allow time to sell/transfer the business so that you can be to ensure a transition to maximize the selling price.

If you have questions about this or other valuation matters, please contact me.

©2011 Florida Business Valuation Group

In the world of valuation, all too often, appraisers answer valuation questions with “it depends”.  Unfortunately, the answer to the question, “what period of time is a valuation valid?” really is “it depends”.

Let me explain.  The value of an interest in a business appraisals is date specific.  It is easy to understand that the value of stock changes over time when we look at publicly traded stocks.  Rarely do prices remain the same from hour to hour, let alone day to day.  While the value of the stock of privately held companies usually do not change so quickly, the value can change.

Events and time can cause the value of a company to change.  In fact, most business owners count on the value of their investment in their businesses increasing over time.

So, depending upon the events and trends impact a particular company, the value can change over any given time period.  Changes in value can be caused be increases or decreases in sales and profitability, increases or declines in the value of assets owned by the Company, or any one of a number of factors.  For example, stock in a company which owns real estate in a market that is recovering from the recession will most likely change in value as the real estate market recovers and the real estate increase in value.  The increase in value can be compounded if the company is also recovering and has increased sales a profitability.

There is no absolute estimate for the period of time that a valuation will be valid.  If you are relying on an old valuation, the more recent it is,  the better the chances are the valuation will be valid.  Depending upon what you are using the value for, you may want to consult with your business appraiser to determine if an update is advisable.

If you have questions about this or other valuation matters, please contact me.

©2011 Florida Business Valuation Group

The transaction databases that I use in the process of valuing businesses generally reflect that there is a discount for all cash deals.  Sellers are usually willing take less money if they get it up front.  I discussed with Marty Fishman, a business broker with Transworld Business Brokers, whether the way a buyer pays for a business changes the price.

There are generally three ways that a buyer can finance a transaction:

• Pay cash,
• Lender financing with some buyer cash, or
• Seller financing with some buyer cash.

The lender financing is financing from a bank based on the business operations and its assets, usually through an SBA program.  When buyers use home equity loans to finance businesses, the sellers view the transaction as a cash transaction.

Even though a seller receives the purchase price in cash in lender financed deals, the buyer does not usually receive a discount.  This is because the types of businesses that qualify for lender financing are sound businesses with good records.  The businesses may even have tangible assets which are part of the deal such as equipment or inventory.  Many of these businesses are even pre-qualified for financing, making them more in demand and more marketable.

So what does this mean in terms of the price that a buyer will pay for cash?  Cash deals are discounted between 5% and 20% according to Mr. Fishman.  The amount of the discount depends upon a number of factors.  Perhaps top of the list is the motivation of the seller.  Motivated sellers are willing to lower the price to sell the business quicker.  Cash deals will often close quicker than financed deals, with less risk of the deal falling apart.   The better businesses have lower discounts;  businesses with poorer records or that have been experiencing downward trends will have higher discounts for cash buyers than more profitable businesses with good records.

The bottom line is that buyers who get a discount for offering cash can negotiate based on the condition of the business and how motivated the seller is.  Good negotiators may get a better deal by understanding the business.

©2010 Florida Business Valuation Group

Within the valuation community the trend has been to refer to “minority” interests as non-controlling interests.  The issue is really whether an owner has control, not how much of a company he owns.  In determining whether an interest is in fact a controlling or non-controlling interest I consider both the rights granted by agreement and by law, as well as what goes on in the business.

Some of the benefits of having control include:

• The ability to elect directors and appoint management
• Determine management compensation and benefits
• Set policy and change the course of business
• Acquire or liquidate assets
• Make acquisitions of other companies
• Liquidate, dissolve, sell out or recapitalize the company
• Sell or acquire treasury shares
• Register the company’s stock for public offering
• Declare and pay dividends or make distributions to owners
• Change the articles of incorporation or bylaws

While some owners feel that control over dividends or distributions is one of the most important aspects of control,  it is not the only aspect which can impact ownership.

In evaluating whether an interest is controlling or non-controlling, I consider how much not having these benefits impact a non-controlling interest.  A few examples may illustrate when a non-controlling interest could be impacted:

• A partnership receives an above market offer for a piece of real estate it owns.  The partner who wants to sell owns 51%.  However, the partnership agreements provides that in order to sell the assets, at least 75% of the ownership must agree to the sale.  The other partners owning 49% refuses to sell.  The opportunity may be lost because the 51% partner does not have control.
• A 10% shareholder works for a company.  He has been paid a salary in the past.  However, his position and salary are eliminated by the management of the company.  He remains a shareholder, but does not have the control necessary to reinstate his position or pay himself a salary.
• An S Corporation, which passes through its income to its shareholders, had profits, but management refuses to disburse money for the owners to pay taxes.  The shareholders agreement says that management at its sole discretion will determine annual distributions.  A non-controlling shareholder cannot force a distribution.

These situations represent real life scenarios where controlling shareholders have been at a financial disadvantage as a result of their lack of control.  In some cases, owners who have more than 50% of the equity may still not have control.  In others, shareholder agreements can give owners with less than 50% ownership control over a company in the form of being appointed as management, the right to hold seat(s) on the board or by virtue of by other shareholders not having voting rights.

In general, non-controlling interests are worth less than controlling interests.  Depending upon the standard of value and purposes of the valuation, a discount for lack of control may apply.

©2010 Florida Business Valuation Group

After speaking to Marty Fishman, a business broker with Transworld Business Brokers, about what buyers are looking for he had the following insights: “Most buyers approach the purchase with a certain level of skepticism. Buyers want solid facts and believable information that a business opportunity is a solid investment. They want information: financial documents, business operation and facility information. Some of this information will be provided prior to an offer and some of it once there has been an executed purchase agreement with contingencies such as the complete and satisfactory review of property, books and records.”

This is in line with the things that I evaluate as a business appraiser that support the value of a business.  Those businesses with good records and documentation of business operations are worth more than businesses that are lacking.  I will go a step further to say, businesses with limited records are significantly less marketable than businesses with good records.

Since buyers approach businesses with skepticism, consistent records are also important.  As a consultant, I advise clients to rely upon tax returns that have been filed with the IRS under penalty of perjury, over hand written documents that track sales.  In cases where cash sales were not reported on a business’s income tax return (or sales tax returns), there may be inadequate documentation of the amount of unreported cash, leaving the buyer with the difficult decision of accepting the seller’s representations on faith.  I advise clients to consider that if a seller was less than truthful in reporting income to the IRS or other taxing authority, how does one know he or she will be truthful in the amount of unreported cash to the buyer.

Mr. Fishman pointed out “The selling and buying of a business is a very complex process. It involves many aspects that most successful business people are not exposed to in day-to-day operation of a company. Both parties should rely on experts trained in the sale of businesses.”

It is important to keep in mind that when you are buying or selling a business, the price is often based on a number of factors, and the buyer and seller may value the business differently.

©2010 Florida Business Valuation Group

It may seem like a cop-out for me to answer most valuation questions “it depends”.  The reality is it really does depend.  It depends upon the facts and circumstances surrounding the particular question.  Each businesses is different.  They are different because they have different organizational structures, they do different things and they have different people (with different skills) running them.

Those are not the only differences that I must consider as business appraiser.  I have to start out with the basics of valuation – what type of value is necessary for the purpose of the valuation.  Then I have consider the interest being valued – is it a controlling interested or a non-controlling (minority) interest?  All of these factors impact my conclusion of value.

You are a potential client and you call and ask, “Can I use a 1 times revenue to value my business, since that is the industry rule of thumb?” In order to begin considering my answer I need to find out what type of value you are trying to establish, the purpose of the valuation, the interest being valued and information about your company to determine if it is average for the industry.  Then you tell me,  “I only need a rough estimate.” For your protection and the integrity of the business appraisal industry, I can’t give an rough guess based on a few facts.

An opinion is an opinion,  I must develop it in accordance with generally accepted appraisal standards.  These standards provide that I need to understand your both your business and the industry that you operate in reaching an opinion of value.

While I would love to be able to give quick short answers, I usually can’t.  I am not trying to be difficult.  Think of it this way, would you want your doctor to give you a clean bill of health without every doing a physical examination or running any tests?  Probably not.

©2010 Florida Business Valuation Group

The value of a business generally includes the value of all of the tangible and intangible assets owned by the business. Whether the value of the business includes all of the assets (and liabilities) of the business will depend upon a few things.  First, either the equity (stock or other ownership interest) that owns the business can be valued or the assets used in the business can be valued.  The general rule is: buyers want to buy assets and sellers want to sell stock.  Sellers want to sell the stock or other ownership interest mostly for tax purposes.  Whereas, buyers want to buy assets for tax purposes, but also to avoid potential liability associated with the entity.

The purposes of a valuation will often dictate what is included in the value. For estate and gift tax purposes, the value is of the stock or equity interest owned.  For transactions, the value may or may not include all the assets and liabilities.  In transactions, the purchase agreement usually specifies which assets and liabilities are included in the transaction.

It is important to distinguish between what is included in the value and what is included in different multiples based on market methods methods.  For example, the multiples from BIZCOMPS®, a transaction database, are assumed to be asset sales which exclude cash, accounts receivable, accounts payable and inventory.  Other operating assets such as the equipment used in the business are included in the value arrived at using BIZCOMPS® multiples.  Multiples from the Pratt’s Stats® database, on the other hand,  are for both asset and stock sales, as indicated for each transaction.  Some transactions include the working capital of businesses while others do not.  Transaction multiples from the Pratt’s Stats ® database need to be examined for the details of each transaction.

Within industries, there are often rules of thumb used by business brokers to estimate the value of business.  Different industries treat the assets differently. Beer taverns, according to the Business Reference Guide, sell for 6 times monthly sales plus inventory OR 1 to 1.5 times annual earnings before interest and taxes OR 55 percent of annual sales plus inventory.  Other types of establishments that sell alcohol have different multiples and treat the assets differently.  Rules of thumb for cocktail lounges either add inventory back, add liquor license and inventory, OR add fixtures, equipment and inventory.  As illustrated, different multiples from different sources result in values that need adjustments for different assets and/or liabilities.

So what does all this mean?  A business valuation will clearly state whether the stock or equity interest in a company or the net assets are being valued. If a business valuation has not been done, understand the value from the multiples you chose.  If necessary adjust for assets and/or liabilities which are not included.

©2010 Florida Business Valuation Group

Unfortunately, this is true.  There are times with a business is worth more dead than alive.  The value of a business can be divided between its tangible and intangible assets.  Tangible assets are the physical assets used in business operations such as equipment, real estate and inventory.  Intangible assets include things such as the goodwill and customer lists.

In general, a business is usually worth at least as much as its net assets (assets less liabilities).  A profitable business is usually worth more than its net assets.

Typically, healthy businesses produce a return on both the tangible and intangible asset in the form of profits and cash flow.

When a business is operating at a loss, it may indicate that the intangible assets have little or no value.  However, losses can arise from situations other than diminished goodwill, such as the current recession.

If a company does not have prospects of operating profitably in the future, a rational owner would choose to close the business and sell the assets. At a loss, the company is not producing a return on its tangible or its intangible assets (assuming there are intangible assets.)  However, if the company is expected to rebound, the business can still have value.  In other words, loss companies can still have value.

The challenge is to determine what value a loss company has in excess of its assets.

©2010 Florida Business Valuation Group

I recently earned the ABAR (Accredited for Business Appraisal Review)  designation from the Institute of Business Appraisers.   The ABAR process is not a valuation, but a review of the valuation process.  The resulting business appraisal review opinion states whether the valuation report is credible.

The valuation process  is based on a body of knowledge and generally accepted appraisal practices.  The appraiser applies his or her informed judgment, based on the facts and circumstances related to the business to arrive at an opinion or conclusion of value.  The appraiser then documents the relevant information and explanations, supporting his or her conclusions in a valuation (or appraisal) report.

The business appraisal review process examines the credibility of the valuation work product, looking at the information in the report and the methodologies used.   If a report fails to disclose sufficient information, has analytical gaps or misapplies methodology, it may be found to lack credibility.

There are three types of review opinions:  a finding of concurrence, a finding of non-concurrence and a finding of no opinion.    A finding of concurrence indicates that the report is credible.  When there is insufficient information for the reviewer to issue a review opinion, a finding of no opinion will be issued.

A business appraisal review is not an opinion regarding the value of a business.  It cannot take the place of a full appraisal as a second opinion.

If you have questions regarding when a business appraisal review is needed, you can post or question or email me.

© 2010 Florida Business Valuation Group