Business Valuations

Business Valuations

The Value of a Business Valuation

Selling a business is different from selling a house or other hard assets where you might find enough comparable sales data that might support a value. Unlike real estate, it is not unusual for 50% or more of an operating business’s value based on intangible assets such as goodwill (cash flow), intellectual property, licenses, location, etc.

Two businesses both showing a net of $150,000 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 requirements, etc. One business may be operating below capacity and the other might require a 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 an assortment of business valuation methods for companies that on the surface are quite alike, but result is different values. Attempting to value a business based strictly on market comps results in a business valuation that does not recognize the distinguishing characteristics and hidden aspects of the business.

The business valuation of intangible assets is based on both the income-based methods and actual sales revenues. Accurate understanding of earnings and seller’s discretionary earnings (SDE) 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? These considerations and may other variables highlight the discovery challenges we must consider in the rationale for a formal business valuation.

Another major reason for a business valuation is to avoid surprises in the due diligence process, which can quickly kill your deal. Full financial disclosure upfront to the buyer is extremely important. Bad news, if fully disclosed, might have an impact on the price but at least the deal is far more likely to survive with upfront disclosure.

With precise earnings information in hand, an appraiser employs several business valuation methodologies and weights the various results according to their 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 a 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.