Private business owners are truly unique. They and their families have spent their lives, perhaps over generations, building their businesses. And while many are small, they have a major impact on the U.S. economy. Small businesses, as defined by the U.S. Small Business Administration as having under 500 employees, account for 99% of all businesses in the United States, and contribute over 40% to the total domestic GDP. But it is not just small companies that are private. A study found that over 87% of businesses with revenues over $100 million are privately held, with smaller and smaller numbers of companies choosing to go public in recent years.
And so while we understand the value of small businesses, most business owners do not have the same clarity on their own business’ value. For many, the best-case scenario may be a vague notion of industry multiples against a financial metric. Business owners often lack clarity, perhaps relying on anecdotal information such as ‘a company in the industry sold for 10x.’ However, this raises the question: 10x of which financial metric? Revenue? Net Income? EBITDA? Net Cash Flow? Such ambiguity provides little actionable insight.
At the most concerning end of the spectrum, many business operators lack fundamental information regarding their business’s true market value.
Why Should I Consider a Business Appraisal?
A business appraisal, or business valuation, is a great place to start by getting a handle on what, for many, is the largest piece of their personal portfolios. Well-executed exit planning, wealth planning, and (eventual) retirement often hinge on understanding your business’s value at the time of an appraisal. A business appraisal is also the first step in understanding the key drivers for your business’ value, helping business owners understand the levers they can pull to meet their long-term objectives.
But What Does a Business Appraisal Entail?
Once you’ve determined why you need a business appraisal, the valuation date, and the purpose of the appraisal, the process is relatively straightforward. In short, the typical steps include:
Step 1 – Data collection: An appraiser will generally ask for five years of financial statements, tax returns, internal metrics, volume data, marketing materials, acquisition offers, and anything unusual or non-recurring affecting the financial statements; to boil it down – anything that could help the appraiser understand your business better.
Step 2 – Management interview: Who knows your business best? You do (or professional management, if you are a passive owner). Appraisers take an initial pass at the data collected, synthesize, and then will sit down with you and your key management team to take a deeper dive into the business. How you got into the business, the ebbs and flows in revenue and profitability, and what your expectations are going forward are all covered in this portion of the analysis. The goal of the interview is to understand the numbers as you, the business owner, do. What is important to focus on for analytical and valuation purposes, and what should be put to the side.
Step 3 – Report and Analysis: Once data has been collected and the management interview held, the appraiser will take all the information and notes and begin layering them into their valuation models and report. For more detailed reports, such as required for transfer tax purposes (or those submitted to the IRS), this includes a write-up of the business’ history, industry analysis, local market conditions, financial statement analysis, and valuation discussion.
To provide greater insight into the valuation methodology, appraisers typically employ three distinct approaches:
- Asset, or cost, approach
- Income approach
- Market approach
The asset approach focuses on the estimated value of the underlying assets held on the balance sheet. This is often relevant for real estate holding companies, dealerships, or other companies with large amounts of assets. Business appraisers will pull in hard-asset and real estate appraisers at this step if there is a need for it.
The income approach analyzes the potential income producing characteristics of the business out into the future from the valuation date. This often includes additional analysis on the true operations of the business, eliminating non-recurring, one-time, and non-core impacts to the profit and loss statement. Business appraisers then use market evidence and appraiser judgement to estimate the relative riskiness of the cash flows. This manifests in a discounted cash flow model, with projections, or other similar methodologies.
The market approach, at its base, compares the subject companies to comparable companies in the broader market. This utilizes two broad categories: publicly traded companies and private transaction data. Both have their strengths and weaknesses, but it is up to the appraiser to use their best judgement to determine what observable multiples are relevant to the subject company of the appraisal.
After each approach is analyzed, the appraiser then makes a judgement as to which approach, or combination of approaches, best reflects a reasonable estimate of value.
Step 4 – Review and Submission:
Following the draft report and analysis, the appraiser then provides a draft report to the client, tax consultants, attorneys, and other parties identified by the client to review the analysis. This is an important step for the client and their advisors to make sure the appraiser has captured what truly drives value, and if there are any holes in the analysis. Following any corrections or amplifications, the report is then submitted to the client to use for the stated purpose agreed to at the beginning of the assignment process.
How Long Will the Process Take? What About Costs?
It bears noting that each valuation process is unique to the specific business being evaluated. The scope and purpose of the appraisal will determine the timing and cost structure of the analysis. The level of detail required in the assignment will drive the required time and cost investment to deliver a report that is useful and adequate in its disclosure and analysis. But to answer more directly, a typical timeframe following information receipt can range from 30 to 60 days for a draft report.
Does it Matter Why I am Getting a Business Appraisal?
Short answer? YES.
The long answer? The purpose of the valuation will inform the assumptions that underly the appraisal process. For example, if the goal is to set a purchase price for an internal transaction, there may be little in terms of adjustments to the company’s income stream. The goal is to maintain operations and pass the business from one owner to the next: the appraisal in this case will aim to capture the ongoing income generation of the business without major changes.
What if the goal is to gauge an offer from an outside buyer, such as private equity or a strategic buyer? A thoughtful valuation will take these factors into consideration when analyzing the ongoing earning potential of the company. Valuation is fundamentally forward-looking, focused on future potential rather than solely on historical performance.
If there are expected future changes following an acquisition, the appraisal will aim to reasonably reflect those changes into the financial performance of the business. These could be the “synergies” you read about in WSJ merger announcements, or other strategic enhancements that, ultimately, de-risk the company or enhance cash flows. But whatever the situation, the purpose of the valuation will have an impact on the appraised “value” of the company.
How Do I Learn More on Business Valuation?
Well-qualified business appraisal groups analyze thousands of businesses, with many having industry expertise that helps them to truly understand your business. HBK’s Valuation Group has been operating for nearly 30 years, and our team is ready to help you with your valuation needs. Give one of our professionals a call at 941-909-7194, or email me at afrank@hbkvg.com to discuss your tax, valuation, or other financial needs.
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