Why the Entrepreneurs of Yesterday Should Get to Know a Good Business Appraiser

By now, we’ve all heard that the U.S. population, on average, is aging and that a large portion of it is getting closer and closer to retirement. This fact has repercussions far beyond its effects on social security, the health care industry, the national workforce, and shifting geographic dimensions. What has gone largely unnoticed but is finally gaining attention is that one of the largest transfers of wealth anyone has ever seen will likely occur over the next 15 years as the Baby Boomers all move into their Golden Age and beyond. For each individual, this wealth transfer should happen according to a structured personalized plan which involves consideration of all forms of net worth, including interests in businesses.

Over the years, I’ve had clients and even business partners who said they plan on working until they can’t work anymore. Whether it’s because of financial necessity, the need to stay active or the enjoyment they receive from working, these entrepreneurs of yesterday deserve being given the opportunity to make their own exit strategies. After all, they are the ones who built the businesses that opened doors for so many others to gain employment and to save toward their own dreams! With a plan in place to gift or sell ownership in such businesses, owners create a viable way to transfer wealth to their kids, trusts or others or to realize the years of sweat equity by cashing out on the measurable value that has accumulated.

A transfer of a business interest should not happen in a reactive fashion to life-altering events that can be tragic in nature. It should happen according to a scheduled and structured plan that considers tax implications for both the donor and the recipient(s). Ultimately, part of the process of transferring the interest involves appraising the business interest. Often, an initial appraisal is done long before the actual transfer occurs so that an estimated value for the interest can be included in the planning itself. This is similar to an appraisal used for the purpose of determining the price to sell an interest, if the owner decides to cash out instead of transfer the value.

With an increase in the population reaching the age where unexpected events affecting health are more likely to occur, such aging business owners should be taking steps to put a plan in place, if they haven’t already, to transfer wealth or sell their interests from a position of strength. Among others, get to know a business appraiser – that person will play a vital role in helping you accomplish this. Feel free to contact me at stevenfultonberg@gmail.com if you want to get the process started or if you just have general questions.

Valuing a Business – Using a Multiple Can Miss by a Mile

Earlier in my career, whenever the fair market value of a client’s business was discussed or needed for a potential sale, a multiple of EBITDA or revenue was the easy go-to approach used. Sometimes a multiple of 2 was chosen, sometimes 3 or, on rare occasion, a multiple of 4. At the time, although it seemed so arbitrary which method should be used and what factor should be applied, I was in no position to question what I was being instructed to do. Over the years, valuation theory and practice developed and slowly replaced this arbitrary, back-of-the-napkin approach. Fast forward to today, to a time when so many accepted and tested approaches to determining fair market value have been endorsed as applicable in any given situation, it’s clear that the old quick and dirty approach of using a multiple probably missed the real value of a business by a mile.

Through the education and experience I have gained, pinpointing which approach to valuing a business should be utilized is now much less of a subjective art and more risk-based than ever before. Don’t get me wrong! Using a multiple can still be a way to check against the results of much more detailed and industry specific calculations. In fact, the valuation profession suggests considering these so called sanity checks, aka Rules of Thumb, but usually only as a reasonableness check. Now, published formulas and methodologies exist that help remove some of the guesswork of determining which approach likely fits best given a particular fact pattern. With so much more information available at the valuation professional’s fingertips than ever before, don’t leave substantial value on the table by taking a shortcut approach to determining what your business is worth!

Feel free to contact me if you have a question about your business or the need to understand its value.

What is the Importance of a Business Valuation?

Unless a business valuation is required by agreement (as in the case of a buy-sell) or by law (such as when a gift is made by a business owner to his/her child) where its necessity is obvious, I am often asked why a business valuation is so important. Business owners often believe that they can determine the value of a business by merely applying a multiple of revenue, net income, EBITDA or some other industry standard. Such generalizations often swing and miss at the true value, not only when it is needed for purposes already mentioned but also when negotiating a value, such as when buying or selling an interest in a business or determining its value for settlement of marital assets in a divorce.

So why do these simple calculations miss the boat on determining value? Here are just a few reasons:

  • Business owners often rely on historical information instead of applying potential future growth rates. If a product or service is expected to trend toward higher or lower growth or profitability, a value can be greatly skewed by ignoring this forecast, which valuations based upon multiples do.
  • The market place has a mind of its own and, like it or not, information about private transactions is publicized and affects perceived as well as actual value. The buyer or seller of a business, the working spouse and soon-to-be ex-spouse, and even the IRS, has access to this information and will use it when calculating their own value. Therefore, market data cannot be ignored but often impacts value to the extent that it lands far from the results of simplified calculations.
  • One size does not fit all when it comes to valuing a business and the associated risks may be substantial. Factors such as the size and depth of a management team, the availability and reliability of financial information, the amount and severity of competition, the position within the industry and its stability, all individually and collectively affect the risk of ownership and, therefore, the value of a business interest. The weight of each of these factors, and many more, are considered in a valuation but are not included in the use of basic multiples.
  • If a transaction involves less than a controlling interest in the business, doesn’t it make sense that it’s worth less than an interest that provides control? This control provides the owner with the ability to make management decisions affecting the future of the business, compensation, distributions, etc. A lack of control prevents an owner from such decisions. Typical calculations cannot incorporate such differences in control into determined value.
When preparing a valuation, all of these factors (and more) are considered and often pulled into the calculation – future growth rates, market data, company risks, and the lack or presence of control. When comparing the sophistication of utilizing numerous factors in a professional valuation versus the oversimplification of using a multiple to determine value, it is easy to see why the outcome may be drastically different and why the cost of swinging and missing may be huge.

If you want further information about why a business valuation would be important in your particular situation, feel free to contact me.