In theory, the value of a business or an interest in a business depends on the future benefits that will accrue to it … (Shannon Pratt, Valuing a Business, 4^th Edition)

If you are deciding to get a business appraisal in Midland, you may be asking yourself what price is someone willing to pay for the business. Price includes the quality of the sales process, negotiation, emotion, economic demand, timing, luck, and financing. Price for private businesses in Midland often includes terms with post-closing price adjustments based on continued business performance or adjustments due to failures of representations and warranties. These terms are hard to translate into useful data, which is where a business appraisal comes in (discussed later).

There are no mechanisms to determine downstream what actually gets paid for earn-outs and seller notes in a business appraisal. There is no verifiable data on how often representations and warranties result in post-closing price adjustments. The importance of emotion in the sales process cannot be overstated. It takes tremendous energy to buy or sell a business. This is diametrically opposed to the business appraisal process for a company in Midland. 

A business appraisal consists of applying established analytical methods and preset assumptions to what is knowns or knowable about a company in order to estimate its value as of a specific date. These assumptions rarely resemble real-world sales situations. Value and business appraisals are useful for sale and exit planning discussions, but they do not represent prices. In the same way, value is useful when there will not be an arm’s length sale. Value is the best that can be done for situations such as adding or removing owners, divorce, litigation, and required compliance situations, for example, bank loans, estate, and gift taxes, Employee Stock Ownership Plans (ESOPS), fairness opinions, and the like. Value and price are related, but not the same. The only way to determine the price of a Midland company is to buy or sell the business. 

Business Appraisal Process

The business appraisal process takes a subject company through the application of different models and estimating a value. Different models work best in different situations. Not every Midland company uses the same business appraisal techniques. Each model is generally referred to as a method in business appraisal terminology. Selecting the correct model is done using professional judgment, reviewing all available information along with the standards of value (fair market value, fair value, investment value, etc.) and the purpose of the business appraisal (buy, sell, merger, gifting, divorce, litigation, etc.).

A key concept is that business valuation models tend to be comparisons. In each case, there are two sides to the comparison of a midland business: the subject company and the comparables. It is important to try to align these two sides as closely as possible when performing a business appraisal for a Midland company. When that is not possible, it may make sense to use another model. Sometimes there is no model that is close, and more professional judgment than is typical will be required.

There is no perfect business appraisal method, only useful methods. However, even a useful business appraisal method can be applied in a misleading way. At every level, the selection of the model and then proceeding to choose and screen the inputs for comparison are key to a supportable business appraisal.

Primary Approaches to Business Appraisals 

There are many models or methods for appraising a Midland business. These fall into three main approaches, known as the asset approach, the market approach, and the income approach. It is important to select the best model or method in order to obtain the most accurate business appraisal. There are three primary approaches, each with different methods for appraising a business. 

1. Asset Approach. The asset approach estimates the current value of the individual assets of the business. These approaches tend to ignore or underestimate the value of intangible assets, such as goodwill. For this reason, the asset method is often referred to as a floor value. If the business is not generating value based on its cash flows in the market approaches and income approaches, then the assets may be sold, establishing a floor value or high liquidation value. The asset method tends to be used when the subject company may be considering whether to stop operating, owns valuable assets such as real estate, definable and protectable intellectual property, valuable equipment, e.g., excavation companies, or the company is a holding company.
2. Market Approach. The market approach in a business appraisal uses comparable sales, which are substituted for the Midland company being appraised. In practice, this means that market comparable cash flows and financial information are compared and substituted for the subject company to estimate a value. This is the primary means used for business appraisals for small and very small businesses.
3. Income Approach. The income approach examines what an investor would pay for a business, based primarily on its cash flows. Investors have many choices on how to deploy their money. Using financial data collected since 1926, the risk and reward actions of investors are used to estimate the value of a Midland company.

Professional Judgment

The National Association of Certified Valuators and Analysts (NACVA) Professional Standards Section 1 states, “The use of professional judgment is an essential component of estimating value.” (effective June 1, 2017).

As clearly stated in the above Professional Standards, judgment is key. Yet how does one apply professional judgment to develop an accurate business appraisal? The answer is simple. You need a professional business appraiser to value your Midland company. Professional business appraisers are not allowed, according to the professional standards, to be biased or advocate on behalf of any one client. So, if you want to know the value of your Midland company, you should trust in a business appraiser who holds an active license in Midland.