Today, we are going to take a look into the important business valuation questions surrounding closely-held private companies. Specifically, we are going to look into how the value of your business affects you directly, when you might need one, and how to find the right business appraiser. Business owners in today’s technological atmosphere are busier than ever, which inspired me to touch on the most important aspects business owners need to know, in layman terms, so they can get on with their lives!
Calling all business owners: The million-dollar question and why you should care (in layman terms). “What is my business worth?”
If you are already familiar with business valuations, then it is at least worth looking at Section 3 of this post titled “Who Do You Call” and the valuation questionnaire available for download. Here you will find convenient ways to locate an appraiser that meets your needs in your area.
Chances are you have checked the balance of your bank account(s), mortgage, 401K, investments, and Kelly Blue Booked the value of your car. Why? Let’s be honest it’s because it is free and fast to check these things. If you could log into a hypothetical business account and check the value of your business for free you would be doing that every day! (By the way: I provide my clients with monthly valuation updates as part of my consulting practice, which is more affordable than you think!)
1. How does this affect me?
A business valuation will tell you how much money you can expect to have as it pertains to your business. The value of your company may change your long-term retirement, succession, and personal estate planning. For example; you may have thought you were going to retire from the proceeds deriving from the sale of your business until you find out it was worth less than you were anticipating. Another example might be if you own a business and are going through a divorce, then a savvy attorney will request an independent business valuation that will be utilized for mediation or court proceedings.
Market factors, such as the sale of other companies, cost of debt, average return on the stock market as well as company specific factors play a huge into the value of your company. To summarize on these points, it is important to value your company now if you are planning to utilize your company’s value for any corporate or personal planning. Knowing the value of your company now will help you work towards your goals like a savings account.
1.1. Value Drivers
Any business appraiser worth his or her salt will tell you that business owners typically over value their own company. A depressed company value is not necessarily a symptom of a bad appraiser or valuation methods used. It is a symptom of not understanding primary drivers that influence the value of your company other than cash flow. Unlike most appraisers, I’ll break the news with you over some chocolate if your value comes in lower than you were expecting!
The primary drivers that may cause a lower value are related to something called valuation discounts and discount rates. While discounts and discount rates are different both have a substantial impact on the value of your company. These value drivers may help you for estate planning and litigation while hurt you when raising or securing capital for the business.
Discounts refer to discounts for lack of control (DLOC) and discounts for lack of marketability (DLOM). Valuation discounts may accumulate, in some cases, to as high as 50% of the total equity value of your company. Let’s pause here. If all else is held constant and the equity value of your company is $1,000,000 before discounts, then the equity value of your company after discounts could be $500,000 based on this example. Of course, this example does not reflect all businesses. However, at least one valuation discount, usually a DLOM, is applied to all businesses that are not publicly traded.
1.3. Discount Rates
To put it simply, a low discount rate equals a higher value for the company and vice versa all else being equal. Typically, a mature company with stable cash flows, an achievable forecast, a strong management team, a diverse customer base, and a manageable amount of debt are some of the primary factors that generate a low discount rate. A company’s discount rate can be managed to an extent.
A discount rate is also referred to the cost of capital “i.e., the expected rate of return available in the market for other investments that are comparable in terms of risk and other investment characteristics” (Pratt, Shannon P. Valuing a Business: The Analysis and Appraisal of Closely-held Companies. Pg. 177). A discount rate is used in the Income Approach, which is one of the more popular methods to derive the value of a company.
2. When do I need a valuation?
The value of a closely held business is typically an individual’s primary asset. A business valuation is an essential part of running a business and sooner or later every business owner will need an accurate and reliable valuation. Generally, a valuation is performed to help owners plan for the future, determine tax liabilities for a transfer of ownership, assist legal counsel with litigation issues surrounding a business, and for financial reporting purposes.
While I have personally valued hundreds of companies, approximately half of the valuations I have performed have been to assist attorney’s with an individual’s estate or financial plan with the other half pertaining to litigation support. If you are planning to gift or transfer a portion of ownership in your company, then you should be working with your attorney/CPA and a professional valuator. If you are going through a divorce, then the value of your company will need to be known.
In my experience, many business owners feel that a valuation is only necessary if you are trying to buy or sell the company. However, this is only one of many components that require a valuation. The words Business Valuation should trigger your thoughts in any of the following general examples:
Of course, this is not a comprehensive list and there are many reasons to value a business including:
3. Who do you call? (Hint: it’s not Ghostbusters)
Your local CPA firm may perform your audit or tax work but that doesn’t necessarily mean that they can or should perform your business valuation. Too often, business owners fall into the trap of feeling that their CPA can handle all of their business and financial needs. In many cases, this can’t be further from the truth. However, finding a business appraiser may be easier than you think and I will give you some guidance on how to find us to get the very best services you deserve.
3.1. Local referrals
Local referrals can be a great starting point to understand what firms are in town. I would suggest talking to your attorney, business associates, and CPA if your CPA does not provide the services themselves. If your CPA provide valuation services, make sure they are credentialed with an appropriate valuation credential. I have outlined the most popular valuation specific credentials in the ‘Credentials’ section below. Also, the last page of this post contains a valuation questionnaire that may help you determine if they are right for you. Word-of-mouth is usually a great resource but not all business appraisers specialize in your needs. One business appraiser may provide litigation services only, whereas another may specialize in corporate transactions.
Use your favorite search engine and type your location followed by the words business valuation. Don’t stop at the first page! Many national firms pay for advertisements to land at the top of your search and they may not even be located locally. It is important to find, if possible, local firms where you can talk face-to-face and establish trust and a business personal relationship.
Professional credentials are important and they indicate that an individual has performed the necessary steps to become a professional business appraiser. To maintain a business valuation credential, like most other professional credentials, business appraisers must obtain continuing professional education. I have listed the most common business valuation specific credentials below in alphabetical order:
Did you buy your car because it was the first one you saw? Probably not. If you have found a list of firms, based on the criteria outlined above, then you or your professional representative can call for a bid and learn more about their prices, specialty, and the value they will add for you.
I have added a downloadable questionnaire to assist you with the bidding process in your area.