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Tom Atkins at

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5 Reasons Why You Need to Appraise Your Business Now

You know about how much your car is worth. Same with your house, or your child’s education, even the watch you are wearing.

If you are a business owner and you know how much most of your possessions are worth – but you don’t know the market value of your business — then you’re missing something terribly important.

 

Many business owners underestimate the value of their business and the value of a proper business appraisal.

When asked why they still haven’t determined the proper value of their business yet, many business owners would say they are not yet ready to sell the company. But a company sale isn’t the only reason for a comprehensive business valuation. Here are a few reasons from the top of the list:

1.            You need to protect your family and loved ones. We will all die someday, but if you do so unexpectedly or if you become disabled, a business appraisal will protect the significant people you leave behind. It will help your family stay on top of the company obligations and help you plan with them now whether they should sell or dissolve the company altogether.

2.            You need to protect yourself. As a business owner, you’ve invested so much of your time building and running your company’s operations. Knowing your company’s worth can keep it safe from bitter divorce proceedings, creditors, or any other predator who may want to take advantage of your business assets.

3.            You need to know how long you still need to work. If you are like most business owners who count on the proceeds from the sale of your business to support your retirement, then you definitely need a good business appraisal. This will give you an accurate and realistic assessment of your business assets, and prevent you from falling into the dreadful trap of having an inflated sense of your company’s worth.

4.            You have greater chances of getting approved for a loan. If you are thinking of expanding or acquiring assets and would need a loan to finance it, then a business appraisal will help you get approved at a competitive rate. A suitable valuation will show how much risk your company has. Provided your company is running well, banks should peg your risk as low – hence giving you better chances of getting financed.

5.            The need to have an accurate estate plan. Your business worth represents a huge chunk of your own net worth. Is you are planning to draw up a will or you’d like to create an estate plan, it would be hopeless to do so without an accurate appraisal. This is of particular importance if you have children or any other family member who would like to take over your business in the future.

Contact me – Tom Atkins directly at BATomAtkins@aol.com for a free consultation.

 

 

BUSINESS APPRAISAL PROCESS

 

A Business Appraisal is an investigation into the law of probabilities with respect to Business value.  Through the Appraiser’s experience, training, and integrity, the Appraiser is able to project the activities of buyers and sellers in the marketplace into an estimation of price-value.  In reaching a conclusion, comparison of Businesses usually involves adjustments due to the individuality and uniqueness of each Business. 

 

A Business Appraisal cannot be guaranteed, nor can it be proven.  The opinion of value can, however, be substantiated and the final opinion is the result of a thorough professional analysis of a large amount of data.  An Appraisal must not be considered absolute but should be used as a starting point of documented value by analysis of the assets and financials that may be used as a basis of negotiations between concerned parties, whatever their interests.

 

The Appraisal process as followed in the preparation the report is an orderly procedure for arriving at an estimate of value.  By following this procedure, the Appraiser begins with a preliminary study of the issues and defines the basis from which the opinion of value is to be made.  Once the data has been collected, a systematic approach is taken to analyzing the data and selecting appropriate valuation methodologies.

 

In assignments to estimate fair market value, the ultimate goal of the  Business Appraisal process is a supported conclusion that reflects the Appraiser’s study of all influences on the value of the company being appraised.  Therefore, the Appraiser studies the Business from various perspectives.  Various questions are raised and answered through research of the industry and the financial capabilities of the subject Business.  Some of the questions researched may be found in the supporting data section of the report.

 

The various Appraisal approaches are interrelated, and each involves gathering and analyzing specific pieces of data relating to the company being analyzed.  From the analysis, the Appraiser derives separate indications of value, of which one or more may be used in determining the final value.

 

To complete the Appraisal process, the Appraiser integrates the information drawn from market research, analysis of data, and from numerous Appraisal techniques to form a conclusion.  This conclusion may be an estimate of value or a range in which the value may fall.  An effective integration depends on an Appraiser’s skill, experience, and judgment.

 

 

 

ELEMENTS OF BUSINESS APPRAISAL

 

Every Appraisal method and technique must comply with and is limited to the following elements if the final results are to be considered significant.

 

Element 1

 

     What a reasonable buyer will pay a reasonable seller.

    

     The term “reasonable” in this context is used in the economic sense.  The buyer

     and seller are each assumed to be comparing alternative investments and when

     the economic incentive to purchase is equal to the economic incentive to sell, a

     deal is made.

 

Element 2

 

     For Appraisal purposes, a Business is defined as an organized method of 

     producing revenues routinely over a period of time.

 

     The value of a Business is divided into two (2) components:

 

1.      The asset value represents the value of machinery, equipment, buildings and

land, usable stock and other legal rights.

 

2.      The intangible Business value of a Business represents the premium value a

buyer will pay the seller for organization and historically recorded cash flows.

 

     Additionally, the intangible value may be broken up into various values

     representing items such as, customer list, covenant not to compete, goodwill and

     any other item documented by seller or buyer CPA.

 

Element 3

 

     Accuracy depends up the standard use of terms, methods, and disclosure of

     information.

 

     The Business Appraisal report is only as good as the data it is based upon. 

     The report makes adjustments for minor mistakes in judgment or interpretation

     of questions; however, accounting or financial data is taken at face value.

 

Element 4

 

     All estimated values are limited by time and adjustments may be made as

     changes occur over time. 

 

     Any sales price is subject to change as the market conditions change.  Therefore,

     the suggested value-price is valid only for a short time relative to the size and scale   

     of a given Business, in a given industry, and in a given market.  Documentation of

     the data used in the report will provide the basis for analyzing how this data will

     change over time.

 

 

 

FAIR MARKET VALUE

 

 

The single most important market factor to impact the value of a Business is the supply and demand of an equally desirable substitute that is available in the marketplace.  According to the element of substitution, the value of a thing (Business) tends to be determined by the cost of acquiring an equally desirable substitute.  A buyer will pay no more for a Business than the cost of purchasing a similar Business.  This concept is the basis of fair market value and is the overriding methodology in this Appraisal report.

 

There are three approaches to determining the value of any Business:

 

1.      The cost approach, which considers the cost of purchasing or producing the

      Business.

 

2.      The income approach, which is a financial analysis consisting of capitalizing

an income stream based on the cost of money and a risk rate that reflects

current market conditions.

 

3.      The market data approach, which values the Business based on current sales

in the marketplace for the same or similar Businesses.

 

 

In the Business Appraisal report you will find as many methods, under each approach, as is reasonably applicable to valuing the subject Business.  In order to arrive at a supportable value, the Appraiser will chose those methods that would best apply to the purchase of the subject Business as reflected by the marketplace.

 

The Internal Revenue service established Revenue Ruling 59-60 as the standard for the Appraisal of closely held companies.  The following summarizes the key factors to consider:

 

1.      History and Nature of the Business.

 

2.      Economic Outlook.

 

3.      Book Value.

 

4.      Earning Capacity of the Enterprise.

 

5.      Dividend Paying Capacity of the Enterprise.

 

6.      Goodwill and Intangible Assets.

 

7.      Recent Sales of Stocks.

 

8.      Market Value of Comparable Companies.

 

 

 

 

 

COST APPROACH

 

 

In considering the cost approach, remember that the cost of something does not necessarily determine its selling price.  This is true in a rapidly changing market, which is highly affected by technological changes or variances in supply and demand.  This is especially true if a company is very young and has not yet established enough of a track record to make a confident analysis of the future performance.

 

Also, in the case of a Business, all serious practitioners of Business Appraisal agree that book value is not necessarily an adequate proxy for representing the underlying net asset value of a Business for Appraisal purposes, much less for representing the value of the Business itself.  However, book value is a figure that is available for almost all Businesses.  Furthermore, it is a value that different Businesses have arrived at by some more or less common set of rules, usually some variation within the scope of generally accepted accounting elements (GAAP).  Also, each asset or liability number that is a component of book value as shown in the financial statements represents a specific set of obligations that can be identified in detail by referring to the company’s records, assuming that the bookkeeping is complete and accurate.  Therefore, book value usually provides the most convenient starting point for an asset value approach to the Appraisal of a Business interest.

 

The nature and extent of adjustments that should be made to book value for the Business Appraisal depend on many factors.  One, of course, is the purpose for the Appraisal.  Another, which is frequently a limiting factor, is the availability of reliable data on which to base the adjustments both for the subject company and for other companies which might be compared in the course of the Appraisal.

 

One concept for fixed assets is value of use, the value of the operating assets to the owner/user, or buyer who will use it in a similar manner.  Value in use is the value that includes consideration for the unique relationship of the item to a particular Business such as the subject.  There is a value for an item, which is already in place and is ready to use in a going Business.  The value might be the item’s retail price, plus applicable taxes, freight, and installation charges.  The summation of these costs, after proper deductions for depreciation and obsolescence, is the value in use of that item.  This value may be different from its fair market value to a buyer who may not use the equipment at its present location.  A definition for value in use is as follows:

 

     The value of an economic good to its owner/user is based on the production

     privacies in income; utility or amenity form) of the economic good to a specific

     individual.  This is a subjective value, however, and may not necessarily

     represent the market value.

 

The Appraiser, therefore, will have to subjectively estimate the value in use of the subject’s assets based on past experience with assets of a similar nature.

 

 

 

 

 

 

 

 

INCOME APPROACH

 

 

The income approach is especially meaningful if assets are used to produce income, such as in the Appraisal of a Business.  However, it still takes root from the market data approach because it is an analysis of what the current market is paying by determining a comparable return that can be capitalized into a comparable purchase price.

 

 

 

 

MARKET DATA APPROACH

 

 

In other types of Appraisals, mainly real estate, the market data approach indisputably will always yield the most accurate results.  It is a true representation of the current marketplace because it is what the market is paying for the same or similar asset.  In the case of a Business, using public or private comparable sales price-to-earnings or income-to-sales ratios require close attention to the factors that make the comparison realistic which are:

 

     Comparing Similar Business Types, sales levels, discretionary earnings and asset 

     values.

 

The comparison starts with a similar Business type.

 

Comparing Business sales levels that are as similar as possible to the Business being Appraised.

 

Using a comparison of Discretionary Earnings -- profit on the tax return means very little -- the sum of all the add backs will determine Discretionary Earnings and that is the number the Business Appraiser looks to compare.  (Some comparables use Discretionary Cash Flow as well)  None use tax return profit.

 

     The Business Appraiser also must compare the asset values of the Comparables               

          and use the comparables that most closely compare to the Business being    

          Appraised.

         

 

The market data approach can be very useful when analyzing data drawn from the market as to what types of ROI (return of investment) ratios are customary, or data based on Price-to-Earning ratios that buyers are willing to pay in order to purchase a certain type of Business.

 

 

 

 

 

 

 

Stock Price Data from Publicly Traded Companies

 

 

It can be argued that the use of stock prices of publicly-owned companies to estimate the market value of privately held companies is a source of comparable data.  However, many Business Appraisers realize that to estimate the market value of a privately held Business by using this data is seriously flawed in several respects:

 

1.      Publicly held companies, whose stock is listed on the major exchanges,

are usually much larger than the closely-held Businesses that are being

appraised.  This difference is size raises serious questions as to whether

the two are, in fact, comparable. 

 

2.      Prices of publicly traded stock reflect the sale of very fractional

ownership interests.  On the other hand, the Appraiser’s objective is

usually to estimate the market value of a major ownership interest,

frequently, one hundred percent ownership of the closely held Business.

 

3.      Selecting appropriate publicly traded companies is tantamount to guess

work, and, thus, cannot be relied upon.

 

4.      The price to earnings ratio represents the ratio of a current stock to an

earnings-per-share figure that can be from a few weeks to several

months old.

          

5.      Probably the greatest fallacy of attempting to use publicly traded stock

prices to estimate the value of a closely held Business lies in the

psychology of the investor.  The potential for a closely held Business is almost always concerned with the anticipated performance of the Business itself. 

Of course, it is sometimes argued that the trend of stock prices of a publicly held company is strongly influenced by the company’s performance.  However, it is demonstrable that, whereas this does tend to be true in the long run, there are many influences on stock that tend to be of short-term nature, and that strongly influence stock prices while bearing relatively little long-term relationship to the company’s performance. Therefore, using the prices of publicly traded stocks is not recommended as a means of estimating the value of closely held Businesses.

 

Comparable Transactions  

 

Still another source of market data is, of course, information on actual sales of companies, such as the subject, in the Appraiser’s local community.  It is unlikely, however, that there will be enough information available on sales similar to the subject to provide a statistically sound basis for estimating the Business’s market value.  However, as mentioned above, when analysis based on research on potential buyers for this kind of investment is made, important insight into what a buyer is willing to pay for a particular Business can assist the Appraiser in determining an accurate opinion of value.  This analysis must include such factors as industry risk, the local and national economy, competition, barriers to entry, and the future potential of Greeting and Name.

 

 

CORRELATION OF METHODS

 

 

It is important to note that under guidelines set by the “The Uniform Standards of Professional Evaluation Practice” (Standards Rule 9-5), the Internal Revenue Service (Revenue Ruling 59-60), as well as most Appraisal societies, the Appraiser is required to use all approaches for which reliable data is available and applicable.  The use of as many approaches and methods within these approaches is useful to the extent that it will establish a range of values for the entity being appraised.

 

Revenue Ruling 59-60 (in Section 3, “Approach to Valuation”) recognizes the fact that appraising is not an exact science:  “(a) sound Appraisal will be based upon all the relevant facts, but the element of common sense, informed judgment and reasonableness must enter into the process of weighting those facts and determining their aggregate significance.”

 

Sometimes it will be obvious that the analyst should rely on a single approach, such as methods under the cost approach whereby earnings are insignificant to the value of the assets.  An example of this would be a new enterprise with little or no longevity or profits, where projections would be meaningless.  Another example would be a company that has longevity, but insignificant profits, and would be a candidate for liquidation.  In other cases, it may be apparent that several methods would be appropriate for the final value conclusion.  When this is the case, the Appraiser must look to the real world to determine which method or methods should receive the most weighting.

 

Service companies can represent a significant problem to the Appraiser in that there are few assets that would give a buyer confidence should the Business someday fail.  In any case, risk is the most important factor to consider in an Appraisal.  As stated earlier, and acknowledged in Revenue Ruling 59-60, value is based on anticipated expectations of the buyer as to future performance.  In other words, what a company did in the past has no significance to its value if the trend is not anticipated in the future.

 

Although assets play an important role in risk calculations, one must remember that earnings and the anticipation of an increasing income stream are the overriding factor in the purchase of a Business.  The process of elimination and an analysis of methods both suggest that Discretionary Income is clearly the most representative of current market value.

 

 

 

 

Month Day, 20

 

Name

Address

Pittsburgh, PA  15220

 

Mr. Name:

 

This report contains the documents and data we have used to appraise NAME OF BUSINESS.  The suggested value-price is the sum of tangible assets and intangible Business value.

 

ASSET VALUE

 

The tangible asset price or asset value represents the current estimated value of the following:

 

1.      Inventories for resale or consumption.

 

2.      Equipment and vehicles.

 

3.      Leasehold improvements.

 

4.      Transferable rights and privileges uncontrolled by scarcity.

 

The estimated current asset value of the company is:  $355,150

 

INTANGIBLE BUSINESS VALUE

 

The intangible asset price of Business value represents the current estimated value of the following:

 

1.      Establishing a customer base which will continue to trade with this company

after being sold.

 

2.      Securing a location, designing and constructing a floor plan and securing and

installing equipment.

 

3.      Management systems in place and producing cash flow.

 

4.      Proprietary rights or limited issue permits.

 

5.      Training and available consulting time.

 

The estimated current intangible value of the company is:  $227,493.

 

ESTIMATED CURRENT MARKET VALUE

 

The Business Appraisal report with supporting documentation offers several values; therefore, our single value-price conclusion is the average of the documented values.

 

The estimated current market value of the company is:  $582,643.

 

Respectfully submitted,

 

 

Thomas D. Atkins

Business Appraiser and Consultant

 

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EXAMPLE OF ONE OF MY APPAISAL PACKAGE

 

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