The Right Buyer, The Right Seller, The Right Price.
Business valuation should be considered a starting point for buyers and sellers. The more informed the parties in a transaction are, the better the likelihood of a good deal. Each party has different motivations, fair market value is the price a ready seller will accept and a ready buyer will pay.
Understanding Business Valuation
Selling a business is far different from selling a house or other tangible asset where there exists exact comparison transactions. A business valuation requires analyzing a business and its intangibles. At ArrayBSA we have that experience. Unlike real estate, it is common for 50% or more of an operating business’s value to be based on intangible assets such as goodwill, intellectual property, licenses, location, etc. Business valuation is a complex process. Part art and part science, it relies on elaborate business metrics, we can put it to work for you.
There are several reasons for valuing a business. In addition to the buying and selling process, a business valuation is an important tool for estate and tax purposes, divorce settlements, and for raising capital. We can help with all of these situations.
Fair Market Value
Fair market value is an estimate of what a willing buyer would pay to a willing seller in a free market (both having equal knowledge of the business and transaction variables), for an asset or piece of property under conditions where neither party feels pressured or obligated to buy or sell. If a transaction occurs within the aforementioned conditions, the transaction price is usually the fair market value. This is not the same as intrinsic value which an individual may place on an asset, meaning what he or she feels the selling/purchasing price should be based on personal preference.
Common methods we use to determine the value of a business
We have found that the businesses we have taken through a formal business valuation process sell closer to asking price than those without valuations. Through the valuation process both sellers and buyers become better informed – making the entire process easier – from start to finish.
Brokers Opinion of Value
A prudent step in deciding if now is the right time to sell your business is to have a Brokers Opinion of Value (BOV) performed by ArrayBSA. A BOV, a proprietary tool of the ArrayBSA team, the BOV combines the elements of a business appraisal, a financing template to determine the amount of cash a lender will give, trends of the business, economy and the industry you are in. The BOV starts with a recast of your financial statements, adding back non-recurring and prerequisite expenses. This is a critical exercise in selling a business because buyers and lenders expect that the tax returns be prepared to minimize taxes. BOV’s also examine the company’s history, management makeup, working capital needs, business selling market, past sales of similar companies, client concentrations, vendor relationships, and countless other critical factors that will comprise your business’s value.
Having a BOV prepared allows business sellers and other decision makers to make an informed judgment. Maybe the market is red hot for selling your business or maybe the BOV will highlight things that if done will enhance the company’s value down the road. When we say, “Trust the Experts” we are proud that ArrayBSA and its affiliates have appraised and sold hundreds of businesses for over thirty years.
When do you need to have a valuation?
A valuation may be used to buy a company, sell a company, mergers and acquisitions of two existing companies, to sell shares of the company to key employees, for divorce estate settlements, to settle estate and tax issues, for insurance issues or to stay current, organized and congruent with the rapid growth of your business. Regardless of the reason, everyone should know the value of their business.
What does Asset Valuation mean?
Asset Valuation is the process of determining the current worth of a portfolio, company, investment, or balance sheet item.
How can I prepare for an asset valuation consultation?
Business appraisers and brokers start off by requesting a copy of the past three years financial statements and tax returns in order to prepare an overall view of your company’s asset valuation. Other key pieces of information include all the salaries and “perks” that are directly paid to the client and his/her family members. From there, we will examine other relevant analyses in order to conduct a detailed asset valuation. Initial consultations allow us to get an understanding of your goals and help us make sure that we take the right steps in helping you reach those goals.
How are assets and earnings best demonstrated?
Most valuations require readjustments to tax returns and financial statements in order to appeal to the buyer. This is not to say we convey a false image of your company. It simply means we examine personal versus operating expenses, for example, and exclude personal expenses from the balance sheet and retain only those that are relevant to a potential buyer.
Capitalization of Income Valuation
Capitalization of income valuation method places no value on fixed assets such as equipment, and takes into account a greater number of intangibles. This valuation method is best used for non-asset intensive businesses such as service companies. “Cap Rates” can be derived from various methodology. One such valuation method is the build-up method where statistical data are used from publicly traded companies. Other cap rates are derived from Industry Rules of Thumb and market sales.
Capitalization of Income Factors
In his book “The Complete Guide to Buying a Business” (Amazon, 1994), Richard Snowden cites a dozen factors that should be considered when using Capitalization of Income Valuation. He recommends giving each factor a rating of 0-5, with 5 being the most positive score. The average of these factors will be the “capitalization rate” which is multiplied by the Seller’s discretionary cash to determine the market value of the business.
The factors are:
- Owner’s reason for selling
- Length of time the company has been in business
- Length of time current owner has owned the business
- Degree of risk
- Growth history
- Entry barriers
- Future potential for the industry
- Customer base
Owner Benefit Valuation
This formula focuses on the seller’s discretionary cash flow, and is used most often for business valuation in which value comes from their ability to generate cash flow and profit. Owner benefit valuation uses a fairly simple formula: multiply the owner benefit times a multiple consistent with the industry to get the market value. ArrayBSA will carefully examine the Seller’s income statement to identify non-recurring and discretionary expenses.
If the expenses are non-requisite to the operation of the company, then they are added to cash flow. Certain non-cash expenses like depreciation and amortization may also be added to cash flow. The total of the owner benefit is usually multiplied by an industry specific number to arrive at market value.
Commonly used by real estate professionals, the market approach determines the value of a business by using an “industry average” multiplier. This industry average is based on the price at which comparable businesses have sold for. As a result, an industry-specific formula is devised, usually based on a multiple of gross sales. These formulas, often called Rules of Thumb, can be troublesome because they may not focus on the bottom line; profits, earnings, EBIT or EBITDA. If an industry Rule of Thumb says company XYZ is selling for 50% of its annual gross sales, would you pay 50% for those sales if the company was not profitable? In most cases, business people want to invest in something that is profitable, sustainable and stable enough to produce growth in the future. The market approach is key to opening the door to opportunities which allow you to make the best business choices.
The appraiser therefore tries to focus on industry formulae where they are applied to a multiple of earnings. This market approach is similar to analyzing a publicly traded company by its P/E (price to earnings) ratio .The approach, if enough empirical data is available, can very often be the most reliable valuation methodology for many industries. ArrayBSA, because of their status as an appraisal and brokerage/intermediary firm, has an extensive data base of actual sales to draw upon. In addition, by means of membership, we also have access to many of the world’s largest data bases of done deals.
Here are a few Industry Multiplier examples:
- 1-1.35x Revenue, Plus Inventory
- 2-3x Seller’s Discretionary Earnings (SDE), Plus Inventory
- 5-7x EBIT
- 4-6x EBITDA
- 2-4x SDE, plus Inventory
- 3-5x EBITDA, plus Reasonable Owner Expenses
- 4x EBIT
- 70-75% annual sales, plus Inventory
- 3x SDE
- 4x EBIT
- 3-3.5x EBITDA
Home Health Care- Care Giving
- 50% annual sales, plus inventory
- 2-4x, SDE, plus inventory
- 4-6x EBIT
- 3-5x EBITDA
- 1.5-1.75x SDE, plus inventory