A seemingly salacious title to a blog post, but the Business Valuation industry originated from alcohol - or lack thereof.In 1920 with the enactment of prohibition many enterprises that were engaged in the alcoholic beverage business were allowed tax breaks by the U.S. Government for “damages” suffered. In order to determine certain tax benefits to these businesses their “intangible value” or “goodwill” had to be determined. Prior to this time it was commonly believed that the value in a business was essentially the value of its assets less its liabilities.But, as we know today, business value comes in many forms - although most notably in the cash and profits it generates, has generated, and will generate. But goodwill is also imputed into a brand name, some special technology that may or may not have materialized into a market, and in a myriad of other ways. Even a stable staff generates goodwill.As a direct result of prohibition the IRS published a document called the Appeals and Revenue Memorandum (or ARM) 34. ARM 34 presented two novel ideas: 1) Goodwill exists if a business has earnings in excess of another “like business” and 2) Goodwill value is determined by calculating the “current value” of those excess earnings. These concepts formed the basis for the practice of business valuation today. Additional questions, responses, and new sophisticated methods dealing with business valuation resulted. Check us out over at Fair Market Valuations to find out more.Posted by: John Klearman, Fair Market Valuations
Not all buyers are created equal. We could debate about the types of business buyers out there but, excluding individuals, lets distill buyers into three categories - financial buyers, strategic or synergistic buyers, and buyers with some DNA of both previously mentioned (or hybrid buyers). In the merger and acquisition (M&A) world we frequently refer to a private equity group (PEG) as a financial buyer. Why? Well, PEGs are formed to pool resources from investors that may have an interest in “sector” investing. Look at a private equity group website like Huron Capital and you’ll see terms that resemble investor terms - minimum EBITDA, Sectors Invested, etc. A PEG may also be a synergistic investor depending upon what types of investments are in its portfolio. A synergistic buyer, by contrast, may consider acquiring a company because it adds synergy to its existing business. Consider Google’s acquisition of DoubleClick for $3.1B. In order for the buyer to justify the acquisition there must be synergy. Is a financial buyer better than a synergistic buyer or is a synergistic buyer better than a financial buyer?
If you’ve given any thought to selling your business it is important to understand the distinctive roles your advisor(s) must play. Besides a CPA and Attorney, or sometimes a Financial Planner, the two key roles in the divestiture process are those of the Valuation Analyst and the Business Sales Intermediary (sometimes referred to as an M&A Investment Banker). Early in the process of understanding if or even when you may choose to sell your business determining value is an analytical process. The analyst looks at key and measurable drivers of value and applies that data to a variety of different models. Certain assumptions are made during the process, like “a market exists” or “neither buyer nor prospective seller are under duress”. Discount rate assumptions are made, and other mathematical assumptions, based on very specific methodology are made as well. Moreover, the financials are recast for non-recurring and key discretionary items to present the business in a “normalized” state. The analyst typically derives either a “Conclusion of Value” or a “Calculation of Value”.
A group of intermediaries within our nationwide network of advisers (The Business House, Inc) has released a strong recommendations list on how to increase small business cash flows. Following these tips can most certainly boost a company’s business valuation. Below is a recap of the key points:
Cash Flow is KING: Cash In - Cash Out = Cash Flow
- Organized Record Keeping (we harp on this topic in other posts)
As a business owner, you obviously want to be cognizant of decisions and factors within your business that will positively or negatively influence its value. Below is a breakdown of some key areas you can focus on today to ensure that your company’s value is protected should you ever need to conduct a business valuation and if you ever plan to sell:
The SBA’s Standard Operating Procedures (SOP) was recently updated and released. It is more streamlined and condensed, allowing for easier reference to and understanding of guidelines.
One specific area we want to highlight is the requirement of an independent, third party business valuation for SBA loans exceeding $350,000. Here is the exert:
(i) Business Valuation
Most Americans continue to read, hear and see troubling news about the U.S. economic outlook. Business owners need some reassurance that the sky is not falling, particularly for business owners considering the future sale of their business. Today is a seller’s market! But, cyclical indicators point that this window will not stay open forever.
CNN Money put out a great Q&A article a couple of weeks ago: How to sell a million dollar business. If you are planning or hoping to sell your 1-2 million dollar small business in the next 2-3 years, save this to your favorites. Highlighted topics include:
- A business broker can be your best ally in selling a business of that size
- Questions to ask a business broker
The NY Times tackles a very important topic for today’s business owner: what to do when partners want to split. A buy-sell agreement protects all owners in a business for events when a minority, majority or equal owner decides or is forced to leave a business. In most cases, a buy-sell agreement will include a provision for determining “fair market value” via a credible third-party business valuation.
If you own a business and are thinking about selling, it is important you recognize the value of a defined plan & strategy and the value of professional advisors. An article featured on Financial Post summarizes a recent study of business owners who sold their business within the past 5 years (more than 100 business owners were surveyed about selling and what they would recommend to other business owners following their own personal experiences):