What’s Your Business Worth? How the experts valuate your business
Whether you’re interested in buying an existing business or selling one which you have built over the years, placing an accurate value on the operation is often a challenging process.
“For many of my clients, selling a business might be the biggest financial transaction of their life,” said Warren Cline, a Traverse City certified public accountant, who is specially accredited in business valuation.
“On the buying side, one of the problem areas is that an inexperienced buyer may not even know that they need advice or they may not be willing to pay for that advice.”
However, setting the right value on a business doesn’t have to be an overwhelming or difficult undertaking. Buyers and sellers alike should remember that valuation is both an art and a science. They should keep in mind that the “asking price” is usually not the final purchase price.
So how do professional valuators calculate the value of a business?
There are three main approaches used, according to Cline, who has more than 30 years of experience in setting business price tags.
- The asset-based approach considers the tangible assets of the business to be transferred to the buyer. Are there vehicles, equipment or property involved? If so, what are their values? “A buyer wants to know what assets they’re buying. What’s tangible and what’s their value,” explained Cline. “Buyers also want to know how much ‘blue sky’ they’re paying for, above the assets. For some businesses, there’s a ‘special sauce’ in the way they do business or special relationships with vendors that are considered. We have formulas we use to determine if a premium is to be paid.”
- The market approach involves searching data on the sale of comparable companies and generating a value by comparing the business with other companies. This approach works well on when buying or selling a franchise business because there is more readily-available data on them. It’s similar to the process used by residential realtors utilizing home comparisons.
- The income approach calculates the expected profits and cash flows of the business. Then the valuator applies rates of return found in similar investments to the business’s figures. When comparing business incomes, there are factors to consider. “How well a business has done during a recession is considered,” said Cline. “Two businesses may show similar profitability, but one has had steady profits over the years. It would have more value than one that showed volatile profits over the same period.”
Wayne Pahssen, a CPA and accredited business valuator with Rehmann Robson in Traverse City, uses a different approach for most businesses he deals with: “For most of (them), I use the income approach. We look at the cash flow that is generated and apply a multiple base on the industry’s rate of return.”
Factors to Consider
What type of difficulties do certified valuators face when determining the right price for a business?
“One of our hardest challenges is determining the real profitability of a business,” explained Cline. “When the owner of a business gets to set his own compensation, it’s sometimes too high or too low. And the same goes for any family members that may be working for the company. And there are other benefits to consider.”
Another factor to think about when selling certain businesses is the value of any real estate involved.
“Some businesses are very invested in real estate,” Cline said. “Motels, hotels, golf courses, assisted living facilities all have real estate to be considered.”
The sale or purchase of a business is not the only time a business may need to be valuated, according to Pahssen, who has been valuing businesses for 35 years.
“Sometimes a business needs to be evaluated for estate or gift tax purposes,” he said. “Often in gifting, businesses are closely held and the owner may want to transfer it to a family member, so a valuation is conducted.”
Sometimes a business is on the market because of divorce proceedings, sometimes it’s a business divorce with a partnership splitting up. Sometimes a Rehmann client is just sort-of-maybe thinking about selling and Pahssen will do a valuation.
Cline and Pahssen agree that one of the biggest mistakes that a business owner or buyer can make is not getting a professional valuation of the company involved.
“Too often they just don’t want to go through the process of obtaining a formal business valuation,” said Pahssen. “People are fee-conscious and don’t want to pay the fee. For many sellers, most of the wealth they have accumulated over the years is tied up in that business. Making sure you have the right value is important.”