How Much is Your Business Really Worth?

The value of having an up-to-date appraisal

How much is your business worth? It all depends on who’s asking. Your shareholders have one view. Your children have another. The Internal Revenue Service has another. Finally, there is the market value—the amount a business broker estimates your business or share will fetch in the open market.

So it behooves the business owner to get a current accounting of the company’s value, before somebody else does. And getting an accurate estimate is essential: If your enterprise is valued improperly, it can make borrowing more costly, leave you in a poor bargaining position in a sale or clobber your heirs in an estate-tax filing.

You need a professional business valuation:

• To determine the funding requirements for a buy-sell agreement
• To price a business interest in the event of al sale
• To price a business interest in the event of divorce (or marriage/remarriage) of a shareholder
• To set a fair price prior to the death of a shareholder
• To get a price that the IRS will accept
• To secure financing

"Owners should know the market value of their company, and they should always be prepared to sell in case an opportunity or motivation emerges,” says James J. Johnston, president of CBI Business Acquisitions, Ltd. in Denver. “The optimal time for working on maximizing a business's value is when the owner is not hurried, or required by an unforeseen event, to sell."

There are thousands of companies and individuals that will appraise your business—for a price that can run from $1,000 to tens of thousands of dollars. A number of professional organizations, including the American Society of Appraisers, the American Institute of Certified Public Accountants (AICPA) and National Association of Certified Valuation Analysts (NACVA) offer training and certification in business valuation. But this is an unregulated business and most states don’t have any requirements for business valuation or appraisal experts, so caveat emptor.

Getting it Right
In addition to having an accurate valuation, you want to use the right kind of appraisal for the situation—cash flow is better for getting a sale price, but lenders look at assets. If you are valuing for a buy-sell agreement you want a true market value; if for a divorce, your state may have rules to follow; if you are planning a sale or transfer to a family member you want a low value.

Asset-Based Valuations
These look at the business’s assets and estimate their value to a buyer. Lenders look at assets, in addition to income, to gauge your collateral. Asset valuation is also used in liquidations. The most common asset-based methods include book value (actual or adjusted) and liquidation value. An appraiser will consider how liquid the assets are. Raw land, which is illiquid, may be valued at below market rates, for example. Machinery, which can be easily sold, may be valued at closer to market value.

Income-Based Valuations
To value a going concern for purposes of a sale, it is common to use income-based measures: A buyer looks at discounted future cash flow, income and other measures of profitability to arrive at a price. In many industries, companies trade at a set multiple of cash flow or within an established range.

An appraiser will look at several years of cash flow to find the trend; a history of steady growth will provide the best multiple; a downward trend will most lead to a discount. Buyers are usually taking on debt to make the deal and want to make sure the business will throw off the cash to pay the financing charges.

Asset/Income
This method, also known as the excess earnings method, looks at both assets and historical earnings (for a more detailed explanation, see CCH Business Owner’s Toolkit). This involves restating earnings to restore personal income and expenses of the business owner that exceed what a hired executive would get, then comparing the results to the average return on assets to determine the excess—the earnings beyond those which can be explained by normal return on assets. This is also known as goodwill (see below).

Market-Based Valuations
Less common, this method is generally used when a business is actually being sold, not just valued for a buy-sell agreement or divorce or similar situation. This method considers the same essential things as a home sale would—the recent selling prices of similar businesses, the current market climate, the pluses and minuses of your actual business, interest rates, and so forth.

Don’t mistake the appraised market value for actual market price. “We have to educate sellers that buyers have limits, often imposed by their available cash and financing options” says Johnston, the business broker. Many factors can make the sale price less than the appraised market price, including the number of similar businesses that happen to be available in your area at the time.

Goodwill
Goodwill is a measure of intangible assets that make the business worth more than its physical assets. These include customer lists, trademarks and the company’s reputation. Measuring goodwill in private companies is very difficult, and is often discounted by professional appraisals, because in small firms the goodwill is often associated with the departing owner, who created the customer relationships, etc.

Minority Interests and Estates
Remember, when valuing a business for estate planning, the appraiser should discount the value of minority shares; the IRS recognizes that the illiquidity of these shares (you can’t sell them unless other shareholders agree) decreases their worth. This is a key way to reduce the appraised value of your estate.

Valuation services are expensive because a good appraiser examines lots of documents—accounting records, financial statements, tax returns, loans, and more. But don’t be shy. If your gut says the number is wrong, talk to the appraiser and point out where you think he has erred—or ask what he might have overlooked in coming up with a too-high or too-low figure.

Finally, remember that a business is a growing (and sometimes shrinking), evolving entity, so the business has to be re-evaluated every few years to keep the numbers “right.”