As some people whined through grammar school, high school, and college, “Math is hard!” But business valuation goes beyond math. It’s the assessment of a business’s hard and intrinsic assets to determine its moneymaking power in the hands of the same owner or a new owner years from now. Not all those items can be totaled up on a calculator. Business valuation occurs when offers or deals are on the table, of course, but business valuation is best used as an ongoing strategic tool to determine the best time to expand, contract, enter, or exit a business. Valuation can be necessary in light of many other circumstances — such as succession, divorce, death of a founder, or erosion in markets — that may signal a good time to sell or liquidate a business. Keep in mind that “sale” reasons for an owner may indicate a “buy” opportunity for the right outsider.
But back to the need for a business appraiser: Why bother with business appraiser experts?
Very few people can keep their business and personal finances at their fingertips. Small-business people are busy and often distracted. A trade-off occurs in focus between business finances and personal finances, as well as in the lifestyle issues that necessarily fill your time — family, friends, and sometimes even leisure. People who have the skills to toggle among all these areas with all the information they need to make the right decisions are rare.
People with the right money skills may still lack a quality essential to the valuation process: objectivity. Asking an owner to value his business objectively is a bit like asking a parent to identify which of his kids is smartest. Most entrepreneurs are too close to their businesses to value them without bias, so you need detached experts and sources of information to rely on. This is why the valuation process rests on the shoulders of people who understand not only the financial aspects of your business but also its future value and what effect a sale or other transaction may have on your estate, your retirement plans, or your plans to get involved in a new business.
I can list type of professional people who commonly participate in the business valuation process [i.e., Accountants and auditors, Business Appraisers, Business brokers, Business consultants, Business intermediaries, Divorce and family-law attorneys, Employee stock ownership plan (ESOP) attorneys, Estate attorneys, Financial planners and advisors, and Tax attorneys], but you don’t get the idea that one is more important than another. Having all these professionals show up in a single deal is rare, but it happens.
Generally, you can break this list down into four categories based on the type of help you need. The big four are:
To be more focus, in this post I emphasize on business appraisers only. First, though, you need to know how to pick out the best people to help you.
Business Appraiser Expert’s Traits [Must Have]
As you begin the valuation process, it helps to understand the concept of self-interest when you’re bringing in experts to help you value your business. These experts are professionals with their own interests at heart: They’re in business for themselves.
They also need to understand your motivations for valuation, and they need to demonstrate the following traits:
- Independence/objectivity – As much as you want to see an asset grow in value, you need professionals to appraise and value those assets without bias. That means that in reviewing your financial statements, interviewing executives, and eyeballing the physical aspects of your business, they need to rely on recognized standards of value — not merely on your influence because you’re paying them.
- Confidentiality – Even if you’re paying for honest, unbiased advice, you need to make sure that your goals are protected from people on the outside who could interfere with your plans. The professionals you bring into the process need to gather and process information legally, but they also need to be savvy about your need for discretion and confidentiality.
- Industry awareness – Experts need to know the current market backward and forward. There’s really no single correct price for a business, but the experts have to price your assets fairly, relative to the market.
- Clarity about fees – Cost isn’t the only factor involved in selecting professional help, but an understandable fee structure is key.
- Clarity about dispute resolution – The best valuation processes may not be dispute-free. Before you enter into any professional agreement, discuss how both sides will handle disputes and differences if they happen. You ask not because you anticipate trouble but because you want to prevent it.
- One point about disputes over valuation – Many professional-services firms write specific language about arbitration or mediation into any contract you sign to hire them. This language may mean that you won’t be able to sue the firm later for results that you find inadequate.
Arbitration is a common dispute-resolution technique in many industries, so make sure you understand the process. As you zero in on the valuation process, certain experts who do very specific things. The next section introduces a few.
Appraisers are trained to analyze and set the value of a particular kind or category of asset. The best appraisers aren’t utility hitters; they’re specialists who not only have specific training in finance and accounting techniques but also have deep experience in certain industries or ownership situations that call for valuation, such as divorce, lawsuits, or bankruptcies.
Why can’t the CPA who does your taxes do a business appraisal?
He may have a sharp eye for figures, but in most cases, appraisal is a separate discipline. Appraisal involves many of the same basic financial skills that accountants and other finance majors are trained in, but appraisers also need other skills.
They need to be able to do the following:
- Read and dissect a balance sheet so that they can compare and analyze various assets for current and future value
- Behave like detectives, questioning officers, management, and staff members about the current and future value of various assets
- Measure the value of both tangible (physical) and intangible (idea-based) assets
- Function under significant time pressure in many cases
- Write clear, extensive, detailed reports on findings
- Be able to defend their findings in court if they’re challenged
How about a CFO? Most chief financial officers (CFOs) don’t have the time or the skills to do what qualified appraisers do. Nor are they truly independent of the organizations being valued. A CFO is to an appraiser what a police chief is to a crime-scene investigator: The top financial officer of a company oversees the big picture on valuation, whereas an appraiser gets called in to go over financial evidence with a fine-toothed comb. Simply put, appraisers strap on the gloves and do the detail work.
In reality, most appraisers don’t get called in to do what they do for companies with less than $1 million in revenue, because local standards of value or written guides provide benchmarks for these kinds of deals.
Before you hire an appraiser, know exactly what you’re going to need to appraise. Individual appraisers generally specialize unless they’re in a rural area, where they may have to know and evaluate several kinds of businesses. If you have a rural farm-implements dealership, bring in someone who knows that business, not someone who just does real estate or retail stores. If you have a variety of assets to appraise, however — such as intellectual property, land, property, and equipment — an appraisal firm or valuation practice may need to subcontract out your job.
How Appraisers Are Trained and Certified
Most business appraisers have four-year college degrees with majors in accounting or finance. Their career paths can take several forms. These individuals may eventually operate as independents, but they may initially join appraisal firms or sign on as full-time or contracted experts with law firms that need valuation services.
One of the most important reasons for appraisers to join an existing firm is for continuing education. New graduates generally don’t have a specialty, but over time and with funded education, they develop one, and that specialty boosts their value in the marketplace.
New college graduates with a background in finance need class time and work hours to qualify for a particular valuation certification. According to the American Society of Appraisers (ASA), such certifications include the ones I list below:
How Professional Business Appraisers Charge You
Business appraisers primarily charge based on the complexity — and the time constraints — of the valuation required. If you’re looking for a rough estimate, a rule of thumb is a basic starting point.
Business valuation isn’t all about green eyeshades and sweat equity. As in most industries, computerization has made a huge difference in business valuation, bringing tons of information to valuation experts via databases and making critical computations easier. Ask a potential valuation professional how much of her work she does on a computer and whether the computer frees her to do more onsite work or other hands-on tasks.
For business valuations tied to specific situations, however — potential purchases or sales, divorce valuations, partnership dissolutions, and so on — the appraiser spends much more time analyzing corporate figures (which may require an audit by a CPA), inspecting assets, and talking with executives about those assets. Depending on the size of the company and the challenges to be met, the fee for the appraiser can easily be thousands of dollars — and sometimes tens of thousands of dollars.
Some valuation professionals charge fixed fees based on particular types of valuation assignments, but you aren’t limited to that fee if the process takes longer for any reason. Know in advance what may “unfix” a fixed-fee arrangement.
Appraisals that are certified by the appraiser usually cost more because they tend to be more detailed. A certified appraisal may include items such as the following:
- An overview of local, national, and international economic factors that affect this particular company and its industry, and what factors may affect the company and industry in the future.
- A review of five years’ worth of financial statements, as well as a review of tax returns and other financial documents for clarity and accuracy
- A balance-sheet analysis and review of the depreciation schedule, including adjustments for machinery, equipment, and other assets to come up with fair market value
- A detailed presentation of the valuation of a company based on several valuation methods that a future buyer or seller may demand
- Onsite visits to gather data and present findings
Anyone hiring a business appraiser should talk to at least two or three prospects to get an idea of his fees and his work process.
How To Examine A Business Appraiser’s Work Process
Work process is all about the assignment — the actual thing or company that needs valuation. The size and scope of an appraisal assignment determine the appraiser’s work process in establishing the fair market value of a single asset or a whole company. Size and scope define the time that the appraiser needs to spend on the job, as well as the number of assets and related issues that she needs to review as part of the valuation process.
The simplest valuation assignments don’t require a face-to-face meeting; a phone call and a few keystrokes into a database later, a very general dollar amount emerges as the value of a particular company.
But when the company’s revenue exceeds $1 million and the reasons for doing the valuation are more complex, the assignment requires the following tasks:
- Extensive research of the company’s industry and its prospects
- Interviews with company officers
- Onsite visits to see the physical facilities and assets being valued
- Exchange of information with company attorneys and tax experts
- Creation of reports and presentations on intermediate or final findings
- Possible after-valuation activities, including testifying in court or in deposition, usually priced as a separate item.
The best valuation efforts are planned and comfortably scheduled for the scope of the project. When interviewing valuation professionals, ask them how long a typical valuation process takes and what they consider a rush job; otherwise, you may end up paying more for a quick valuation that doesn’t give you as much depth as you need. Of course, smart valuation professionals know their limits and communicate them.
What To Ask A Prospective Business Appraiser
Much of how your valuation will go is determined by the questions you ask a professional before you hire him. Here are some basics:
- What’s your specialty? (Ideally, you’ve checked this information beforehand, but let the prospect describe his expertise to you.)
- What are your training and certification?
- What basic information will you need from me to estimate the job, and what kind of information will you need from me on an ongoing basis?
- What do you think the features of this appraisal will be, and how long could the appraisal take?
- Is there a cost range you’re prepared to offer at this time? If not now, when?
- Will you need to call in other experts to complete the valuation based on the assets I need you to value?
- How much experience have you had in valuing companies like mine (or like the one I want to buy)?
- I have specific reasons for valuing this company. Have you dealt with those circumstances in other valuations you’ve done?
- What did you find out about my company and me before we got here?
- Offhand, do you know what valuation methods you might use in computing fair market value for my company?
- How will we deal with each other during the valuation process, and how will I be apprised of your progress?
- Can you show me an example of what a finished appraisal report will look like? Will you meet with me and my colleagues when you’re done and present those results?
- What happens if I have a problem with your results? What dispute resolution process do you typically follow?
Beware of any valuation professional who automatically dismisses any valuation as “simple” without asking pointed questions about what you’re trying to do.