"After all the grief, sweat and years of long hours . . . What can I get for it?"
There comes a time in the life cycle of every enterprise when it becomes necessary, if not vital, to learn what the enterprise is as a matter of fact worth.
Why value a going business?
This "handle on value" may be needed for any number of reasons, but the following list covers at least some of the more beloved ones:
1. Contemplated sale of the business
2. Mergers & acquisitions
3. Adding or withdrawing partners or shareholders
4. Buy-sell agreements
5. Esops
6. Estate and/or financial exit planning
7. Insurance or other economic losses
8. Re-capitalization of the business
9. Arranging funding for expansion
10. Marital dissolution (Divorce)
11. Determination of loan value
12. Purchase of enterprise from family estate
To put it simply, when you own a business, the whole process of choosing "to add, to change, to buy or to sell," best begins with a expert enterprise valuation to settle the "real world" store value of the enterprise at a given point in time. And when the enterprise has been valued properly, every person wins. Let's look at a representative example drawn from our feel with thousands of businesses we have worked with over the years.
Typical Buy-Sell Scenario
Considering a definite objective for a enterprise valuation helps to understand the process. In this context we can assume that in the following scenario the goal is to sell the business. But within this concept to sell there must be one base thread that guides the way things work. And that is the fair treatment of the enterprise being valued, and also of the ultimate buyer who ultimately acquires the business. The following hypothesis then, illustrates the details of the sale, both from the seller's and buyer's perspective. Here a expert enterprise valuation was used as the basis to begin discussions once the distinguished buyer had expressed a sincere interest in the business.
Business: commercial seller with products and services marketed within a 100 mile radius from its Midwest location. gift each year sales - ,750,000. 25 year history, with a staff of 13 including the owner and two sales people.
Seller's Rationale: This owner used the numbers generated by the valuation service as a basis for negotiation, wherein the final buy price agreed upon was an even ,000,000. At the time of closing, the buy price included assets in the number of 0,000 consisting of catalogue for the most part. Based upon the buy-sell agreement, the seller receives a total down payment of 0,000 in cash and marketable securities. The balance of 0,000 is to be carried as an owner financed loan at 10% interest over a payback duration of 10 years. The real net profit of this enterprise amounts to 5,000 per year, allowing the each year debt service of ,160 (,930/Mo including essential and interest) to be handled without undue strain on cash flow. Thus our seller receives a fair price for the business, with the down payment to be used by the owner to withhold retirement plans and also to pay off a small enterprise bank loan which is the only remaining debt in the business. In this case the owner also benefits in that the finance balance (0,000) paid by the buyer, will be disbursed over the next 10 years, minimizing tax implications.
Buyer's Rationale: With a background in the distribution enterprise and having ready a uncut enterprise plan, the buyer is purchasing this enterprise because the firm has a good, carport history, roughly no citizen turnover, is priced right and has exquisite increase potential. In the enterprise plan the buyer has calculated a modest 9% increase rate to reach ,000,000 in sales by the end of 10 years. Because of definite reinvestments that are necessary, the buyer anticipates that the current 12% net profit (pre-tax) will remain the same, even though definite cost savings will be instituted to lower overhead and heighten margins. This will produce enough additional net profit beyond the gift 5,000/year to retire the owner financed loan early, or to use for reinvestment, personal recompense or a aggregate thereof. Per the enterprise plan, within 10 years or less, the enterprise will reach the point where it is debt free and producing 0,000 annually in real net profit. Had the purchaser placed his 0,000 in the store and earned 10% interest per year, the venture would have grown to ,037,496 (with compounding) in the same 10 year period. This compared to owning the above enterprise on a debt free basis (including its inventory, equipment, vehicles and fixtures) at the end of the same 10 year period, and be producing 0,000/year in profit.
So in this scenario, the definite implications of the enterprise valuation are abundant. The valuation has come to be the basis for the monetary buy-sell discussions which have proven equitable for both seller and buyer. Recognize, however, this is just a projection and is only used to implicitly expound that to be as a matter of fact meaningful and worthwhile, the valuation results must project fairness for all parties concerned.
Valuation Methods Now In Use
Here the approach to a given end is seemingly endless. On the one hand you have a group "know-all specialists in their niche" that will use magic ratios to equate to enterprise value. I can recall a discussion with an owner of a super store years ago who said he could place a value on any store execution by naturally using the ratio of 7.5 x earnings. A quick response to this might be . . . "how and who defines earnings?"
Then on the other ultimate we can respectfully mention that group of enterprise appraisers that have completed course requirements offered by the two major valuation associations . . . . The build of enterprise Appraisers (Iba), Plantation, Fl; and the American community of Appraisers (Asa), Washington, Dc. Both associations offer exquisite programs and their graduates ordinarily do a very thorough and detailed pathology of a given enterprise to then produce its fair store value.
And somewhere in in the middle of the methodologies offered above, we have two other approaches that bear mention. First is the "financially based" private who may value one or two enterprise per year and is a self proclaimed "expert." (Comment directed to the enterprise owner . . . "since its your business, with whom will you feel comfortable enough to entrust with its confidential financial information to settle its real worth? The self proclaimed expert, or the experienced professional?") Second is the available range of off-the-shelf software programs for those individuals (sellers, buyers or others) who satisfaction in purchasing a Cd for their computer or lap top and then spend the next 10 or 100 hours in learning and working the program. And when the rehearsal is complete and they have the final value "in hand" . . . they may nervously hope an error hasn't been made somewhere along the way. I can't tell you how many times I have received a call from person who purchased a software program because a buyer contacted them about acquiring their business, and now they were "scared to death" with the software results, and their date to talk to the buyer was . . . "next week!"
Revenue Ruling 59-60
In terms of definite methods to value a business, most methodologies now in place go back to the Internal wage Code of 1954, later updated to wage Ruling 59-60, to deal with the valuation of stocks of intimately held corporations. This ruling specified a group of "relevant factors" which were thorough for observation when placing a value on an operating business, or its share value in a intimately held corporation. These factors included things like; the nature and history of the business, economic outlook, book value of the stock, financial condition, presence of goodwill and the store value of stocks of corporations engaged in a similar line of business. All good information - but sometimes difficult and high-priced to acquire.
Since for the most part, valuation methodologies today have grown out of the ideas represented by Rr 59-60, we can note the approaches most often used currently in assessing enterprise value. They are labeled the Cost, store and wage methods. In brief they can be defined as follows:
Cost recipe - The enterprise is valued based upon its cost of replacement.
Market recipe - Here the valuation expert researches the sales price of similar publicly traded businesses for comparison purposes.
Income recipe - In this case the value discipline involves the estimation of time to come economic benefits as an expression of gift enterprise worth.
In an exertion to be open to all "practitioners of valuation" (including software programs), it would be fair to state that the methods in use today normally embrace elements of relative authenticity. Beyond that we must identify that determining store value for a enterprise is as much an "art" as it is a science. In the final analysis, in the scenario where a enterprise is to be sold, the ultimate valuator is the buyer whose skill, interest and judgment is reflected by the buy price offered. We've all heard it before . . . "a enterprise is worth what a willing and distinguished buyer is willing to pay for it." ***
Part Ii Topics Include:
o Financial Data
o Present Debt - A Factor?
o What does a valuation cost?
o How to opt a valuation service
o Aids to help sellers
What Is The Fair market Value of Your Business? Part 1