There’s this comparative analogy about what makes something American that people like to use: “as American as apple pie.” But, I kind of think we should update that comparison to “as American as starting a small business.”
Not as catchy, I know (or as yummy). But, it’s just the truth. Small business ownership is the epitome of independence.
Don’t want to work for someone else? Don’t want to depend on someone else to pay your bills? Don’t want to follow someone else’s rules and regulations?
Then start something where you call the shots and own the profit. And that’s what you did. You had a dream, and you made it happen. And your small business, along with hundreds of thousands of others, are the spirit and backbone of this economy.
So, when you’re watching all those fireworks “bursting in air,” know that, in a way, it’s celebrating people like you who have built something valuable.
Your business has value in our way of life beyond the dollar signs it produces.
There might come a time though, when you want to know just how valuable it is and how many zeroes are actually attached at the end. Say you want to sell your little empire or exit it and hand the reins over to somebody else.
That’s when you want to consider getting a business valuation. But when you do, you’ll want to make sure the assessor is taking into consideration all the various aspects that affect business value for you. Even when the assessor is qualified, there are still elements of your business and the market you serve that might get overlooked in the process.
Let me explain what I mean here…
How Owners Can Measure Business Value Correctly
“When things go wrong, don’t go with them.” – Elvis
In our previous two articles, we covered what goes into a business valuation and why and when you might need one — from M&As to divorce. By now, it’s apparent that a valuation can be an important tool for running your company…
So it’s especially important to realize what could go wrong with one.
Here’s a look at some of the biggest potential trouble spots to determining business value.
Devil in the details
A business valuation is a waste of your time and money if it uses wrong or incomplete models. Let’s go through these here so you can check them along the way — and never hesitate to question your valuation specialist. You’re the one paying for this, after all.
Generally, whether the valuation primarily examines your income/earnings, market standing, or overall assets, it should address your company’s non-operating assets and liabilities, taking into account past litigation, tax problems, interest-bearing debt (especially as rates rise), and owners’ worth as related to the business.
Among other possible business value assessment problems are:
- Earnings: Small-business valuation specialists often use Seller’s Discretionary Earnings (SDE) or Earnings Before Interest, Taxes, Depreciation, and Amortization (EBITDA) — sometimes using these for the wrong-sized businesses. SDE works better if your company has less than a million dollars in earnings, and EBITDA is best if your company has more than 1.5 million dollars. Businesses with earnings between these two figures can use either.
- Profits and cash flow: A valuation might accord profits more importance than cash flow. Profits are immediate and important of course, but cash flow is a clearer determinant of future earning potential — probably a much more important figure to a prospective buyer.
- Non-operating assets: High-value assets (such as real estate or equipment) unused in the day-to-day operations of your company can get overlooked.
- Goodwill: For business goodwill, a company must generate earnings above a fair return on its tangible assets. Valuations frequently overestimate this factor.
- Risk: These can include customer concentration, patent expiration, changing market demographics, or product obsolescence — a host of problems not specific to any one industry. An experienced valuator’s judgment might help you most in this area but a less-experienced professional might miss them.
- Projections: There’s a ton to look at in any business, and valuation is beyond simple addition; it requires judgment. But predictions must depend on evidence. Ask to see what your valuation professional is using — and have yourself and your senior people do your own projections to see if there’s much difference. If there is, discuss it.
- Estimates: Cash flow, location, human capital, competition, debt, and assets are just a few of the details that should go into your valuation. But often valuators (and a company’s management, too) will leap to some multiple of earnings or some other single factor based on assumption — or on recent headline deals in the company’s industry.
- Frequency: In today’s rocky economy, a valuation within every five years is recommended, barring unusual circumstances. If you look to sell or attract investors, do one every few years. For exit planning or acquiring another company, even more frequently is recommended.
Who to look for and what to ask
Just as it isn’t cheap, proper valuation is no ad-hoc skill. Look for the right qualifications.
For valuations for some of its loans, for instance, the U.S. Small Business Administration lists such credentials as Accredited Senior Appraiser, accredited through the American Society of Appraisers; Certified Business Appraiser, accredited through the Institute of Business Appraisers; Accredited in Business Valuation, accredited through the American Institute of Certified Public Accountants; and Certified Valuation Analyst, accredited through the National Association of Certified Valuation Analysts.
The questions to ask your valuation profession depend on why you want your business value. If you are:
- Buying or selling a business or seeking funding: How many valuations have you performed in the past year? How many businesses have you sold — and how close to the valuation price?
- In a legal proceeding: Have you performed valuations used in court before? Are you willing to testify? Are you familiar with IRS Ruling 59-60 (for the valuation of assets) and the Uniform Standards of Professional Appraisal Practice for valuation?
- Exit planning or tax planning: Do you provide context in your valuations so business owners can take steps to improve their business value?
If you want to do a little preliminary work before shelling out for a valuation pro, M&T Bank also has an online tool to use for a rudimentary valuation of your company.
As you can see, a valuation of your company is a big job — and a really critical one. These are just a few examples of what to watch for.
Need a valuation for your company? I can give recommendations specific to your situation and help ensure it’s done in the way most beneficial for your business. Just reach out. I’m right here:
All the best,
The TCG Accounting Team
