Tuesday, April 28, 2015
Appraising businesses accurately is not an easy task. There are many different methods that can be used along with variations for the purpose of the appraisal. None of these methods, by its self addresses the total value of a business. One method might look at cash flow value, another at asset value and another at a capitalization rate. It is up to the appraiser to pick what he thinks is the appropriate method. Some appraisals may use five different approaches and gives each of the approaches used a percentage of the final value with no justification as to why one may be 75% and another 5%. Purpose also changes, as an appraisal done for the sale of a business will be different than one done for a divorce or an IRS requirement. One of the methods often used for divorce purposes is the “Excess Earnings Method” which was developed in 1920 to estimate lost goodwill suffered by breweries and distilleries because of Prohibition. It was never intended to be used to appraise businesses. I believe it is used because the math involved is very confusing and the method can be easily manipulated to provide a wide range of business values. There is great variance in the quality of business appraisals. It is easy to pick up an accounting book and find the different methods of doing an appraisal, picking out a formula and plugging in some numbers. This process doesn’t give you an accurate appraisal. Most accountants know this and turn to an experienced Business Appraiser for an appraisal. Also, be aware that there are appraisers that stuff the appraisal with irrelevant and highly technical information to exaggerate the complexity of the appraisal to charge a higher fee for their services. Some over inflate the appraisal to make an owner feel he has a high value business. During my 23 years of running my own Business Brokerage business I used the data from the business sales we made to develop a method that gave me the accuracy I wanted. I came up with a blended method of appraisal consisting of cash flow, asset value and market analysis. This blended method evaluates all items that create value in a business. I never have to guess if I am using the correct method or find percentages to use for each component. I have successfully used this process for over 25 years for business sales and business appraisals. My goal has always been to provide clear, accurate and affordable appraisals that meet the needs of my clients.
Wednesday, February 11, 2015
Rule of thumbs are general averages of similar types of businesses. If all businesses were equal then the rule of thumb method would work, but no two businesses are alike. The problem to a buyer is that there are excellent and terrible businesses in this group of similar businesses. The only way to make sure you are buying one of the excellent businesses is to have all the financial records evaluated by an expert. It may cost to do this, but it could be the difference between success and failure.
Tuesday, January 27, 2015
Recently, I was involved in a divorce trial testifying on behalf of the wife who had an interest in the business her husband ran. Besides my business appraisal there was another business appraisal presented by the husband’s appraiser. The method he used is called “The Excess Earnings Method” and was developed by the US Treasury Department in 1920 to estimate lost goodwill suffered by breweries and distilleries because of Prohibition. It was never intended to be used to appraise businesses. The problem with this method is that it is hard to understand and therefore very easily manipulated. . The sales of the business were $635,000, with cash flow of $266,000 and assets of $186,000 (including $146,000 cash). The husband’s appraiser came in at $196,000. My appraised value was $560,000. My appraisal worked out to be less than two times the cash flow plus the assets and was an accurate valuation. Don’t take for granted that every appraiser will produce an unbiased appraisal, especially those using the Excess Earnings Method.