A Guide to Business Appraisals

There are a number of standard appraisal methods used to value a business that include, Asset approach, Income approach, Market approach (Comps), Capitalization of Earnings and Discounted Future Earnings. Each one of these methods individually does not always represent the true value of a business. We have seen appraisals where the derived value of these five different approaches varied by 500%. Also used are Rule of Thumb values based on multiples of adjusted profits or percentages of gross sales. The rule of thumb methods only work when there are many similar businesses having the same operating expenses and assets. This doesn’t always happen and when you use the method on more unique businesses it just doesn’t work. Using Comps tends to give the average value of the compared businesses and not the value of the business being appraised. Capitalization of Earnings and Discounted Future Earnings are less often used and tend to end up with values that also tend to give the average value of the type of business. After working with the standard methods for some time and evaluating what creates value in a business we learned that combining the Asset, Income and adding market influences into a single method gave an accurate market value. Having been involved with our own Business Brokerage for over twenty years we were also able to look at the businesses we sold and adjust and refine the combined method to reflect a True Market Value Appraisal. The next step was to find a way to keep the through detailed analysis of the business being appraised and present it in a simplified easy to read manner. By looking at the components of a business that created value and categorizing them into Income, Assets and Market related we were able to create an Excel program to present the appraisal. The program was designed to be flexible so that it can be changed to meet different types of businesses and the many different purposes for business appraisals. This system may look simple but the complexities of doing an appraisal are still applied. There are many things that we still consider that are not listed in every report. When they are needed we add them into the Excel program. Appraisal Requirements For an appraisal system to work it must address the following: 1. the profitability of the business 2. the tangible assets of the business 3. the presence of intangible assets 4. the value derived should represent the market value 5. have flexibility to allow for the terms of a sale. 6. simplicity - Usable and understandable. The first step was to determine what components in a business have value. These are some of them: 1. a functioning business with modest growth 2. skilled employees 3. working equipment 4. adequate usable inventory 5. a quality product or service 6. a profit 7. collectable receivables 8. a broad customer base with no very large customer 9. some new product development capabilities 10. a good reputation (name) in the market place 11. a clean, adequately sized work area 12. a financially sound operation with a good accounting system 13. the business located correctly for its market place 14. a good base of suppliers After building this list it has to be divided to fall into a profit/asset based appraisal system. They are categorized as follows: 1. Profit based items. a. business profit b. a functioning business c. business size - gross sales d. intangible assets 1. skilled employees 2. a quality product or service 3. a broad customer base - customer list 4. new product development capabilities 5. a good reputation - business name 6. good financial management 2. Asset based items: a. inventory b. equipment c. receivables d. contracts e. patents f. trademarks g. real estate By Robert A. Klein, President and owner of Business Appraisals, providing business appraisals on all types of businesses. Former President and owner of Business Search, Irvine, California, a Merger & Acquisition firm specializing in the sale of manufacturing, distribution and related businesses, with programs for both buyers and sellers.

5 Ways To Raise Extra Money When Buying A Small Business It's common for someone buying a business to discover he or she will need more cash than expected to take over the company. In addition to the down payment, money will be required for working capital. Here are five of the most popular strategies buyers have employed to get the extra funding needed. A surprise that some entrepreneurs encounter when buying a small business is that the amount of money expected to go into the purchase will not cover every expense involved in becoming the new owner. Not only is it necessary to come up with the down payment, but in order for the business to succeed the buyer will need working capital when taking over. Smart strategies for raising that extra money include: 1. Seller Financing: If the deal calls for an all cash purchase, and the buyer is emptying his bank account to p ay off the seller, perhaps the agreement can be modified to include a promissory note to be used by the buyer for part of the price being paid. That will free up some of the cash originally intended for the down payment. The seller may find tax benefits to this arrangement. Besides, making sure the buyer has sufficient working capital is an important way to help her succeed. 2. Inventory On Consignment: The buyer can save the money that would ordinarily go for purchase of the inventory at close of escrow, by paying the seller the wholesale costs for inventory items only as they are sold to customers of the business. Rather than the buyer's several hundreds or thousands of dollars tied up with parts or products, it can be used for other expenses and the seller will be paid for each item of inventory as the buyer sells it. 3. Earn-Out Agreement: Another way for buyer and seller to work together to make sure th e business won't run into trouble for lack of working funds, is their agreement to establish a lower selling price than was originally planned. That can call for a lower down payment than the amount stated in the sales agreement. The seller will be compensated later, under the earn-out provision of the sales contract. It would specify that the price is linked, by an agreed-on formula, to a specific low performance level for the business. As the business outperforms this initial projection, the price would rise according to that formula. That means the seller sacrifices at first, with lower payments for the balance of the price than he wanted. But as the price of the business goes up, so will the amount owed to the seller, as expressed in larger payments. 4. Borrow From Financial Institution: The buyer may be able to get extra money from a bank or other financial institution. If there is seller financing involved in the deal, another lender i s more likely to agree to approve an application for a loan to help fund working capital. And it's a good idea for the buyer to start shopping among financial institutions before he or she finds a business to buy. That way the buyer will know which company is likely to offer the needed cash. 5. Assume Seller's Debt: If the seller will need cash at close of escrow to pay off business creditors and deliver the business free and clear of debt, the buyer may be able to assume that debt instead. That will require the cooperation of the vendors to the business. Some or all are likely to go along with the plan as it will insure their continued relationship with the business. A shortage of cash to take over a business need not stop a buyer from proceeding if he or she can use one or more of these methods to raise additional funds before taking over the business. About The Author: Peter Siegel, MBA is the Founder & President of BizBen.com (businesses for sale, businesses wanted to buy, resources, & articles) and the BizBenNetwork Online Community. He advises and consults with business buyers, business sellers/owners, brokers, agents, investors, & advisors on a daily basis. Reach him direct at 866-270-6278 to discuss strategies regarding buying, selling, (or financing a puchase of) small to mid-sized businesses.

Buainess Appraisal Reports Clarified

Most people would think that the business appraisal sector would be a very organized group, but they are not. I recently reviewed an article on a business appraisal technique by a writer from a Business Appraisal Association and half the professional appraisers responding did not agree with the writer.

First off, there is not a single standard method of appraising a business and none of the individual methods used by its self provides an accurate appraisal. There is also a vast divergence of quality business appraisers and business appraisal reports. I classify them into six different groups.

1.      The dedicated professional appraisers who mainly do large private corporations and charge large fees to do these complicated assignments. They understand the complexity of business appraisals and provide quality work.

2.      The typical small business appraisers may use four or five different methods in the same report and give each method a percentage weight. How they come up with the different weights I’m not sure. It seems as if they have already decided on the appraised value and adjust the weight percentages to justify their final appraisal number.

3.      The smoke and mirrors group will fill the appraisal with all kinds of useless reports and complex terminology. I have seen reports that are so grammatically and mathematically complex that they are totally impossible to understand. The writers rely on impressing their clients with their brilliance, hoping the reader can’t understand the report enough to realize they wasted their money. These appraisals tend to be extremely inaccurate.

4.      There are the on line groups charging very little for an appraisal. They can’t afford and probably don’t spend much time analyzing the business, its Financial Statements, Tax Returns and other important documents. The sample appraisals I have seen were inaccurate. I spend much more time analyzing the business and its financial documents than I do writing the report. A business appraisal is not an on line fill in the blanks type of report. It takes a knowable experienced expert who will take the time to truly analysis the business.

5.      Those that use the capitalization rate and rule of thumb methods are providing their clients with the average value of all the business used to determine the capitalization rate or rule of thumb numbers. Each business is different and an appraisal has to address the specific parameters of the business being appraised to be accurate.

6.      The blended method uses a combined report using the cash flow, asset and market value approaches to determine the business value. This blended method looks at all the elements that create value in a business and provides an appraisal unique and accurate for each business appraised. This method consistently works. Check out my blog for more information on this method. http://appraisalsbusiness.blogspot.com/

Most of the inaccurate appraisals I have seen appraised the businesses with a much higher value than they were actually worth. Some of the values were three times higher than the actual value. It also seems like the larger and more complex the reports, the less accurate they were. Quantity over Quality.

Market Value Business Appraisals www.businessappraisals.com

Clear
Our business appraisals are written to be easily understood. We use common business terms, comprehensive step-by-step mathematical analysis and a thorough explanation of each step in the process. The result is an easy to read and understand report.

Accurate
By researching and analyzing business sales to determine components that represent value, we have created an accurate appraisal process. It is realistic and represents true market value. No rule of thumb or comps, our appraisals are unique to each individual business.

Affordable
By standardizing and simplifying the appraisal process we can offer more affordable pricing for our services.
Business Appraisals 800-829-4842
949-254-4062 Cel
714-639-6085 Direct
www.businessappraisals.com/rklein@businessappraisals.com

Searching for Market Value

There are a number of standard appraisal methods used to value a business that include, Asset approach, Income approach, Market approach (Comps), Capitalization of Earnings and Discounted Future Earnings. Each one of these methods individually does not always represent the true value of a business. We have seen appraisals where the derived value of these five different approaches varied by 500%.

Also used are Rule of Thumb values based on multiples of adjusted profits or percentages of gross sales. The rule of thumb methods only work when there are many similar businesses having the same operating expenses and assets. This doesn’t always happen and when you use the method on more unique businesses it just doesn’t work.

Using Comps tends to give the average value of the compared businesses and not the value of the business being appraised.

Capitalization of Earnings and Discounted Future Earnings are less often used and tend to end up with values far from Market Value.

After working with the standard methods for some time and evaluating what creates value in a business we learned that combining the Asset, Income and adding market influences into a single method gave an accurate market value. Having been involved with our own Business Brokerage for over twenty years we were also able to look at the businesses we sold and adjust and refine the combined method to reflect a True Market Value Appraisal.
Robert Klein

Business Sales Multiples

First we need to figure out what multiples we are talking about and what we are using them for. There are multiples of gross sales, seller’s discretionary earnings (SDE), earnings before interest and taxes (EBIT), earnings before interest, taxes, depreciation and amortization (EBITDA). Multiples are also used as general rules of thumb. For this article I will concentrate on the methods used for the purpose of the sale or purchase of a business.

Multiples of gross sales are the least accurate as they do not account for the quality and profitability of a business as they tend to be averages for classes of businesses. Some business owners know how to run a business and make excellent profits while others barely survive. These multiples are generally used for business categories that have large numbers of the same type of businesses, such as franchises.

Multiples determine the relative value of the business’s cash flow, but they do not measure the business asset value. I use a multiple to determine only the cash flow portion of the business. An asset bases analysis is a separate part of the appraisal.

For a sale of a business we need to know the SDE and the EBITDA In other words, the net income plus the seller’s discretionary earnings, interest, taxes, depreciation and amortization are necessary. This number should represent the amount of money a new buyer would expect to have available after purchasing the business. Interest and taxes will depend on how the business is financed and run. Depreciation and amortization are tax credits and the money remains in the business.

Differences in businesses will require use of different multiple values. Manufacturing businesses will have a middle of the road value while construction companies will have a multiple of about half and some high demand businesses may be double. Size matters, as larger businesses will have larger multiples.

Changes in economic conditions don’t change the basic multiples I use for appraisals. As economic conditions grow or deteriorate the gross sales and adjusted net profit of a business will go up or down thus increasing or decreasing the businesses value. I also use certain economic changes to adjust the net profit based on such things as growth or decline in sales over prior years, businesses having customers that represent a large percentage of their business and other cash flow influences. I very rarely find reason to adjust the multiples I use for an appraisal and I have been doing this for over 20 plus years.

Importance of a Business Appraisal

Would you buy or sell a house or commercial property without first having an appraisal? Most buyers and sellers of small businesses don’t bother determining a business’s true market value. Buyers are reluctant to spend money on an appraisal and sellers usually pick an arbitrary price or one higher than the business is actually worth. It is the selling broker’s responsibility to get the highest possible price for his client. Yes, the broker has a responsibility to be honest and fair to the buyer, but his primary responsibility is to his client. This leaves the buyer hanging out there with little sense of the business’ true value. He may bring in his accountant or other advisors but these people who are probably very good in their profession may not have the years of experience and skills necessary to determine the true market value of the business. Buying or selling a business is probably the largest financial transaction a buyer or seller will ever make in his life. It may involve his life’s savings, new debt or his entire retirement prospects. There are many situations where a buyer has paid too much for a business and can’t make it work. The buyer looses his investment, a bank may loose on its loan, and the seller will loose money he has lent to the buyer and possibly get a worthless business back. Doesn’t it seem important to confirm that the business you are buying or selling is a wise, or at least not a foolish sale or purchase? A Business Appraisal should be a mandatory process for any business sale or purchase. It definitely will increase the chance of success and protect the buyer’s and seller’s hard earned assets.