Business Valuations

 People who have purchased a residence are familiar with real estate appraisals. With a business there are times when both the real estate the business itself needs to be appraised. The business appraisal does not include the real estate and is more commonly called a business valuation.

Business Valuations are part of the due diligence that will be conducted when there is a possible acquisition of the business, or business financing is needed. Business Valuations place a reasonable market value on a business after consideration has been given to factors such as, but not limited to: assets, financial statements, tax returns, goodwill, customer lists, licensing, competitive advantages, regulatory concerns, management team, inventories, and industry comparisons.

There are a number of accepted methods for valuing a business. Each method has its own perspective and the business owner should have a reasonable understanding of the method being used.

One simple method is to use “multipliers” This is when someone takes the net profit, gross sales, or some other figure from the financial statements and then multiplies that number by 3, 5, 8 times (whatever the case may be). However, when using simple methods such as multipliers you need to understand a few points:
1. Financial statements are typically prepared to justify the lowest possible taxes.
2. Stated profits are not usually the actual cash flow of the company.
3. Due to tax reasons company assets probably have a different value than what is on the books.

Understanding the above points, you can understand that a simple valuation based on multiples may not reflect the true market value of the business.

When financing is involved simple multiplier methods will not be acceptable. Banks and finance companies will require a third party unbiased valuation completed using advanced calculations, knowledge of the industry, and sound financial reasoning.

There are a number of business valuation companies, investment banks,  accountants, and attorneys that provide business valuation services. Some of these companies also provide sources of funding.

When a company specializes in a specific industry, that company will be able to offer a more precise and credible valuation. Specialists usually have more industry data than someone who does not normally value businesses in that industry. The results of not having the proper industry data will result in a more ambiguous valuation.

An example of a specialist is Washburn & Associates who values businesses in the pharmacy industry. Due to the aging population sales are increasing as the older generations are purchasing more prescriptions. However at the same time, government and insurance reimbursements have been drastically reduced causing a major decline in nets profits for the pharmacy industry. Lower profits means it is harder for the business to service debt. That in turn means it is harder to obtain funding, and when there is funding it will be in lower amounts. Someone who is not a pharmacy specialist and used a gross sales multiplier would be way off in their calculation compared to other pharmacy valuations. A banker that sees valuations that are not within realistic industry comparisons is not going to fund the deal and due diligence fees that paid for the business valuation will have been wasted.

When it is necessary to have a business valuation completed, it is strongly advised to pay more for a specialist that can provide a banker realistic and current information. Don’t try and save a few bucks by cutting corners, and then end up wasting time, money, and possibly even ruin a chance of obtaining the funding the business required.

Tips:

1. Since many companies that offer Business Valuations also have sources of funding, the business owner or Consultant may want to start by looking at these companies first.

2. Garbage in, garbage out is a simple term that also applies to business valuations. If the company conducting the valuation is not properly trained or does not have the industry data to support their analysis, then the business valuation will be faulty.

3. It is more cost effective to use a specialist than waste time and money on business valuations that will not be acceptable to a banker.

4. Business Valuation Definitions.

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