October 19th, 2011 
Christopher George 
Are you in the market to buy or sell a business? If so, it is in your interest to be well educated in the process of valuing a business for sale.
There seems to be a lot of confusion regarding the rationale and justification of completing a formal business valuation prior to offering a business for sale. Today, we will discuss the importance of this process, i.e. the value of a valuation. Selling a business is far different from selling a house or other tangible asset. When dealing with real estate, there often exists comparable sales information sufficient to support a value. However, when dealing with a business for sale, it is not unusual for 50% or more of an operating business’s value to be based on intangible assets such as goodwill, intellectual property, licenses, location, etc.
For example: Two businesses, both netting $250,000, can have considerably different market values due to comparative considerations such as revenue growth rate, equipment condition, customer concentration, intellectual property, barriers to entry, competitive situation, owner’s role, administrative systems, labor and capital intensity, and on and on. One business for sale may be operating below capacity while the other may require significant capital investment in order to grow and expand. One business for sale may have an absentee owner with strong operating management while the other is highly owner-dependent. There can be myriad valuation variances for companies which on the surface seem quite similar. Attempting to value a business for sale based strictly on market comparables will result in an average valuation that is insensitive to distinguishing characteristics and hidden aspects of each business for sale.
The valuation of intangible assets relies on income-based methods. Accurate discernment of earnings as well as the seller’s discretionary cash flow (SDCF) are essential if the value is to be considered true. The business valuation process begins with a detailed examination of the company’s revenue and expenses in order to accurately determine the true earnings performance of the business for sale. Examples of questions to ask during a business for sale valuation: Is the brother-in-law’s salary of $50,000 really needed? Is a Porsche Cabriolet really necessary for delivery purposes? If the seller owns the building, is the rent at a fair market rate? How much business is actually being conducted from the addition to the owner’s house which the company’s maintenance crew built? What about stockholder compensation mystique in S versus C corporations? Inventory pricing creativity? All of these exemplify the discovery challenge of the appraiser and the reasoning behind the need for a formal valuation if a business for sale is to be given a true value.
Another solid reason for a business valuation is to avoid surprises during the due diligence process, which can quickly kill a deal (and nobody wants that to happen!). Full financial disclosure upfront to a buyer is extremely important. Bad news, if fully disclosed, may have an impact on final price, but at minimum, the deal is far more likely to survive with upfront disclosure.
With precise earnings information in hand, the appraiser can then employ several valuation methodologies and weigh the various results according to their pertinence to the business for sale in question. For a business with significant tangible assets, the appraiser incorporates those asset values with the intangibles through methods such as Capitalization of Excess Earnings to arrive at a fully integrated value.
Finally, the appraiser subjects the valuation to an extensive set of qualification criteria from over 100 SBA lenders for further validation of the value of the business for sale. If the value withstands the SBA’s requirements standards, there is added basis for its validity.
Every business for sale has a range of fair market value—the valuation process is not completely scientific. The challenge of the business for sale valuation process is to determine a business’s true earnings, to assign fair market value to its intangible assets and to uncover the hidden value drivers of the business for sale that reside below the radar of superficial valuation techniques.
As a business buyer or an owner of a business for sale, being educated about the valuation process and the ‘value of a valuation’ can make a huge difference in how you approach a business sale. It has been our experience that both sellers and buyers become well informed when a formal valuation in involved, resulting in a more enlightened process for all concerned.
Christopher R. George has been engaged in mergers and acquisitions for 25 years. He is a business appraiser, broker/intermediary, and a consultant specializing in the valuation, sale, and financing of closely held companies. His appraisal reports have been used in conjunction with buy/sell agreements, stockholder actions, motions for divorce, re-organization, estate issues, litigation support, etc. As a business intermediary, Chris has brokered hundreds of transactions, and he recently sold a specialty metal fabrication company for $36 million. Chris’s knowledge and contacts in the world of finance allow the sellers in most transactions to receive predominately cash at closing.
He has served as President of the New England Business Brokers Association, is a member of the International Business Brokers Association, and a life member of the Institute of Business Appraisers.
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