Most small business owners and attorneys know the basics of the business valuation process. They probably know that there are three approaches to value: the cost, market and income approaches.
One thing attorneys and small business owners also understand is that the process of valuing a business is not simply a matter of plugging numbers into black boxes and having the answer spit out the other end. Instead, the valuation analyst uses professional judgment to arrive at a reasonable conclusion of value.
Factors to Consider
Getting to a reliable value starts with the company’s financial information, including tax returns and financial statements from the last three to five years. Valuators also think about forecasts, projections, and business plans.
A comprehensive valuation goes beyond the numbers. It includes site visits, management interviews and an evaluation of any nonfinancial factors that could impact value.
Professional valuators use and rely on various standards and publications to guide them through this part of the valuation process. These tools help appraisers know what information to request and what questions to ask.
The AICPA Statement on Standards for Valuation Services No. 1 suggests considering the following non-financial information when valuing a business:
- Nature, background and history of the business
- Organizational structure
- Management team
- Ownership interests and any associated rights
- Products or services
- Geographic markets
- Key customers and suppliers
- Any significant business risks
- Future plans
- Governmental or regulatory considerations
Many of the items valuators consider relate specifically to the subject company. However, valuation analysts also consider other, external, factors that could impact value. These factors will affect every business differently, so appraisers need to make subjective judgment calls.
An appraiser’s conclusion is only valid as of a specific point in time. For example, a restaurant located in a small, rural community that recently lost its major employer would likely be adversely affected by its current market conditions.
On the other hand, if the restaurant was in a town with a prosperous economy,despite a weak national economy, the value might increase.
Government regulations can also impact the value of a company. For example, the Affordable Care Act (ACA) could increase overhead costs, therefore decreasing future cash flows for companies with 50 or more full-time equivalent employees. It’s the appraiser’s job to determine what impact the ACA will have on the subject company’s value going forward.
A company that operates in an industry with low barriers to faces ongoing competition. The valuation analyst needs to determine the competitive situation when determining value.
Conversely, a business that operates in an industry with high barriers to entry might not be as concerned about new competitors entering the marketplace
The state of the company’s industry also impacts value. A business that operates in a declining industry may not be worth much more than its liquidation value, even if it has years of positive operating cash flows. Conversely, companies in emerging growth markets may be worth more than their historic financial performance might suggest.
Putting the Pieces Together
Valuation analysts piece together various types of internal and external data to get a complete picture of how much a business is worth. Like a trained artist, valuators use their professional tools, accepted methods and business experience to finesse the data into reliable value conclusions. Attorneys and business owners who understand what happens behind the scenes can facilitate the valuation process. Talk with Filler & Associates for more information.