Every so often I'll have a conversation or a specific valuation problem to solve, that engenders a specific thought or two. I'll post some here to share, keeping all names confidential. If you have a specific question you would like to ask, please do.
Phone: (208) 749-3116 - Email: CanyonValuations@gmail.com
April 4, 2023 - Costs of Capital for Privately Held Businesses
This month’s topic is going to be a heavy one, so if you want a lighter read from me this month, I suggest you check out some of my prior posts. For those of you who want to get deeper into the weeds on this topic, here we go!
In this posting, I am assuming that my readers have a good understanding of the basics regarding business valuation theory and the various puzzle pieces that one may use to complete an analysis. I am going to bold certain lines below that you may want to pay attention to. These are assumptions that will be affecting the overall theme of this post.
‘Cost of Capital’ is a topic that is of interest to a variety of business professionals besides appraisers. One of my readers had suggested that I write up a discussion on those three words and what they mean for us as business appraisers. (This is all your fault, Michael!) I’m discussing a variety of options a business appraiser has for calculating a discount rate, and I mention some of the ins and outs of those options below. If you would like to discuss any of these topics in further detail, feel free to reach out.
To start out, I Googled ‘Cost of Capital’ and found a link to the Harvard Business School with the following definition:
"Cost of capital is the minimum rate of return or profit a company must earn before generating value. It’s calculated by a business’s accounting department to determine financial risk and whether an investment is justified.
Click here to see the whole post!
This month’s topic is going to be a heavy one, so if you want a lighter read from me this month, I suggest you check out some of my prior posts. For those of you who want to get deeper into the weeds on this topic, here we go!
In this posting, I am assuming that my readers have a good understanding of the basics regarding business valuation theory and the various puzzle pieces that one may use to complete an analysis. I am going to bold certain lines below that you may want to pay attention to. These are assumptions that will be affecting the overall theme of this post.
‘Cost of Capital’ is a topic that is of interest to a variety of business professionals besides appraisers. One of my readers had suggested that I write up a discussion on those three words and what they mean for us as business appraisers. (This is all your fault, Michael!) I’m discussing a variety of options a business appraiser has for calculating a discount rate, and I mention some of the ins and outs of those options below. If you would like to discuss any of these topics in further detail, feel free to reach out.
To start out, I Googled ‘Cost of Capital’ and found a link to the Harvard Business School with the following definition:
"Cost of capital is the minimum rate of return or profit a company must earn before generating value. It’s calculated by a business’s accounting department to determine financial risk and whether an investment is justified.
Click here to see the whole post!
March 14, 2023 - Keeping an Open Mind
There are a LOT of different types of businesses out there, each with different characteristics that affect how they can be appraised.
As business appraisers, we run into businesses with poor financials, detailed financials, businesses that operate in multiple industry codes, businesses that are very profitable, and others that are losing money every year. We see businesses that hold excess assets, some that only hold assets and never generate a dollar of income. There are businesses that operate as non-profits, C-corporations, S-corporations, sole proprietors, Limited Liability entities, or partnerships and some that have never filed a tax return.
We could be asked to appraise any of these businesses for a wide variety of purposes ranging from a 100% controlling interest to any size of a non-controlling ownership interest. There could be a partner dispute, or maybe a partner wants to buy in. We could be appraising the equity position or an invested capital interest in a business. We could be asked to appraise a 100% interest in the assets that typically transfer in a sale or we could be asked to appraise a non-controlling equity interest in a holding company.
All of these factors can have an effect on how we reach our value conclusions.
Click here to see the rest of the post!
There are a LOT of different types of businesses out there, each with different characteristics that affect how they can be appraised.
As business appraisers, we run into businesses with poor financials, detailed financials, businesses that operate in multiple industry codes, businesses that are very profitable, and others that are losing money every year. We see businesses that hold excess assets, some that only hold assets and never generate a dollar of income. There are businesses that operate as non-profits, C-corporations, S-corporations, sole proprietors, Limited Liability entities, or partnerships and some that have never filed a tax return.
We could be asked to appraise any of these businesses for a wide variety of purposes ranging from a 100% controlling interest to any size of a non-controlling ownership interest. There could be a partner dispute, or maybe a partner wants to buy in. We could be appraising the equity position or an invested capital interest in a business. We could be asked to appraise a 100% interest in the assets that typically transfer in a sale or we could be asked to appraise a non-controlling equity interest in a holding company.
All of these factors can have an effect on how we reach our value conclusions.
Click here to see the rest of the post!
January 10, 2023 - Why Do We Do What We Do? - Comparative Financial Analysis Edition
Happy New Year!!
As Business Appraisers, we look at a lot of numbers. We examine financial statements and tax returns so we can identify historical trends, and help identify risk drivers, but I have noticed quite a few reports this last year where the appraiser omitted a comparative financial ratio analysis. I thought I’d start off this year’s newsletter with a discussion on this basic analysis.
Revenue 59-60 lists as one of the eight factors we are to consider in the valuation of a privately held business as, “The book value of the stock and the financial condition of the business.” If all we look at is the subject company’s financial data, we are only going to see the part of the picture that the subject company portrays. If we also compare the subject company’s data to industry averages, then we can really see how the Company has been performing amongst its peers. If a business’ ratios indicate that it is underperforming, then we can draw the conclusion that the subject business may have higher operating risk. If the industry ratios are showing the subject business to be performing better than average, then we can use that to support the selection of a higher than average market multiple and also a lower discount rate.
Click here to see the rest of the post.
Happy New Year!!
As Business Appraisers, we look at a lot of numbers. We examine financial statements and tax returns so we can identify historical trends, and help identify risk drivers, but I have noticed quite a few reports this last year where the appraiser omitted a comparative financial ratio analysis. I thought I’d start off this year’s newsletter with a discussion on this basic analysis.
Revenue 59-60 lists as one of the eight factors we are to consider in the valuation of a privately held business as, “The book value of the stock and the financial condition of the business.” If all we look at is the subject company’s financial data, we are only going to see the part of the picture that the subject company portrays. If we also compare the subject company’s data to industry averages, then we can really see how the Company has been performing amongst its peers. If a business’ ratios indicate that it is underperforming, then we can draw the conclusion that the subject business may have higher operating risk. If the industry ratios are showing the subject business to be performing better than average, then we can use that to support the selection of a higher than average market multiple and also a lower discount rate.
Click here to see the rest of the post.
December 13, 2022 - Explaining the Build-Up Method
Merry Christmas, Everybody!
This is a question I get asked several times a year, and I thought I'd expand on it here as a good wrap-up to the year. Most likely, you won't be seeing any more newsletters from me for the rest of this year, so I hoped to make this one a good one. :-)
The Build-up method is one of the most commonly used techniques, for estimating the risk rate applicable to the valuation of a privately held business. As business appraisers, we know where to get the data to provide the Risk-free rate, the Equity risk premium, the Size premium, and all about what goes into the selected Specific company risk premium (SCRP). I know we all love the SCRP!
But…when one of our readers asks us, “what do all these different rates mean and how do they apply to the valuation of my business?”
Here is how I answer that question:
“The value of a business is equal to its expected future earnings divided by the risk of achieving those earnings. On the one hand, we have our forecast of expected future earnings, now we just need to figure out what the hypothetical, willing and able buyer might expect and a hypothetical, willing and able seller might accept.”
(It was so much easier just linking the newsletter to my blog postings for last month, so I am going to start doing that each time. Click here to read the rest of my post.)
Merry Christmas, Everybody!
This is a question I get asked several times a year, and I thought I'd expand on it here as a good wrap-up to the year. Most likely, you won't be seeing any more newsletters from me for the rest of this year, so I hoped to make this one a good one. :-)
The Build-up method is one of the most commonly used techniques, for estimating the risk rate applicable to the valuation of a privately held business. As business appraisers, we know where to get the data to provide the Risk-free rate, the Equity risk premium, the Size premium, and all about what goes into the selected Specific company risk premium (SCRP). I know we all love the SCRP!
But…when one of our readers asks us, “what do all these different rates mean and how do they apply to the valuation of my business?”
Here is how I answer that question:
“The value of a business is equal to its expected future earnings divided by the risk of achieving those earnings. On the one hand, we have our forecast of expected future earnings, now we just need to figure out what the hypothetical, willing and able buyer might expect and a hypothetical, willing and able seller might accept.”
(It was so much easier just linking the newsletter to my blog postings for last month, so I am going to start doing that each time. Click here to read the rest of my post.)
November 8, 2022 - That First Phone Call from a Potential Client...
In today’s newsletter, I thought I’d write out and present a basic transcript of how that initial phone call tends to go, when a potential client picks up the phone and calls me. The following is a based on a call I had not too long ago, although I did take some artistic license and added a few things. I hope the conversation bubbles actually help you, my readers, keep track of the conversation, because it was a pain to put together. It starts with my phone ringing…
In today’s newsletter, I thought I’d write out and present a basic transcript of how that initial phone call tends to go, when a potential client picks up the phone and calls me. The following is a based on a call I had not too long ago, although I did take some artistic license and added a few things. I hope the conversation bubbles actually help you, my readers, keep track of the conversation, because it was a pain to put together. It starts with my phone ringing…
(Ok, adding all those images to the blog here, is going to be more difficult than I thought. Instead, if you are interested in reading the whole conversation, please click on the image and the newsletter I sent it out in will open up. You can read the whole thing there. Thanks!)
October 4, 2022 - Some Comments on Valuation Report Reviews
I review a lot of valuation reports. I may have mentioned that once or twice before. USPAP Standard number 3 talks about what should go into an appraisal review and Standard 4 covers what should be included in the review report, but I don’t typically get asked to go that route. Instead, I am often asked to read through a report and identify any areas where the appraiser may have mis-stepped with valuation theory or logic somewhere in the process of drawing their conclusions.
The point of most of the reviews I am paid to perform, is to help the appraiser to know where the weaknesses are in their report, and then to identify ways to shore up those analyses so their report is stronger when it is presented to their client.
As we all know, valuation is just as much an art as it is a science. That means that each appraiser’s opinion is just as valid as our own. Each appraiser may draw a different conclusion from their analysis of available data, sometimes the data that is available to one appraiser is not made available to another. In cases where I am reviewing another appraiser’s work, I need to keep in mind that appraisers may work differently than myself.
When reviewing a report for any sort of litigation issue, I prefer to focus on the big issues, where key assumptions make a large impact on the overall analysis. If I see typos or formatting issues, I may flag them, but those are not what I am looking for. (Unless the report was so poorly written that the errors get in the way of understanding the assumptions, then that does become a USPAP issue and I will need to point that out.)
One of my pet peeves is when I see an appraisal review where the reviewer went through and picked out every single misspelled word, typo, or formatting error, yet forgets to look at the assumptions and to consider how the report fits within basic valuation theory. I wonder if the reviewer in cases like this was an English major, instead of a valuation expert. Oftentimes, these reviews will also point out any method used that the reviewer is not familiar with and state that the appraiser who used it was ‘wrong’ to do so. How can a difference of opinion be ‘wrong’?
I had a case fairly recently, where the other appraiser managed to do almost everything exactly opposite to the way I performed my own valuation. I used the build-up method to develop my discount rate, the other appraiser used the Weighted Average Cost of Capital. I used the discounted future cash flow method and the other report used a capitalization of earnings model. I discussed the financial ratios in detail explaining where the subject company differed from the industry average, the other appraiser mentioned in passing the results of their financial analysis in the discussion of the risk rate.
I did find a few points where the underlying logic inherent in the appraiser’s assumptions caused the conclusion of value to differ significantly from mine, but it is important to note that I never once said that the other appraiser was wrong. In fact, during the comparison of my report with the other expert’s, I actually did find a math error, but it was in MY OWN REPORT. Once I corrected my error, the gap between our two numbers did widen some more, but neither of our conclusions of value were wrong, at least once I corrected my own error.
The key to providing a good review, is to be thorough, but to also be open minded. Consider what affect the assumptions made might have on the overall conclusion of value but don’t get mired down in minutiae that won’t matter in the long-term. If you have any questions you’d like to ask, give me a call sometime.
I review a lot of valuation reports. I may have mentioned that once or twice before. USPAP Standard number 3 talks about what should go into an appraisal review and Standard 4 covers what should be included in the review report, but I don’t typically get asked to go that route. Instead, I am often asked to read through a report and identify any areas where the appraiser may have mis-stepped with valuation theory or logic somewhere in the process of drawing their conclusions.
The point of most of the reviews I am paid to perform, is to help the appraiser to know where the weaknesses are in their report, and then to identify ways to shore up those analyses so their report is stronger when it is presented to their client.
As we all know, valuation is just as much an art as it is a science. That means that each appraiser’s opinion is just as valid as our own. Each appraiser may draw a different conclusion from their analysis of available data, sometimes the data that is available to one appraiser is not made available to another. In cases where I am reviewing another appraiser’s work, I need to keep in mind that appraisers may work differently than myself.
When reviewing a report for any sort of litigation issue, I prefer to focus on the big issues, where key assumptions make a large impact on the overall analysis. If I see typos or formatting issues, I may flag them, but those are not what I am looking for. (Unless the report was so poorly written that the errors get in the way of understanding the assumptions, then that does become a USPAP issue and I will need to point that out.)
One of my pet peeves is when I see an appraisal review where the reviewer went through and picked out every single misspelled word, typo, or formatting error, yet forgets to look at the assumptions and to consider how the report fits within basic valuation theory. I wonder if the reviewer in cases like this was an English major, instead of a valuation expert. Oftentimes, these reviews will also point out any method used that the reviewer is not familiar with and state that the appraiser who used it was ‘wrong’ to do so. How can a difference of opinion be ‘wrong’?
I had a case fairly recently, where the other appraiser managed to do almost everything exactly opposite to the way I performed my own valuation. I used the build-up method to develop my discount rate, the other appraiser used the Weighted Average Cost of Capital. I used the discounted future cash flow method and the other report used a capitalization of earnings model. I discussed the financial ratios in detail explaining where the subject company differed from the industry average, the other appraiser mentioned in passing the results of their financial analysis in the discussion of the risk rate.
I did find a few points where the underlying logic inherent in the appraiser’s assumptions caused the conclusion of value to differ significantly from mine, but it is important to note that I never once said that the other appraiser was wrong. In fact, during the comparison of my report with the other expert’s, I actually did find a math error, but it was in MY OWN REPORT. Once I corrected my error, the gap between our two numbers did widen some more, but neither of our conclusions of value were wrong, at least once I corrected my own error.
The key to providing a good review, is to be thorough, but to also be open minded. Consider what affect the assumptions made might have on the overall conclusion of value but don’t get mired down in minutiae that won’t matter in the long-term. If you have any questions you’d like to ask, give me a call sometime.
September 6, 2022 - What Documents Do We Ask For and Why?
One of my hobbies, ever since I was a small child able to hold my own books, has been reading. I really enjoy getting lost in a story told by an author who can weave images and characters in my mind with nothing more then a clever arrangement of letters on the page! I am one of those who will look up from a particularly good story only to realize that I wasn’t actually experiencing those events myself, that they were just images conjured up by a talented writer.
As a business appraiser, when we write up our valuation reports, we are in fact telling a story. Generally speaking, not as exciting a story as some of my favorite authors have written, but a story nonetheless. We are explaining how we arrived at our opinion of value, what factors we considered, what information we gathered, and what our conclusions were after analyzing it all. In order to begin an analysis, we typically ask for a certain selection of information from the client. This information will help us to either identify the future operating income, or the risk of achieving that income.
I like to ask for the last five years’ of tax returns and financial statements. Yes, I ask for both sets of documents for the same time periods. I ask for both sets, because often there is information on the tax returns that is not included in the more detailed balance sheets and income statements. I request the financials be provided to me on an accrual basis if possible, because I want to know what the business’ accounts receivable and payables would be as well as any bad debts they may have had. I will be analyzing historical results in order to help me predict the future. For startup businesses and those with a very brief history of operations, this analysis becomes much more abbreviated, but it is still important as it drives part of the risk analysis.
If the owner has family members on the payroll, that are actually attending school out of state, I want to see those W-2 forms so I can know the magnitude of that potential adjustment. Family members on the payroll who are actually not part of the operation is one of the adjustments that is easy to make and support, if we have the documentation to do so.
I generally don’t see detailed lists of equipment owned on the financial statements, so I tend to ask for a copy of their most recent depreciation schedule. That way I have a good collection of data, in case I need to place more weight on a method under the asset approach.
If there are contracts or leases in place with related parties, I want to see them as well. I’ll need to factor in potential adjustments to risk, as well as their impact on the earnings of the operation. Do they have a covenant not to compete with a partner who wants to be bought out? Do they have loans to or from shareholders that have a written and agreed upon payback schedule?
Sometimes the Company operating agreements will have language in them that limits or defines some of the adjustments that I can make. I need to know about those as part of the analysis.
Who owns the facility the business operates out of? If the building is owned by the company directly, or is held in a separate entity with similar ownership, or if the property is leased from a third party, I want to know. I’m asking for any prior appraisals of the business, the property, or anything else related to the assignment for any background information, and to see if there are any other factors that I need to consider.
If the business owners generate budgets or projections for the Company, I’d like to see the last five years’ of them so I can see how good management is at projecting their future results. If management tends to forecast really close to what their actual results are, then I would feel much better about incorporating their analyses for the future instead of relying on other sources.
I want a written history of the business. I want to know when the business started, who started it, what it used to do, and what the business does now. I want to know if the business has changed their focus before, if so, how it went and if the operation has plans to modify their operations going forward as well.
In addition to those documents, I am going to be researching the industry to see what trends are affecting businesses operating in similar fields. I’ll be looking at a comparative financial ratio analysis to see how the subject’s operations compare to the industry average. I will be looking at the economic situation and any particular risk drivers that will affect the business from that area as well.
All told, that is a significant amount of information to wade through. As I read and study and compare, I’m collecting information that explains why the business is operating as it does today. I’m looking for reasons that might explain how the future growth is expected to be achieved, and I’m looking for data that will support my conclusions as I write the report to explain how everything ties together and points me at the conclusion of value I arrived at.
I’ll be writing my report, which is the story of my analysis, explaining what I examined, and how it affected my overall conclusions, and what data I relied on to draw those conclusions. Occasionally, I’ll get a call from a client asking me to appraise a business, but when they see the sheer quantity of data I ask for, they will change their mind, or only give me a small part of what I requested. When that happens, I may have to rely more on approximations and generalities in my assumptions which will lead to my delivering a range of values instead of single number.
When I think about everything that goes into a business appraisal, all the mental effort, thought, logic exercises and sheer quantity of material I have to run through, one thought keeps coming to my mind.
It’s been a very good thing that I like to read!
One of my hobbies, ever since I was a small child able to hold my own books, has been reading. I really enjoy getting lost in a story told by an author who can weave images and characters in my mind with nothing more then a clever arrangement of letters on the page! I am one of those who will look up from a particularly good story only to realize that I wasn’t actually experiencing those events myself, that they were just images conjured up by a talented writer.
As a business appraiser, when we write up our valuation reports, we are in fact telling a story. Generally speaking, not as exciting a story as some of my favorite authors have written, but a story nonetheless. We are explaining how we arrived at our opinion of value, what factors we considered, what information we gathered, and what our conclusions were after analyzing it all. In order to begin an analysis, we typically ask for a certain selection of information from the client. This information will help us to either identify the future operating income, or the risk of achieving that income.
I like to ask for the last five years’ of tax returns and financial statements. Yes, I ask for both sets of documents for the same time periods. I ask for both sets, because often there is information on the tax returns that is not included in the more detailed balance sheets and income statements. I request the financials be provided to me on an accrual basis if possible, because I want to know what the business’ accounts receivable and payables would be as well as any bad debts they may have had. I will be analyzing historical results in order to help me predict the future. For startup businesses and those with a very brief history of operations, this analysis becomes much more abbreviated, but it is still important as it drives part of the risk analysis.
If the owner has family members on the payroll, that are actually attending school out of state, I want to see those W-2 forms so I can know the magnitude of that potential adjustment. Family members on the payroll who are actually not part of the operation is one of the adjustments that is easy to make and support, if we have the documentation to do so.
I generally don’t see detailed lists of equipment owned on the financial statements, so I tend to ask for a copy of their most recent depreciation schedule. That way I have a good collection of data, in case I need to place more weight on a method under the asset approach.
If there are contracts or leases in place with related parties, I want to see them as well. I’ll need to factor in potential adjustments to risk, as well as their impact on the earnings of the operation. Do they have a covenant not to compete with a partner who wants to be bought out? Do they have loans to or from shareholders that have a written and agreed upon payback schedule?
Sometimes the Company operating agreements will have language in them that limits or defines some of the adjustments that I can make. I need to know about those as part of the analysis.
Who owns the facility the business operates out of? If the building is owned by the company directly, or is held in a separate entity with similar ownership, or if the property is leased from a third party, I want to know. I’m asking for any prior appraisals of the business, the property, or anything else related to the assignment for any background information, and to see if there are any other factors that I need to consider.
If the business owners generate budgets or projections for the Company, I’d like to see the last five years’ of them so I can see how good management is at projecting their future results. If management tends to forecast really close to what their actual results are, then I would feel much better about incorporating their analyses for the future instead of relying on other sources.
I want a written history of the business. I want to know when the business started, who started it, what it used to do, and what the business does now. I want to know if the business has changed their focus before, if so, how it went and if the operation has plans to modify their operations going forward as well.
In addition to those documents, I am going to be researching the industry to see what trends are affecting businesses operating in similar fields. I’ll be looking at a comparative financial ratio analysis to see how the subject’s operations compare to the industry average. I will be looking at the economic situation and any particular risk drivers that will affect the business from that area as well.
All told, that is a significant amount of information to wade through. As I read and study and compare, I’m collecting information that explains why the business is operating as it does today. I’m looking for reasons that might explain how the future growth is expected to be achieved, and I’m looking for data that will support my conclusions as I write the report to explain how everything ties together and points me at the conclusion of value I arrived at.
I’ll be writing my report, which is the story of my analysis, explaining what I examined, and how it affected my overall conclusions, and what data I relied on to draw those conclusions. Occasionally, I’ll get a call from a client asking me to appraise a business, but when they see the sheer quantity of data I ask for, they will change their mind, or only give me a small part of what I requested. When that happens, I may have to rely more on approximations and generalities in my assumptions which will lead to my delivering a range of values instead of single number.
When I think about everything that goes into a business appraisal, all the mental effort, thought, logic exercises and sheer quantity of material I have to run through, one thought keeps coming to my mind.
It’s been a very good thing that I like to read!
August 2, 2022 - Why Use an Average Multiple?
I remember when I learned about averages, summing a collection of numbers and then dividing by how many there were in order to determine the average of the collection of data. That was an eye opening lesson. Then, later on I was taught about medians, modes, and the whole concept of central tendency and the impact outliers have on a statistical analysis! I was probably one of the few kids in that middle school math class who actually found all of that very interesting, and now that I use that knowledge everyday in my valuation practice, I have found that I am even more animated by them, but not in the way you might expect.
One of my biggest pet peeves about the valuation industry, is how prevalent the use of an average or a median is when selecting a risk rate, market multiple, or in any other type of analysis. Each time I review a report for another appraiser, and I see an average or a median market multiple selected, I like to ask the question, “So, is the subject business you are appraising an average or a median business?”
Very often an appraiser will analyze a collection of market datapoints, transactions of other similar businesses that have been reported to one of the various databases business appraisers and brokers have access to, and decide to select an average or median price to revenues or price to seller’s discretionary earnings multiple for use in their valuation report. Often, there will be a few outliers that were too low, or too high for the analyst’s comfort level and those were removed, but there will be no reason for why they were removed other than they were outside the selected range.
WHY WERE THEY OUTSIDE THE SELECTED RANGE??
What parameters did the analyst place on the data to arrive at the selected range? Usually, there will be a revenues range filter applied, which means that the analyst will remove from consideration those businesses that were either much larger or much smaller than the subject. That is a good start, but within the remaining data, there may often be individual transactions that sold for much more or much less than the others, but for specific reasons.
Sometimes, a broker might sell the real estate in addition to the business. Sometimes a seller might accept a lower price due to their particular motivations. Occasionally, a business might sell for much more than others because it was acquired by a publicly traded business. These are reasons why specific datapoints may need to be removed from an analysis, but it doesn’t seem very scientific to throw away data simply because it doesn’t meet one’s preconceived notions. Granted, we typically don’t have access to a lot of data for each individual transaction, so we often need to exercise our professional judgment when making determinations about specific transactions.
As business appraisers we are most often asked to develop our opinion of the fair market value of the subject business, and as part of our analysis we look at the market approach to help derive that answer.
What we need to keep in mind however, is that not a single one of those transactions we are looking at, was ever consummated at the standard of value of fair market value.
Each transaction was the result of two parties, each of whom had some form of compulsion to buy or sell, at least one of which may or may not have had reasonable knowledge of all relevant facts, and most importantly, both parties were NOT hypothetical. See the differences between the standard of value these transactions were sold at and the definition of fair market value?
We analyze these transactions because they exist and the market approach and valuation standards say we should include this analysis when appropriate, but the selection of the final multiple to apply in our valuation method is completely up to the appraiser. I look at the financial ratio comparative analysis which shows me if the subject business is weaker or stronger than the industry average. I gauge this overall strength or weakness by the quantity of the ratios that show the business is weaker or stronger than the average business in the subject industry. Then I adjust my average or median multiple accordingly, up or down, in order to derive my opinion of the value of the subject business.
As professional business appraisers and analysts, we are tasked to share our opinion of the value of a business. It only makes sense to me that in order to do so, we step a little further along the path of analysis than were taught back in elementary school. We don’t have a source or chart to refer to for the magnitude of the adjustments we might make to an average or median multiple, but that is why we have professional judgment. In our opinion, based on our training, education and experience, the selected market multiple may very well NOT be simply an average or a median multiple. I look forward to reading the explanation of why those adjustments were made in your reports!
As always, I am happy to chat if you have a question or would like some help on a particular valuation project.
I remember when I learned about averages, summing a collection of numbers and then dividing by how many there were in order to determine the average of the collection of data. That was an eye opening lesson. Then, later on I was taught about medians, modes, and the whole concept of central tendency and the impact outliers have on a statistical analysis! I was probably one of the few kids in that middle school math class who actually found all of that very interesting, and now that I use that knowledge everyday in my valuation practice, I have found that I am even more animated by them, but not in the way you might expect.
One of my biggest pet peeves about the valuation industry, is how prevalent the use of an average or a median is when selecting a risk rate, market multiple, or in any other type of analysis. Each time I review a report for another appraiser, and I see an average or a median market multiple selected, I like to ask the question, “So, is the subject business you are appraising an average or a median business?”
Very often an appraiser will analyze a collection of market datapoints, transactions of other similar businesses that have been reported to one of the various databases business appraisers and brokers have access to, and decide to select an average or median price to revenues or price to seller’s discretionary earnings multiple for use in their valuation report. Often, there will be a few outliers that were too low, or too high for the analyst’s comfort level and those were removed, but there will be no reason for why they were removed other than they were outside the selected range.
WHY WERE THEY OUTSIDE THE SELECTED RANGE??
What parameters did the analyst place on the data to arrive at the selected range? Usually, there will be a revenues range filter applied, which means that the analyst will remove from consideration those businesses that were either much larger or much smaller than the subject. That is a good start, but within the remaining data, there may often be individual transactions that sold for much more or much less than the others, but for specific reasons.
Sometimes, a broker might sell the real estate in addition to the business. Sometimes a seller might accept a lower price due to their particular motivations. Occasionally, a business might sell for much more than others because it was acquired by a publicly traded business. These are reasons why specific datapoints may need to be removed from an analysis, but it doesn’t seem very scientific to throw away data simply because it doesn’t meet one’s preconceived notions. Granted, we typically don’t have access to a lot of data for each individual transaction, so we often need to exercise our professional judgment when making determinations about specific transactions.
As business appraisers we are most often asked to develop our opinion of the fair market value of the subject business, and as part of our analysis we look at the market approach to help derive that answer.
What we need to keep in mind however, is that not a single one of those transactions we are looking at, was ever consummated at the standard of value of fair market value.
Each transaction was the result of two parties, each of whom had some form of compulsion to buy or sell, at least one of which may or may not have had reasonable knowledge of all relevant facts, and most importantly, both parties were NOT hypothetical. See the differences between the standard of value these transactions were sold at and the definition of fair market value?
We analyze these transactions because they exist and the market approach and valuation standards say we should include this analysis when appropriate, but the selection of the final multiple to apply in our valuation method is completely up to the appraiser. I look at the financial ratio comparative analysis which shows me if the subject business is weaker or stronger than the industry average. I gauge this overall strength or weakness by the quantity of the ratios that show the business is weaker or stronger than the average business in the subject industry. Then I adjust my average or median multiple accordingly, up or down, in order to derive my opinion of the value of the subject business.
As professional business appraisers and analysts, we are tasked to share our opinion of the value of a business. It only makes sense to me that in order to do so, we step a little further along the path of analysis than were taught back in elementary school. We don’t have a source or chart to refer to for the magnitude of the adjustments we might make to an average or median multiple, but that is why we have professional judgment. In our opinion, based on our training, education and experience, the selected market multiple may very well NOT be simply an average or a median multiple. I look forward to reading the explanation of why those adjustments were made in your reports!
As always, I am happy to chat if you have a question or would like some help on a particular valuation project.
July 19, 2022 - What is Actually Being Appraised?
This is a very important question! When I receive a request to appraise a business, one of the first things I attempt to find out, is what aspect of that business exactly, am I being asked to appraise?
There are several different business valuation assignments that I could be asked to complete for any specific business, and each will arrive at a different answer, so you can see why I would need to figure this part out rather quickly.
I could be asked to appraise a controlling equity ownership in the company stock, member units, depending on how the entity is organized. I could be asked to appraise a non-controlling equity ownership interest, or I could be asked to appraise what many business brokers refer to as the “Most Probable Selling Price” (MPSP). I tend to refer to these projects as an appraisal of the “Assets That Typically Transfer in a Sale”.
Each one of those options includes different underlying assumptions, assuming each is governed by the standard of value of Fair Market Value. (If another standard of value needs to be used, then many of the following assumptions are modified again.)
If I am appraising a controlling equity interest, I am going to be looking for discretionary expenses to add back, I am going to be looking for non-operating assets and/or liabilities to adjust out, and I am going to be working this appraisal from the perspective of a potential buyer buying into the scenario as presented with all the assets and liabilities held by the business being considered.
If I am appraising a non-controlling equity ownership interest, I am not necessarily going to be adjusting out discretionary expenses, I may still be looking for non-operating assets and liabilities, but as a non-controlling equity interest holder cannot decide to sell of those assets, I am also not going to be adjusting them out. I am working this appraisal scenario from the perspective of an investor considering the risk of buying into a partnership where distributions to non-controlling shareholders are reduced by the need to fund non-operating assets. I will also be including discounts for lack of control and marketability, IF I am using the fair market value standard of value.
If I am appraising only those assets that typically transfer in a sale, or MPSP, certain adjustments need to be made to many of the methods used. (However, sometimes a buyer will request to purchase some working capital, and that request could throw another wrinkle into the appraisal. Most of the time, that adjustment can be handled by adding a dollar for dollar increase to the appraised value for the requested working capital. Most of the time.)
Let’s look at some of the modifications an appraiser must make to application of commonly used valuation methods in order to deliver an analysis of the MPSP.
Any use of the adjusted book value method considering the tangible assets held by the business will need to have cash, and accounts receivable excluded, and the liabilities removed as a buyer in this scenario will not be taking possession of any of those.
Depending on what income stream is selected to run the capitalization of earnings or the discounted cash flow methods, the analyst will have to select a risk rate that matches it, but the most commonly taught income stream is net cash flow, and the most commonly selected rate comes from the build-up method, which means that the indication of value will include an operating level of cash, accounts receivable and the associated amounts of working liabilities. Depending on if the analysis used net cash flow to equity or net cash flow to invested capital, the indication of value may or may not include the effects of the long-term liabilities held. In order to adjust the indication of value to get a MPSP, an operating level of cash must be removed, (If the business holds excess cash, watch out for double counting by removing the excess again at this step.) accounts receivable need to be removed and again, depending on what version of net cash flow was used, liabilities need to be dealt with.
The excess earnings method can derive an equity value or an MPSP value, depending on how the selected income stream was calculated, and if equity or assets were used to calculate the return on tangible assets rate.
Methods under the market approach, if using data from the databases of privately held businesses, typically arrive at an indication of value of the Most Probable Selling Price (MPSP) for an asset sale right out of the gate, but depending on the database used, the analysis may or may not include transactions that were sold as stock deals. When a business appraiser reports a transaction as being sold as a stock deal, it is generally unknown if that transaction included a level of working capital, or if the transaction was structured that way solely for tax purposes, and the buyer did not actually acquire any AR or assume any debt making it more of a modified stock deal. Typically, the transactions reported as asset sales were structured as MPSP deals, but watch out for those transactions where the broker also sold the associated real estate, which would skew the analyzed multiples upwards based on the value of the real property included in that sales price.
I recently had a request to appraise her business from a potential client. As I went through my normal questions to see what purpose she needed the appraisal for, and to make sure I knew which of the various scenarios described above was needed, she asked me a very interesting question. “Why did I need to know all this information?”
Apparently, she had just been on several websites and received several “valuations” for her business already, and she did not realize that those numbers she had received, were likely for a MPSP scenario, but she was considering selling to an Employee Stock Ownership Plan (ESOP). Quick question to all of the business brokers and advisors reading this:
When you provide your analysis to determine a likely selling price for a business, how confident are you that your same analysis could also be used to fund an ESOP sale?
Most likely, not very confident, as an ESOP valuation requires an entirely different set of assumptions, even beyond what we include when appraising an equity interest.
That first phone call is key, and finding out what we are being asked to appraise and why is also extremely important. Not only for our peace of mind, but also to determine what we are going to charge for the project. An analysis for a MPSP, is likely a lot cheaper than running a report for review by the US Department of Labor.
This is a very important question! When I receive a request to appraise a business, one of the first things I attempt to find out, is what aspect of that business exactly, am I being asked to appraise?
There are several different business valuation assignments that I could be asked to complete for any specific business, and each will arrive at a different answer, so you can see why I would need to figure this part out rather quickly.
I could be asked to appraise a controlling equity ownership in the company stock, member units, depending on how the entity is organized. I could be asked to appraise a non-controlling equity ownership interest, or I could be asked to appraise what many business brokers refer to as the “Most Probable Selling Price” (MPSP). I tend to refer to these projects as an appraisal of the “Assets That Typically Transfer in a Sale”.
Each one of those options includes different underlying assumptions, assuming each is governed by the standard of value of Fair Market Value. (If another standard of value needs to be used, then many of the following assumptions are modified again.)
If I am appraising a controlling equity interest, I am going to be looking for discretionary expenses to add back, I am going to be looking for non-operating assets and/or liabilities to adjust out, and I am going to be working this appraisal from the perspective of a potential buyer buying into the scenario as presented with all the assets and liabilities held by the business being considered.
If I am appraising a non-controlling equity ownership interest, I am not necessarily going to be adjusting out discretionary expenses, I may still be looking for non-operating assets and liabilities, but as a non-controlling equity interest holder cannot decide to sell of those assets, I am also not going to be adjusting them out. I am working this appraisal scenario from the perspective of an investor considering the risk of buying into a partnership where distributions to non-controlling shareholders are reduced by the need to fund non-operating assets. I will also be including discounts for lack of control and marketability, IF I am using the fair market value standard of value.
If I am appraising only those assets that typically transfer in a sale, or MPSP, certain adjustments need to be made to many of the methods used. (However, sometimes a buyer will request to purchase some working capital, and that request could throw another wrinkle into the appraisal. Most of the time, that adjustment can be handled by adding a dollar for dollar increase to the appraised value for the requested working capital. Most of the time.)
Let’s look at some of the modifications an appraiser must make to application of commonly used valuation methods in order to deliver an analysis of the MPSP.
Any use of the adjusted book value method considering the tangible assets held by the business will need to have cash, and accounts receivable excluded, and the liabilities removed as a buyer in this scenario will not be taking possession of any of those.
Depending on what income stream is selected to run the capitalization of earnings or the discounted cash flow methods, the analyst will have to select a risk rate that matches it, but the most commonly taught income stream is net cash flow, and the most commonly selected rate comes from the build-up method, which means that the indication of value will include an operating level of cash, accounts receivable and the associated amounts of working liabilities. Depending on if the analysis used net cash flow to equity or net cash flow to invested capital, the indication of value may or may not include the effects of the long-term liabilities held. In order to adjust the indication of value to get a MPSP, an operating level of cash must be removed, (If the business holds excess cash, watch out for double counting by removing the excess again at this step.) accounts receivable need to be removed and again, depending on what version of net cash flow was used, liabilities need to be dealt with.
The excess earnings method can derive an equity value or an MPSP value, depending on how the selected income stream was calculated, and if equity or assets were used to calculate the return on tangible assets rate.
Methods under the market approach, if using data from the databases of privately held businesses, typically arrive at an indication of value of the Most Probable Selling Price (MPSP) for an asset sale right out of the gate, but depending on the database used, the analysis may or may not include transactions that were sold as stock deals. When a business appraiser reports a transaction as being sold as a stock deal, it is generally unknown if that transaction included a level of working capital, or if the transaction was structured that way solely for tax purposes, and the buyer did not actually acquire any AR or assume any debt making it more of a modified stock deal. Typically, the transactions reported as asset sales were structured as MPSP deals, but watch out for those transactions where the broker also sold the associated real estate, which would skew the analyzed multiples upwards based on the value of the real property included in that sales price.
I recently had a request to appraise her business from a potential client. As I went through my normal questions to see what purpose she needed the appraisal for, and to make sure I knew which of the various scenarios described above was needed, she asked me a very interesting question. “Why did I need to know all this information?”
Apparently, she had just been on several websites and received several “valuations” for her business already, and she did not realize that those numbers she had received, were likely for a MPSP scenario, but she was considering selling to an Employee Stock Ownership Plan (ESOP). Quick question to all of the business brokers and advisors reading this:
When you provide your analysis to determine a likely selling price for a business, how confident are you that your same analysis could also be used to fund an ESOP sale?
Most likely, not very confident, as an ESOP valuation requires an entirely different set of assumptions, even beyond what we include when appraising an equity interest.
That first phone call is key, and finding out what we are being asked to appraise and why is also extremely important. Not only for our peace of mind, but also to determine what we are going to charge for the project. An analysis for a MPSP, is likely a lot cheaper than running a report for review by the US Department of Labor.
July 5, 2022 - Rules of Thumb are Useful Tools, But...
Rules of thumb have been around almost as long as there have been thumbs. People enjoy using a measurement that is always at hand, as it were, without having to do a lot of complicated research and analysis. Unfortunately, there is no standard thumb size so each measurement performed by each individual with their own thumb will be different than any other’s measurement of the same thing. That sort of confusion has spawned a multitude of different rules of thumb that different experts have formulated to help themselves perform various measurements. One example would be a measurement of the length of a specific piece of wood. Depending on the size of the individual, a rule of thumb of “three handspans in length” might be equal to another’s “4.5 handspans in length”. It doesn’t mean that the length of that board changed, it just means that one individual has smaller hands than the other. The next set of carpenters to come by and measure that same piece of wood, remembering the easy rules of thumb mentioned by those before, will be expecting to see a length of wood of between 3 and 4.5 times the width of their hands, but it will actually be a slightly different multiple of handspans for each carpenter.
When it comes to business valuation, pricing a business for sale, or simply checking to see what it might cost to buy out a partner, rules of thumb are an easy option; but there are so many variables affecting that answer, that the best answer one can get with a series of rules of thumb is really a range of values, and that range will be different for each thumb used to measure it. Not to mention that rules of thumb are also always changed and growing over time as market conditions and businesses evolve.
Let’s explore that concept about rules of thumb changing over time. I own a copy of a book first published in 1987, but my copy is the third edition and was published in 1993. It is the Handbook of Small Business Valuation Formulas and Rules of Thumb by Glenn Desmond, published by Valuation Press. In it there is a rule of thumb for Automobile Dealerships that says the following:
Use a stabilized Owner’s Cash Flow (OCF).
OCF multiplier typical range: 0.0x – 1.25x OCF
Formula assets included in the indicated value:
Add fixed assets at market value to formula assets.
Please note that the above ‘rule’ can be summarized by saying, “Apply a multiple to earnings, then add fixed assets.” What also needs to be pointed out is that the multiple range varies from zero to 1.25 times, and the selected multiple depends on a variety of other factors described in the book, such as the type of dealership, trends in the national economy, the location of the facility and the terms of the lease. Let’s use the following simplified sample data for pricing an auto dealership owned back in the early 1990s:
(Please note that most rules of thumb for business pricing like this one, do NOT include the value of any real property the owner may actually have.)
The range of indicated pricing for our hypothetical 1990s auto dealership is shown below:
Rules of thumb have been around almost as long as there have been thumbs. People enjoy using a measurement that is always at hand, as it were, without having to do a lot of complicated research and analysis. Unfortunately, there is no standard thumb size so each measurement performed by each individual with their own thumb will be different than any other’s measurement of the same thing. That sort of confusion has spawned a multitude of different rules of thumb that different experts have formulated to help themselves perform various measurements. One example would be a measurement of the length of a specific piece of wood. Depending on the size of the individual, a rule of thumb of “three handspans in length” might be equal to another’s “4.5 handspans in length”. It doesn’t mean that the length of that board changed, it just means that one individual has smaller hands than the other. The next set of carpenters to come by and measure that same piece of wood, remembering the easy rules of thumb mentioned by those before, will be expecting to see a length of wood of between 3 and 4.5 times the width of their hands, but it will actually be a slightly different multiple of handspans for each carpenter.
When it comes to business valuation, pricing a business for sale, or simply checking to see what it might cost to buy out a partner, rules of thumb are an easy option; but there are so many variables affecting that answer, that the best answer one can get with a series of rules of thumb is really a range of values, and that range will be different for each thumb used to measure it. Not to mention that rules of thumb are also always changed and growing over time as market conditions and businesses evolve.
Let’s explore that concept about rules of thumb changing over time. I own a copy of a book first published in 1987, but my copy is the third edition and was published in 1993. It is the Handbook of Small Business Valuation Formulas and Rules of Thumb by Glenn Desmond, published by Valuation Press. In it there is a rule of thumb for Automobile Dealerships that says the following:
Use a stabilized Owner’s Cash Flow (OCF).
OCF multiplier typical range: 0.0x – 1.25x OCF
Formula assets included in the indicated value:
- Lease
- Intangibles
Add fixed assets at market value to formula assets.
Please note that the above ‘rule’ can be summarized by saying, “Apply a multiple to earnings, then add fixed assets.” What also needs to be pointed out is that the multiple range varies from zero to 1.25 times, and the selected multiple depends on a variety of other factors described in the book, such as the type of dealership, trends in the national economy, the location of the facility and the terms of the lease. Let’s use the following simplified sample data for pricing an auto dealership owned back in the early 1990s:
- Owner’s Cash Flow - $100,000
- Fixed Assets at Market Value - $250,000
- Annual Sales - $1,000,000
(Please note that most rules of thumb for business pricing like this one, do NOT include the value of any real property the owner may actually have.)
The range of indicated pricing for our hypothetical 1990s auto dealership is shown below:
I am going to compare that rule of thumb, to those described in the current version (2022) of the Business Reference Guide, published by Business Brokerage Press and compiled by Tom West for Auto Dealerships – New Cars that shows two completely different rules of thumb. The new terminology of ‘Seller’s Discretionary Earnings’, is equivalent to the older style phrasing of ‘Owner’s Cash Flow’, so I am going to use those same sample numbers described above.
4 x Seller’s Discretionary Earnings (SDE)
Or
30% of Annual Sale
4 x Seller’s Discretionary Earnings (SDE)
Or
30% of Annual Sale
Please note, these modern multiples do not add back the market value of any fixed assets the business owns, because the value of those items required by the operations, are included in the use of the selected (larger) multiple. Just like the book I cited above published in 1993, if one reads further, there are directions explaining what factors need to be analyzed that will affect the size of the selected multiple used by the rules of thumb. The overall price of a specific business will depend on the market value of the operating inventory, the furniture, fixtures, and equipment, and other factors. That means an analysis of the subject dealership could indicate that the selected SDE multiple should be smaller or larger than 4, and a similar adjustment may be appropriate for a revenue multiplier.
(It also means that if the subject business owns certain assets that are not necessary for operations, those assets are not included in the indication of value determined.)
One of the most significant challenges we all face as professionals determining a value for a business, regardless of the purpose requiring that valuation, is to make sure that we are always using the correct variables for whatever formula we are attempting to use. Imagine what would happen to an expert who conflated several rules of thumb, and used parts from one and parts from another and combined them to make up their own rule of thumb, without ever having actually personally measured that one board the original rules of thumb were based on? An example is illustrated below:
(It also means that if the subject business owns certain assets that are not necessary for operations, those assets are not included in the indication of value determined.)
One of the most significant challenges we all face as professionals determining a value for a business, regardless of the purpose requiring that valuation, is to make sure that we are always using the correct variables for whatever formula we are attempting to use. Imagine what would happen to an expert who conflated several rules of thumb, and used parts from one and parts from another and combined them to make up their own rule of thumb, without ever having actually personally measured that one board the original rules of thumb were based on? An example is illustrated below:
The above example is double counting the value of the fixed assets held by the business. The selected multiple of 4x, includes the assets that are required by the operation to generate those cash flows. If the business did not have those assets, then it would also not have that level of earnings. A conflated rule of thumb will typically return an inflated value, as most people tend to pick and choose the larger variables from any ‘rule of thumb’ they happen to remember having read once upon a time.
Just because the math works in the example above, doesn’t mean a deal will close under those terms. Remember that length of wood we talked about at first? Using this conflated example, a professional is basically attempting to sell a 32-inch board by telling interested parties that it is actually 48 inches long. As soon as one of those interested parties brings out their own tape measure and runs through their own due diligence, they will know that the board’s length had been grossly overestimated. Logic, reasonableness, and basic valuation theory must be a part of the process, or the numbers that we end up determining for the Companies we service, simply won’t be realistic.
Just because the math works in the example above, doesn’t mean a deal will close under those terms. Remember that length of wood we talked about at first? Using this conflated example, a professional is basically attempting to sell a 32-inch board by telling interested parties that it is actually 48 inches long. As soon as one of those interested parties brings out their own tape measure and runs through their own due diligence, they will know that the board’s length had been grossly overestimated. Logic, reasonableness, and basic valuation theory must be a part of the process, or the numbers that we end up determining for the Companies we service, simply won’t be realistic.
June 24, 2022 - Business Valuation Basics
When a client asks you if you can appraise a specific business, there are always questions we ask to make sure that we can in fact accomplish that task.
“What kind of businesses is it? What type of financial statements will I have access to? What is the purpose of the assignment? When do I need to have the report done by?”
All of those a very good questions and their answers allows us to manage client expectations or decide if another appraiser might work better for that client.
Once we accept an assignment, and we have received the financial data we requested, there are a few steps that we all go through.
2. We analyze the operational risk of the company
This can be done via a comparative financial ratio analysis, where we check to see if the operational characteristics of the business are stronger, weaker, or about the same as the industry average. Some appraisers prefer to use a Strengths, Weaknesses, Opportunities, Threats (SWOT) analysis, or some other such comparative analysis, but we are all measuring risk, because income divided by risk equals value.
3. We predict the future
This is the step that catches certain appraisers off guard. “But I am using a weighted average of historical earnings, I’m not forecasting anything.” Actually, you are. If you are using that technique, you are still predicting the future, you are just predicting the future to look somewhat similar to historical results. If your weighted average shows a lower expected income because the business has been growing over the past five years, perhaps the future will not look exactly like operations did three years ago. Revenue Ruling 59-60 talks about how valuation is a prophecy as to the future, and we are expected to look forward, basing our choices on data that was knowable as of the effective date.
4. We select and calculate applicable methods
This is another area I see certain appraisers run into trouble with. Not every method is applicable to every assignment. If your report always includes the same twelve methods, and your value conclusion is some average of all of them, I am going to suggest that you may need to rethink your overall approach. Each method has a wide degree of flexibility to it, as each method relies on an appraiser’s judgment and experience to calculate the number. If your various indications of value are all over the board, that simply shows that you are lacking in control over your own appraisal. What assumptions are you making without even knowing about them? Each method includes a variety of assumptions based on usage and/or underlaying data, and it is an appraiser’s job to harness those and to make sure that each method is pointing in at least the same direction. Are your assumptions for one method arriving at a stock value, while others are determining the value of the Company’s assets? If one method measures a company’s equity value, yet another is looking at its invested capital, it is your job to both know that and adjust for it.
5. We conclude to a final value
Each indication of value from each method used, will provide a slightly different indication of value. That is normal and expected. Some methods ae simply more appropriate for certain types of projects than others. Some methods require significant adjustments to make them provide an accurate indication of value, and sometimes our underlying data is simply not as accurate as we would like it to be which will skew the results. In those cases, we need to exercise our judgement and explain how and why certain methods are less applicable and why we chose to either ignore, or place significantly less weight on certain of them.
6. We write our report
The communication of our reasonings and how we approached the appraisal problem, is just as much, if not more important then the actual numbers we used. Not only are our clients going to be looking for reasons why the concluded value is lower than they expected, so may our clients’ bankers, lawyers, spouse’s appraisal experts, potential buyers, and the occasional brother-in-law. If our reports do not clearly outline how we applied basic valuation theory, we may end up spending even more unpaid time answering questions that a little forethought on our part could have handled. (I do enjoy answering certain questions by telling the questioner what page of the report answers that particular question.)
Overall, valuation is fairly simple industry. We collect data, analyze it, draw conclusions, and then communicate our findings. Even those first few questions we ask our potential client about deadlines and appraisal purposes are gathering data so we can analyze and draw our conclusion of if we want that project or not. The basics are easy, but occasionally the details can become complicated.
If you have any questions you’d like to bounce off of a third-party, you can reach me at CanyonValuations@gmail.com.
Your friendly neighborhood business appraiser,
Shawn Hyde, CBA, CVA, CMEA, BCA
When a client asks you if you can appraise a specific business, there are always questions we ask to make sure that we can in fact accomplish that task.
“What kind of businesses is it? What type of financial statements will I have access to? What is the purpose of the assignment? When do I need to have the report done by?”
All of those a very good questions and their answers allows us to manage client expectations or decide if another appraiser might work better for that client.
Once we accept an assignment, and we have received the financial data we requested, there are a few steps that we all go through.
- We analyze historical results
2. We analyze the operational risk of the company
This can be done via a comparative financial ratio analysis, where we check to see if the operational characteristics of the business are stronger, weaker, or about the same as the industry average. Some appraisers prefer to use a Strengths, Weaknesses, Opportunities, Threats (SWOT) analysis, or some other such comparative analysis, but we are all measuring risk, because income divided by risk equals value.
3. We predict the future
This is the step that catches certain appraisers off guard. “But I am using a weighted average of historical earnings, I’m not forecasting anything.” Actually, you are. If you are using that technique, you are still predicting the future, you are just predicting the future to look somewhat similar to historical results. If your weighted average shows a lower expected income because the business has been growing over the past five years, perhaps the future will not look exactly like operations did three years ago. Revenue Ruling 59-60 talks about how valuation is a prophecy as to the future, and we are expected to look forward, basing our choices on data that was knowable as of the effective date.
4. We select and calculate applicable methods
This is another area I see certain appraisers run into trouble with. Not every method is applicable to every assignment. If your report always includes the same twelve methods, and your value conclusion is some average of all of them, I am going to suggest that you may need to rethink your overall approach. Each method has a wide degree of flexibility to it, as each method relies on an appraiser’s judgment and experience to calculate the number. If your various indications of value are all over the board, that simply shows that you are lacking in control over your own appraisal. What assumptions are you making without even knowing about them? Each method includes a variety of assumptions based on usage and/or underlaying data, and it is an appraiser’s job to harness those and to make sure that each method is pointing in at least the same direction. Are your assumptions for one method arriving at a stock value, while others are determining the value of the Company’s assets? If one method measures a company’s equity value, yet another is looking at its invested capital, it is your job to both know that and adjust for it.
5. We conclude to a final value
Each indication of value from each method used, will provide a slightly different indication of value. That is normal and expected. Some methods ae simply more appropriate for certain types of projects than others. Some methods require significant adjustments to make them provide an accurate indication of value, and sometimes our underlying data is simply not as accurate as we would like it to be which will skew the results. In those cases, we need to exercise our judgement and explain how and why certain methods are less applicable and why we chose to either ignore, or place significantly less weight on certain of them.
6. We write our report
The communication of our reasonings and how we approached the appraisal problem, is just as much, if not more important then the actual numbers we used. Not only are our clients going to be looking for reasons why the concluded value is lower than they expected, so may our clients’ bankers, lawyers, spouse’s appraisal experts, potential buyers, and the occasional brother-in-law. If our reports do not clearly outline how we applied basic valuation theory, we may end up spending even more unpaid time answering questions that a little forethought on our part could have handled. (I do enjoy answering certain questions by telling the questioner what page of the report answers that particular question.)
Overall, valuation is fairly simple industry. We collect data, analyze it, draw conclusions, and then communicate our findings. Even those first few questions we ask our potential client about deadlines and appraisal purposes are gathering data so we can analyze and draw our conclusion of if we want that project or not. The basics are easy, but occasionally the details can become complicated.
If you have any questions you’d like to bounce off of a third-party, you can reach me at CanyonValuations@gmail.com.
Your friendly neighborhood business appraiser,
Shawn Hyde, CBA, CVA, CMEA, BCA
March 4, 2021 - Forecasting
The value of an operating business is based on its expected future earnings. Many business appraisers have been used to relying on some sort of weighted average of historical operations, generally placing the most weight on the most recent year, in order to predict the future of a business. With the year 2020's COVID-19 impact, that method may no longer be as viable. 2020's results may not be indicative of future performance. Some businesses will take several years to recover from the loss of revenues, while others will slowly come back down to 'normal' operations. In any case, a business appraiser will have to consider that a weighted average of historical results is not the answer it used to be. We need to be able and willing to consider other alternatives to predicting the future.
The value of an operating business is based on its expected future earnings. Many business appraisers have been used to relying on some sort of weighted average of historical operations, generally placing the most weight on the most recent year, in order to predict the future of a business. With the year 2020's COVID-19 impact, that method may no longer be as viable. 2020's results may not be indicative of future performance. Some businesses will take several years to recover from the loss of revenues, while others will slowly come back down to 'normal' operations. In any case, a business appraiser will have to consider that a weighted average of historical results is not the answer it used to be. We need to be able and willing to consider other alternatives to predicting the future.
January 7, 2020 - Now I Will Have a Book Out
So, I wrote some step by step instructions on how to build business appraisal templates in Microsoft Excel for classes I have been teaching for the International Society of Business Appraisers as part of the training to obtain one's Business Certified Appraiser (BCA) designation. The idea was to help attendees be able to begin work on their demonstration reports as soon as they finish the classes. I have since submitted the manuscript to Business Valuation Resources, LLC and they have agreed to publish it and offer it for sale along with a copy of the templates that the book provides instructions on how to build. The book will be called Building the Essential Business Valuation Templates in Excel or something like that, and will be available for purchase on January 15th, 2020.
I recommend people actually read the thing and build their own template, so they understand how it works, but I know some folks won't do that.
So, I wrote some step by step instructions on how to build business appraisal templates in Microsoft Excel for classes I have been teaching for the International Society of Business Appraisers as part of the training to obtain one's Business Certified Appraiser (BCA) designation. The idea was to help attendees be able to begin work on their demonstration reports as soon as they finish the classes. I have since submitted the manuscript to Business Valuation Resources, LLC and they have agreed to publish it and offer it for sale along with a copy of the templates that the book provides instructions on how to build. The book will be called Building the Essential Business Valuation Templates in Excel or something like that, and will be available for purchase on January 15th, 2020.
I recommend people actually read the thing and build their own template, so they understand how it works, but I know some folks won't do that.
February 15, 2019 - International Society of Business Appraisers
I continue to enjoy appraising businesses and educating new business appraisers. While I will continue to operate Canyon Valuations and provide business and machinery & equipment appraisal services, I have also been working with the International Society of Business Appraisers as their Executive Director. I am spending quite a bit of time training new business appraisers and writing and updating educational materials.
As always, if you have a valuation related question, I am happy to provide an answer. You can always reach me at the contact data above.
I continue to enjoy appraising businesses and educating new business appraisers. While I will continue to operate Canyon Valuations and provide business and machinery & equipment appraisal services, I have also been working with the International Society of Business Appraisers as their Executive Director. I am spending quite a bit of time training new business appraisers and writing and updating educational materials.
As always, if you have a valuation related question, I am happy to provide an answer. You can always reach me at the contact data above.
September 12, 2018 - Excel and Business Appraisers
I have been analyzing data for over 20 years using spreadsheet software. I started out with Lotus 1-2-3 and am now using Microsoft Excel 365. Spreadsheets can be an analyst’s best friend, or their worst enemy.
In a spreadsheet, one can insert data, move columns around, and organize everything to present the analysis in a clear and specific manner. I love it and enjoy sharing my analysis with the readers of my valuation reports, using the data to support my position! The only problem with software, Excel or any other program, is that it does exactly what you tell it, and not what you really want it to do.
One of my biggest problems years ago, was linking a formula to a very specific number on a different spreadsheet, then after completing my analysis, finding out that the very specific number I had selected originally had been replaced by some other number. I used to spend hours at the end of each assignment, painstakingly checking every calculation to make sure that every formula did exactly what I wanted it to do, switching back and forth among several worksheets in the same workbook.
I tried several different strategies, but always seemed to end up with at least one formula reference changing; if I would sort income statement expenses to read in an alphabetical order, or if I would insert a column to move the calculation one slot over to make room for an extra explanation. Almost every project included a modification to organize my analysis in just the way I wanted to present the data, but had the unintended consequence of moving references or adding error messages to my spreadsheets. The IFERROR function would prevent my analysis from showing errors, but it also prevented me from finding them myself.
A number of years ago, I was introduced to a pair of magical functions, that when utilized together solved almost all of my problems. It took some time to get to where I could type out the formula, but once I mastered it, has saved me hours of work and prevented many headaches. These magical functions are INDEX and MATCH. Let me explain how they work.
INDEX, by itself, functions pretty much exactly the way I used to operate. I used to type an = or a + and then click on the number I wanted on a different spreadsheet to begin to write a formula. Just using the = or + paved the way for my formula references to move around without my noticing, so I was not excited about a longer method of doing exactly that. However, MATCH is genius! MATCH works by identifying a target on a different sheet that matches the item I am looking for.
When used together, the effect is awesome because it now incorporates the very labels I use in my spreadsheets to identify my data in the exact formulas I use to analyze that data! For example, I will often have a line in my spreads labeled “Officer Compensation”, and this expense may need a normalizing adjustment in my analysis, so instead of typing = or + and then clicking on the number in my spreads and hoping it stays there, I use the INDEX and MATCH functions which make sure I always know that my data is not being mislabeled. If my data happens to move on my spreadsheet, the references are locked in so it doesn’t matter, as the formula will always return exactly what it says it is presenting.
I made a brief video showing how this works and posted it on my LinkedIn Profile. If you are interested in seeing these functions in action, you can search out Shawn Hyde, CBA, CMEA, BCA and you will find me there. Or you can search on LinkedIn for the two tags I placed in my description - #valuation #excel and find it that way.
I have been analyzing data for over 20 years using spreadsheet software. I started out with Lotus 1-2-3 and am now using Microsoft Excel 365. Spreadsheets can be an analyst’s best friend, or their worst enemy.
In a spreadsheet, one can insert data, move columns around, and organize everything to present the analysis in a clear and specific manner. I love it and enjoy sharing my analysis with the readers of my valuation reports, using the data to support my position! The only problem with software, Excel or any other program, is that it does exactly what you tell it, and not what you really want it to do.
One of my biggest problems years ago, was linking a formula to a very specific number on a different spreadsheet, then after completing my analysis, finding out that the very specific number I had selected originally had been replaced by some other number. I used to spend hours at the end of each assignment, painstakingly checking every calculation to make sure that every formula did exactly what I wanted it to do, switching back and forth among several worksheets in the same workbook.
I tried several different strategies, but always seemed to end up with at least one formula reference changing; if I would sort income statement expenses to read in an alphabetical order, or if I would insert a column to move the calculation one slot over to make room for an extra explanation. Almost every project included a modification to organize my analysis in just the way I wanted to present the data, but had the unintended consequence of moving references or adding error messages to my spreadsheets. The IFERROR function would prevent my analysis from showing errors, but it also prevented me from finding them myself.
A number of years ago, I was introduced to a pair of magical functions, that when utilized together solved almost all of my problems. It took some time to get to where I could type out the formula, but once I mastered it, has saved me hours of work and prevented many headaches. These magical functions are INDEX and MATCH. Let me explain how they work.
INDEX, by itself, functions pretty much exactly the way I used to operate. I used to type an = or a + and then click on the number I wanted on a different spreadsheet to begin to write a formula. Just using the = or + paved the way for my formula references to move around without my noticing, so I was not excited about a longer method of doing exactly that. However, MATCH is genius! MATCH works by identifying a target on a different sheet that matches the item I am looking for.
When used together, the effect is awesome because it now incorporates the very labels I use in my spreadsheets to identify my data in the exact formulas I use to analyze that data! For example, I will often have a line in my spreads labeled “Officer Compensation”, and this expense may need a normalizing adjustment in my analysis, so instead of typing = or + and then clicking on the number in my spreads and hoping it stays there, I use the INDEX and MATCH functions which make sure I always know that my data is not being mislabeled. If my data happens to move on my spreadsheet, the references are locked in so it doesn’t matter, as the formula will always return exactly what it says it is presenting.
I made a brief video showing how this works and posted it on my LinkedIn Profile. If you are interested in seeing these functions in action, you can search out Shawn Hyde, CBA, CMEA, BCA and you will find me there. Or you can search on LinkedIn for the two tags I placed in my description - #valuation #excel and find it that way.
March 27, 2018 - Business Appraisal and Real Estate
I recently had a conversation with a real estate appraiser that led into some very interesting territory. We discussed the concluded value of one of his most recent projects. He told me the property operated with two different businesses on it, but because they were both owned by the property owner and neither operation showed a profit, he could only use the market and cost approaches to value the real estate. He wanted to know if I could incorporate the income approach by appraising the businesses, making certain normalization adjustments to the income statement and conclude to a value that way.
As we delved deeper into the conversation he asked a certain question that highlighted some of the differences between a real estate appraiser and a business appraiser for me. He asked if there weren't some normalizing adjustments that I could make, irregardless of any support or reasoning behind them, that would show the businesses as making a profit. In particular he mentioned how I could add back depreciation and some of the salaries.
I explained that if I added back depreciation, I would still need to subtract out an expense for capital expenditures. As far as the salary expense went, unless he could identify how the amount spent included excessive or discretionary amounts, I could not make those adjustments. I further explained that even if I were able to conclude to a value of the two businesses, I would not be including the value of the real estate as the risk of investing in real property is generally much lower than the risk associated with investing in the businesses.
There are operations where the real estate is an operating asset of the associated business, however in order to appraise those businesses, the real estate needs to be appraised first. Be careful which income stream the real estate appraiser uses, the Net Operating Income (NOI) from the hypothetical lease to the business, or the actual business' Net Income. The two income steams are not interchangeable.
I recently had a conversation with a real estate appraiser that led into some very interesting territory. We discussed the concluded value of one of his most recent projects. He told me the property operated with two different businesses on it, but because they were both owned by the property owner and neither operation showed a profit, he could only use the market and cost approaches to value the real estate. He wanted to know if I could incorporate the income approach by appraising the businesses, making certain normalization adjustments to the income statement and conclude to a value that way.
As we delved deeper into the conversation he asked a certain question that highlighted some of the differences between a real estate appraiser and a business appraiser for me. He asked if there weren't some normalizing adjustments that I could make, irregardless of any support or reasoning behind them, that would show the businesses as making a profit. In particular he mentioned how I could add back depreciation and some of the salaries.
I explained that if I added back depreciation, I would still need to subtract out an expense for capital expenditures. As far as the salary expense went, unless he could identify how the amount spent included excessive or discretionary amounts, I could not make those adjustments. I further explained that even if I were able to conclude to a value of the two businesses, I would not be including the value of the real estate as the risk of investing in real property is generally much lower than the risk associated with investing in the businesses.
There are operations where the real estate is an operating asset of the associated business, however in order to appraise those businesses, the real estate needs to be appraised first. Be careful which income stream the real estate appraiser uses, the Net Operating Income (NOI) from the hypothetical lease to the business, or the actual business' Net Income. The two income steams are not interchangeable.
March 15, 2018 - Range of Values
The vast majority of my valuation assignments have been for a purpose that required me to provide a final value conclusion consisting of a single value. Recently I was approached with a question that requires a different answer. A business owner is thinking about selling a business and wanted to know what the likely range of values would be if a buyer were to make an offer for the business.
This was a very insightful question, as "value is in the eye of the beholder". Depending on certain motivations and a buyer's specific outlook on risk, an offer to purchase might very well be different than the business' fair market value.
The fair market value of a business is based on a hypothetical condition; part of which is that both the buyer and the seller are not motivated to buy or sell. In real life, these motivations actually do exist. As a seller becomes more motivated to sell over time, that seller becomes more open to accepting a lower overall price. The opposite is also true. If the business is desirable and marketed appropriately, different buyers may be encouraged to pay more than they otherwise would have.
Sometimes the answer to the question, "What is my business worth?" may best be answered in two words. It depends.
The vast majority of my valuation assignments have been for a purpose that required me to provide a final value conclusion consisting of a single value. Recently I was approached with a question that requires a different answer. A business owner is thinking about selling a business and wanted to know what the likely range of values would be if a buyer were to make an offer for the business.
This was a very insightful question, as "value is in the eye of the beholder". Depending on certain motivations and a buyer's specific outlook on risk, an offer to purchase might very well be different than the business' fair market value.
The fair market value of a business is based on a hypothetical condition; part of which is that both the buyer and the seller are not motivated to buy or sell. In real life, these motivations actually do exist. As a seller becomes more motivated to sell over time, that seller becomes more open to accepting a lower overall price. The opposite is also true. If the business is desirable and marketed appropriately, different buyers may be encouraged to pay more than they otherwise would have.
Sometimes the answer to the question, "What is my business worth?" may best be answered in two words. It depends.
March 5, 2018 - Communication
I have been thinking quite a bit recently about how important communication is.
Occasionally, I am hired as a mutually agreed upon expert, which means that two opposing parties agree to hire me to determine the fair market value of a business. In this type of situation, good communication is extremely important. As an independent expert, I need to be able to explain to all parties exactly what I am doing and what information I am looking at to do it. My solution, is to create an email group with all parties' email addresses attached, so every time I have a question or am providing an update, everyone receives the exact same information at the same time. I believe that provides a solid conduit for some good communication.
I have been thinking quite a bit recently about how important communication is.
Occasionally, I am hired as a mutually agreed upon expert, which means that two opposing parties agree to hire me to determine the fair market value of a business. In this type of situation, good communication is extremely important. As an independent expert, I need to be able to explain to all parties exactly what I am doing and what information I am looking at to do it. My solution, is to create an email group with all parties' email addresses attached, so every time I have a question or am providing an update, everyone receives the exact same information at the same time. I believe that provides a solid conduit for some good communication.
February 27, 2018 - Upcoming Training
I am presenting on the valuation of businesses for sale and purchase in conjunction with the Small Business Development Center (SBDC) on March 16th at Canyon Springs Golf Course, Twin Falls, Idaho. There are two half day sessions. The first session is going to be focused on buying a business, how the SBDC can help and how the SBA loan process works. I will walk participants through the process of buying a business, beginning with where does one look to find a business for sale, what to look for, how to avoid paying too much for a business, making offers, and actually closing the deal.
The afternoon session will discuss how the SBDC can help a business owner prepare the business for sale, what to do with your proceeds once the deal has closed, and I will discuss getting ready to sell a business, determining an appropriate asking price, walking you through the process of confidentially marketing a business for sale, dealing with offers and counter offers, and getting to closing and the transition period afterwards.
Call the Twin Falls SBDC (208) 732-6450 if you are interested in either or both of these sessions. I'm interested in the lunch being provided.
I am presenting on the valuation of businesses for sale and purchase in conjunction with the Small Business Development Center (SBDC) on March 16th at Canyon Springs Golf Course, Twin Falls, Idaho. There are two half day sessions. The first session is going to be focused on buying a business, how the SBDC can help and how the SBA loan process works. I will walk participants through the process of buying a business, beginning with where does one look to find a business for sale, what to look for, how to avoid paying too much for a business, making offers, and actually closing the deal.
The afternoon session will discuss how the SBDC can help a business owner prepare the business for sale, what to do with your proceeds once the deal has closed, and I will discuss getting ready to sell a business, determining an appropriate asking price, walking you through the process of confidentially marketing a business for sale, dealing with offers and counter offers, and getting to closing and the transition period afterwards.
Call the Twin Falls SBDC (208) 732-6450 if you are interested in either or both of these sessions. I'm interested in the lunch being provided.
January 30, 2018 - Link to an Article I Wrote Online
I wrote a brief article for the Small Business Expert Forum providing some thoughts about getting your business ready for sale. My latest on @SMBExpertForum #smallbiz #finance
http://www.smallbusinessexpertforum.com/entrepreneurship/get-ready-sell-business/
I wrote a brief article for the Small Business Expert Forum providing some thoughts about getting your business ready for sale. My latest on @SMBExpertForum #smallbiz #finance
http://www.smallbusinessexpertforum.com/entrepreneurship/get-ready-sell-business/
January 24, 2018 - Misinformation about Businesses Potential Sale Prices
I had a conversation yesterday that drove home to me the fact that there are many business owners who are relying on only partial information found on the internet as to the likely price a buyer would pay for their business. This business owner told me he wanted to sell their company for about $200,000. As a business broker who also happens to be a valuation expert, I told him I would take the financial statements back to my office and bring back an analysis that would make sense to a potential purchaser.
This small business generated last year, about $35,000 on its bottom line. If I were to use a multiple of 5 times, I see a value of $175,000. ($35,000 times 5 = $175,000) That is very close to the $200,000 price the Seller wants. However, the seller does not pay himself any kind of salary. Also, the business operates out of a shop built to the side of the owner's personal residence, so there is no rental expense either.
Purchaser's of small businesses like these are generally looking to buy themselves a job, where they can work and earn a reasonable amount of money to put towards living expenses. So, I subtract out $25,000 for an owner salary. Unfortunately, the shop itself stays with the seller and a purchaser will have to move the business to another location. This will incur a rental expense the business has never paid before. I estimate another $10,000 a year for rent expense.
These two adjustments to the Company's bottom line change a few things. Instead of making $35,000, it is now barely breaking even. ($35,000 minus $25,000 minus $10,000 = $0) At this point, it does not matter what multiple I use as anything multiplied by zero is zero. My follow-up conversation with this seller is going to be very sad. I do not believe any purchaser will want to pay $200,000 for this business.
I had a conversation yesterday that drove home to me the fact that there are many business owners who are relying on only partial information found on the internet as to the likely price a buyer would pay for their business. This business owner told me he wanted to sell their company for about $200,000. As a business broker who also happens to be a valuation expert, I told him I would take the financial statements back to my office and bring back an analysis that would make sense to a potential purchaser.
This small business generated last year, about $35,000 on its bottom line. If I were to use a multiple of 5 times, I see a value of $175,000. ($35,000 times 5 = $175,000) That is very close to the $200,000 price the Seller wants. However, the seller does not pay himself any kind of salary. Also, the business operates out of a shop built to the side of the owner's personal residence, so there is no rental expense either.
Purchaser's of small businesses like these are generally looking to buy themselves a job, where they can work and earn a reasonable amount of money to put towards living expenses. So, I subtract out $25,000 for an owner salary. Unfortunately, the shop itself stays with the seller and a purchaser will have to move the business to another location. This will incur a rental expense the business has never paid before. I estimate another $10,000 a year for rent expense.
These two adjustments to the Company's bottom line change a few things. Instead of making $35,000, it is now barely breaking even. ($35,000 minus $25,000 minus $10,000 = $0) At this point, it does not matter what multiple I use as anything multiplied by zero is zero. My follow-up conversation with this seller is going to be very sad. I do not believe any purchaser will want to pay $200,000 for this business.
January 9, 2018 - Engagement Agreements
I have always thought that every business appraiser began every assignment with an engagement agreement. Recently I discovered this is not always the case, and I have wondered why. I refer to my engagement agreements several times throughout the assignment.
First, it provides a written record signed by the client of exactly what it is I am appraising and why. Sometimes it takes a client weeks to respond to my requests for financials or other data and I use the agreement to refresh my memory of what I am being asked to do.
Second, it lists the correct spelling of my client's name and address for when I begin writing my report and for when I am ready to send out my final invoice. There is nothing more embarrassing than forgetting the name of the person who agreed to pay my bill, even if the agreement occurred six months ago.
Third, my Errors and Omissions insurance carrier insists that every one of my assignments begin with a signed engagement agreement. I don't want to pay any higher insurance premiums than I have to, so I have gladly acceded to their request.
I have always thought that every business appraiser began every assignment with an engagement agreement. Recently I discovered this is not always the case, and I have wondered why. I refer to my engagement agreements several times throughout the assignment.
First, it provides a written record signed by the client of exactly what it is I am appraising and why. Sometimes it takes a client weeks to respond to my requests for financials or other data and I use the agreement to refresh my memory of what I am being asked to do.
Second, it lists the correct spelling of my client's name and address for when I begin writing my report and for when I am ready to send out my final invoice. There is nothing more embarrassing than forgetting the name of the person who agreed to pay my bill, even if the agreement occurred six months ago.
Third, my Errors and Omissions insurance carrier insists that every one of my assignments begin with a signed engagement agreement. I don't want to pay any higher insurance premiums than I have to, so I have gladly acceded to their request.
December 31, 2017 - End of the Year 2017 - More Fun with Excel!
Another fun Excel tip since 2017 has come to a close! Excel has a function called YEAR. When you use it, you are able to isolate the year out of any date format used in Excel. If there is a date mentioned in the spreadsheet, type =YEAR( then select the cell with a date in it and use the close paren ) then hit enter. Voila! There is the year all by itself.
This function can also be used to create dates for use in other analyses, in conjunction with the DAY and MONTH functions. You can use a set of criteria, use those functions to create the applicable date and measure lengths of time from a date that varies based on whatever criteria you need!
For example, one of my favorite projects I was asked to create once, was a payroll calendar. I needed the spreadsheet to list only those clients whose payroll was due the week the payroll department was focused on. I needed it to update itself every week. I needed it to show when bank holidays were observed so payrolls would not be filed too late and I needed it to allow for clients whose employees were paid twice a week, those who were paid every Thursday, and those who were always paid on the 23rd or before if the 23rd fell on a weekend. That was a very entertaining project and it was all done without any VBA or macros. The YEAR, MONTH, and DAY functions were very useful.
Let me know if you have any Excel projects you would like some help on.
Another fun Excel tip since 2017 has come to a close! Excel has a function called YEAR. When you use it, you are able to isolate the year out of any date format used in Excel. If there is a date mentioned in the spreadsheet, type =YEAR( then select the cell with a date in it and use the close paren ) then hit enter. Voila! There is the year all by itself.
This function can also be used to create dates for use in other analyses, in conjunction with the DAY and MONTH functions. You can use a set of criteria, use those functions to create the applicable date and measure lengths of time from a date that varies based on whatever criteria you need!
For example, one of my favorite projects I was asked to create once, was a payroll calendar. I needed the spreadsheet to list only those clients whose payroll was due the week the payroll department was focused on. I needed it to update itself every week. I needed it to show when bank holidays were observed so payrolls would not be filed too late and I needed it to allow for clients whose employees were paid twice a week, those who were paid every Thursday, and those who were always paid on the 23rd or before if the 23rd fell on a weekend. That was a very entertaining project and it was all done without any VBA or macros. The YEAR, MONTH, and DAY functions were very useful.
Let me know if you have any Excel projects you would like some help on.
December 12, 2017 - Excel Functions Are Fun! - MID
Just to be different, today I wanted to share one of my favorite Excel tips I use all the time! I use this to pull a number out of a sentence written in a cell in my spreadsheet, and then use that number to do math. I'm going to provide step by step instructions on the full version of this post so anyone can learn by doing. Let me know what you think.
Let's say I have a phrase in my spreadsheet describing the percentage of lines Vizzini has in the movie, The Princess Bride, where he says the word, "Inconceivable." I type out the words just like this in a random cell in Excel. In my spreadsheet it is in cell I26.
40% of Vizzini's lines include the word, "Inconceivable."
(Some of you may be wondering why would I write the whole sentence out in one single cell and not simply place the 40% in it's own cell to make the next math formula so much easier to write. I actually have many reasons for why I do this and will be happy to explain them if you would like to send me a private message to do so, but perhaps the most important reason is that I like my spreadsheets to look pretty and not forced. Also, "Because I can" is a fun reason too. )
Now, there are many methods one can use to pull the number out of the text string. The choice of which to use depends on where in the sentence the number is actually located. In this case my number is at the front so I will use the MID function in combination with the FIND function.
Click the cell immediately to the left of of the phrase you typed, and either copy and paste the following, or type it out. I'll explain how I type this formula next.
=MID(I26,1,FIND(" ",I26)-1)
As I begin typing any function out, I start with the 'equals sign' and then type the first 2 or 3 letters. At that point, you may have noticed a list shows up with several functions that start with those same letters, I make sure the function I want is selected in that list and then I tap the TAB key. That finishes the spelling out of the function's name as well as placing the beginning parentheses for the formula to work. That leaves me with the following:
=MID(
Then, I simply tap the arrow key to select the cell that has the data I want in it. The next step is to type a comma so Excel knows that I am ready to move on to the next step in the MID function's operation. In this case the start number is 1, as the very first part of the number is the first character on the text string. Another comma follows and this is where it gets real fun! I include the FIND function to tell Excel how far I want it to look for the end of my number. This way I can have 15 digits or only 1 digit involved and Excel will grab them all.
I have FIND looking for the first space between words. That is what the quotes surrounding a space are describing. This way, I can have a percentage, or not, and it won't matter as there will always be a space after the last part of a number. The comma in the FIND function is used to tell Excel in what cell you want it looking for that space. Generally, this is in the same cell as the original text. The next step is to close the FIND formula with a closing parentheses, but you are not done. I include a minus one as part of the last portion of the MID formula, because once Excel has found that first space between words, I don't want Excel to include that space in my result. Then a closing parentheses for the MID function.
Voila! Now you have a number sitting outside the text string ready for you to do math with it. If you do not use this result in a further equation, Excel will list the value returned, in this case a 40%, as a text formatted number. If you would like, you can use the NUMBERVALUE function to force Excel to treat the result as the number it looks like, or you can simply include the results from your analysis of how many times the Fire Swamp is mentioned throughout the same movie.
If you have any questions or would like to learn about any other feature that Excel makes available, please let me know.
Just to be different, today I wanted to share one of my favorite Excel tips I use all the time! I use this to pull a number out of a sentence written in a cell in my spreadsheet, and then use that number to do math. I'm going to provide step by step instructions on the full version of this post so anyone can learn by doing. Let me know what you think.
Let's say I have a phrase in my spreadsheet describing the percentage of lines Vizzini has in the movie, The Princess Bride, where he says the word, "Inconceivable." I type out the words just like this in a random cell in Excel. In my spreadsheet it is in cell I26.
40% of Vizzini's lines include the word, "Inconceivable."
(Some of you may be wondering why would I write the whole sentence out in one single cell and not simply place the 40% in it's own cell to make the next math formula so much easier to write. I actually have many reasons for why I do this and will be happy to explain them if you would like to send me a private message to do so, but perhaps the most important reason is that I like my spreadsheets to look pretty and not forced. Also, "Because I can" is a fun reason too. )
Now, there are many methods one can use to pull the number out of the text string. The choice of which to use depends on where in the sentence the number is actually located. In this case my number is at the front so I will use the MID function in combination with the FIND function.
Click the cell immediately to the left of of the phrase you typed, and either copy and paste the following, or type it out. I'll explain how I type this formula next.
=MID(I26,1,FIND(" ",I26)-1)
As I begin typing any function out, I start with the 'equals sign' and then type the first 2 or 3 letters. At that point, you may have noticed a list shows up with several functions that start with those same letters, I make sure the function I want is selected in that list and then I tap the TAB key. That finishes the spelling out of the function's name as well as placing the beginning parentheses for the formula to work. That leaves me with the following:
=MID(
Then, I simply tap the arrow key to select the cell that has the data I want in it. The next step is to type a comma so Excel knows that I am ready to move on to the next step in the MID function's operation. In this case the start number is 1, as the very first part of the number is the first character on the text string. Another comma follows and this is where it gets real fun! I include the FIND function to tell Excel how far I want it to look for the end of my number. This way I can have 15 digits or only 1 digit involved and Excel will grab them all.
I have FIND looking for the first space between words. That is what the quotes surrounding a space are describing. This way, I can have a percentage, or not, and it won't matter as there will always be a space after the last part of a number. The comma in the FIND function is used to tell Excel in what cell you want it looking for that space. Generally, this is in the same cell as the original text. The next step is to close the FIND formula with a closing parentheses, but you are not done. I include a minus one as part of the last portion of the MID formula, because once Excel has found that first space between words, I don't want Excel to include that space in my result. Then a closing parentheses for the MID function.
Voila! Now you have a number sitting outside the text string ready for you to do math with it. If you do not use this result in a further equation, Excel will list the value returned, in this case a 40%, as a text formatted number. If you would like, you can use the NUMBERVALUE function to force Excel to treat the result as the number it looks like, or you can simply include the results from your analysis of how many times the Fire Swamp is mentioned throughout the same movie.
If you have any questions or would like to learn about any other feature that Excel makes available, please let me know.
November 30, 2017 - Overpayment for a Business Purchase
BUSINESS BUYERS BEWARE!!! Paying too much for a business is the fastest way to kill a profitable enterprise, and even worse, its death happens soon after your big check has been deposited into the Seller's bank account.
A business requires cash to "live". You need cash to pay your suppliers, your employees, your operating expenses, your own salary, and your debt service. If you pay too much in a business purchase transaction, your debt service sucks down all your excess cash and if you have even a slight hiccup in operations, you may not have enough to cover your loan, your employees salaries, or your suppliers. Once you stop paying one or the other, the whole operation falls down and you are left with having paid a lot of money for a now bankrupt company.
As a business appraiser who is also a business broker, I have run into many different businesses that are offered for sale at prices that at first glance seem only slightly high, but after looking closely and completing my own analyses, are actually outrageously expensive. I am always very happy to assist anyone looking to buy a business, to verify that they are not overpaying for it.
When a person buys a business, there are typically several goals in mind besides simply owning one's own business. Some people want to live the lifestyle that owning a certain business makes possible. Others are looking for something within a specific geographic area in order to live near family or for other reasons. Whatever the extra goals are, they tend to lead a buyer into deciding that paying a, "little extra" to get just what they want is ok.
Where people get into trouble is not understanding that neither their CPA, lender, or attorney can be relied on to tell them what the business they want to buy is actually worth. Unless an adviser actually has specific valuation training, he or she doesn't necessarily understand the difference between book value and fair market value, or if they do, simply do not know how to identify the difference.
Operating businesses typically have some intangible value, but unless one knows how to identify it, it is easy to fall into the trap of assuming that the all of the portion of an asking price that exceeds the value of the tangible assets is actually Blue Sky. Sometimes, a large portion of it is actually located further up, in Outer Space. So, in order to avoid fiscally orbiting the moon without a spacesuit, make sure the business purchase you are contemplating is well grounded.
BUSINESS BUYERS BEWARE!!! Paying too much for a business is the fastest way to kill a profitable enterprise, and even worse, its death happens soon after your big check has been deposited into the Seller's bank account.
A business requires cash to "live". You need cash to pay your suppliers, your employees, your operating expenses, your own salary, and your debt service. If you pay too much in a business purchase transaction, your debt service sucks down all your excess cash and if you have even a slight hiccup in operations, you may not have enough to cover your loan, your employees salaries, or your suppliers. Once you stop paying one or the other, the whole operation falls down and you are left with having paid a lot of money for a now bankrupt company.
As a business appraiser who is also a business broker, I have run into many different businesses that are offered for sale at prices that at first glance seem only slightly high, but after looking closely and completing my own analyses, are actually outrageously expensive. I am always very happy to assist anyone looking to buy a business, to verify that they are not overpaying for it.
When a person buys a business, there are typically several goals in mind besides simply owning one's own business. Some people want to live the lifestyle that owning a certain business makes possible. Others are looking for something within a specific geographic area in order to live near family or for other reasons. Whatever the extra goals are, they tend to lead a buyer into deciding that paying a, "little extra" to get just what they want is ok.
Where people get into trouble is not understanding that neither their CPA, lender, or attorney can be relied on to tell them what the business they want to buy is actually worth. Unless an adviser actually has specific valuation training, he or she doesn't necessarily understand the difference between book value and fair market value, or if they do, simply do not know how to identify the difference.
Operating businesses typically have some intangible value, but unless one knows how to identify it, it is easy to fall into the trap of assuming that the all of the portion of an asking price that exceeds the value of the tangible assets is actually Blue Sky. Sometimes, a large portion of it is actually located further up, in Outer Space. So, in order to avoid fiscally orbiting the moon without a spacesuit, make sure the business purchase you are contemplating is well grounded.
November 21, 2017 - Thankfulness
'Tis the season to be extra grateful for turkey dinners and clients who understand that I actually do need those documents that I asked for on my document request list. "Here are two years' worth of tax returns. Value the business, please."
It's one thing if the business has only been around for two years, but if the Company in question has 20 years or more of operational history it is helpful to look at more than two years' worth of data. I want to see if I can identify any trends going forward; for example, have costs of goods sold been creeping up as a percentage of revenues?
Why do I need copies of the last five years tax returns and financial statement for the same period? Well, tax returns are prepared for tax purposes and they do provide some good information, but financial statements are prepared with the idea of actually showing how the business has been performing. I need to see both perspectives in order to fully understand the operations.
A depreciation schedule is also quite helpful. I need to know how often certain equipment is being replaced and what will likely be on the Christmas wish list for next year. This helps me identify how much cash I need to allocate in my projections for future capital expenditures.
A copy of the lease allows me to identify potential risks going forward, such as the last renewal option was exercised two years ago, and now the Company will have to renegotiate a new lease in order to continue operations out of the same location. Have market lease rates increased in the last 10 years?
I am very grateful for all the work I have been able to do for all of my clients! I am just slightly more grateful for the ones who don't make me beg and plead for information pertinent to the assignment. Happy Thanksgiving to all, and to all a great work season!
'Tis the season to be extra grateful for turkey dinners and clients who understand that I actually do need those documents that I asked for on my document request list. "Here are two years' worth of tax returns. Value the business, please."
It's one thing if the business has only been around for two years, but if the Company in question has 20 years or more of operational history it is helpful to look at more than two years' worth of data. I want to see if I can identify any trends going forward; for example, have costs of goods sold been creeping up as a percentage of revenues?
Why do I need copies of the last five years tax returns and financial statement for the same period? Well, tax returns are prepared for tax purposes and they do provide some good information, but financial statements are prepared with the idea of actually showing how the business has been performing. I need to see both perspectives in order to fully understand the operations.
A depreciation schedule is also quite helpful. I need to know how often certain equipment is being replaced and what will likely be on the Christmas wish list for next year. This helps me identify how much cash I need to allocate in my projections for future capital expenditures.
A copy of the lease allows me to identify potential risks going forward, such as the last renewal option was exercised two years ago, and now the Company will have to renegotiate a new lease in order to continue operations out of the same location. Have market lease rates increased in the last 10 years?
I am very grateful for all the work I have been able to do for all of my clients! I am just slightly more grateful for the ones who don't make me beg and plead for information pertinent to the assignment. Happy Thanksgiving to all, and to all a great work season!
November 16, 2017 - Questions
Google has a great gig! When I'm lost, Google knows how to get me to my destination. When I need to find information on almost anything, Google points me in the right direction. Most of the time! However, Google does not know the "why" behind the questions I am asking and the responses Google comes up with are not necessarily the responses I need. What can get most frustrating is when I have spent 30 or 40 minutes chasing down a piece of information, only to discover that it doesn't actually help me at all.
This is why I really appreciate being able to ask questions of knowledgeable experts. They take the time to find out why I'm asking these questions, and can guide me to the answers that I actually need.
I have had several occasions this past week to answer questions from fellow valuation experts, and I take great pleasure in exploring the "why" behind those questions. I feel like I am paying forward all the help that I have received over the years. Google does have a great gig, but I really enjoy mine!
Google has a great gig! When I'm lost, Google knows how to get me to my destination. When I need to find information on almost anything, Google points me in the right direction. Most of the time! However, Google does not know the "why" behind the questions I am asking and the responses Google comes up with are not necessarily the responses I need. What can get most frustrating is when I have spent 30 or 40 minutes chasing down a piece of information, only to discover that it doesn't actually help me at all.
This is why I really appreciate being able to ask questions of knowledgeable experts. They take the time to find out why I'm asking these questions, and can guide me to the answers that I actually need.
I have had several occasions this past week to answer questions from fellow valuation experts, and I take great pleasure in exploring the "why" behind those questions. I feel like I am paying forward all the help that I have received over the years. Google does have a great gig, but I really enjoy mine!
November 8, 2017 - Quality of financial statements
I've had this same discussion with a few different people over the years. We've discussed the impact poor financial records have on the analysis in the valuation of a privately held business. Now I understand that not everyone feels the need to pay for audited financial statements with a full set of accountant's notes, however I wish that their balance sheets would at least balance and that the income statements and balance sheets would always flow together nicely! I have had two assignments now, almost back to back, where the quality of the data provided to me was much less than ideal.
Please note, that if I run into issues with the financial statements, the indicated value of the company will likely decline. If the statements are hard to decipher or if there are multiple errors in them, the associated risk of a hypothetical buyer investing in the company will increase. Higher risk = lower value.
If anyone would at least like a recommendation for an accountant who does a great job and has a reasonable billing rate, I can provide names of quite a few, in several states.
I've had this same discussion with a few different people over the years. We've discussed the impact poor financial records have on the analysis in the valuation of a privately held business. Now I understand that not everyone feels the need to pay for audited financial statements with a full set of accountant's notes, however I wish that their balance sheets would at least balance and that the income statements and balance sheets would always flow together nicely! I have had two assignments now, almost back to back, where the quality of the data provided to me was much less than ideal.
Please note, that if I run into issues with the financial statements, the indicated value of the company will likely decline. If the statements are hard to decipher or if there are multiple errors in them, the associated risk of a hypothetical buyer investing in the company will increase. Higher risk = lower value.
If anyone would at least like a recommendation for an accountant who does a great job and has a reasonable billing rate, I can provide names of quite a few, in several states.
November 1, 2017 - Listing a business for sale?
I'm currently working with a local business owner, who has been involved in his industry for over 40 years. I came across his name while cold calling last month. I asked him if he'd ever thought about selling his business. He said that he had been considering selling recently. I scheduled a time to swing by when he had some time to spare. The meeting went well. I was able to tour the shop and see how the widgets were made. It is very obvious that the Seller knows how to operate in his industry and has spent the last number of years acquiring the equipment to do it well. I asked for the last three years worth of financial statements and some year-to-date numbers so I could go compare his operation to the industry average and pull market comparables to see what price we should set for the business.
Last night, as I went through his numbers I discovered something. The reason he had been considering selling is because he has gotten tired. Revenues have been decreasing, large accounts have switched to different providers and he hasn't replaced them. If he had decided to sell his business two years ago, it would likely have sold for twice what it is worth now.
This is one of the most disappointing messages to share with a business owner. Today, I am going to be sharing my conclusions with him, and I am going to watch his face fall as I confirm his fears. He knows the shop is not as profitable as it has been, but he has been hoping that its value hasn't been impacted. He will have a difficult decision to make, does he list it for sale and hope for the best, or does he continue as he has, knowing that eventually his business will simply close its doors, leaving him with nothing but some equipment and inventory to sell off.
I'm currently working with a local business owner, who has been involved in his industry for over 40 years. I came across his name while cold calling last month. I asked him if he'd ever thought about selling his business. He said that he had been considering selling recently. I scheduled a time to swing by when he had some time to spare. The meeting went well. I was able to tour the shop and see how the widgets were made. It is very obvious that the Seller knows how to operate in his industry and has spent the last number of years acquiring the equipment to do it well. I asked for the last three years worth of financial statements and some year-to-date numbers so I could go compare his operation to the industry average and pull market comparables to see what price we should set for the business.
Last night, as I went through his numbers I discovered something. The reason he had been considering selling is because he has gotten tired. Revenues have been decreasing, large accounts have switched to different providers and he hasn't replaced them. If he had decided to sell his business two years ago, it would likely have sold for twice what it is worth now.
This is one of the most disappointing messages to share with a business owner. Today, I am going to be sharing my conclusions with him, and I am going to watch his face fall as I confirm his fears. He knows the shop is not as profitable as it has been, but he has been hoping that its value hasn't been impacted. He will have a difficult decision to make, does he list it for sale and hope for the best, or does he continue as he has, knowing that eventually his business will simply close its doors, leaving him with nothing but some equipment and inventory to sell off.
October 12, 2017 - What is Value?
"Value is what someone would pay for it!"
This was explained to me by a person who had made an offer to buy a particular business, and wanted me to use their offer as the basis for my business appraisal. I explained that there are several different definitions of value, and what the lender wanted me to use was Fair Market Value. This buyer had some very specific reasons for why he was trying to buy this particular business and the profits he was going to derive were based, in no small part, on the expected synergies that adding this operation to what he currently had were going to generate. I explained the difference between Investment Value, Fair Market Value and several other value definitions, and how the applicable standard of value impacted the valuation process. Afterwards, I was able to complete the assignment and there were no further objections from the buyer, even though my value conclusion was different than the amount he was offering.
It is important to use the appropriate standard of value, and to watch for potential "mission creep" in the assignment. My purpose was to value the business to assist a lender in financing the acquisition, not to validate the buyer's investment criteria.
"Value is what someone would pay for it!"
This was explained to me by a person who had made an offer to buy a particular business, and wanted me to use their offer as the basis for my business appraisal. I explained that there are several different definitions of value, and what the lender wanted me to use was Fair Market Value. This buyer had some very specific reasons for why he was trying to buy this particular business and the profits he was going to derive were based, in no small part, on the expected synergies that adding this operation to what he currently had were going to generate. I explained the difference between Investment Value, Fair Market Value and several other value definitions, and how the applicable standard of value impacted the valuation process. Afterwards, I was able to complete the assignment and there were no further objections from the buyer, even though my value conclusion was different than the amount he was offering.
It is important to use the appropriate standard of value, and to watch for potential "mission creep" in the assignment. My purpose was to value the business to assist a lender in financing the acquisition, not to validate the buyer's investment criteria.
October 11, 2017 - Maximizing or Minimizing the Value of a Business
The Magic Valley Estate Planning Council, www.mvepc.org, invited me to speak to them yesterday morning. I gave an excellent presentation about strategies to maximize the value of a privately held business. (I also talked briefly about how one could minimize the value of a business.) There was quite a bit of discussion and many very good questions. I hope I get invited to speak again!
The Magic Valley Estate Planning Council, www.mvepc.org, invited me to speak to them yesterday morning. I gave an excellent presentation about strategies to maximize the value of a privately held business. (I also talked briefly about how one could minimize the value of a business.) There was quite a bit of discussion and many very good questions. I hope I get invited to speak again!
October 5, 2017 - Confidentiality as a Price Multiplier
I was asked how to increase the value of a business being placed on the market the other day. Part of my response made an impression. For some reason, they hadn't ever considered the impact advertising their business for sale would have on the value of their business. Confidentiality is important for trade secrets, intangible property, proprietary processes, and selling businesses.
Some people think that offering to sell their business to their main competitor is a good idea. What happens when your competition includes a note along with his competing bid for new business, that he knows that you trying to sell? How likely are you to win new contracts, even if you have the better bid?
I have run into others who place a sign on the front of their building that says, "Business for sale, inquire within." What happens to one's employees, vendors, and suppliers when they find out the business is for sale? Or even worse, one's landlord? Maintaining a full staff of well trained employees, a strong relationship with vendors and suppliers and making sure the building does not get leased to someone else while marketing your business for sale, are all key assets that add value to the business. A buyer wants the staff to stay and to be able to rely on an uninterrupted supply chain, and to be able to continue to use the same location customers have been coming to for years.
There are other ways to increase the value of a business; if you are interested, let me know.
I was asked how to increase the value of a business being placed on the market the other day. Part of my response made an impression. For some reason, they hadn't ever considered the impact advertising their business for sale would have on the value of their business. Confidentiality is important for trade secrets, intangible property, proprietary processes, and selling businesses.
Some people think that offering to sell their business to their main competitor is a good idea. What happens when your competition includes a note along with his competing bid for new business, that he knows that you trying to sell? How likely are you to win new contracts, even if you have the better bid?
I have run into others who place a sign on the front of their building that says, "Business for sale, inquire within." What happens to one's employees, vendors, and suppliers when they find out the business is for sale? Or even worse, one's landlord? Maintaining a full staff of well trained employees, a strong relationship with vendors and suppliers and making sure the building does not get leased to someone else while marketing your business for sale, are all key assets that add value to the business. A buyer wants the staff to stay and to be able to rely on an uninterrupted supply chain, and to be able to continue to use the same location customers have been coming to for years.
There are other ways to increase the value of a business; if you are interested, let me know.
September 28, 2017 - Why is it Always 35%
Thirty-Five Percent!! I have read a lot of business appraisal reports over the years. Quite a few of them were prepared for estate and gift taxes. Years ago, someone noticed that the average discount allowed by the IRS is around 35%. It is amazing how many reports tend to arrive at around that percentage discount.
I believe that the risk of the underlying assets held by the Company being appraised should factor significantly in the analysis. If the holding company owns only cash and marketable securities, the risk is much less and the overall discount for a partial ownership interest should be smaller. However, if the holding company is holding a single parcel of undeveloped real estate, located well away from the path of development, and generating little to no income, then that partial ownership interest's overall discount should be higher than the average.
A well written report provides support for the selected discounts, presented in a logical and easy to follow manner. Don't simply plug about 35% and move on. Neither your client, nor the end user of the report are well served by that.
Thirty-Five Percent!! I have read a lot of business appraisal reports over the years. Quite a few of them were prepared for estate and gift taxes. Years ago, someone noticed that the average discount allowed by the IRS is around 35%. It is amazing how many reports tend to arrive at around that percentage discount.
I believe that the risk of the underlying assets held by the Company being appraised should factor significantly in the analysis. If the holding company owns only cash and marketable securities, the risk is much less and the overall discount for a partial ownership interest should be smaller. However, if the holding company is holding a single parcel of undeveloped real estate, located well away from the path of development, and generating little to no income, then that partial ownership interest's overall discount should be higher than the average.
A well written report provides support for the selected discounts, presented in a logical and easy to follow manner. Don't simply plug about 35% and move on. Neither your client, nor the end user of the report are well served by that.
September 17, 2017 - Art vs. Science
Business appraisal has been described as being as much an art as it is a science. This weekend I explained the "why" behind that description. The science part is mathematical operations, data gathering, and statistical analysis. Most of these are things any computer can do, but what earns good appraisers their fees is the art portion. Once data has been gathered, who decides if it was even the right data to collect? A good appraiser will pull all sorts of puzzle pieces together and identify holes where additional information is needed, or will identify what that missing information should have been, based on the part of the picture the other pieces show.
Some businesses simply do not have all the data that a simple calculation needs to provide a reasonable value. I've had an assignment where the business seller had sold down his inventory in the six months prior to closing a sale in an attempt to gain a "premium" in the sale of the business. In another, the owner had stopped replacing older equipment for two years, driving up the reported earnings of the business with his "saved" capital expenditures dollars. A knowledgeable appraiser can point out deficiencies like these and account for them in the analysis. Being able to understand the interplay between various aspects of a business' operations and their impact on both cash flow and overall value is just as important as being able to accurately calculate all of the formulae that make up the application of a Discounted Cash Flow Model.
I am happy to answer any questions, just give me a call.
Business appraisal has been described as being as much an art as it is a science. This weekend I explained the "why" behind that description. The science part is mathematical operations, data gathering, and statistical analysis. Most of these are things any computer can do, but what earns good appraisers their fees is the art portion. Once data has been gathered, who decides if it was even the right data to collect? A good appraiser will pull all sorts of puzzle pieces together and identify holes where additional information is needed, or will identify what that missing information should have been, based on the part of the picture the other pieces show.
Some businesses simply do not have all the data that a simple calculation needs to provide a reasonable value. I've had an assignment where the business seller had sold down his inventory in the six months prior to closing a sale in an attempt to gain a "premium" in the sale of the business. In another, the owner had stopped replacing older equipment for two years, driving up the reported earnings of the business with his "saved" capital expenditures dollars. A knowledgeable appraiser can point out deficiencies like these and account for them in the analysis. Being able to understand the interplay between various aspects of a business' operations and their impact on both cash flow and overall value is just as important as being able to accurately calculate all of the formulae that make up the application of a Discounted Cash Flow Model.
I am happy to answer any questions, just give me a call.
September 11, 2017 - Good Work, Cheap Work, Fast Work
I remember seeing on the wall of a manufacturing company, a sign that announced clearly to all who cared to read it, that this shop did three types of work; Good work, Cheap work, and Fast work. A customer could have any two of the three options. If you wanted your job done good and fast, it wouldn't be cheap. If you wanted your job done good and cheap it wouldn't be fast. If you wanted your job done cheap and fast it wouldn't be good.
I've often considered that particular sign as I am asked to bid on valuation work that comes my way. I realized the other day, that I only offer the first two types of work. If someone wants their company appraised using the cheap and fast method, there are several options available to them, but I am not one of them.
I am however, always willing to answer questions, and if I am able to provide additional assistance as well, I will.
I remember seeing on the wall of a manufacturing company, a sign that announced clearly to all who cared to read it, that this shop did three types of work; Good work, Cheap work, and Fast work. A customer could have any two of the three options. If you wanted your job done good and fast, it wouldn't be cheap. If you wanted your job done good and cheap it wouldn't be fast. If you wanted your job done cheap and fast it wouldn't be good.
I've often considered that particular sign as I am asked to bid on valuation work that comes my way. I realized the other day, that I only offer the first two types of work. If someone wants their company appraised using the cheap and fast method, there are several options available to them, but I am not one of them.
I am however, always willing to answer questions, and if I am able to provide additional assistance as well, I will.
September 4, 2017 - Machinery & Equipment Appraisals
Occasionally, the business I am asked to appraise, generates a good income for the owner, but not much else. In cases like these, the best approach is often to use an asset based method. Depending on the specific situation, a machinery and equipment appraisal may be useful. Used equipment, even if fully depreciated, still has value. Especially if it is still in use generating income for the business. Unfortunately, the cost to buy new equipment, while useful for insurance purposes, is not typically applicable in the valuation of an operating business. One needs to identify the cost to replace equipment in a similar condition to that owned by the business in question. Part of this process involves knowing the hours on the meter, miles on the odometer, and the maintenance schedule of each piece. The whole process can take some time, but providing a supportable value of the assets owned, can be a key part of the analysis.
Occasionally, the business I am asked to appraise, generates a good income for the owner, but not much else. In cases like these, the best approach is often to use an asset based method. Depending on the specific situation, a machinery and equipment appraisal may be useful. Used equipment, even if fully depreciated, still has value. Especially if it is still in use generating income for the business. Unfortunately, the cost to buy new equipment, while useful for insurance purposes, is not typically applicable in the valuation of an operating business. One needs to identify the cost to replace equipment in a similar condition to that owned by the business in question. Part of this process involves knowing the hours on the meter, miles on the odometer, and the maintenance schedule of each piece. The whole process can take some time, but providing a supportable value of the assets owned, can be a key part of the analysis.
August 27, 2017 - Reviewing Reports
I was recently asked to review a business appraisal report performed by another expert. Appraisal review is its own art. Since each appraisal is actually an opinion developed by the appraiser, it can be easy to fall into the trap of taking your red pen and marking up all the areas where your own opinion and the other expert's differ. In order to provide a useful review, one needs to stick to the facts. Was there a math error, and if so, what was its impact? Did the other expert make an assertion that you disagree with or was the assertion factually incorrect? Remember, just because you have a different opinion, does not make the other expert's opinion wrong.
I was recently asked to review a business appraisal report performed by another expert. Appraisal review is its own art. Since each appraisal is actually an opinion developed by the appraiser, it can be easy to fall into the trap of taking your red pen and marking up all the areas where your own opinion and the other expert's differ. In order to provide a useful review, one needs to stick to the facts. Was there a math error, and if so, what was its impact? Did the other expert make an assertion that you disagree with or was the assertion factually incorrect? Remember, just because you have a different opinion, does not make the other expert's opinion wrong.
August 21, 2017 - Premise of Value
Some businesses are worth more dead than alive. There are two sets of basic assumptions for appraising a privately held business; these are called Premises of Value. Either a business will be valued under the Premise that it will continue as a going concern on into the foreseeable future, or the Premise is that the business will undergo a liquidation in the foreseeable future.
I have had a few appraisal assignments where the Premise changed in the middle of the analysis. Halfway through the one of these projects, I realized that the Premise of Value I was using of a going concern simply did not make sense. This business was not going to survive much longer operating as it was. I completed the assignment under the Premise of Value of liquidation, and explained to the owners that once the business runs out of cash, it becomes impossible to make payroll or pay suppliers and once that happens, they will no longer either have product to sell or employees to sell it.
Selecting the correct Premise of Value is one of the key steps in any business appraisal assignment.
Some businesses are worth more dead than alive. There are two sets of basic assumptions for appraising a privately held business; these are called Premises of Value. Either a business will be valued under the Premise that it will continue as a going concern on into the foreseeable future, or the Premise is that the business will undergo a liquidation in the foreseeable future.
I have had a few appraisal assignments where the Premise changed in the middle of the analysis. Halfway through the one of these projects, I realized that the Premise of Value I was using of a going concern simply did not make sense. This business was not going to survive much longer operating as it was. I completed the assignment under the Premise of Value of liquidation, and explained to the owners that once the business runs out of cash, it becomes impossible to make payroll or pay suppliers and once that happens, they will no longer either have product to sell or employees to sell it.
Selecting the correct Premise of Value is one of the key steps in any business appraisal assignment.
August 14, 2017 - Independence
According to the definition of Appraiser as listed in USPAP, we are, "expected to perform valuation services competently and in a manner that is independent, impartial, and objective." I would like to focus on the word "Independent" for a moment. Why do people rely on an appraiser to be independent? I came up with a few reasons.
It is because an independent appraiser does not gloss over potential detrimental facts. It is because an independent appraiser knows that transactions are made up of two parties and BOTH the sellers and buyers have to agree that the deal is reasonable if it has any chance of taking place. It is because an independent appraiser is able to explain the reasoning behind uncomfortable assumptions. It is because an independent appraiser is able to see both the forest and the trees while simultaneously pointing out which of the trees are stronger and which might need some pruning. An independent appraiser performs a real service to the listed users of an appraisal report, regardless of who is footing the bill.
According to the definition of Appraiser as listed in USPAP, we are, "expected to perform valuation services competently and in a manner that is independent, impartial, and objective." I would like to focus on the word "Independent" for a moment. Why do people rely on an appraiser to be independent? I came up with a few reasons.
It is because an independent appraiser does not gloss over potential detrimental facts. It is because an independent appraiser knows that transactions are made up of two parties and BOTH the sellers and buyers have to agree that the deal is reasonable if it has any chance of taking place. It is because an independent appraiser is able to explain the reasoning behind uncomfortable assumptions. It is because an independent appraiser is able to see both the forest and the trees while simultaneously pointing out which of the trees are stronger and which might need some pruning. An independent appraiser performs a real service to the listed users of an appraisal report, regardless of who is footing the bill.
August 7, 2017 - Test of Reasonableness
Part of the valuation process that sometimes gets neglected is a test to verify that one's concluded value actually makes sense. With all the puzzle pieces a business appraiser has to wrangle and fit together, it is not unheard of to occasionally miss something which will lead to a value conclusion that does NOT make sense. One such test is to use various industry rules of thumb to see if the concluded value falls within the range they provide. It's not quite as simple as it sounds. Rules of thumb are used by business brokers to help determine the price a business should sell for. Most privately held businesses are sold as asset sales, not stock sales. Most business appraisals are for stock values, not asset values. In order to accurately use the industry rules of thumb as a test for reasonableness, the concluded value needs to be converted from a stock value, to an asset value; otherwise the appraiser is comparing apples and pineapples and the reasonableness check is not valid.
Part of the valuation process that sometimes gets neglected is a test to verify that one's concluded value actually makes sense. With all the puzzle pieces a business appraiser has to wrangle and fit together, it is not unheard of to occasionally miss something which will lead to a value conclusion that does NOT make sense. One such test is to use various industry rules of thumb to see if the concluded value falls within the range they provide. It's not quite as simple as it sounds. Rules of thumb are used by business brokers to help determine the price a business should sell for. Most privately held businesses are sold as asset sales, not stock sales. Most business appraisals are for stock values, not asset values. In order to accurately use the industry rules of thumb as a test for reasonableness, the concluded value needs to be converted from a stock value, to an asset value; otherwise the appraiser is comparing apples and pineapples and the reasonableness check is not valid.
July 25, 2017 - How to Improve a Business' Value
Many people have seen this formula: Value = Income/Risk. In the world of business valuation experts, determining those two variables, "Income" and "Risk" occupy most of our efforts. Recently I was asked how a business owner could increase the value of his business. After sharing this formula with him, I pointed out he could either make more money, or reduce the risk of achieving that income stream. His next question was, "How do I reduce my risk?"
Well, first we have to find out where the risk is. That is one of the benefits of having the business appraised. We have to find out what that "Risk" variable is as part of our analysis. Once we identify it, we can help answer that question of how to reduce it.
Many people have seen this formula: Value = Income/Risk. In the world of business valuation experts, determining those two variables, "Income" and "Risk" occupy most of our efforts. Recently I was asked how a business owner could increase the value of his business. After sharing this formula with him, I pointed out he could either make more money, or reduce the risk of achieving that income stream. His next question was, "How do I reduce my risk?"
Well, first we have to find out where the risk is. That is one of the benefits of having the business appraised. We have to find out what that "Risk" variable is as part of our analysis. Once we identify it, we can help answer that question of how to reduce it.
July 17, 2017 - Weighted Average of Historical Earnings
The value of a going concern, is based on its expected future income. A very common method used by some business appraisers to project the future for a stable business, is to use the last several year's financial statements and weight them on a sliding scale of which year is most representative of the future. Oftentimes the weightings are 5, 4, 3, 2, 1 where Five is placed on the most recent year. What is very interesting about this method, is assuming there is any inflation at all going forward, the results will indicate a decline in growth for the projected future year. If the business has been showing 3 - to 5% growth each year previously, does it make sense to project a 5 - 6% drop the next year?
The value of a going concern, is based on its expected future income. A very common method used by some business appraisers to project the future for a stable business, is to use the last several year's financial statements and weight them on a sliding scale of which year is most representative of the future. Oftentimes the weightings are 5, 4, 3, 2, 1 where Five is placed on the most recent year. What is very interesting about this method, is assuming there is any inflation at all going forward, the results will indicate a decline in growth for the projected future year. If the business has been showing 3 - to 5% growth each year previously, does it make sense to project a 5 - 6% drop the next year?
July 6, 2017 - Real Estate Professionals and Business Valuation Work
I had a very interesting meeting this afternoon with a couple of real estate professionals who had several businesses listed for sale. One of them showed me how he had calculated the "value" of one of these businesses in order to come up with a "List price". He took the reported pretax earnings from the latest tax return, divided it by an 8.25% capitalization rate, and began marketing the business. The seller was happy with the value, but guess how many offers they had received for this business? That's right, none. It is interesting how many real estate professionals don't consider businesses to be any riskier an investment than your basic commercial property. Be careful who you have "appraising" your business.
I had a very interesting meeting this afternoon with a couple of real estate professionals who had several businesses listed for sale. One of them showed me how he had calculated the "value" of one of these businesses in order to come up with a "List price". He took the reported pretax earnings from the latest tax return, divided it by an 8.25% capitalization rate, and began marketing the business. The seller was happy with the value, but guess how many offers they had received for this business? That's right, none. It is interesting how many real estate professionals don't consider businesses to be any riskier an investment than your basic commercial property. Be careful who you have "appraising" your business.
June 20, 2017 - Private Label Valuation Work
Last year, I read an article Rod Burkert wrote about Private Label Valuation Work where one valuation firm hires another practitioner to perform a business valuation, ON THE FIRST ONE'S LETTERHEAD. (Emphasis added.) At my first time reading through the article I wondered why anyone would ever do that. Now, months later and after I've completed several assignments for other valuation professionals, I understand the benefits to both parties. In fact, I had one client tell me that he preferred referring assignments to me as I do not have a tax practice.
So thank you Rod, for opening my eyes to this idea that has benefited both myself and my professional business valuation clients!
Last year, I read an article Rod Burkert wrote about Private Label Valuation Work where one valuation firm hires another practitioner to perform a business valuation, ON THE FIRST ONE'S LETTERHEAD. (Emphasis added.) At my first time reading through the article I wondered why anyone would ever do that. Now, months later and after I've completed several assignments for other valuation professionals, I understand the benefits to both parties. In fact, I had one client tell me that he preferred referring assignments to me as I do not have a tax practice.
So thank you Rod, for opening my eyes to this idea that has benefited both myself and my professional business valuation clients!
June 6, 2017 - The Usefulness of Various Analyses
Have you ever seen a report that weighed more than you do? It's almost like some appraisers charge by the pound of report delivered. (That last comment is supposed to be funny.) I was visiting with a local banker the other day and the content of a business valuation report was brought up. I mentioned that I believe that everything contained within the covers of a report should have significance to the final value concluded within its pages. His response was thought provoking. "That's not always the case."
We agreed that certain sections of explanatory 'boiler plate' language is necessary, but he has seen many reports that included sections of narrative that could have been removed entirely from the report without impacting any of the conclusions. We also discussed conclusions included in reports without any supporting narratives, which is also a bad idea.
After a business appraiser has completed their analyses, writing the report should tell the story of the journey the appraiser went through to arrive at the final value conclusion. However, it is not necessary to include every side trip that ended in a dead end. I've occasionally spent hours tracking down and analyzing market data, only to find that none of what I found is actually comparable to my subject. Is a detailed description of how I spent those hours useful to the reader of the report? If the answer is 'No', than don't include it.
Have you ever seen a report that weighed more than you do? It's almost like some appraisers charge by the pound of report delivered. (That last comment is supposed to be funny.) I was visiting with a local banker the other day and the content of a business valuation report was brought up. I mentioned that I believe that everything contained within the covers of a report should have significance to the final value concluded within its pages. His response was thought provoking. "That's not always the case."
We agreed that certain sections of explanatory 'boiler plate' language is necessary, but he has seen many reports that included sections of narrative that could have been removed entirely from the report without impacting any of the conclusions. We also discussed conclusions included in reports without any supporting narratives, which is also a bad idea.
After a business appraiser has completed their analyses, writing the report should tell the story of the journey the appraiser went through to arrive at the final value conclusion. However, it is not necessary to include every side trip that ended in a dead end. I've occasionally spent hours tracking down and analyzing market data, only to find that none of what I found is actually comparable to my subject. Is a detailed description of how I spent those hours useful to the reader of the report? If the answer is 'No', than don't include it.
May 11, 2017 - Value of a Business for Sale
I recently obtained my license to sell Idaho businesses. As part of this process I have been focusing on what the value of a small business offered for sale is. The answer that most people come up with is, "Whatever someone will pay for it." I've spent some time considering that response and have decided that it is not completely accurate. There are people out there who have made offers to purchase a business for outlandish sums of money, however once these people attempt to get financing, they typically find out that a bank won't fund their purchase at the offered price. If financing was one of the conditions to the sale, than the business was not actually sold.
Unfortunately, once an outrageous offer has been made, a Seller will be disinclined to accept more reasonable offers, and may end up holding the business far longer than originally intended.
The value of a business needs to be based on what a reasonable person would pay for it. A reasonable person looks at things like, an expected return on investment (ROI), the risk of continuing operations, the impact of future capital expenditures, working capital requirements, and a variety of other things that business appraisers already consider in every one of our analyses.
I recently obtained my license to sell Idaho businesses. As part of this process I have been focusing on what the value of a small business offered for sale is. The answer that most people come up with is, "Whatever someone will pay for it." I've spent some time considering that response and have decided that it is not completely accurate. There are people out there who have made offers to purchase a business for outlandish sums of money, however once these people attempt to get financing, they typically find out that a bank won't fund their purchase at the offered price. If financing was one of the conditions to the sale, than the business was not actually sold.
Unfortunately, once an outrageous offer has been made, a Seller will be disinclined to accept more reasonable offers, and may end up holding the business far longer than originally intended.
The value of a business needs to be based on what a reasonable person would pay for it. A reasonable person looks at things like, an expected return on investment (ROI), the risk of continuing operations, the impact of future capital expenditures, working capital requirements, and a variety of other things that business appraisers already consider in every one of our analyses.
May 1, 2017 - Private Company Market Data
The various market databases we have access to such as Pratt's Stats, BizComps, the IBA market database, or a personal business broker's database all have one thing in common. Each individual business sale, did not occur under the standard of fair market value. Each data point represents a sale where there was a specific buyer, a specific seller, and certain motivations were involved.
As business appraisers, we are typically asked to provide an estimate of the fair market value of a company. We use these market databases because that's where the market data is. This issue is just one of the reasons we use as many similar data points as we can get; trying to use a sea of investment values to identify where the overall market values might lie.
I love this job! Every project brings a new puzzle!
The various market databases we have access to such as Pratt's Stats, BizComps, the IBA market database, or a personal business broker's database all have one thing in common. Each individual business sale, did not occur under the standard of fair market value. Each data point represents a sale where there was a specific buyer, a specific seller, and certain motivations were involved.
As business appraisers, we are typically asked to provide an estimate of the fair market value of a company. We use these market databases because that's where the market data is. This issue is just one of the reasons we use as many similar data points as we can get; trying to use a sea of investment values to identify where the overall market values might lie.
I love this job! Every project brings a new puzzle!
April 28, 2017 - Risk Management Associates (RMA)
I recently had a discussion with a lender with a prominent bank located here in Idaho, about the data collected and published by RMA. This data is used by bankers, some business appraisers, IBISWorld, and other financial analysts as benchmarking data for comparing a specific company's financial ratio characteristics with other similar businesses. There are issues with almost any data source used today in the analysis of a privately held company's operations as compared with its industry, but not everyone understands those that RMA's data brings to to the table.
RMA collects their data from member banks located in 38 states at my last count. These banks obtain financial statements from their clients who submitted loan applications for various financing requests. The vast majority of these clients' will have shown profits in order to prove to the bank that they should be granted the financing they have asked for. The point of this discussion is to point out that RMA's data is not nationwide, and it is perhaps the data most biased towards profitability.
Be careful when you are using the RMA data in your financial analyses. Please note that it does not show industry averages, but it is a cross section of a portion of each of the industries reported. If the Company you are analyzing has a stronger ratio performance that that described in the RMA data, than you are looking at a very strong company. However, if the financial ratio analysis shows the Company is weaker than the RMA data indicates is normal, the Company may still be perfectly fine and operating within industry norms.
I recently had a discussion with a lender with a prominent bank located here in Idaho, about the data collected and published by RMA. This data is used by bankers, some business appraisers, IBISWorld, and other financial analysts as benchmarking data for comparing a specific company's financial ratio characteristics with other similar businesses. There are issues with almost any data source used today in the analysis of a privately held company's operations as compared with its industry, but not everyone understands those that RMA's data brings to to the table.
RMA collects their data from member banks located in 38 states at my last count. These banks obtain financial statements from their clients who submitted loan applications for various financing requests. The vast majority of these clients' will have shown profits in order to prove to the bank that they should be granted the financing they have asked for. The point of this discussion is to point out that RMA's data is not nationwide, and it is perhaps the data most biased towards profitability.
Be careful when you are using the RMA data in your financial analyses. Please note that it does not show industry averages, but it is a cross section of a portion of each of the industries reported. If the Company you are analyzing has a stronger ratio performance that that described in the RMA data, than you are looking at a very strong company. However, if the financial ratio analysis shows the Company is weaker than the RMA data indicates is normal, the Company may still be perfectly fine and operating within industry norms.
April 19, 2017 - Time
It has been about a month since I last posted about some thoughts I've had. This morning I focused on Time as both a concept and a driver of value. As a concept, Time gives us a measuring stick that points out the distance between events in life or business. My calendar is a very useful tool that helps makes sure I arrive in time for my various appointments and meetings. Time as a driver of value is a little more difficult. There is always the "time value of money" concept, but that is not what I have been thinking about. The time it takes to get through a special training, or to accomplish a difficult task, or even to simply sit and consider the various relationships between Time and Value all have an impact. The problem is figuring out which impact will have the greatest influence over how the rest of our Time will drive the values of both our personal and professional lives, and then keeping the other distractions down to manageable levels.
It has been about a month since I last posted about some thoughts I've had. This morning I focused on Time as both a concept and a driver of value. As a concept, Time gives us a measuring stick that points out the distance between events in life or business. My calendar is a very useful tool that helps makes sure I arrive in time for my various appointments and meetings. Time as a driver of value is a little more difficult. There is always the "time value of money" concept, but that is not what I have been thinking about. The time it takes to get through a special training, or to accomplish a difficult task, or even to simply sit and consider the various relationships between Time and Value all have an impact. The problem is figuring out which impact will have the greatest influence over how the rest of our Time will drive the values of both our personal and professional lives, and then keeping the other distractions down to manageable levels.
March 15, 2017 - Non-Marketable
The term, "Non-Marketable", is mentioned many times in an appraisal of a privately held business. There is some confusion in the industry as to what exactly this phrase means. Part of the issue comes from the fact that business appraisers look at the public markets for data in order to appraise a privately held company. A publicly traded company generally has shares that are freely traded on the stock market. These are often referred to as "Marketable Securities" on a financial statement. The shares of stock that John Smith owns in ABC Manufacturing, Inc. are not freely traded, because there is no line of investors waiting to purchase his shares. The lack of an open and freely traded marketplace for privately held shares means that these shares are, "Non-Marketable."
The term, "Non-Marketable", is mentioned many times in an appraisal of a privately held business. There is some confusion in the industry as to what exactly this phrase means. Part of the issue comes from the fact that business appraisers look at the public markets for data in order to appraise a privately held company. A publicly traded company generally has shares that are freely traded on the stock market. These are often referred to as "Marketable Securities" on a financial statement. The shares of stock that John Smith owns in ABC Manufacturing, Inc. are not freely traded, because there is no line of investors waiting to purchase his shares. The lack of an open and freely traded marketplace for privately held shares means that these shares are, "Non-Marketable."
March 10, 2017 - Levels of Value
The term, "levels of value", refers to the variation inherent in the methods available for use in the calculation of the value of a privately held business. When a business appraiser uses the market approach, the level of value derived depends on the method utilized. For example, if the appraiser uses minority interests in publicly traded companies in the analysis, the indicated level of value calculated will be a non-controlling, as if freely traded, value. Shares in a privately held business are not "freely traded" so an adjustment would be required to move the indicated value to the appropriate level of value for the assignment.
The term, "levels of value", refers to the variation inherent in the methods available for use in the calculation of the value of a privately held business. When a business appraiser uses the market approach, the level of value derived depends on the method utilized. For example, if the appraiser uses minority interests in publicly traded companies in the analysis, the indicated level of value calculated will be a non-controlling, as if freely traded, value. Shares in a privately held business are not "freely traded" so an adjustment would be required to move the indicated value to the appropriate level of value for the assignment.
February 28, 2017 - Discounts Again
Discounts such as the DLOC and DLOM discussed previously only exist because the valuation methods available for use for privately held businesses do not always derive the same level of value required by the assignment. Some methods provide a controlling, non-marketable level value while others return a non-controlling, marketable, and still others fall somewhere in the middle.
The terms "Non-Marketable" and "Levels of Value" will make great discussion points for future topics.
Discounts such as the DLOC and DLOM discussed previously only exist because the valuation methods available for use for privately held businesses do not always derive the same level of value required by the assignment. Some methods provide a controlling, non-marketable level value while others return a non-controlling, marketable, and still others fall somewhere in the middle.
The terms "Non-Marketable" and "Levels of Value" will make great discussion points for future topics.
February 28, 2017 - DLOM
In keeping with my current theme on discounts, the discount for lack of marketability (DLOM) has some interesting variations. Some appraisers believe that a controlling ownership interest in a privately held enterprise is more "marketable" than a non-controlling interest in that same business as there is a larger market of potential buyers for a controlling interest. I tend to agree. Everything can be sold eventually, but both the time and cost to sell an ownership interest in a privately held company should also be considered. An appropriate DLOM considers both of those items, as well as the limited pool of potential buyers.
In keeping with my current theme on discounts, the discount for lack of marketability (DLOM) has some interesting variations. Some appraisers believe that a controlling ownership interest in a privately held enterprise is more "marketable" than a non-controlling interest in that same business as there is a larger market of potential buyers for a controlling interest. I tend to agree. Everything can be sold eventually, but both the time and cost to sell an ownership interest in a privately held company should also be considered. An appropriate DLOM considers both of those items, as well as the limited pool of potential buyers.
February 24, 2017 - DLOC
A discount for lack of control (DLOC) is a mathematical representation of how much incentive an arm's length investor would require to invest in the subject non-controlling privately held ownership interest. The idea is, if one gives up the ability to control distributions, and the ability to decide how the Company is going to generate its profits, there should be some benefit to that investor. Otherwise, there would be far fewer investors willing to invest in privately held partnerships and other similar entities. How a business appraiser calculates this incentive, is another topic for another day.
A discount for lack of control (DLOC) is a mathematical representation of how much incentive an arm's length investor would require to invest in the subject non-controlling privately held ownership interest. The idea is, if one gives up the ability to control distributions, and the ability to decide how the Company is going to generate its profits, there should be some benefit to that investor. Otherwise, there would be far fewer investors willing to invest in privately held partnerships and other similar entities. How a business appraiser calculates this incentive, is another topic for another day.
February 20, 2017 - Discounts
Many people are often surprised when they find out that in a fair market value appraisal of an ownership interest consisting of a 50% or less ownership interest, the value is often much less than its proportionate share. For example, if a privately held company's fair market value is $1,000,000 and the shareholders need to know the value of a 30% ownership interest; its fair market value is not $333,334. There are many reasons and factors that are considered in such an analysis. The two most commonly discussed are Discounts for Lack of Control and Marketability. Each of these discounts will likely be a subject of another post on this page at some point.
Many people are often surprised when they find out that in a fair market value appraisal of an ownership interest consisting of a 50% or less ownership interest, the value is often much less than its proportionate share. For example, if a privately held company's fair market value is $1,000,000 and the shareholders need to know the value of a 30% ownership interest; its fair market value is not $333,334. There are many reasons and factors that are considered in such an analysis. The two most commonly discussed are Discounts for Lack of Control and Marketability. Each of these discounts will likely be a subject of another post on this page at some point.
February 15, 2017 - Startup Business
Startup businesses are actually quite fun to appraise! Since a business that has been in operation for less than a year has very little in the way of historical financials to rely on, I have to use skills I've learned over the years to develop projections about how I think the Business is going to grow, and what trends I think a reasonable buyer and seller would agree will come to exist. My favorite technique is to create three forecasts. Since I do not have a crystal ball to show me what will happen, I look at the Company's business plan, current economic and industry data, and the working capital needs of the Business in order to estimate what I think will happen. I call this my expected case. Then I do it again under an assumption that the Company will do better than I expect. The last projection is always bankruptcy, because failure is always an option. I then weight all three forecasts together; the expected, the best, and the worst cases in order to derive an indication of value that meets the definition of fair market value.
Startup businesses are actually quite fun to appraise! Since a business that has been in operation for less than a year has very little in the way of historical financials to rely on, I have to use skills I've learned over the years to develop projections about how I think the Business is going to grow, and what trends I think a reasonable buyer and seller would agree will come to exist. My favorite technique is to create three forecasts. Since I do not have a crystal ball to show me what will happen, I look at the Company's business plan, current economic and industry data, and the working capital needs of the Business in order to estimate what I think will happen. I call this my expected case. Then I do it again under an assumption that the Company will do better than I expect. The last projection is always bankruptcy, because failure is always an option. I then weight all three forecasts together; the expected, the best, and the worst cases in order to derive an indication of value that meets the definition of fair market value.
February 13, 2017 - Undivided Interest in Real Estate
When two or more people own real estate together without having formed a legal entity such as a partnership to facilitate the ability to divide their ownership easily, they own what is called an "undivided interest in real estate". Most real estate appraisers are uncomfortable appraising less than a 100% ownership interest. It is important to remember, when appraising an undivided interest in real estate, that each owner has the right to partition their interest into a separate portion. Including the partition analysis is an important part of the overall valuation, but it is not the only item to consider.
When two or more people own real estate together without having formed a legal entity such as a partnership to facilitate the ability to divide their ownership easily, they own what is called an "undivided interest in real estate". Most real estate appraisers are uncomfortable appraising less than a 100% ownership interest. It is important to remember, when appraising an undivided interest in real estate, that each owner has the right to partition their interest into a separate portion. Including the partition analysis is an important part of the overall valuation, but it is not the only item to consider.
February 6, 2017 - Significant Debt
Recently I appraised a company that held a significant amount of debt on its balance sheet. The amount of debt was such that after applying methods under the asset, market, and income approaches; there was simply no value to the enterprise. The business has been operating for many years, but its lack of profitability has led to a fair market value of $0. The business could definitely still be sold, however the owner would take a loss on the sale.
I've run into a few of these now. Having gone through the analysis required by a business appraisal, I am able to identify certain areas of the operation that are higher risk. With some time and effort, this business could turn a profit.
Recently I appraised a company that held a significant amount of debt on its balance sheet. The amount of debt was such that after applying methods under the asset, market, and income approaches; there was simply no value to the enterprise. The business has been operating for many years, but its lack of profitability has led to a fair market value of $0. The business could definitely still be sold, however the owner would take a loss on the sale.
I've run into a few of these now. Having gone through the analysis required by a business appraisal, I am able to identify certain areas of the operation that are higher risk. With some time and effort, this business could turn a profit.
January 31, 2017 - Rules of Thumb
Rules of thumb are very interesting. I'm often asked why business owners can't simply use the various rules of thumb that are applicable to their businesses to determine their value. The answer I give is always the same; they can. There is nothing in the world stopping anyone from using a rule of thumb as their valuation method of choice. The only thing to watch out for when relying on a rule of thumb, is to decide whose thumb is going to be used; Verne Troyer's or Andre the Giant's.
Rules of thumb can be very good for developing a range of potential sale prices, but there are many variables to consider that simple rules of thumb just don't cover.
Rules of thumb are very interesting. I'm often asked why business owners can't simply use the various rules of thumb that are applicable to their businesses to determine their value. The answer I give is always the same; they can. There is nothing in the world stopping anyone from using a rule of thumb as their valuation method of choice. The only thing to watch out for when relying on a rule of thumb, is to decide whose thumb is going to be used; Verne Troyer's or Andre the Giant's.
Rules of thumb can be very good for developing a range of potential sale prices, but there are many variables to consider that simple rules of thumb just don't cover.
Phone: (208) 749-3116 - Email: CanyonValuations@gmail.com
Mailing Address: P.O. Box 5197 - Twin Falls, Idaho 83303