Business valuation is not an exact science.
In the analytical nuts and bolts business world, it would be nice to think of it as a black and white proposition, but the layers upon layers of gray that accompany the appraisal of any company can make determining an exact dollar amount a difficult process.
For business appraisal experts like Rand Curtiss, president of Loveman-Curtiss Inc., the task is most successful when there is a little human judgment thrown into the mix. That’s why he believes the abundance of software programs that promise to provide a business appraisal through pure numbers offer little in the way of accuracy.
What people don’t realize, Curtiss says, is that the value of a business can vary widely based on when and how the appraisal is conducted.
“The purpose for the appraisal is critical,” he explains. “A business could very legitimately have different values at the same time, depending on the reason why it’s being appraised.”
For example, someone hoping to sell a metal fabricating operation for top dollar would likely try to target a “strategic buyer,” who would receive some benefit from purchasing the operation. On the other hand, business owners are only required to consider a “financial buyer,” or someone who can only bring cash to the table and generally would pay much less for the same company, when it comes to tax appraisals.
There are three basic approaches to business appraisals: the market approach, the asset approach and the income approach. Each keys in on a different factor to determine the value of a business and each provides widely varying results.
Here are the good and the bad of each.
Market approach
This method is most comparable to the appraisal of real estate. When trying to value a home, an appraiser will look at the value of other homes of comparable size and location. This can also be done for businesses, but Curtiss says when it comes to closely held family businesses, there usually is not enough information to make an accurate determination.
“Even though you think the market approach may be ideal, the problem is we don’t have enough data,” says Curtiss. “So it doesn’t fail in theory, it fails in practice.”
Asset approach
This approach to setting a value for a business is fairly direct. Values of property like land, buildings and machinery are totaled and the company’s debts are subtracted from that figure. The limiting factor, says Curtiss, is that intangibles like public image and personnel value cannot be figured into the equation.
That leaves the asset approach best reserved for situations in which the business is being liquidated or will not operate the same as it did before the sale.
“Usually a company’s most important asset is its people and they are not reflected there,” explains Curtiss. “In other words, intangible assets are not very well measured by current financial and accounting practices. It is very hard to use the asset approach for most operating businesses.”
Income approach
The income approach is the most common but also the most complex. Value is determined by measuring the profitability of a company today and in the past, while making an educated prediction about how likely it is for that trend to continue.
Undoubtedly, this is the most complex way to appraise a company. But Curtiss points out it is the only method that also considers intangible factors such as personnel, which most often affects customer satisfaction and, consequently, improves the bottom line.
“You’re looking at a business in terms of the expected earnings or cash flow it will generate,” he says. “That’s where you really get into looking at the business’s historical financial performance, its current situation and its projected financial performance and all the elements that affect that and requires a total review of the business operations and financing.” How to reach: Loveman-Curtiss Inc., (216) 831-1795
Jim Vickers ([email protected]) is an associate editor at SBN.
