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    February-2013  


Planning To Sell A Business? Think Like an Appraiser

Recent reports say the number of small businesses being offered for sale is down. 

Lower also are the prices being offered for smaller enterprises.

One reason being offered is that an estimated 80% to 90% of business-sales failures occur because of unrealistic price or improper positioning.

What this reveals is a widespread and fundamental misunderstanding among business owners of what constitutes value in a business.   

According to David Fein, president and chief executive of ValuSource (http://www.valusource.com/), two of the most common errors small-business owners make when considering selling a business is that they don’t get professional advice, and tend to rely too heavily on “rules of thumb” in determining their own assessment of value (i.e., the belief that business value can easily be determined by calculating a multiple of revenue, earnings, or book value).   While rules of thumb can be helpful, they only provide an “average” value and don't take into account many of the things that make companies more or less valuable.

The good news is that by learning to think like an appraiser, small-business owners can significantly increase business value through good planning, improving certain financial metrics and making key operational changes.   A good valuation is not simply something to do when preparing a business for sale.  Understanding business value and value drivers is also a management and planning tool. 

Regularly assessing business value is arguably the best business dashboard.   Getting a business valuation is important for business owners for a variety of reasons—including raising capital or obtaining loans, adding or changing partners, selling all or part of the company, strategic planning, buying another company, planning an exit strategy and/or estate plan, and maintaining the value of a business through a divorce.

Appraisers are looking to determine both business risk and potential for ongoing cash flows.  Fein offers these questions that small-business owners should ask themselves as part of their assessment of business value:

  • What kind of return on investment is a typical buyer looking for, and what would the business need to sell for to give them that level of return?  (Look at business value through the buyers’ eyes.)
  • Has the company done any “normalizing” adjustments? Normalizing adjustments adjust the income statement to show the prospective purchaser the return from normal operations.
  • What is the market value of all business assets (including licenses, patents, etc.)?
  • How concentrated is revenue in a small portion of the customer base?
  • How steady is business revenue?  
  • How fast is the business growing?
  • What is the overall risk of the business—low, medium or high? (Note: To increase value, lower the risk.)
  • How loyal are employees, and are there employee problems that need resolving?
  • How much is the owner tied to bringing in revenue?  (When the owner leaves, how much revenue leaves?)
  • Is the business owner’s value greater than the salary he or she would receive as an employee in that position?  If not, why not?
  • How much cash flow is the business generating, and is it at, above or below industry norms as a percentage of sales?
  • What three things could be done to enhance value in the next 12 months?

It is also helpful for business owners to regularly look at business comparables—data about business sales from the same industry and geographical region as their own.  Business-sale data show owners the range of multiples businesses sell for based on size, industry and geography. It’s compelling to review what other businesses have sold for and to understand where the business fits in the wide selling price range.

Besides looking at comparable sales (the market approach), business owners need to also consider looking at income and asset approaches to valuation.

“Rules of Thumb provide some quick and easy ways to value businesses that some owners rely on, but professional business appraisers take a much more thorough and standards based approach,” Fein says. “It pays to learn a bit about how appraisers assess value and why they focus on the things they do.”


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