Valuation Tips

Value...What is it?

Value, whether it is related to a business, house, collectable, stock, or any other marketable item, is subject to a number of variables. Some of these variables are easily measured and factored into the value calculation. Other variables impacting value can be subjective, and not easily measured. The value of a business is impacted by both subjective and easily measurable factors. Subjective factors are based on the viewpoint of the different people (or stakeholders) involved. It is not uncommon for the value of a business to be interpreted differently by two people viewing the business from different lenses or perspectives.

In a similar way that houses or any other asset traded in a public marketplace are appraised to define a common value based on standard appraisal concepts, businesses are valued based on a defined set of basic criteria. The standard methodology to valuing a business allows for potential buyers, lenders, and sellers to assess a business with common standards.

It is not unusual for the perspectives of a lender, seller, and buyer regarding the value of a business to be inconsistent.

The Lenders Lens

Lenders are interested in getting the money back that they have loaned to buy the business. The lender generally looks at the business through a slightly pessimistic lens (which they may call realistic). They critically assess the buyers background in terms of ability to repay the loan. Lenders apply standard ratios (such as debt coverage ratio) to evaluate the risk associated with a business loan. The value of a business is based on the defined ratios in relation to the risk tolerance of the lender.

The Buyers Lens

Buyers are typically assessing a number of business opportunities to determine which one (if any) make sense for them. In looking at various businesses, buyers have the unique opportunity to objectively review the different business using a number of metrics including 1) Gross Sales, 2) Earnings Before Interest, Taxes, Depreciation, and Amortization (EBITDA), 3) Owners Discretionary Income, 4) Listing price, and a number of other evaluation criteria. Ultimately, buyers are interested in getting the best deal possible on a business that fits their needs. Assuming a business fits all of the buyers needs in terms of profile, value to a buyer is in large part based on the return on and of investment. It is important for a buyer to be able to clearly see how the business can generate the required financial return and allow the buyer to obtain financing if needed to buy the business.


The Sellers Lens

Sellers have worked hard to build the business that they are now planning to sell. In many cases the sellers business represents a lifetime of sweat, and perseverance. The seller usually has a great deal of pride in the business they have built, and generally know how the business has operated over time. As a result, sellers are usually very confident in the ability of the business to generate cash flow based on the historical financial statements.

It is often hard for a seller to see a potential buyer or lender objectively questioning the performance of the business. Sellers tend to see value in their business with very little adjustment made for risk or unknown factors. In fact, this may be the most accurate lens of value, however in order to sell the business, a seller, buyer and lender need to see similar value.

ABMI helps to bring the lens of each stakeholder into common a focus.

Financial Statement Review

Financial statements and accounting practices of a business are typically designed to minimize taxable income. The financial performance of a business is assessed using the net financial benefit to the owner as opposed to simply pulling the taxable income from the P&L statements. You may have heard the process of adjusting the financial statements referred to as Earnings Reconstruction (ERCON), or Recasting. The reconstructed net benefit is referred to as Net Owner Benefit or Owner Discretionary Income. Other adjustments are usually also required to normalize the financial statements to reflect the true picture. These additional adjustments typically include 1) reducing depreciation and amortization expenses, 2) reducing interest expenses for existing loans (not transferred with the business), 3) pulling out owners compensation and replacing it with a fair market compensation for a replacement manager, and 4) adjusting for other owner perks that are considered discretionary.

Review of the financial statements can be confusing, and the ABMI consultants can help make the process seem effortless.


Other factors that can affect business value

Many other factors should be considered in the assessment of the value of a business. Other factors can include: