So you'd like to buy or sell a small business. Congratulations, says a business appraisal firm that specializes in evaluating companies. Either way, selling or buying, you couldn't have picked a better time.
According to Ed Turner, business development manager in the Denver office of American Appraisal Associates, an international appraisal firm based in Milwaukee with 50 offices worldwide, some 16,000 companies, most of them worth under $5 million, are expected to change hands in 1988 and a tax loophole that expires at the end of this year makes buyouts of such companies very attractive.If you're looking to be one of the sellers, said Turner, beware of undervaluing your company. And don't settle for easy answers in putting a price tag on your business.
Don't just assume that worth is easily equated with book value or even a "rule of thumb" multiple of reported earnings, cautioned Turner. Book value and fair market value are often very different.
Private businesses may suppress profits to lower taxes and thus have lower reported earnings and a low book value. A company is also worth more, said Turner, if the potential buyer stands to gain economies of scale or other pluses through the purchase.
And until the end of 1988, sellers of companies with assets under $10 million should be able to negotiate a higher price for their companies based on the partial tax break that buyers will receive, he said.
Buyers of such companies will benefit from greater cash flow resulting from the higher depreciation of the stepped-up tax basis of the assets.
"Cash flow is rapidly gaining acceptance as the single best measure of management's ability to combine assets and liabilities in a going business concern," said Turner.
He said the Financial Accounting Standards Board has recognized its importance by enacting new rules that require a business to include a statement of cash flow when issuing a complete set of financial statements.
That's not to say that net asset value and price-earnings ratios don't have their application in many situations. Turner said valuation experts usually use, and in some cases are required to use, a combination of approaches to arrive at fair market value.
Here are some of the things they look at in pricing a business:
- In a discounted cash flow analysis for the purpose of a sale, appraisers typically review financial statements from a number of prior years and strip out any expenses or excess assets that probably wouldn't be part of the purchased firm. These items could include excess management compensation and perks, vacation homes or luxury cars, and perhaps overfunded pension plans. They also remove any extraordinary gains or losses.
- Using this data, they will project cash flow over a future time period that is then discounted to its present worth at market-based rates of return. The analysis recognizes that the current value of an investment is dependent upon the economic benefits that can be expected in the future, such as receiving dividends.
- Valuation advisers also examine the market prices of comparable companies whose stock is publicly traded. A comparison of companies in the same or similar line of business may be valid.
- Questions about the health of the business are also asked. What's your company's overall financial condition, competitive position, market share, consistency of earnings and depth of management? If you are your company's only executive, for example, and plan to move on to other things after a sale, you might have to settle for a lower price since the buyer will be assuming a greater risk.
- Market and economic factors are evaluated. What's the outlook for your specific industry and for the overall economy?
- Intangibles can be very important to the value of your company. If the new owners will benefit from your patents, trademarks, propriety software, customer lists or good will, for example, these need to be considered.