Determining Your Company's Value
There comes a time in the life of every small business when its owner looks up momentarily from the daily letting of blood, sweat and tears to ask the question: Just what is this thing worth?
Whether you're considering selling the business, recruiting new investors, bringing employees into ownership or gifting the business to heirs, a business valuation can help you put a more precise number on its present and future value. But the valuation of a privately held business--particularly a small company that may not have a lot of comparable statistics in its industry to look at--is an imprecise science based partly on hard numbers and partly on soft figures, such as cash-flow projections and other intangible assets and subjective criteria. How, then, can you be sure you're getting a fair number?
For starters, you need a reputable valuation expert, preferably one recommended by an attorney or accountant you already trust, says Paul Rich, CPA and principal with the business consulting group at Rothstein Kass, a New York City-based accounting and consulting firm. Look for a CPA who is also a certified valuation analyst, or CVA, and who belongs to one or more of the various accounting associations and groups like the American Society of Appraisers, says Rich. Why? "There are rules of ethics in those societies that [members] have to subscribe to." A less scrupulous appraiser might be willing to discount your business heavily to give you the lower number you want for gifting purposes, but you could run afoul of the IRS and find yourself in hot water later on.
If the appraiser specializes in your business or industry, that's a big plus, says Harvard Business School professor Mark Bradshaw. "You have to understand the business to be able to value it--it's not just a spreadsheet exercise," he says. He adds that a specialty in small, private business valuation isn't critical, but it helps. "You could argue that since small companies have simpler operations, they should be easier to get right," he says. With smaller companies, though, doing a comparable analysis, which acknowledges that business prices fluctuate relative to the market, is more challenging than conducting a stand-alone analysis, which looks at the company's value in a vacuum. "It's harder to find that peer group," says Bradshaw. An expert or group that has experience with small, private companies will understand that complexity.
Ask for the valuation expert's method of appraisal, and make sure they're willing to sit down and explain it. David Ellrich Jr., accredited senior appraiser, CVA, and managing shareholder of Moore, Ellrich and Nealin Palm Beach Gardens, Florida, considers it part of his work to educate the business owner on the valuation process and to explain why it needs to be approached from different perspectives. Take, for example, a machine shop owner who has invested a lot in his equipment and makes a decent living. "If you look at that business from a cost approach, it might be worth a million dollars," says Ellrich. "But then you look at it [from] the market approach and you see there are machine shops going out of business all over the country, selling their machinery for pennies on the dollar. That's why you have to look at all the approaches and reconcile the conclusions."
Beware of a valuations expert who tends to rely on one simplistic calculation, such as multiplying the earnings of your business by a price/earnings ratio that's common for companies in your industry, whether big or small--you're likely to end up with a less reliable number that way. "Every simplification has problems," says Bradshaw. "The bottom line is it's an inexact science, so anyone who tries to say they know exactly what a business is worth--they're just wrong."
Rather than present you with a magic number, the valuation expert should give you a range. "I'd want someone who [could] give me sensitivity information... someone who [could] give you different scenarios and tell you what levers drive the business," says Bradshaw. "For example, if we assume your top-line sales are growing at 10 percent, this is your valuation; but if it's 12 percent, it'd be this; and if it was 8 percent, it'd be this."
Armed with that information, even if you decide not to sell the business or end up not needing the valuation, you will learn a lot about your business's current and future performance, and what it will take to keep it on track.