Bringing in a Pro to Value Your Business: The Questions You Must Ask

There are certain times in the life cycle of a business when you need more than your best guess on what your company is worth. Those reasons can vary from the practical (an owner has an opportunity to sell the business and needs to know how much to ask for) to the painful (an owner is in the middle of a divorce and needs to know how to split personal assets). In such situations, just looking at your accounts may not be enough. Rather, the best choice can be to bring in a professional to value your business. business appraiser or a certified valuation analyst has the education and e!pertise necessary to put a dollar value on a company. "inding the right match for your business does re#uire you know a little more about the process, though.

The Right Business Appraiser

$umi %radshaw, the valuation director of sgill &ost, suggests that the first #uestion a small business owner consider is why the valuation is necessary. '(hat is the purpose of the valuation) If it*s for buying or selling a business and you are just looking for the appraiser*s opinion, an estimate will suffice. There are issues that will influence the transaction value, including the buyer or seller*s urgency, the availability of financing, the structure of the transaction (will or will there not be seller financing, is it paid all up front, are there other details attached to the transfer, etc.). If it*s for divorce or litigation, your legal counsel may be aware of local professionals, you may be able to find them through internet searches, through the professional organi+ations (searching their databases), or through word of mouth (,hamber of ,ommerce, etc.). If it is for an -./& (-mployee .tock /wnership &rogram), you will want a professional with some familiarity, who can provide the service on an ongoing (probably annual) basis.' (hile any business appraiser can theoretically handle the valuation process for any business, there are many who speciali+e in specific services. If, for instance, you*re putting together a stock program for your employees, as %radshaw notes, there are appraisers who can offer you continuing help so that your employees will continue to know the value of their stock. nother consideration can be how rigorous an appraisal needs to be. %radshaw e!plains that cost is directly related to how in0depth of an appraisal you need. '1itigation0related valuation typically costs #uite a bit more than, for e!ample, valuation for the purpose of pricing a business for sale. There are different levels of reports as well 2 letter form reports, limited reports, full reports, etc.'

Finding Your Business Appraiser

business appraiser isn*t too different from the other professionals who work with your business. The initial search for an appraiser can be relatively simple. 'I would start with the yellow pages, look in the ,hamber of ,ommerce, research the databases at the different organi+ations (Institute of %usiness ppraisers 3 I% , 4ational ssociation of ,ertified 5aluation nalysts 3 4 ,5 , merican .ociety of ppraisers 3 . ), or 6oogle them (look up business valuation 3 business appraisal and your general location),' says %radshaw. /nce you have a few names to consider, there are specific #uestions that are important to ask. 7ust as you wouldn*t want to have a lawyer represent your business who you knew nothing about, you should have some information to make sure that a business appraiser will be able to help you. %radshaw suggests four #uestions to ask a potential appraiser. "irst, what are their credentials) ' re they an accredited member of any professional valuation organi+ations)' 8ou should also ask for references from their past clients. It*s important to ask an appraiser about his familiarity with your industry and how they can bring their knowledge to bear on your business. 1astly, ask the appraiser for an outline of his process. %radshaw notes, 'They should be able to clearly indicate to you what information they will be looking to assess.' There are a number of appropriate credentials a business appraiser might hold, depending on the type of appraisal you need. There can also be some variation if you are hiring an appraiser outside the 9... Those credentials include ,ertified 5aluation nalyst (,5 ), ccredited 5aluation nalyst ( 5 ), ccredited in %usiness 5aluation ( %5), ,ertified %usiness ppraiser (,% ) and ccredited .enior ppraiser ( . ).

Making Your Decision

%radshaw points to the importance of having an accredited and impartial business appraiser. The accreditation process guarantees a certain ethical standard that an appraiser will be held to, which can be especially important in particularly contentious situations. 9nfortunately, such situations aren*t out of the #uestion, especially when personal issues are mi!ed with business considerations. 'I strongly recommend carefully researching your appraiser for divorce or litigation matters and it may be wise to consider mutual retention (by both parties) of the appraiser.'

It*s also important to work with an appraiser who can make sure that you understand each step of the appraisal process. (hile the process is generally similar in each business valuation, being sure that you understand the final report 2 as well as the work that goes into it 2 is important. Typically, you and your business appraiser will go through a si!0step process: a preliminary conversation, a proposal, an information re#uest and assessment, a valuation calculations and report draft, a valuation review, and the delivery of the completed valuation report. good appraiser should be able to provide you with a clear picture of what*s going on at any step in the process. ;ake your decision based on how well a particular business appraiser will fit with your business, his e!perience and education, and how comfortable you personally feel working with him.

The Value of a Business

&lacing a value on your business is rarely a simple matter. If you*ve poured time and sweat into building up your company, your view of the value will reflect the effort you*ve put in. %ut an independent appraisal can offer a very different number than what you might come up with. It*s important to have an objective idea of what a business* true value is, if only because you may consider selling it in the future.

The Real Earnings of a Business

7oseph ,affrey, a business broker with (orldwide %usiness %rokers, e!plains that the value of a business can*t simply be based on what you*ve put into it yourself. To a large degree, a business is valued based on what the benefits of owning that business are. Though such benefits can be intangible (being your own boss, for e!ample), the benefits that concern us are monetary. (e want to determine, as closely as possible, the value of the benefits enjoyed by the owner. This effort entails a process known as recasting the earnings 2 i.e., we analy+e the business* profit and loss numbers to try to identify the true *discretionary earnings* or *owner*s benefits* of owning that business. /ffering an e!ample, ,affrey describes the following situation:

%y way of e!ample, let*s imagine a business with revenue of <= million. glance at the &>1 reveals net income of <?@,AAA. If the business is a corporation, we e!amine "orm ==BA of the business* ta! return and see that ta!able income is also <?@,AAA. (e then analy+e both &>1 and the ta! return to identify which or to what degree certain e!penses are really *owner*s benefits.* (e look for what is called *discretionary spending* 2 spending the owner has control over, unlike payroll, utility costs or rent. /ur objective is to determine the business* true profit or .eller*s Ciscretionary -arnings (.C-).

!ner"s Benefits: The Deter#ining Factor

"or small business owners, there are many financial benefits that go along with owning your own business. There is a lot of discretionary spending that occurs in many businesses that owners directly benefit from, beyond the business necessities of certain e!pense. ,affrey says: -!amples of such discretionary e!penses include the owner*s health insurance (and that of the owner*s family), life insurance and disability insurance. In many cases, the business pays for the owner*s vehicle, its insurance and its maintenance. (e determine these costs, pull them out and put them in the .Ccolumn on the spreadsheet we*ve built. nother modest benefit is that it is not uncommon for the business to pay for cell phones for the owner*s family. ;ore significant items include travel for tradeshows and association meetings, client dinners and, in the case of restaurants, the amount of food and drink enjoyed by the owners, etc. s an e!ample, a business owner in 7acksonville, "1 may get a mailer from his industry*s association that the association*s regional meeting will be held in tlanta, 6 and that the annual association meeting is in Donolulu, DI. The owner can attend the regional conference for <BAAA or the national conference for <BA,AAA. The <=E,AAA difference would be considered discretionary for our purposes and moved over to our .C- column. nother e!ample is a real estate brokerage we*ve worked with that speciali+es in waterfront property. It is reasonable to assume that a boat, properly named, of course, is critical to the owner*s business. The costs of owning3leasing and operating that boat are largely picked up by the business but are really benefits of owning the business. .imilarly, there*s a #uestion of the cost of the salary an owner draws against the business. If the salary is more than an owner would need to pay a manager to run the business 2 if the owner was absent from the day0to0day operations of the company 2 then the difference is also added to the .C- column.

$onsidering %i#ilar Businesses

(hen putting a value on your business, it*s also helpful to have an understanding of what similar businesses have sold for. ,affrey points out: s in the real estate industry, databases e!ist recording business sales, by industry classification, by region, nationally and, to a lesser e!tent, internationally. (e can determine what similar businesses have sold forF n analysis of such other sales will give the analyst a range of multiples that can be used to determine the *comparable* value of the subject business. /ne e!ample is a multiple of revenue in which the analyst will plot the sales price0to0revenue numbers on a chart, eliminate outliers, average the remaining sample and apply the result to the subject business. There are other metrics used to determine the value of a business that take into account both the values of similar businesses and the .C-, according to ,affrey. database search shows that si! similar businesses have sold in the past =B months at .G?, .@H, .?B, .HI, .G@ and .@G of revenue. The analyst eliminates the outlier (.HI), averages the remaining sample (.GI) and applies it to the subject business. Though this is a very simplistic e!planation of this stage of the process, the value of the subject business, using the ;ultiple of Revenue approach, would be <GIA,AAAF more important metric is the ;ultiple of -arnings approach which will provide a more meaningful valuation because it is based on actual earnings (.C-) and shows what the buyer can e!pect as a return on his or her investment. The process is similar to the ;ultiple of Revenue approach in that the analyst looks at the same si! similar businesses, calculates the sales price as a multiple of .C- (B.I, =.H, B.B, J.=, B.= and =.E), eliminates the outlier (J.=), averages the remaining sample (B.AE) and applies it to the subject business. gain, though this is a very simplistic e!planation of this stage of the process, the value of the subject business, using the ;ultiple of -arnings approach, is <@EB,IAA. Taking a look at the different valuations that can be placed on your business is a useful process because each metric can help you along to the clearest understanding of the true value of your business.

& Must 'a(e Business Agree#ents

Dollywood movie mogul .amuel 6oldwyn, founder of ;6;, once said: K verbal contract isn*t worth the paper it*s written on.L ItMs a good idea for small business owners to put agreements in writing. Dere are three agreements that you should definitely consider getting in writing.

Confidentiality Agreement
8our company many not have a secret formula as valuable as those used by ,oca0,ola and $",, but every company has some information that it does not want to become public. (hether customer lists and pricing information or new products and processes, you have valuable business secrets. To help protect that info, use a confidentiality agreement (also called a nondisclosure agreement). confidentiality agreement is a contract signed by your employees or any third parties with whom you intend to share confidential information. %y signing the agreement, the employee or third party agrees not to share that information. "or e!ample, if youMre considering a joint venture with another company, youMll likely need to divulge certain information about your businessN make sure it remains confidential by having an agreement in place before you discuss it. "ind free sample confidentiality agreements at:

I&watchdog.com (agreement for inventors) ;ore%usiness.com (agreement with third0parties) one,1- (employee agreement)

Buy-Sell Agreement
If you have co0owners in your business, itMs wise to decide what happens to an ownerMs interest when he or she retires, dies, or just wants out. This can be settled by the terms of a buy0sell agreement. The agreement can be constructed in several ways:

Cross-purchase agreement, in which the remaining owner or owners buy out the interest of the departing owner. This type of agreement works best if there are only two owners in a businessN it gets cumbersome when multiple owners are involved.

Redemption agreement, in which the company buys back the interest of the departing owner. This type of agreement works best when there are several owners. Hybrid agreement, which can include both a purchase and buyback.

The buy0sell agreement should be made when the company is started, but can be created at any time. Dere are some features to include:

The type of buy0sell agreement (e.g., cross0purchase agreement)N list of triggering events, such as retirement, disability, personal bankruptcy, divorce, or deathN mechanism to determine the value of the departing ownerMs interest. This can be a formula clause in the agreement, a re#uirement that an appraisal be obtained at the time of the triggering event, or some other method. ItMs usually not a good idea to set a fi!ed value in the agreement because it may not reflect changes in value by the time of the triggering eventN The funding that will be used to pay for the buyout. 1ife insurance usually is used for buyouts at deathN other funds must be used for buyouts for other triggering events.

"ind free sample buy0sell agreements at:

Coc.toc (for limited liability companies) 7ian.com (for corporations) ;eg "inancial (for corporations)

Independent Contractor Agreement

;any businesses hire contractors as a way to lower operating costs while still getting things done. The problem is that the IR. and the states will look at how you classify your workers, and if itMs determined that your contractors are really employees, you are liable for payroll ta!es, employee benefits, workers compensation, and unemployment coverage for them, too. (orker classification is primarily based on the degree of control you e!ercise over the workers. /ne factor in determining control is the relationship of the parties. If you and the workers agree up front that the relationship involves independent contractors and is not an employer0employee relationship, this helps to avoid reclassification of workers as employees. good way to show the relationship is with an independent contractor agreement.

The agreement should include the following points:

statement about the relationship of the partiesN statement that the worker acknowledges responsibility for ta!es and insuranceN 1anguage bolstering independent contractor status, such as that the worker is re#uired to furnish his3her own tools.

(hile the agreement is not binding on the IR., it can help demonstrate worker classification if the IR. has #uestions. "ind free sample independent contractor agreements at:

Coc.toc.com "ind1aw 1ect1aw.com

Bottom Line
(hile sample agreements may be useful in getting ideas for your situation, it is highly advisable to have any agreement you prepare reviewed by your attorney. 8our attorney can tailor your agreement to your companyMs specific needs and make sure it complies with the laws in your state.

)hat E(er* Business $ollateral

!ner %hould +no! A,out

6iven the way banks are getting the hairy eyeball from the "eds these days, if you want a loan you can be sure you*ll have to pledge something as collateral 2 your signature won*t be good enough. The bank will re#uire something of value they can sell 2 if worse comes to worst 2 to recoup the money they gave (rented) to you. .ounds straightforward, but establishing the collateral value of an asset is often a point of contention in loan negotiations. 1et*s say you bought a truck just last week with <?@,AAA of your hard earned cash. (%ad move using your cash, by the way, but that*s a different issue.) .till spanking new, and paid for, you offer your truck as collateral on an e#uipment

loan for your start0up business. %ut the bank says it*s only going to assign a collateral value of <I@,AAA to your vehicle. (hat gives) The difference in value is due to the reality that, if the bank has to sell your truck because you can*t make your loan payments, there*s no way they*ll get =AA cents on a dollar. nyone who*s tried to sell a relatively new car understands the problem. The same principle applies in spades if, say, you*re in the ditch digging business and want to use that custom built backhoe as collateral. If the bank thinks they*ll have a hard time selling it, even if it*s dirt cheap, they*ll assign a low collateral value. ,onsider this e!traordinary e!ample: 1ehman %rothers offered 7&;organ over <E billion in cash and securities as collateral on a guaranty. 4ot long after the transaction 1ehman declared bankruptcy. 7&;organ figured they were in good shape because they had all that collateral until they discovered the securities couldn*t easily be converted to cash and their value was hard to determine. .o, as part of a bankruptcy settlement reached a couple weeks ago, 7&;organ is transferring the securities back to 1ehman and accepting a cash payment of about <@GA million 2 less than =A cents on a dollar. -ven when you*re talking thousands 2 never mind billions 2 of dollars, valuing collateral is always a source of contention between you and your lender. They want as much as they can get, and you want as high a value as possible for what you*re offering. &art of the problem is that details about the value of your collateral may be common knowledge to you, but your lender may not understand the basis for your understanding. The best thing you can do is educate them on what your collateral is really worth, and you need to know where they*re coming from. Dere are some rules0of0thumb to help you understand how a lender*s likely to value your collateral: =. Accounts recei(a,les ( 3R) less than GA0HA days old are generally valued at @A0E@O. The collateral value of your 3R will be valued on the high end of the range if you sell to:

%usinesses vs. consumersN 1arge businesses vs. businessesN ;any businesses vs. just a few.

8our 3R will be valued lower if you sell to:

Digh risk businesses (say, restaurants)N "oreign customersN .low paying customersN ,ustomers with past due balances.

B. -n(entor* will be valued, as collateral, at anywhere from =A0GAO of the %alance .heet value. It will be valued on the low end of the range if:

Inventory turnover is slowN 8ou sell many locations especially out of stateN It*s in a leased facility (unless your lender has a landlord*s waiver)N ;ost of it*s work0in0progress (unfinished stuff that the lender would have a hard time selling)N It*s perishable, fashionable, or re#uires special storage.

J. Furniture and e.uip#ent will be valued from =A0EAO. 1ower values will be assigned if it*s speciali+ed e#uipment that will difficult to sell or if it has little value in the secondary market. Dere*s a good e!ample of why it*s important to educate your lender: transportation company owned hundreds trailers that rode piggyback on freight trains. "ully depreciated their %alance .heet value was +ip so the bank wanted to give them +ero collateral value. %ut these trailers spent most of their life on a train and had very little wear. (ith a fresh coat of paint they could actually sell at greater than their purchase price, given favorable market demand. n appraisal proved the point and a JAO collateral value was established. If the trailers weren*t located all over the country, and difficult to find, the assigned value would have been a lot higher. I. Real estate generally is given a collateral value of @A0HAO of the appraised value (less any liens or mortgages). Real estate will be valued lower if it*s investment real estate, special0use property, located in a distressed area, or if the real estate market is e!periencing a 'trough of demand,' such as, say, BA=A. @. $ash, believe it or not, can be used as collateral. 8ou can pledge money to borrow money) Con*t laughP 1enders will accept cash in the form of a certificate of deposit (,C) from their bank as collateral. %ut, because of li#uidating it, even a ,C from their bank won*t be given =AAO collaterali+ation value, and one from another bank will be valued even lower. .ome lenders will accept stock, bonds,

or other people*s assets (like real estate or certificates of deposit) as collateral, too. G. $ontracts or purchase orders might be accepted by some government lending programs, and occasionally by conventional lenders. In either case, their worry will be how they*ll be paid if you don*t perform 2 in most cases it won*t be easy for them to find someone else to fulfill the order so they can collect the proceeds. These may not be the best economic times, but if you*re refinancing or trying to negotiate a loan, keep the guidelines we*ve listed above in mind. ;ore importantly, make sure your lender understands the realities about what you*re offering as collateral so you get the best possible valuation.

ffice %pace: %hould You Bu* or /ease0

;ore often than not, office space isn*t the biggest concern for a small business. Retail may be a different matter, but when it comes to an office where you can just get some work done, priorities are a bit different. If you absolutely have to have a place to meet clients, there are conference rooms you can rent out, office spaces rented on a shared basis, and even coworking spaces. %ut there will likely come a day when you do need office space of your own. home office can work for a while, but when you need to bring in an employee, you*ll want some office space that you can call your own. "rom there, you have two options: 8ou can buy, or you can lease. 1nderstanding the /ife %pan of Your Business There*s a certain ideal that implies owning your office space makes sense 2 after all, why pay rent when you can build up an asset for your business with a property) %ut the key deciding factor should be the life span of your business. If you are certain that not only will your business be around in ten years, but that you*ll need to be in the e!act same place, buying the office space you need may not be out of the #uestion. %ut if your business has a less0certain future, tying its health to a mortgage can simply tie up your resources from the start.

"or a business that is still evolving, renting offers a certain fle!ibility, even though you aren*t spending your rent money on anything that will turn into an asset for your company. If you need a bigger space, you have the fle!ibility to move. If you need speciali+ed e#uipment (and therefore a speciali+ed space), you have the fle!ibility to move. If you need to add retail space, you have the fle!ibility to move. %ut in each of those situations, if you buy office space, you*ll either need to sell it or rent it out to be able to move. /ook at Your $ash in 'and secondary #uestion comes down to how much cash is sitting in your business*s coffers. (hile getting a mortgage on a house is a fairly simple proposition, it*s harder to finance the purchase of office space (especially for a small business with a short credit history). t the bare minimum, you*ll need to have a down payment of JAO of the cost of the property, and you can*t e!pect particularly great interest rates on any mortgage you take out. "urthermore, you*ll be facing the costs for an appraisal, a building inspection and other odds and ends before you get to the closing. In contrast, renting a space will cost you the first month*s rent and a deposit (probably around the cost of a month*s rent). That*s a fraction of what you*ll need to have up front to buy space. The ta! factor can also tip the scales: (hile your business can deduct the full amount paid for rent in a given year, the cost of buying commercial real estate (as well as improving it) is depreciated over JH years. That means that your ta! situation will likely be better renting office space, although it*s important to check with a ta! professional to be sure of your own situation. Read* for a %econdar* Business0 %y choosing to buy office space rather than rent it, you*re putting yourself into a second business 2 real estate investing. If you buy a property with more space than your business currently needs (generally a good plan if you e!pect your business to grow at all), you*ll put yourself in the position of needing to rent the rest of that space to others until you*re ready to use it. (hile that can be a good thing (at the very least, renting out space makes it easier to be sure you can pay the mortgage every month, no matter how your business is doing), that does mean that you have to pick up the nuts and bolts of being a landlord while still focusing on growing your business. The financial situation may work out, but it*s worth looking into what it takes to be a landlord before making a decision.

%uying a property may also put you in the position of selling it for a profit down the road, at least if you were able to select a piece in an area where land values are appreciating. That sort of financial boost can be pleasant, especially for a small business owner who may be looking for capital to invest back into the company. Making the Final Decision "or most small businesses, renting office space is by far the easiest option. 8ou don*t need to come up with much cash up front, you aren*t tied to a property, and you don*t have to figure out how to run two businesses at once. /f course, those obstacles aren*t insurmountable, and there are some points when buying office space makes sense. If, for instance, you do have the capital available and you can cut what you*re paying in rent as well as pick up an investment, buying makes a lot more sense. .imilarly, if you*re in a market where renting is more of a gamble 2 an area where rental prices fluctuate dramatically 2 buying can be a way to keep control of your costs. t the end of the day, it*s important to look at what your business needs. .ee what*s happening in terms of commercial real estate in your area and how that impacts you, too. 8ou should consult with a financial advisor, as well as a ta! professional, to see what will be the best fit for you. ll these factors must contribute to the right decision for your business. /nly then will you know if renting or buying is the best choice.