What is Your Business Worth
It is ultimately the market that determines the selling price a business owner can achieve. Gauging this value, or the most probable selling price (MPSP), is a nuanced skill that extends beyond mere valuation. This is where the expertise of a certified business intermediary becomes invaluable.
Conducting a formal appraisal of your business before you decide to sell can serve as a guide to enhance its value and reduce tax liabilities, ultimately leading to greater financial gain. Such appraisals are also crucial for other purposes, like buying out a business partner, dividing assets during a divorce, for estate planning purposes, freezing assets for tax planning, or transitioning them into a family trust.
Our approach begins with a comprehensive appraisal to ascertain the Fair Market Value (FMV), employing methods sanctioned by the International Business Brokers Association (IBBA).
Based on the FMV, we then calculate the MPSP. This figure reflects a realistic price, considering the actual (recast) earnings, market trends, buyer willingness, and seller’s intent. Armed with this information, sellers are better positioned to engage in informed negotiations.
Value is understood in current monetary terms, adjusted for risk, and determined objectively rather than through negotiation. On the other hand, price is not bound by time or risk adjustments; it stems from the established value and is open to negotiation.
Recasting Financial Statements
It's vital for a seller's price expectations to align with the actual market conditions. However, small business financial statements often don't accurately represent the business's true operations, as they're usually designed to reduce tax liabilities. The initial step in valuing the business involves adjusting, or 'recasting', the most recent balance sheet and the income statements from the past three to five years, item by item.
This recasting process gives a more accurate picture of the business's assets, liabilities, and genuine earning potential. For small and medium-sized enterprises, especially those that are owner-operated, income-based metrics like seller discretionary earnings (SDE) and Earnings Before Interest, Taxes, Depreciation, and Amortization (EBITDA) are crucial for ascertaining value.
Benchmarking Process
Valuations also consider the fair market value of both tangible and intangible assets and compare ratios from similarly sold businesses. Collaborating with a business broker who can access specialized databases and brokerage records is beneficial for effectively comparing a business against its industry, market, and similar entities.
Various factors like business patterns, competition, market dynamics, service or product quality, staff, and operational aspects are predictors of future profits and must be considered. This begins with adjusting the company's earnings, accounting for operational cash flow and adding back any discretionary, extraordinary, non-recurring, or non-cash expenses. Discretionary expenses are those not essential for generating revenue; extraordinary expenses are unusually high or above normal; non-recurring expenses are one-time costs; and non-cash expenses typically relate to depreciation.
Interest expenses are also added back as they represent capital costs, which might vary for a new owner. The same approach applies to income tax.
Rethinking with Recasting
While recasting is a common practice in business valuation, it often requires time for both buyers and sellers to understand and accept the concept. Accurately portraying the business is crucial for both parties in the transaction.
Sellers should realize that these documents are meant for valuation, not for tax purposes. A healthier bottom line, all other factors being constant, typically results in a higher valuation of the business. Without proper financial adjustments, an owner might underestimate the operational cash flow, leading to a lower-than-appropriate asking price.
On the other hand, a buyer needs assurance that the modifications made to the earnings are legitimate, and they need evidence that the cash flow is adequate. This includes being sufficient to cover their salary, service any debt acquired for purchasing the business, invest in business growth or reinvestment, and yield a reasonable return on their investment.
For both parties, as well as their legal and accounting representatives, it's essential that all these adjustments and claims are thoroughly substantiated during the due diligence process.
