How to value a business: A guide to business appraisals and valuations.

Whether you’re considering buying or selling, restructuring, or simply gauging your position in the market, a business appraisal or valuation is the compass that guides your decisions. However, there’s no one-size-fits-all approach as it requires a deep understanding of the factors that influence business value, experience with business transactions, as well as knowledge of market expectations and different valuation methodologies. So, how do you unpack a business’ value, what makes a good appraisal or valuation, and how can you ensure you’re getting an accurate assessment?

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Business Valuation vs. Appraisal: Is There a Difference?

While the terms “business valuation” and “appraisal” are often used interchangeably, there are differences between the two. A business valuation report is more comprehensive and formal, suitable for legal purposes or significant transactions. A business appraisal is often used to gauge the market value of a business. Whilst similar methodologies and factors are used to come to a figure, one approach is much more detailed than the other and will take significantly more time, effort, and cost.

• Business Valuation Report: A business valuation is a thorough investigation into the various facets of a company’s operations, assets, liabilities, and potential. This meticulous scrutiny naturally translates to higher costs and time investments.
• Business Appraisal: On the other hand, a business appraisal is a more streamlined affair, offering a condensed evaluation of a company’s value. It serves as a practical tool, suitable for scenarios where a detailed, exhaustive assessment isn’t necessary. Appraisals are often favoured when the primary objective is gaining an estimate of a business’s worth, such as when contemplating a sale.

There are different levels of appraisals depending on the business. For smaller, more common and straightforward types of businesses, for example a cafe, the appraisal can be conducted relatively quickly. For larger businesses, valued at say more than $2 million, a much more thorough appraisal is necessary, which leans towards what might be considered a valuation. However, the confirmation or evidence of the information provided may be more refined, as it is not intended for legal purposes.

When to Conduct a Business Valuation

• Legal Proceedings: In situations involving disputes, divorce proceedings, or regulatory compliance, a formal business valuation is typically necessary to meet legal standards and provide a robust foundation for any legal actions.
• Complex Transactions: For intricate business transactions like mergers, acquisitions, or restructuring, a detailed valuation report offers clarity and ensures all parties involved have a comprehensive understanding of the all aspects of the business.

When a Business Appraisal Suffices

• Contemplating a Sale: If the primary goal is to gauge market value before putting a business up for sale, a business appraisal can provide a swift and cost-effective solution, offering insights without the need for exhaustive analysis.
• Internal Assessments: When business owners seek to understand their company’s value for strategic planning, without the need for formal documentation, a business appraisal can offer a practical snapshot of current worth and potential areas for improvement.

Important Factors to Consider for Valuations and Appraisals

When delving into business valuation and appraisals, it’s essential to consider a multitude of factors beyond just financials. While analysing financial statements over multiple years and the current period is crucial, non-financial elements like client base, working capital requirements, contracts, and even the owner’s role play a significant part in valuing a business. Additionally, factors such as the lease on premises and industry-specific metrics can also come into play.

Catherine Jones, Director at Zircom Business Brokers says being able to provide accurate and timely accountant prepared financials is crucial.

“Transparency regarding both positive aspects and potential issues within the business is essential for a smooth acquisition process. Addressing these matters beforehand facilitates a seamless transaction for all parties involved, as all the matters can be considered, understood and a path forward determined that works for everybody,” Catherine says.

Financial Analysis, such as:

• Historical Performance: Examining the financial performance over the past few years provides insights into revenue trends, profitability, and potential growth patterns.
• Future Projections: Forecasting future earnings and cash flow helps predict future earnings streams.
• Adjustments: It’s common to make adjustments to financial statements to reflect the true economic reality of the business, such as removing one-time expenses or adding back owner perks.

Non-Financial Considerations, such as:

• Client Base: The composition and stability of the client base can significantly impact the perceived value of the business.
• Working Capital: Understanding the working capital requirements and cash flow cycles is crucial, especially in industries with significant inventory or receivables.
• Contracts and Agreements: Long-term contracts with clients or suppliers can provide stability and predictability to cash flow.
• Owner’s Role: Assessing the owner’s involvement in day-to-day operations and the extent to which the business relies on their expertise is essential.
• Depth of management: The depth and competency of the management team is crucial for evaluating the business’s ability to sustain and grow operations beyond the current ownership.
• Importance of key personnel: Is the business heavily reliant on the owners or a few key individuals for its success?
• Stability of the industry: Assessing the stability and growth potential of the industry can provide insights into the business’s long-term viability and potential for future earnings.
• Diversification of product or service: The diversification of revenue streams can help assess risk and resilience to market fluctuations.
• Geographic location: The location and market potential for expansion into new areas can impact the perceived value of the business.

Catherine says it’s vital to obtain an accurate appraisal, especially considering the significant decision the seller faces in deciding whether or not to sell the business.

“It’s important to have a realistic expectation and understanding of business value. There is no point commencing the sale process if the seller is unlikely to achieve their target sale price required to  pay off their debts or retire. Investing considerable effort into the appraisal process helps avoid surprises later on.”

Exploring Your Options

When seeking a business valuation or appraisal, you have several avenues to explore:

• Business Brokers: Qualified business brokers play a pivotal role in facilitating business transactions and often possess in-depth market insights and transactional experience. Ideally, you’ll want to engage a broker who holds relevant qualifications and memberships, such as those offered by the Australian Institute of Business Brokers (AIBB).Catherine Jones says understanding the market is important when appraising a business because the market sets the prices, not the seller, the buyer or the accountant for either party.”Brokers obtain this market knowledge from past transactions undertaken, consulting with other business brokers, and leveraging reliable sources such as business valuers, the Australian Institute of Business Brokers database, and industry bodies,” she says.
• Registered Business Valuers: Some business advisers specialise in business valuations, and many may also be business brokers. Ensuring they are qualified and have demonstrated experience in the industry is going to give you more confidence in their services.
• Online Tools: There are many valuation tools available online that provide quick estimates of a business’ worth based on predefined algorithms. While convenient and accessible, it’s important that you understand how these tools arrive at the valuation and what factors have been taken into account. If in doubt, it’s always recommended to seek the advice of experts such as business brokers or professional valuers. Below are a few tools and guides that you might find helpful:
  • Exit Advisory Group: This simple tool provides instant clarity by analysing just two factors: your industry and revenue band. In less than 30 seconds, you’ll discover your industry’s valuation multiples across various methodologies, including EBITDA, revenue, profits, and assets. Click here to start: https://exitadvisory.com.au/whats-my-multiple/
  • LINK Business Brokers: The Valu.LINK business valuation appraisal calculator estimates your business’s value utilising its unique algorithm, drawing from extensive data accumulated over many years. Click here to start: https://linkbusiness.com.au/business-value-calculator/
• Accountants: Engaging an accountant for valuation services is a common practice, given their familiarity with financial data and business operations. However, it’s essential to recognise that some accountants may not have as much market knowledge as a business broker or professional advisor, particularly regarding recent transactions and industry trends.
• Tap into Your Network: Reach out to fellow business owners, industry peers, or professional associations for recommendations. Personal referrals can often provide valuable insights into the reputation and reliability of potential providers.

Choosing the Right Methodology

Some business owners may choose to undertake a business appraisal themselves using a variety of methods. However it is always best to engage a professional who is not only qualified but has experience and a thorough understanding of the market and what other businesses are selling for.

Choosing the right methodology will depend on the type of business and the industry you are in, as well as the reason for the valuation. Each industry may favour a different approach, be it the market approach or industry-specific methods. The key is to align with the current market expectations and trends.

Common Valuation Methods:

• Market Approach: This method compares your business to similar businesses that have been sold recently, using metrics such as EBITDA multiples.
• Income Approach: The income approach determines value based on the present value of expected future cash flow, often using techniques like the discounted cash flow (DCF) analysis.
• Asset-Based Approach: This method calculates the value of the business based on the underlying assets, subtracting liabilities to determine the net asset value.
• Industry-Specific Methods: Some industries have unique valuation methodologies tailored to their specific characteristics, such as the excess earnings method for professional service firms.

Qualifications Matter

Whilst appraisals can be conducted by a variety of professionals, it’s important to note that valuations – which is a much more comprehensive and formal process – can only be conducted by qualified business valuers. This is a prerequisite for acceptance by the courts. Business valuers must have passed recognised courses and have the appropriate qualifications.

Either way, the qualifications to look out for are:

• Certified Practicing Business Broker: An accreditation program covering the skills and knowledge business brokers are expected to possess to be licensed to operate.
• Registered Business Valuer: This certification is for experienced business brokers wanting to provide their services as business valuers for small- to medium-sized businesses. You can read more about these qualification on the Australian Institute of Business Brokers and also search their online directory of qualified business valuers and licensed business brokers.
• Experienced Accountant: Chartered Accountants that meet education and experience criteria can receive formal recognition with the CA Business Valuation Specialisation.

Finding the Right Valuer

Choosing the right business valuer is a decision that shouldn’t be taken lightly. Tap into your network, seek recommendations, and compare providers diligently. Look for professionals who are thorough in their appraisal process, considering both financial and non-financial aspects.

Qualities to look for:

• Transparency: A reputable valuer should be transparent about their methodologies, assumptions, and findings throughout the valuation process.
• Thoroughness: Look for a valuer who conducts a comprehensive analysis, considering both quantitative and qualitative factors to arrive at a well-supported valuation.
• Experience: Seek out valuers with a track record of success in valuing businesses similar to yours, preferably within your industry or niche.

According to Catherine, a red flag to look out for is how engaged the valuer is with the seller as part of the process.

“If the individual conducting the appraisal or evaluation fails to enquire adequately or ask the pertinent questions — both financial and non-financial — this could hinder a comprehensive understanding necessary for determining the business’ true market value. Additionally, visiting the premises at some point during the appraisal process is important,” Catherine says.

How to know the valuation you’ve received is any good

• Comprehensive Analysis: A good valuation should involve a comprehensive analysis and rationale of various factors influencing the business’s value, including financial performance, market conditions, industry trends, competitive landscape, and risk factors.
• Alignment with Industry Standards: Assess whether the valuation methodology used is widely accepted within the industry.
• Qualifications and Experience of the Valuer: Verify that the valuer holds relevant certifications or credentials in business valuation.
• Transparency and Documentation: The valuation report should clearly document the methodology used, assumptions made, data sources relied upon, and any limitations or uncertainties associated with the valuation.
• Consistency with Market Trends: Assess whether the valuation aligns with current market trends and comparable transactions in the industry.

The Pitfalls of Chasing the Highest Valuation

While it may be tempting to gravitate towards the highest valuation offered, it’s generally a risky move. A valuation should be realistic and logical, in line with market expectations. If a business’ asking price is misaligned to what buyers think the business is worth, a transaction is less likely to occur.

Going with the highest bidder without considering other factors could lead to frustration for both buyers and sellers.

Catherine says its not uncommon for sellers to obtain an accurate valuation from her firm only to opt for a higher valuation obtained elsewhere.

“This often results in a prolonged and draining process, with the business not selling or eventually selling closer to the value provided in our initial valuation. Overpricing can deter buyers, reducing the marketability of the business, especially in larger private enterprises where strategic buyers are common,” Catherine says.

Considerations when evaluating valuations:

• Market Realism: Assess whether the valuation aligns with market realities and industry standards rather than relying solely on the highest number.
• Transaction Structure: Consider the terms of the deal beyond just the valuation, such as payment terms, earn-outs, or non-compete agreements.
• Buyer Fit: Evaluate the compatibility between the buyer’s strategic objectives and the business’s long-term goals to ensure a successful transaction beyond just the price.

In conclusion, understanding the true value of your business requires a multifaceted approach that considers both financial and non-financial factors. By leveraging the right methodology and working with qualified professionals, you can navigate the complexities of business valuation with confidence, ensuring that your decisions are informed and strategic.

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