BY NORMAN G. GRILL
There are good reasons to do an appraisal of your business regularly or, at least, to familiarize yourself with the process so you”™re ready when the time comes.
Much of the hesitancy surrounding valuations has to do with uncertainty. Many business owners just don”™t know what to expect. To simplify matters, let”™s look at three basic pillars of the appraisal process:
Ӣ Purpose. ThereӪs no such thing as an all-purpose valuation. Each one needs to have a specific focus. This could be as clear-cut as an impending sale. Or perhaps an owner is divorcing his spouse and needs to determine the value of the business interest thatӪs includable in the marital estate. In this context, goodwill (the intangible asset arising from factors such as the ownerӪs recognizable name or customer loyalty to the companyӪs product line) may require special treatment, depending on relevant laws and precedent in your venue.
In other cases, an appraisal may be driven by strategic planning. Have I grown the business enough to cash out now? Or how much further could we grow based on our current estimated value? The valuation”™s purpose strongly affects how an appraiser will proceed.
”¢ Standard of value. Generally, business valuations are based on “fair market value” ”” the price at which property would change hands in a hypothetical transaction involving informed buyers and sellers not under duress to buy or sell. But some assignments call for a different standard of value.
For example, say you”™re contemplating selling to a competitor. In this case, you might be best off getting an appraisal for the “strategic value” of your company ”” that is, the value to a particular investor, including buyer-specific synergies.
”¢ Basis of value. Private business interests typically are designated as either “controlling” or “minority” (nonmarketable). In other words, do you truly control your company or are you a noncontrolling owner?
Defining the appropriate basis of value isn”™t always straightforward. Suppose a business is split equally between two partners. While each owner has some control, stalemates could impair decision-making. On the other hand, a 2 percent owner might possess some elements of control if the remaining shares are divvied up equally between two 49 percent owners. An appraiser will need to definitively establish basis of value when selecting valuation methodology and applying valuation discounts.
A prospective ownership transfer is indeed a common purpose for a valuation. Yet strategic investments (such as a new product or service line) can also greatly benefit from an accurate appraisal. As growth opportunities arise, business owners have only limited resources to pursue chosen strategies. A valuation can help plot the most likely route to success.
Why not simply rely on our tried-and-true projected financial statements for strategic planning? One reason is that projections ignore the time value of money because, by definition, they describe what”™s going to happen given a set of circumstances. Thus, it can be difficult to compare detailed projections against other investments under consideration.
Valuators, however, convert your financial statement projections into cash flow projections and then incorporate the time value of money into your decision-making. For instance, in a net present value, or NPV, analysis, an appraiser projects each alternative investment”™s expected cash flows. Then he or she discounts each period”™s projected cash flow to its present value, using a discount rate proportionate to its risk. If the sum of these present values ”” the NPV ”” is greater than zero, the investment is likely worthwhile. When comparing alternatives, a higher NPV is generally better.
Often, we all find it difficult to be objective about the things we hold close. There are few better examples of this than business owners and their companies. But a valuation can provide you with an unbiased, up-to-date perspective on your business that can help you make better decisions about its future.
Norm Grill (N.Grill@GRILL1.com) is managing partner of Grill & Partners LLC, certified public accountants and advisers to closely held companies and high-net-worth individuals, with offices in Fairfield and Darien.
