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October 1999

Managing: Valuation

How Much Is Your Business Worth?

Is it the price of equipment and facilities? Revenue? Net income? The answer is all of the above and more

Jewelers should know the actual fair market value of their closely held corporations, partnerships or sole proprietorships, but in reality many do not. Compounding this problem are cases where the value of a fractional interest (just part of the business) is in question. Hiring a professional business appraiser is a possible solution. Among the many reasons to have an appraiser conduct a valuation are to complete a traditional sale transaction, to complete a partnership dissolution or buyout, during divorce proceedings or when establishing a succession plan where an interest (or portion) of the business will be given as a gift.

The appraiser will consider many factors when determining how much your business is worth, including:

  • Asset value (book value).
  • Value of capitalized earnings (a "multiple" of income or cash flow).
  • Value derived in recent sales or other arm's– length transactions of similar businesses.

In appraiser– speak these items are referred to as the cost, income and market approaches to value.
There also are valuation formulas, which may combine two or more of these factors. The weight given to any single approach depends on the business. Is it a viable concern or is it a losing venture that should be liquidated?

Is it capital– intensive (lots of equipment, cash and/or inventory needed) or labor– intensive? (Jewelers clearly have high– value inventory and could have high labor costs if they have a large business.)
What is the store's location and reputation in the community? What selection of jewelry does it carry? (Location, reputation and jewelry selection are intangibles and normally are valued using a capitalization rate agreed to by buyer and seller.)

Here's a closer look at the three factors listed in the first column.

Asset Value

Asset value is a controlling factor only when the business being appraised has mostly hard assets (such as a manufacturer) rather than assets that are harder to value (such as service– oriented companies). Because most jewelry stores have a large proportion of their capital investment in inventory, this would be a relevant factor.

Capitalized Earnings

Most buyers consider a business' capitalization of earnings, which reflect profits expected in the future. It's assumed that past performance is an indicator of future potential. Average past earnings are capitalized (using a multiplier) by taking the ratio of price to earnings.
Capitalized earnings, dividends and cash flow values are methods used in the income approach to valuing a business and are relevant to valuing most going concerns. These factors are used to set a purchase price and allow the buyer to know whether he or she will reach a targeted rate of return on the investment.

Recent Sales

Has there been a recent sale of any interest in the business? Recent sale value would carry a lot of weight, but recent transactions are rare. Liquidation value is significant only if a forced sale of a company is anticipated. It might include a discount from the fair market value because of the forced sale and expenses to liquidate.

These are just a few of many factors to consider in arriving at an accurate figure for business value. For business owners wishing to sell or merge their companies, or for those who just want to know what their business is worth, determining the proper value is a must. The work should be done by a trained professional and then backed up with a review by a second professional appraiser (see box). Simply placing a number on the value of a business without taking the proper factors into consideration could cost the owner or prospective buyer a lot of money. And that's just not good business.

Appraisal Basics

Just as not every car mechanic is the same, neither is every appraiser. It's often a good investment to hire another appraisal company to review an appraisal report or scenario for accuracy. A review might include questioning the appraiser's experience and technical knowledge of appraisal industry standards.

If there's some doubt about the results, the entire appraisal is subject to doubt. For instance, a reviewing appraiser can check for math errors and look for consistent application of variables that produce adjustments. Perhaps a comparable business has been listed for sale for an excessive period and no, or minimal, adjustments have been made.

Meanwhile, an appraisal report should indicate the appraiser has performed the appraisal in conformance with the Uniform Standards of Professional Appraisal Practice and that the appraiser gets continuing education with one of several nationally recognized appraisal organizations.

When discussing fees, ask the appraiser for an estimate of the overall cost, not hourly rates. A low per– hour fee doesn't translate into a lower fee if the appraiser takes more time. Expect completion in two to six weeks, depending on the complexity of the assignment and a fee typically beginning at $1,500, with costs sometimes ranging from $3,000 to $5,000.

By Carl Lloyd Sheeler

Carl Lloyd Sheeler is an expert witness in business valuation and the managing partner of Allison Appraisals & Assessments, a 45– year– old nationwide appraisal company with offices in Providence, RI, and San Diego, CA. Allison Appraisals & Assessments specializes in appraisal review, litigation support and valuation for estate planning. He can be reached at (800) 286– 6635 or csheeler@AAppraisals.com, or visit the company's comprehensive Web site at www.Aappraisals.com.

 

 



Copyright © 1999 by Bond Communications.



 

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