Business Valuations – Des Moines (IA)

While many believe a business valuation is only needed when considering the purchase or sale of a business, this is not true. There are many situations when a valuation may be needed including during the succession planning process, estate and gift planning purposes, during divorce proceedings, to obtain financing, litigation support, partner buyouts, and even for strategic planning purposes

Business valuations are conducted by qualified professionals who have undergone specialized training and experience and have obtained specific credentials in the field. Due to the broad application of a valuations including legal and tax purposes, this work cannot be completed by other financial professionals including Certified Public Accountants (CPAs). There are several credentials that business valuation professionals often hold.

• Certified Valuation Analysts (CVA) – This credential is awarded by the National Association of Certified Valuation Analysts (NACVA). These professionals are CPAs or financial professionals that have undergone significant training and taken several examinations focused on valuation standards and methodologies. These individuals are best suited to perform a valuation for several purposes.
• Accredited in Business Valuation – This credential is primarily for existing CPAs and other financial professionals that have valuation experience. Those who hold this credential have expertise in valuation methods, including income, market, and asset-based approaches. Companies and business owners looking for a valuation can turn to these professionals for assistance with mergers and acquisitions, litigation support, tax and estate planning, and financial reporting.
• Accredited Senior Appraiser – This credential is offered by the American Society of Appraisers (ASA) and is provides professional appraisers with rigorous instruction and testing. Applicants must have a minimum of 5 years’ experience and are discipline specific (real estate, machinery, real property, etc.). It is considered the most difficult valuation certification to obtain.

Economic conditions play a crucial role in determining value. Valuators strive for balanced assessments, avoiding excessive pessimism or optimism. Valuations that overlook the cyclical nature of economic conditions or double-count risk factors could lead to incorrect business value. Variables influencing value include:

• Expected cash flows: Future earnings dictate value according to both market and income valuation approaches. Changes in demand, pricing trends and adjustments to historical financial statements to reflect future expectations are essential considerations.
• Perceived risk: Higher risk results in increased discount rates (income approach) and lower pricing multiples (market approach), leading to lower values, and vice versa. Buyers like companies that are predictable, so the less risky you can make your operations, the higher value you will receive at a sale.
• Marketability: A marketability discount is intended to account for the reduced ability to convert an ownership interest into cash. An ownership interest in a business is worth less if it is not readily marketable. Given the option between two investments with equal return, a prudent investor will choose the investment with less risk. Part of that risk is inherent in the investor’s ability to quickly convert their investment into cash, which is the purpose of the marketability discount.

Various factors affect the extent of valuation discounts, influencing the attractiveness of a business to potential buyers. Here’s a breakdown of how these factors contribute to the discount:

• Financial performance: A business with a consistent history of profitability and strong financials is generally valued higher than one with a history of losses or volatile performance. Investors appreciate companies who have predictable and consistent cash flow. Less volatility leads to less discount.
• Portfolio diversification: A business with a diversified customer base and product offering is generally considered less risky than one reliant on a single customer or product. Less risk translates to a lower discount.
• Leverage: The amount of debt a business carries (leverage) can affect its valuation. High debt levels increase the risk for potential buyers, leading to a higher discount.
• Owner rights: The rights and control granted to owners can influence valuation. Limited voting rights or restrictions on transferring ownership can decrease attractiveness and lead to a discount.
• Distribution history: The history of dividend payments or profit distributions can impact valuation. A consistent history of distributions indicates a business generates steady cash flow, which can be attractive to buyers and potentially reduce the discount.
• Personal characteristics of general partners or managing members: In closely held businesses, the experience, reputation and expertise of the key personnel can significantly impact valuation. The potential loss of these individuals could decrease the business’s value and lead to a higher discount.

Discounts can vary significantly depending on the specific circumstances of a business, potentially exceeding 40 percent of the entity’s net asset value. A thorough understanding of these factors is crucial for business owners and their advisors when determining the fair market value of a business for succession planning purposes.

The information needed for a valuation will vary based on the specific business and industry. The appraiser should be able to fully understand every aspect of the appraised business. This information is gathered through a formal information request. Some of the items typically found on an information request include:

• Historic and forecasted financial statements
• Listing of personal expenses within the company
• Listing of extraordinary or nonrecurring expenses
• Depreciation schedules
• Management census
• Listing of main competitors
• Description of market area
• List of key customers and suppliers
• Description of facilities

An information request should be coupled with an interview of management and key personnel within the company to gain a full understanding of operations necessary to render accurate value.

This approach is similar to how value is determined in residential real estate. The value of a business is determined by comparing it to similar companies that have recently been sold. In some cases, the valuation professional may also look at like/kind public companies for an indication of value. This approach relies on the principle that the value of a business is determined by observing comparable assets in the marketplace.

When relying on the approach it is essential to identify a selection of appropriate or comparable companies. Essentially, they would be those that closely resemble the business being valued in terms of size, industry focus, financial performance, and potential growth opportunities. Since there are often differences amongst companies that appear to be similar, it is important to find the right comparable otherwise one may get misleading results.

This method is often used during Initial Public Offerings (IPOs) when a company goes public using existing market comps. It is also used when business owners engage in strategic benchmarking, to value against competitors.

This approach uses the expected cash flow or future earnings to determine the value of a business. Rather than focusing on market value based on business assets, it analyzes its ability to generate future income. Under this approach, a business valuation professional will compile all the assets and subtract liabilities to determine a value.

This approach is commonly used before placing a company for sale to determine a reasonable sales price. Others can use it during a transactional event to determine the value of a target company. Finally, it may also be used by those looking to expand services or products to quantify the impact of expansion.

This approach determines value by focusing on assets and liabilities. It calculates value by subtracting total liabilities from the market value of assets. Essentially, it focuses on what the business owns versus what it owes to determine a net asset value. This approach is commonly used by those with significant tangible assets, those encountering financial issues, or by holding companies. It may also be used in the process of creating buy/sell agreements.

When making a critical decision, such as selecting a heart surgeon, cost rarely takes precedence over the surgeon’s expertise. Similarly, when hiring a valuation analyst to determine the worth of a business you’ve built over years, their qualifications and experience should be your primary focus. A competent professional will not only evaluate your business accurately but may also defend their analysis in a legal setting if necessary. Experience is crucial in these scenarios, and while it may come at a higher price, the risks of cutting corners can lead to costly mistakes.

The field of business valuation demands proficiency in several disciplines, including accounting, finance, economics and law. Valuation professionals undergo rigorous training and certification processes and are required to maintain their qualifications through continuing education and professional practice. These qualifications represent the baseline for competent service in this highly specialized field.

Research Your Options

• Not all valuation professionals are created equal. A thorough business valuation process often includes site visits, interviews with management and detailed financial analysis. Research potential analysts carefully to ensure they have the skills and experience required to handle your specific needs. Consult trusted sources, such as attorneys or certified public accountants, for recommendations.
• Think Long-Term - Focusing solely on the cost of valuation services today may lead to greater risks tomorrow. An experienced professional will understand the unique aspects of your business, industry, and associated risks, providing a more accurate valuation. Inaccuracies in risk assessment can significantly impact the final valuation, far outweighing the savings from hiring a less experienced provider.
• Be Transparent - Open communication with your valuation expert is essential. Share all relevant details about your business during the valuation process. Providing comprehensive information ensures the analysis is as accurate and thorough as possible.