"The first thing we look at is the balance sheet and what assets go along with the transaction," says Jones. The method he uses here is a method from the Asset- based Approach: the Accumulated-Asset Method. This method sets for the floor for selling price of the business. "At a minimum, a business is going to be worth what the tangible assets are worth," he says. "We're trying to discover what the hurdle needs to be for the earnings to support a value higher than that."
Next, Jones looks at the earnings of the business to determine if it is providing a return on all assets, both tangible and intangible. In specific, Jones uses a popular method for valuing very small businesses (less than $1 million in revenues), the Multiple of Discretionary Earnings Method (See Method Examples). Here, Jones looks at the earnings that are available to the owner to pay himself a salary and get a return on both the debt and equity capital in his business. Next, he selects a multiplier derived from his analysis of how the risk factors (See Risk Factors) might affect the price of the business.
"Risk factors are what make one business different than another," Jones says. Three key risk factors he notes are depth of management, diversity of products or services, and geographic dispersion. Questions he might ask are does all of the company's critical knowledge reside in only one or a few people? How narrow is your marketplace? The answers to the questions help him determine the multiplier that he then applies to the valuation of the business, which either pushes the price up, if the business is deemed less risky, or slides it down, if the questions aren't answered favorably.
Last, a Market Approach, the Direct Market Data Method, offers Jones perspective on how businesses in the company's industry are selling. Based on two data points, Price to Gross (P/G) and Price to Earnings (P/E), Jones evaluates subject companies against industry data. "I adjust the subject company up or down from that, and adjust those ratios based on my whether my company is better than average," he explains. "If my company isn't one of the top players, then I might reduce my value."
After considering all three approaches, Jones selects one or more methods that he deems applicable. "Then based upon my final analysis of the company, I have to correlate those indications of value into my opinion of value," he says. "It's a subjective analysis that may put more weight on one method than another."
It's clear that professionals can certainly help business owners arrive at a selling price more accurately than they could do on their own, but professionals can also help in another way -- by helping an owner determine how to get more for the business.
"If you're going to sell your business, the best thing to do is to get it professionally appraised a least one full economic cycle before you put it on the market," says Miles. That will tell you what you business is worth and you can sit with an appraiser to determine why it isn't worth more. An appraiser will tell you such things as your technology is outdated, you haven't any non-competes, which puts your business at risk, or you have too many eggs in one client's basket. He or she will explain all of these things in a report, and then you'll have a full economic cycle to fix them and make your business a more attractive offering.
SIDEBAR: Choosing an Appraiser
If you're convinced you need an appraiser, make sure they have the following skills to ensure you get the most for your money.
Professional accreditation: There are four organizations in the United States, the Institute of Business Appraisers (IBA), the American Society of Appraisers (ASA), American Institute of Certified Public Accountants (AICPA), National Association of Certified Valuation Analysts (NACVA), that certify business appraisers, according Michele Miles, executive director of the IBA. "Everyone's requirements are a bit different based on education and the backgrounds of the founders," she says, but each organization will ensure the appraiser has been trained and tested. These organizations require their designated members to have taken educational courses, attend national conferences, have their appraisal reports reviewed by a peer committee, and subscribe to a code of ethics and professional standards.
Small-business appraisal experience: "Some appraisers tend to specialize in the larger businesses and may not have much experience in valuing small businesses," says Jeff Jones, president of Certified Business Appraisers Inc., and chairman of certified Business Brokers, both based in Houston, Texas. An appraiser who is experienced in appraising smaller business is important, especially when a businesses value is less than $500,000.
Ability to conduct in-depth research and financial analysis: An appraiser should be able to create forecasts, conduct thorough research and adjust financial statements. "[You] have to be able to find info about an industry to project the future for the industry and look at financials and do some pretty heavy analysis, and you have to be able to do that with a copy of a word processing program and a financial spreadsheet program and nothing else," Miles suggests. "Everything else has to come from your brain."
Ability to be subjective and to be forthright: Because a lot of owners don't want to hear bad news about business and don't want to report hidden income. You have to be able to be comfortable to deliver bad news and not living for others approval.
Ability to do an appraisal independent of a valuation software program: There's a lot of subjectivity that goes into pricing a business to sell. In most cases, valuation software programs are not flexible enough to make adjustments that are needed for each individual business. And they rarely provide enough disclosure on how it arrived at the number. "Most full-time appraisers don't use computer programs," Jones says. "They use their own templates."
