That's just one thing a good business valuation will tell you
Doug Roberson and his partner started thinking about selling their data-communications company, Atlantic Network Systems, in 1994. "Because we wanted the best outcome and knew very little about the mergers-and-acquisitions market, we decided to get as prepared as possible," explains Roberson.
The partners' instrument of choice? A corporate valuation, which they hired a large mergers-and-acquisitions firm to perform at a cost of about $15,000. "That turned out to be one of the smartest things we could have done," Roberson recalls. "We received a 25-page report that allowed us to get a completely different perspective on our company." The valuation helped him and his partner pinpoint issues that might trouble an independent outsider, such as the company's reliance both on certain key employees and on major customers. "What it did was allow us to prepare ourselves to respond to worries on the part of a prospective buyer," Roberson explains. "It helped us become stronger negotiators."
Here's the happy ending: One year ago Roberson and his partner merged their $18-million, Raleigh, N.C., company with a bigger company. In return for their stock in Atlantic Network Systems, the partners received $5.7 million worth of the larger company's stock, as well as five-year management contracts. "That valuation was worth every penny for the added insights it gave us," Roberson concludes.
There may be no business document as maligned or misunderstood as the corporate valuation, also known as a business appraisal. Although they're especially useful for business owners contemplating the sale of their companies, valuations are seldom commissioned by sellers at all--since most are convinced that nobody knows their companies' value better than they do. And while valuations can also have an enormous impact on strategic planning, they're typically overlooked there, too. Most business owners choose to pay for a formal valuation only when they absolutely must--usually when a financing or other kind of transaction requires one.
So here's a wake-up call. Pricey though they may be, valuations can and should be used at key stages in any growth company's development. (See "Valuation Time," below.) "The thing to keep in mind is that when you own a private company, no one can look up its value in a newspaper. So when circumstances require that kind of information about a private company, its owner must hire someone to perform a study of its value that is logical and defensible," explains Thomas Giordano, director of valuation services for the accounting firm Goldstein Golub Kessler & Co., in New York City.
That formal valuation study can give new meaning to the word in-depth. The valuation process, including the appraiser's interrogation of management, key customers, and others, can last a whopping 90 days or more.
"The conclusion about a company's value will be based on an analysis of all kinds of information, such as the historical profit-and-loss picture, other financial records, the customer base, internal controls, key employees, competitive details, and much more," says Catherine Bienert, CEO of Bottom Line Management, an Atlanta business-brokerage and business-appraisal firm. A full appraisal can cost anywhere from $5,000 to $20,000--or even higher. The final document might run 60 pages or longer, although briefer versions can be commissioned.
But the results can be well worth the costs, as Roberson learned. Just consider the financial risks entrepreneurs run, for example, if they give company stock to their children as part of a long-term estate-planning strategy--only to have the IRS step in years later and challenge the claimed taxable value of the gifts. "The IRS will always start out from the premise that your company is worth the highest possible number," explains John J. Ferro, senior director of the corporate finance group at Arthur Andersen in New York City. "Unless you've got a good, defensible valuation to back up your claim of a lower value, you can face real difficulties."
Don't expect the IRS to accept a defense based only on the so-called valuation rules of thumb, the industry guidelines that sometimes appear in textbooks or industry newsletters. (The rule of thumb on pizza shops, for example, is that they're worth, for sale purposes, 30% to 40% of gross annual sales.) Rules of thumb are nothing more than the roughest of starting points, warns Ed Telling, a business broker and appraiser based in Cortland, N.Y. At best, they can only help you approximate typical market prices for typical businesses in your industry.
Like Uncle Sam, bankers and investors are generally skeptical about rules of thumb. You can expect both groups to require a valuation--usually to be performed by appraisers of their choice--whenever a company seeks either a significant increase in credit or a new infusion of equity capital. A banker is likely to waive the valuation requirement only when a company's loan is fully collateralized by personal or corporate assets.
Not every valuation story has a happy ending. Stephen Davies, president of US Computer Group, a $25-million Farmingdale, N.Y., company, recently spent three months and $20,000 hiring two appraising firms. The double hit was required by a bank that was considering the company's application for a major financing package. The bank, Davies says, wanted to assess the value of some of US Computer Group's contacts. "Both valuations verified the value of those contracts," says Davies. "They essentially agreed with everything I had said and then, at the final moment, a senior officer at the bank decided he had 'conceptual problems' with the loan. Why didn't he raise them at the beginning rather than require us to get those two valuations?"
Davies has had better luck with the regular "mini-valuations" he commissions as part of US Computer Group's employee-benefits package. "We include a company-stock component in our 401(k) plan, which means we need a small-scale valuation each year. All that costs is about $2,500, and it's really just a matter of routine," he explains. "The result is well worth it."
Jill Andresky Fraser is Inc.' s finance editor.
All sorts of events could trigger a need for a valuation; check with your accountant or lawyer whenever major changes occur within your business. You may need a valuation if you're--
Though most valuations claim to assign a fair-market value, the results can vary widely. Here are some reasons:
Want to know more about valuations, particularly from the viewpoint of buying or selling a business? There is one (and only one) book to buy: The 1997 Business Reference Guide (Business Brokerage Press, 508-369-5254, $72), edited by Thomas L. West. This 550-page book doesn't bog you down with unnecessary appraisal jargon and yet is full of fascinating tidbits. You'll find rules of thumb, useful listings of business brokers, mergers-and-acquisitions resources, and valuable sample contracts and checklists.