The final documents seem, at first glance, to be deceptively modest in scope. Each begins with a short letter that outlines the goal of the appraisal: to determine fair market value. The meat of the report consists of several pages in which Jones calculated the value of each company according to a variety of different appraisal methods.
A careful reader of those methods would quickly come to the conclusion that valuation is indeed an art and not a science. Different methods yield different numbers. Jones emphasized the inexactness of the numbers by the way he listed them on the bottom line of each page, using the word say, as in "Let's say it's about somewhere in the range of...."
For the Patriot Group, an asset-based approach that used book-value numbers yielded a "say" value of about $973,000. Relying on market rules of thumb for companies in the distribution business produced considerably higher numbers, although those figures also varied widely. Such companies tend to sell at 30% of gross sales. Factoring in such things as tangible and intangible assets and long-term liabilities, the appraiser came up with a $5.1-million valuation based on pro forma 1998 revenues of $14.4 million. Relying on current business-sale trends related to annual adjusted earnings, the result was a range from $2.2 million to $2.6 million.
It was Jones's job to make sense of those various sets of numbers and come up with a defensible fair market value range, based upon the particulars of each company's situation (which included its net working-capital position, long-term debt, nonoperating asset profile, and other key details). In Patriot Group's case, Jones's range was a value of $2.9 million to $3.2 million. Wallace Business Technology's value range was $409,000 to $445,000. In each case, Jones concluded that the business was worth more than the marketable sum of its tangible assets (his acknowledgment that the ongoing business operations were indeed valuable in themselves).
When Hotze and Watts received the reports, they shared a quick telephone call in which they confirmed that they both felt good about the numbers. Using the valuations as the basis for their equity split, Patriot's original owners (Hotze; his wife, Cindy; and their partner, Patty Brown) received 87% of the stock in the new company, which kept Patriot's name; Watts and his wife, Jo Ann, received the rest.
Of course, as with any corporate merger, that was the beginning and not the end. The new partners share a vision for accelerated growth, which will include building up strong sales and service operations in their home state's other major cities: Dallas, San Antonio, and Austin. They intend to build a business with roughly twice this year's current combined sales of $16 million. Says Hotze: "Kent's instinct is to start from scratch. I want to make certain that nothing great already exists which we can buy or merge with. But the one thing that our valuation experience gives us is a blueprint for how to carry out another merger, if that's the route we go. We're not going to argue. We're not going to lowball other entrepreneurs. We're not going to interject a whole lot of gamesmanship. We're just going to build a really good business."
Jill Andresky Fraser is Inc.'s finance editor.
the HIGHLIGHTS
REASON FOR VALUATION: To value proposed merger of two business-equipment distributors
the PLAYERS
COMPANY ONE: Patriot Group, in Houston, founded in 1979 * CEO, Jim Hotze, age 45 * 1997 revenues, $12 million * 26 employees * specialty: selling highend printers to corporate clients
COMPANY TWO:
Wallace Business Technology, in Bellaire, Texas, founded in 1947 by father-in-law of current president, Kent Watts, age 55 * 1997 revenues, $1.6 million * 12 employees * specialty: selling business machines and computer-network support primarily to small and midsize companies
APPRAISER:
Jeff Jones, owner of five-person Certified Appraisers Inc., in Houston, with 25 years in the business of valuing private companies
the PROCESS
TYPE of valuation: A limited appraisal
TIME from contract to written valuation: Three months
COST: $2,500 for each company
FINAL VALUATION: For Patriot Group, $2.9 million to $3.2 million; for Wallace Business Technology, $409,000 to $445,000
the FUTURE
THREE THINGS the merged company could do to increase the value of the business:
1. Accelerate revenue growth
2. Add new sources of income by broadening product and service lines
3. Diversify customer base
the BIGGEST SURPRISE
HOTZE:"If Kent and I had known how much time would be involved in all this, we would have eloped."
WATTS:"I didn't know what to expect when it came to the final valuation number. I just didn't have the financial background."
SELF-WORTH
When it comes to valuations, many entrepreneurs prefer to just say no. Here are some findings from a U.S. membership survey recently conducted by TEC Worldwide Inc., an international CEO-education and -development organization based in San Diego. The 258 respondents are chief executives of small to large companies.
Q: Have you ever hired an independent appraiser to conduct a valuation of your company?
Q: If you have hired an outside appraiser, please list all reasons that apply:
| Estate planning |
42.6% |
| Company merger or sale |
41.3% |
| Curiosity about the value of the business |
21.9% |
| Bank or investor financing |
15.5% |
| Growth-management strategies |
12.3% |
| ESOP |
5.8% |
| Planning to go public |
4.5% |
| Divorce |
1.9% |
| Other |
18.7% |
Q: If you haven't hired an outside appraiser, why not?
| Unnecessary |
69.9% |
| Trust your own judgment |
17.5% |
| Too expensive |
8.7% |
| Other |
20.4% |
Source: Inc. magazine-Tec Business Valuation Survey, September 1998.
