Business valuation questions

Maximize your business valuation: Ask these five questions

Ask these five questions during the business valuation process. It could save you more than you think.

CNBC recently reported that 98% of business owners do not know the value of their company. It is not surprising to see why. The business valuation process is complex. In hindsight, it can be easy to overlook things that seem obvious. With all the moving parts around legal and financial due diligence, it can be difficult to catch all the subtle factors that can make a big difference in the final valuation amount. Do not leave dollars on the table. Here are five things often missed during various stages of the valuation process.

Have we normalized the earnings stream?

After reviewing the business’s nature, history, and documents, it is time to assess financial performance. Many determine a multiple and apply the multiple to the stated earnings streams. However, before doing so, we should ensure those earning streams are normalized. In other words, assume the company is generating returns as if an unrelated party is running the company. Payments to related parties should be adjusted appropriately, personal expenses should be removed entirely, and any other non-operating or non-recurring expenses and income should be reviewed and adjusted out of the earnings stream as needed. By normalizing the earnings stream, a defensible value of the company can be obtained.

Is an asset-based valuation approach appropriate?

Once we factor in the financial, industry, and economic conditions, we apply valuation methods. However, one approach is often overlooked. An asset-based approach to valuation should always be considered for valuation in addition to an income or market-based approach. These latter two approaches may indicate less value than an asset-based approach.

In cases where income generated is a nominal return on the value of the assets and for asset-intensive or real estate holding companies, this asset-based approach may be your best bet to garner the true value of the business. Examples of prime candidates for the asset-based approach would be a distressed company, a trucking company, or one that holds farmland.

What about the non-operating assets?

After applying valuation methods, we apply valuation adjustments including non-operating assets. When valuing a business based on earnings streams, non-operating assets are not included in the result.

What is a non-operating asset? Anything that does not contribute directly to the business’s earnings but is still an asset that is included in the purchase agreement (intentionally or not). Items like real estate titled under the company but used for owner’s personal use, club memberships, vehicles, airplanes, etc. Even seasoned valuators overlook these balance sheet items because of their focus on the income statement during the prior valuation step.

What is the strategic value?

Now that we have a good idea of what the business is worth on its own, is there any added value to the buyer from buying this business? If the buyer is making a strategic purchase, a purchase they think will augment their current operations, then that buyer may be willing to pay more than just the earnings streams previously valued under a fair market value standard. Using that standard, valued earning streams are not adjusted for items like acquisition-related revenue growth and cost savings, size premiums, and other strategic benefits that accrue to the buyer once the target is purchased. These strategic value items need to be considered when you have a strategic buyer, as opposed to an internal or family buyer.

What is the tax cost of this deal structure?

Finally, we have established a value for the business that reasonably reflects the value for the buyer. However, a preferred deal structure for the buyer may not be in the best interest of the seller. Accordingly, each side’s tax advisors need to be an integral part of the transaction process to ensure both parties are minimizing their tax liabilities. By ignoring the deal structure and related income tax consequences, the transaction reduces the overall value of the parties’ net proceeds.

In summary

We have highlighted five critical items that we see overlooked in the business valuation process. By assessing these items during your valuation process, you can ensure you are not leaving any extra money on the table for the seller or the IRS.

If you would like to learn more about these questions or our valuation process or have questions about your business’s value, contact Cathy Mitchell using the information below.

Cathy Mitchell, ABV

Senior Vice President
Business Valuation Services

Cathy Mitchell joined AGH in 2010. Her focus is providing valuation and tax services primarily to closely held and family-owned businesses. Related to her valuation work, Cathy has completed extensive training in the specialized field of business valuation and earned the American Institute of Certified Public Accountants (AICPA) accreditation in business valuation (ABV) credential. In addition to providing valuations for many purposes, she provides litigation support services for those integral to divorces and other contested matters.

Prior to joining AGH, Cathy was a member of an international CPA firm, where she was promoted to tax manager. Following that, she established and managed her own tax preparation and business consulting firm for 14 years. She received her bachelor’s degree in accounting from the University of Kansas and earned gold key for top scorer in Kansas and the Elijah Watts Sells award for earning one of the top scores nationwide on the CPA exam. Cathy is a member of both the AICPA and the Kansas Society of Certified Public Accountants, for which she serves on the steering committee for its annual business valuation conference. She also speaks regularly on business valuation and other topics to professional groups and students.

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