What's It Worth?

An estimated  75 percent of businesses are sold for less than their fair market value. Do you know what yours is worth?

By Eileen Zagone

Eileen Zagone is Associate Editor of Scrap.

How much is your business worth?

Guess again. There’s a 75-percent chance you underestimated its value, say business valuation experts, who assert that about three-quarters of businesses are sold for less than their fair market value.

Why does this happen? For one, many business owners sell too hastily, without taking the time to find out the true value of their companies. Others may use oversimplified formulas to arrive at a selling price. Often, these formulas value a business based on its past performance rather than its future potential, which is really what you’re selling. And many owners fail to look beyond the balance sheet and factor in elements that add real value to their businesses, such as specific operating procedures, the firm’s reputation, and its unique customer relationships. Some of these factors may be intangible, but they shouldn’t be ignored or given away for free.

Fortunately, you don’t have to make the mistake of undervaluing your business. You can have it professionally valuated. Determining the proper value of your business might be the last—and best—business investment you make.

The Value of Valuating

But wait a minute. Isn’t valuation only for companies seeking to be sold? So why do it now, when the scrap industry consolidation locomotive has slowed and there’s precious little buying and selling going on?

For starters, the consolidation trend will likely pick up again at some point, so isn’t it wiser to stay a step ahead and know what your business is truly worth before a selling opportunity arises?

More importantly, valuation isn’t just for companies on the selling block. Knowing the value of your firm is a good business idea at any time, say valuation experts. According to the National Association of Certified Valuation Analysts (NACVA), business valuations can be necessary and invaluable in a broad spectrum of situations, including mergers and acquisitions, liquidations or reorganizations, eminent domain actions, partner disputes, employee stock ownership plans, financing situations, estate planning, and initial public offerings.

So let’s assume you make the wise decision to find out what your company is truly worth. Here are the basics you need to know.

A valuation is an estimate or opinion of the fair market value of a business at a specific date that uses various valuation methods, such as adjusted net assets, capitalization of earnings, price-to-earnings ratio, dividend paying capacity, excess earnings, and discounted earnings.

Which methods are used depends on the facts and circumstances of each unique valuation situation. The truth is that there’s no such thing as one “right” valuation for a business. The purpose and circumstances of the valuation process, as well as the perspective of the parties involved, will change a company’s value. For instance, there’s a big difference between value-in-use and liquidation value. In the former case, a company is operating fine and can seek a buyer over an extended period for the best possible price, while in the latter case it’s being liquidated, often for less than its fair market value.

As you might expect, the valuation process also differs between public and private companies. While the market value for a share of publicly traded stock may be readily determined by reference to the public stock markets, the value of an ownership interest in a closely held business is often more difficult to determine.

The Process

Most business valuations begin with a company’s financial statements, either prepared under generally accepted accounting principles or a tax basis of accounting. “Those financial statements generally need to be recast into ‘economic financial statements’ to better reflect the true economic financial position and results of operations, and to serve as the basis for determining market values,” says William H. Black, an independent consultant and valuation professional based in Atlanta. Typical adjustments include depreciation, inventory, intangible assets, and others as appropriate for the particular business.

The financial statements are only the starting point, however. There’s much more to the process of determining value. As Black explains, “The valuation professional must develop an understanding of the business and its markets through discussions with management, staff, suppliers, clients, and competitors, review of relevant industry and trade information, consideration of specific assets (inventories, accounts receivable, fixed assets) and obligations, borrowing capacity, and many other factors that combine to form the operating environment of the company.”

Numbers, facts, figures, balance sheets, and financial statements by themselves aren’t accurate measures of the true fair market value of your assets, NACVA says. Different approaches and methods of valuation analysis should be reviewed and selectively matched to the business being valued. Determining the most appropriate methodology—along with various analyses, sophisticated mathematical calculations, ratios, industry comparisons, economic and market analyses, business risk assessments—is needed for a competent valuation of your business.

“A business can’t be valued out of context,” Black adds. It must be examined “in relation to its potential earnings, assets and liabilities, particular advantages/disadvantages versus its competition, environmental and regulatory factors, and prospects for future earnings.”

Upon completion of the valuation process—which can take months—the valuator provides a report that supports his or her conclusion of the fair market value for your business at that particular date. Among the topics that the report might cover are the company’s equipment, production, marketing, management, projections, competition, earnings, and a thorough financial analysis of the firm’s economic health, including a look at its earning potential for the next five to 10 years and the outlook for the industry as a whole. The report may highlight both strengths and weaknesses of the business, but a good appraiser can help put the negatives in perspective in the report.

Obviously, valuating your business is a complex process and an educated guess simply won’t do. No wonder businesses are sold all too often for inappropriate amounts.

Selecting a Valuator

Given the complexity of the valuation process, most experts advise business owners to hire an independent appraiser with a focus on and experience in valuating businesses. Though you may know your business backward and forward, valuating your business is likely an event unlike any you’ve experienced, so it’s certainly in your best interest to have someone help you get the most for your hard work.

How to Choose? There’s no lack of business valuation professionals in the world, as any review of the phone book and Internet will prove. In addition to hiring a business valuator, you may need to consult a qualified appraiser to determine the best value for a specific asset or class of assets, such as real estate or equipment. Sometimes a business valuator can also serve as an appraiser.

When selecting the professional who will put a price tag on your business, it’s well within your rights to talk with the person’s former clients, discuss what processes and methods he or she will use to valuate your company, and what type of report will result from the analysis.

In addition to interviewing a few different valuators before choosing one, it’s a good idea to select someone who is certified by a professional valuation and/or appraisal organization. NACVA, for instance, provides three professional designations to its qualified members, including certified valuation analyst, government valuation analyst, and accredited valuation analyst.

Similarly, the American Society of Appraisers maintains a member database of appraisers by location and specialty who have passed its meticulous accreditation process that fosters accurate, impartial, and credible appraisals. (For more on these and other valuation/appraisal organizations, see “Valuation Resources ... and More” on page 78.)

No (Scrap) Experience Necessary. You might assume that finding a valuator or appraiser with experience in analyzing scrap processing businesses would be a plus. In reality, that isn’t necessary. Such professionals are trained to valuate any business, regardless of what the business does. It’s more important to work with someone who specializes in valuating private businesses in the same market value category as your business. For most scrap processing companies, that translates to “middle-market” specialists who primarily valuate private companies valued between $1 million and $50 million.

One oft-cited key to properly valuating a business is an understanding of the specific company’s market. Each appraisal should be an individually prepared assessment based on the unique factors affecting that business as well as the field in general. So more important than experience with the scrap industry is an appraiser who is capable of and interested in learning about the market minutiae of the particular operation being valuated.

Business Brokering. If you are in the market to sell your company, hiring a broker to find a buyer is another approach. Sometimes valuation and appraisal firms offer brokerage services as well, while other times a broker may be consulted independently either before or after a business valuation.

Working with a broker is especially helpful if you’ve decided to sell but haven’t identified any potential buyers; when the principal owner of the business can’t be as involved in the sale as he or she might wish, such as in the event of serious illness or death; or when the surviving family members are charged with the task of selling the business.

Typically, brokers will come up with a selling price range for the business—either on their own or by enlisting the help of an appraiser—then find a few potential buyers and negotiate the terms of the sale.

Doing It Yourself

In some cases, business owners may feel they don’t need to enlist the services of an outside valuation professional. After all, in this information age, there are certainly many books, software programs, and Web sites available to guide you and offer advice if you decide to go it alone.

One scrap processor who sold his business said that when he was approached by the buyer, he immediately consulted with his accountant and attorney. The trio discussed whether to bring in an appraiser to valuate the business. In the end, they decided that wasn’t necessary.

Instead, the accountant’s and attorney’s firms served as the consultants guiding the valuation. The company owner was intimately involved with every stage of the analysis. Since he was very much on top of his company’s financials and operations all along, he, the accountant, and the attorney were able to accurately determine the company’s sale price. A significant point in their favor, he says, is that the buyer approached him without making an offer. Instead, the buyer asked him to come up with a selling price. In short, the buyer really wanted the business.

“Once we came up with the selling price, there wasn’t much negotiation,” the processor says. Still, it wasn’t cheap to contract for his attorney and accountant to work on the valuation and, ultimately, the deal. “Selling your business does cost money,” he notes.

Would he hire an appraiser if he could do it all over again? No, he says. “We weren’t outlandish in our asking price, yet I feel it was definitely not under the real market value,” he explains. “I’d describe the selling price as fair to everyone involved, and I think we came up with a very accurate selling price.”

His only selling condition was that the purchase be made in cash. And that, he says, was his smartest move regarding the entire transaction. Perhaps he could have negotiated a higher price with other payment terms, he says, but that risk wasn’t one he was willing to take. “I wasn’t willing to negotiate on that. If I wasn’t going to be paid in cash, I wasn’t going to sell.”

Of course, going it alone isn’t for everyone. But the point is—whether you’re planning to sell your company or not, whether you opt to work with a professional valuator or not—determining the fair market value of your firm is simply a smart business move.

Valuation Resources . . . and More

The following organizations can help you learn more about business valuations and appraisals and help put you in touch with professionals in those fields:

• National Association of Certified Valuation Analysts, 1245 E. Brickyard Road, Suite 110, Salt Lake City, UT 84106; 801/486-0600 (fax, 801/486-7500); www.nacva.com.
• International Valuation Standards Committee, 12 Great George Street, London, United Kingdom SW1P 3AD; 44/171-203-4645 (fax, 44/171-823-5174); www.ivsc.org.
• American Society of Appraisers, P.O. Box 17265, Washington, DC 20041; 703/478-2228 (fax, 703/742-8471); www.appraisers.org.
• Institute of Business Appraisers, P.O. Box 1447, Boynton Beach, FL 33425; 561/732-3202 (fax, 561/732-4304); www.instbusapp.org.
• American Institute of Certified Public Accountants, 1211 Avenue of the Americas, New York, NY 10036-8775; 212/596-6200 (fax, 212/596-6213); www.aicpa.org.•