Beauty, they say, is in the eye of the beholder. This is especially true when it comes to the attractiveness — or in other words, the value — of a closely held business.

Not surprisingly, business owners looking to sell their companies usually see their businesses differently than outsiders who might be interested in buying the company. Your business is your “baby” — you’ve spent many years, maybe most of your life, nurturing and building it, so you have an emotional connection to your business that an objective outside buyer obviously doesn’t have.

From the buyer’s perspective, your business’ value is derived from cold, hard numbers that will determine their potential return on investment in your company. Buyers put little if any value in the “sweat equity” you have invested in growing your business over the years. Instead, they are primarily interested in how much potential there is to increase future cash flow and earnings in the business.

So how can you, as a business seller, and potential buyers narrow the gap between your differing perceptions of business value in order to arrive at an agreed-upon selling price? A good starting point is to hire a trained business appraiser to perform a professional business valuation.

The Valuation Process: How It Works

The appraiser’s first priority usually is to identify all of your company’s assets and assign a value to them. This includes both tangible assets (cash, accounts receivable, inventory and fixed assets) and intangible assets (customer lists, patents, industry reputation, etc.). In addition, company profit and loss statements and cash flow projections will be analyzed to determine potential future earnings. Other factors typically considered by the appraiser when valuing your business will include:

  • Company history
  • Management team strength
  • Competitive factors and unique selling position
  • Overall economic conditions
  • Industry outlook

There are several different approaches appraisers use when assigning value to a closely held business. The appraiser will assess a variety of different factors, both qualitative and quantitative, to decide which valuation method is best for your situation. The three main valuation approaches are:

  1. The asset-based valuation - This approach is based on the fair market value of the company’s tangible assets. Fair market liabilities are then subtracted from this amount to arrive at a final business valuation. The asset-based valuation is typically used when liquidating a failing business rather than the method to establish a value for a healthy business.
  2. The market valuation - With this approach, the appraiser will base your company’s value primarily on the selling price of other companies that have sold recently that are similar to yours. It’s the same approach used by most real estate agents when they price homes based on the selling price of other similar homes, or comps.
  3. The income-based method - This is more of a number-crunching approach. The appraiser will look at cash flow, price-earnings multiples and other financial indicators to calculate the adjusted earnings capitalization and project future earnings for the business.

One of these valuation approaches will result in the assignment to the business of a fair market value, or FMV. In its International Glossary of Business Valuation Terms, the American Institute of Certified Public Accountants (AICPA) defines FMV as:

“The price, expressed in cash equivalents, at which property or business would change hands between a hypothetical willing and able buyer and a hypothetical willing and able seller, acting at arm’s length in an open and unrestricted market, where neither is under compulsion to buy or sell and when both have reasonable knowledge of the relevant facts.”

Choosing the Right Business Appraiser

Many CPAs offer business valuation services, but all CPAs aren’t necessarily specialists in business valuation. When choosing a professional business appraiser, you should make sure he or she is certified or accredited by one of several national business valuation organizations. These organizations and their associated designations include:

An accredited business appraiser has received extensive training in the latest valuation techniques. And he or she must observe a code of ethics imposed by his or her accrediting organization that specify strict standards of behavior and performance. In particular, an accredited appraiser must remain neutral throughout the business appraisal process to ensure objectivity and avoid any hints of bias or favoritism toward either the buyer or the seller.

Finally, using an accredited business appraiser will help ensure that your business valuation stands up in a court of law if it is ever legally challenged for any reason.

It’s important to assemble your team of business advisors to assist you throughout the process. Most advisory teams are comprised of a CPA, an attorney with business and estate planning experience, a financial planner, a banker, an insurance agent, in addition to your certified business appraiser. Working together, they can help you formulate a plan that successfully addresses the key issues of tax and retirement planning, business ownership, and management.

To learn more about how our planning professionals can help you achieve your financial goals, give us a call at (800) 773-7100 or Contact us to request that a Relationship Manager contact you.

City National, as a matter of policy, does not give tax, accounting, regulatory or legal advice. The effectiveness of the strategies presented in this document will depend on the unique characteristics of your situation and on a number of complex factors. Rules in the areas of law, tax and accounting are subject to change and open to varying interpretations. The strategies presented in this document were not intended to be used, and cannot be used for the purpose of avoiding any tax penalties that may be imposed. The strategies were not written to support the promotion or marketing to another person any transaction or matter addressed. Before implementation, you should consult with your other advisors on the tax, accounting and legal implications of the proposed strategies based on your particular circumstances.