Archive for August, 2014

Business valuation has traditionally been used to support a business selling price, resolve a legal dispute, raise additional capital and other situations. What is common to all these scenarios is that business valuation is used as part of the established business strategy: business people know what they want to do and need to determine business value to support their objectives.

Increasingly, business valuation is becoming an essential part of business strategy. Instead of getting a numerical answer, business owners want to know what drives business value and what they can do to increase it in order to meet long term goals.

This turns the conventional business valuation on its head. Instead of getting a number to justify your expectations, you look for insights that can help you develop a plan to meet your financial objectives.

How can business valuation help here? In short, by identifying key value drivers in your business and then seeing how a number of well designed changes can significantly increase the value of the business going forward.

A number of business valuation methods exist that can help you in this regard. Consider the multiple of discretionary earnings technique. Here the business is valued based on its earnings and a set of 14 value factors that you assess.

The power of the method is that it enables you to translate these value factors into a numerical answer. How does the presence of an experienced management team affect what the business is worth? What if you reduced customer concentration, or lowered employee turnover? Will adding another product or service help smooth out the business earnings over time?

The multiple of discretionary earnings method helps you to quickly construct any number of valuation scenarios with different value factor selections. The resulting business value that you calculate shows you which of the potential initiatives has the biggest bang for the buck. Armed with this information, you can proceed to develop an action plan that gets to your target business value.

Business Valuation as a Planning Tool

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If you tackle valuation of a company with significant real property and fixed assets, there is a possibility that you can encounter environmental issues that require remediation. Most business appraisers are not experts in environmental engineering.

What you can do is conduct an inspection of the business property. If there are signs of environmental problems, it is a good idea to get an estimate of the cost to cure it from an expert engineering firm. Business owners are often aware of such problems and may have had an environmental study done.

Business valuation is usually done under the assumption that all underlying assets are free of any problems. If remediation is required, the cost of the effort is subtracted from the fair market value of the business property. For example, if the property is valued at $500,000 and the cost of an environmental clean-up is $100,000; then the value of the property is $400,000.

But what if the cost of remediation exceeds the business property value? In this case, it is possible that the fair market value of such property is negative. Some business people have trouble dealing with this. Yet it is possible that the cost of a clean-up can exceed the value of the business property. In this case, business buyer prospects are unlikely to be interested.

In addition, the effect on the value of business property can be indirect. If there are two properties on the market, one with environmental issues and the other without; most buyers would prefer the trouble free property even if the two properties are valued at the same amount.

When environmental problems are present, business buyers never know if the current clean-up estimate is truly accurate. Regulations may change requiring additional expenses to comply, or some areas of contamination can be missed on initial inspection.

It is difficult to state just how much the presence of environmental issues can affect the value of business property. Some business appraisers conservatively estimate an additional 10% reduction in the value of a remediated business property.