If you are working on a business appraisal, a big part of the analysis is reviewing the industry outlook. In many ways, the industry in which the business competes is far more important than the general economic situation. If you are valuing a strong company in a growing industry, its valuation is likely to be higher than that of a failing business that operates in a shrinking industry sector.
As part of your business valuation, you need to determine the overall industry growth potential, and the ability of your subject business to compete successfully. Some of the elements that should go into your analysis are the strength of the management team, the skill set of the key staff, financial condition of the firm, customer base, technology and other intellectual property assets, among other factors.
Your business appraisal report should outline clearly the industry sector and how the company fits into the competitive landscape. Business people and professionals reading your business valuation report should be able to gain a solid understanding of the risks faced by the company, its competitive advantages, and see how your conclusion flows from this thinking.
To make a compelling argument, you would need to provide a well researched description of the industry and the company’s plan on staying competitive. This is necessary in order to come up with realistic business valuation scenarios, such as the forecast of business earnings and assessment of the risks it is likely to face going forward.
Without this foundation, your valuation methods will merely generate unsupportable numbers. Remember the old adage, “Garbage in, garbage out.”
When it comes to business valuation, forecasting the business future financial performance is one of the most challenging, yet necessary tasks. Business value is about risk and returns going forward. Assessing how well you expect the business to do is at the core of establishing its value.
There are two ways to prepare the assumptions about the possible future financial performance of the company. One approach is for the business appraiser to come up with his or her best assessment. An alternative is to use the business management estimates.
Independent business valuations
If you expect the business appraisal to be subjected to serious scrutiny, objectivity of an independent business appraiser is key. This argues in favor of letting the appraiser do the forecasts of business earnings and expenses.
Rosy forecasts and overstated business value
Business management created financials are often rosy and based on aggressive goals. Many business people tend to underestimate the potential pitfalls that sharply limit the company’s ability to achieve such lofty objectives. This is especially the case when a company is facing serious headwinds currently, but hopes the coast will clear in the near future. More trouble ahead may well be overlooked.
The effect of these projections changes your business valuation result significantly. Take, for example, the discounted cash flow valuation method. The forecast of future earnings is a key input. If your cash flow forecast is unrealistic, especially in the early years, the value of the company will be overstated.
Unrealistic business valuation – uncomfortable questions
Valuations that are unexpectedly high are sure to generate skepticism from savvy business people and professional reviewers. An appraiser could state in the business valuation report that the assumptions of company’s management have been used in the analysis. The reader is put on notice, but is still left wondering why the business appraiser went with the management’s point of view.
Independent business earnings forecast – the objectivity advantage
If the business appraiser creates the earnings forecast from scratch, the readers of the business valuation report would likely expect a less enthusiastic but more sober set of assumptions. After all, business appraiser is not bound to endorse high expectations, but rather expected to provide a realistic measurement of what the business is worth.
Has the business appraiser covered all the angles?
The downside is that the business appraiser may not have the in-depth knowledge of the company to make the best projections. As an outsider, you may lack the understanding of the value drivers that can support the earnings growth the company’s management expects.
So what is the best approach? No clear answer exists. Perhaps close interaction between the experienced company management team and business appraiser is the best strategy.
When you face a dispute, whether partner disagreement or legal challenge, the parties are usually wide apart in their expectations of business value. To bridge the gap, keep in mind that a reasonable estimate of the future business outcome is usually achievable. If you expect to be challenged on your business valuation, be sure you or your business appraiser are as objective as possible and the key assumptions underlying your valuation are well supported by facts.
Business valuation controversy – when results are wide apart
Why so many disagreements? When trust between parties is lacking, they expect the opposite side to pressure their appraiser into producing the results they want. After all, they are paying for the business valuation. So suspicions abound: he who pays the piper calls the tune.
When in doubt, go to the key assumptions made in the business appraisal. Take a step back and ask the question, “Do you believe these assumptions?” If you don’t buy the assumptions, explore the alternatives that sound more realistic. See the difference it makes to the business valuation results.
Business valuation in divorce and other disputes
In a legal challenge, you are very likely to run across adversarial positions. The trust between the parties has been broken, and each side is pushing for its own point of view. Expect this to show up in the valuation results. Needless to say, this is immediately challenged by the opposing party.
Objective business valuations are best
Even in the most difficult situations, being objective in your business valuation is the best policy. The goal is to come up with the correct answer rather than push the envelope expecting to make a compromise down the road.
Hidden agendas like this only breed more distrust and endless arguments. Work to get it right the first time.