A business appraisal is a serious project. Making sure clients understand what to expect is something you would want to handle with care. Spelling out what happens each step of the way can save you some grief down the road.
Consider just some possible situations that could lead to client disappointment. Let’s say you prepare a business valuation report for the client’s eyes only. Unbeknownst to you, the client shares the appraisal report with a lender who demands additional disclosure before making a loan. The client is frustrated facing more costs and delay. The moral? Agreeing on who your business appraisal is intended for is very important.
In fact, business appraisal standards such as Uniform Standards of Professional Appraisal Practice (USPAP) require that you state in your report what format your valuation follows. If your client is the only party intended to read the report, you can opt for the Restricted Appraisal format. On the other hand, if others are expected to see the valuation results, USPAP standard requires you to choose the broader Appraisal format.
The level of information disclosure you provide could make a lot of difference. An outside investor or business buyer may not have the information that the business owners take for granted. Hence, if the business is put up for sale, you should consider additional disclosure to make your report useful in a business sale or equity investment situation.
Want to avoid phone calls from an irate client over the bill? It would be wise to state what your fees are going to look like up front.
You may also spell out the rules of engagement, especially how possible misunderstandings are to be resolved. Limiting your exposure in case of a dispute could save you a lot of trouble as well.
These are just some of the reasons you should consider preparing a letter of engagement before starting on a business valuation project. Let the client see what the project is going to take in terms of cost, time, and effort both on your client’s part and your own.
Here are some key elements to include in your letter of engagement:
Purpose of the proposed business appraisal
Scope of the valuation project
How the results will be reported
Who will do the work
Project fees and how the client is to be billed
What the client’s responsibilities are
Limitation of your liability and how disputes are to be resolved
How the valuation project can be terminated by the parties
Any assumptions made at the outset
Prepare an engagement letter and share it with the client. Getting a client buy-in early on can help you grow a steady following of happy customers and well managed valuation projects.
Before setting out on a valuation of a retail pharmacy, consider these industry stats:
Just in the US alone there are over 42,000 pharmacy businesses classified under SIC code 5912 and NAICS 44611. As an industry group these companies generate a total of $202B in annual revenues. The industry sector employs some 815,000 staff. The average sales per establishment are $4.8M per year with a staff of 20.
Business valuation of pharmacies
Established privately owned retail pharmacies with a solid track record of profits offer an attractive acquisition target. Selling prices of such companies give you an indication of what a similar pharmacy may be worth on the market.
For tools to value your pharmacy, start with the selling prices from recent deals and relate them to the companies’ financial figures. The statistical ratios you get from this are known as valuation multiples that you can use to calculate the value of a pharmacy.
The typical valuation multiple for this retail industry sector is the price to gross revenues and an addition of inventory.
Example: Pharmacy business valuation based on annual revenue
Let’s consider an example pharmacy with a gross revenue of $4,800,000 and inventory of $2,000,000.
We pick a set of reasonable valuation multiples to do our value calculations:
Average Business Value
As is customary in valuing pharmacies, the value of the inventory is added to the multiple based calculation. This is mainly because levels of inventory tend to vary quite a bit over time and from one business to another.
Current pharmacy sales offer you an excellent way to determine the value of any other pharmacy business. You can delve into details by running additional calculations based on other financial figures such as net profits, EBITDA, cash flow and assets.
One of the key assumptions made for any business appraisal is the premise of value. Depending on the circumstances surrounding business valuation the results may differ greatly.
By far the most common assumption for valuing a business is that it will continue operating in the foreseeable future as a going concern.
However, there are situations when other premises of value apply. When a valuable asset is bought, the owner is likely to ensure it. Insurances companies are concerned with total loss of the asset. The insurable value is thus the cost of reproducing the lost asset.
On the other hand, a lender that considers the business asset as a collateral is more likely to value it on the liquidation basis. The worst case scenario for the lender is the possibility of having to dispose of the asset at an auction. The price fetched in these circumstances is likely to be considerably lower than the fair market value. In addition, the lender incurs additional costs associated with the sale.
Small wonder that the replacement cost value and liquidation value are usually far apart. This makes sense because the circumstances of valuing the business asset are so different here.
If a business asset is lost in needs to be replaced. So the cost of acquiring a new asset dictates its value. On the other hand, a lender is probably not interested in using the business asset nor in incurring the maintenance and marketing costs to get the highest price possible. A forced sale under the auctioneer’s hammer is likely to fetch a lower price.
On a value continuum, the replacement cost and liquidation values are at the opposite ends of the value range. Somewhere in the middle is the fair market value that indicates what the business asset is worth in use. In business appraisals, this value is determined as the replacement cost less the depreciation due to use, aging and obsolescence.
Before you can apply business valuation methods, you should determine the level of cash flows generated by the company. The question here is what cash flow?
For the purposes of business appraisal, the net cash flow is the typical choice. Here is its definition:
Net income, after tax
Plus depreciation and amortization
Plus tax affected interest expense
Minus capital expenditures
Minus increases in working capital
Note that the net cash flow represents the cash that is seen by the shareholders and long-term interest bearing debt holders of the firm. In other words, it is the earnings that defines the value of all equity and debt interests in the company.
A couple of comments are in order here. First, net cash flow is an after tax concept. The reason we start with the after tax income is to focus on the earnings regardless of the company’s capital structure, i.e. what levels of equity and debt capital it uses.
To do so, the net cash flow is adjusted for the tax effect, as you can see in the above list.
Secondly, adjustments done for purely accounting purposes need to be added back. The typical ones are the paper expenses such as depreciation and amortization.
Finally, the funds needed to keep the company going need to be factored out. This includes both the long term capital expenditures and the working capital requirements. These funds cannot be taken out of the business and distributed to owners or lenders. The money is needed to buy new equipment, inventory, and other valuable assets the business needs to operate.
Net cash flow represents the level of business earnings most relevant to business appraisal. It shows the cash flow the owners can direct at their discretion toward business expansion or distribution to the shareholders. The effect of capital structure is removed since the owners can decide what levels of equity or debt they want to use in their business.
The ValuAdder team has completed yet another major milestone in product design. The new ValuAdder 8 comes with all the tools and features business people and professional valuation experts would want in a modern business valuation system.
All new reporting system based on Open Source Scala software technology
A major addition to ValuAdder 8 is the all new reporting system. Using the leading edge Scala software development technology, ValuAdder engineers have created a truly powerful reporting engine. Each business valuation method and financial analysis tool in ValuAdder features a dedicated report. You can create a report with a mouse click as you do any calculation.
The report you produce has a clean, professional look, crisp design and high quality fonts. Data tables are laid out to enhance presentation.
Each report includes a helpful explanation of what the reported calculation is about and what each item means.
You can share your business valuation results in a number of ways: print it in any format you like, create an electronic copy in the PDF format or email the report for review by colleagues or clients.
All valuation multiples, discount and capitalization rates updated
In addition, there are critical updates you will find essential. All the parameters that make your business appraisal timely and relevant have been updated to match the current market conditions.
All ValuAdder software products, whether intended for a PC or Mac computer, are digitally signed to ensure security and integrity of your computers. This is especially important if you choose to download your software for immediate installation. The digital signature is verified prior to installing software by your Windows or Mac computer. This is your assurance that you get a product that is free of malware threats and performs as you expect.
If you discuss business valuation with a professional, chances are you will hear the notion of standard of value. Think of this value standard as a measuring stick the appraiser uses to come up with the business value.
Selecting the correct standard of value can make a difference to the result. The circumstances and facts of each business valuation dictate the best choice. Here are a couple of central definitions of business value:
IRS Revenue Ruling 59-60 standard of fair market value
Fair market value is defined by the Internal Revenue Service (IRS) in its Revenue Ruling 59-60 as “the price at which the property would change hands between a willing buyer and a willing seller when the former is not under any compulsion to buy and the latter is not under any compulsion to sell, both parties having reasonable knowledge or relevant facts”.
Fair value is typically used in cases of dissenting shareholders’ rights to business appraisal. This would be the case, for example, of company sale on the terms the shareholder finds objectionable.
Fair value as defined by the Model Business Corporation Act
This standard of value varies from state to state. The most common definition comes from the Model Business Corporation Act:
Fair value of a company is determined immediately before the conclusion of a corporate action to which the shareholder objects (e.g. company sale at a certain price and terms); using customary and current valuation concepts and techniques; and without discounting for lack of marketability or shareholder minority status. Here minority refers to ownership of less than controlling block of company shares.
Fair value according to the FASB
The Financial Accounting Standards Board offers a good definition of fair value as the “price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date”. Note though that this definition is still open to interpretation.
Most business appraisals are done to the fair market value standard. If you get a formal business valuation report, the selected standard of value should be stated along with the reasons why it was chosen.
According to the IRS Revenue Ruling 59-60, you should consider a number of factors if you choose to determine your business value to the fair market value standard:
The nature of the business and its history from its inception.
The economic outlook in general and the condition and outlook of the industry the company operates in.
The book value of the stock and the financial condition of the business.
The company’s earning capacity.
The dividend paying ability of the company.
Whether the company has intangible assets including goodwill.
Sales of the stock and the size of the block of stock to be valued.
The market price of the stocks of corporations in the same or similar line of business having their stock actively traded in a free and open market, either on an exchange or over the counter.
Fair market value or fair value – choice is up to you
Most business valuation methods you are likely to encounter can be used to value a business under either fair market value or fair value definitions. One possible exception to this is the market based valuation methods. Business sales that are used to develop valuation multiples for these methods are usually done by unrelated business sellers and buyers. So the fair market value definition makes the most sense here.
If you are like many business people you probably use a number of computers in your work. For example, you may have a PC workstation in the office and a Mac laptop or iPad tablet at home.
Sometimes you may find it convenient to continue a project at home that you started in the office. If you are working on valuing a business this would mean sharing your work in progress across the Windows and Mac computers.
With ValuAdder this task is a snap. You can have a Mac version of ValuAdder at home and a Windows software in the office. Anytime you want to you can save all your work as a project scenario file. The same format works on both OS X and Windows. So you can send the scenario file to your home office, for example using your network connection or email.
One you are ready, just double click on the file name on your Mac. ValuAdder comes up with the scenario data open. You can continue your business valuation analysis right where you left off. Of course, the work you do at home can be shared back with your computer in the office.
Incidentally, the ValuAdder tour you can see online shows the Windows version of the software. All the features are identical for both the Mac OS X and Windows products. However, the Mac version of ValuAdder looks and acts like a Mac application and behaves in the familiar way you expect of any professional OS X software.
Before you can use any method for business valuation you need to prepare a number of key inputs that the methods require. Usually, you would start your analysis with a set of the typical business financial statements such as its income statements and balance sheets.
But the accounting financial statements are just a starting point. The statements are usually prepared for tax filing purposes. One objective business owners have is to minimize taxable income. Thus the financial statements may not show the business earning potential in the best possible light.
That is the main reason why the company’s financials typically require a number of adjustments, known to business appraisers as the financial statement reconstruction or recasting. The goal of recasting is to reveal the earning power of the business focusing on cash flow metrics such as the net cash flow or discretionary earnings (SDE).
Business value is about the earnings you can expect from the business in the future. Historic financial statements are useful to the extent that they assist you in generating an accurate earnings forecast. In fact, the business valuation methods you are likely to use, such as the discounted cash flow technique, require that you provide a future cash flow projection.
In addition to establishing the cash flow, you would need to assess the company’s risk. This step gives you the important discount and capitalization rates to use in your business valuation calculations.
Valuation methods under the asset approach will require that you review and adjust the business asset base and its liabilities in order to establish its current economic position. This may be quite different from the cost-basis financial picture that you get from a typical accounting balance sheet.
ValuAdder software includes financial statement recasting worksheets that help you complete all these important tasks:
analyze and adjust your historic income statements
generate an accurate earnings forecast
review and adjust the values of assets and liabilities
assess the company’s risk and calculate the discount and capitalization rates
prepare all the inputs you need for the various business valuation methods
ValuAdder worksheets also include these important figures you may find useful in your valuation:
Based on your inputs, ValuAdder worksheets summarize the inputs to use for any of the business valuation methods. The worksheets also capture all your financial statements and adjustments on a single page that you can easily share with others, print out or include into a report.
You may be aware that market comparisons are a common tool to value private businesses. Not surprisingly, this methodology gets a full coverage in ValuAdder business valuation software.
In fact, the ValuAdder Market Comps tools use a combination of the industry-standard Comparative Transaction and Guideline Public Company methods under the market approach. This gives you an increased coverage across a wide range of industry sectors.
For industries where private companies abound the direct review of comparable sale transactions is the typical method. On the other hand, in some sectors where companies grow rapidly with a goal of going public, comparison to small cap publicly traded firms is a solid strategy for small professionally managed private companies. Typically, you would adjust the numbers for lack of private firm marketability when making such public to private company comparisons.
There are a number of data sources to choose from. One of the most reliable and best known is the EDGAR database maintained by the US Securities and Exchange Commission (SEC). You can access EDGAR freely online.
The current Market Comps coverage in ValuAdder features 425 distinct industry sectors arranged by the SIC and NAICS codes. The sectors include:
business and personal services
food and drink industry
wholesale and distribution
and many others
To give you the broadest coverage possible, the ValuAdder valuation multiples are designed for valuation of private small to mid-market companies with market capitalization under about $500M. This includes the vast majority of private businesses and professional practices.
When you use the ValuAdder Market Comps tool, your valuation results are reported in the standard Low – Median – Average – High format. This reflects the statistical nature of the market approach – you compare your company to others that are similar but not identical to your business.
With the summer 2012 release of Mac OS X 10.8 Mountain Lion, Apple has raised the bar on computer security. For you as a Mac user, the key piece of technology is Mac Gatekeeper.
As the name implies, Mac Gatekeeper’s role is to protect your laptop or desktop from malware attacks. Gatekeeper runs a number of security checks on any downloaded software. Before such software is allowed to access your Mac, Gatekeeper checks that:
The software is free of malware
The software is signed by a genuine Apple Identity certificate
The software has been correctly downloaded and the product integrity maintained
The result of these checks is that your Mac OS X computer will only run the software that is fully functional, free of security threats and comes from a software company clearly identified and recognized by Apple.
Business valuation apps for Mac
All software companies wishing to offer their products on Apple Mac computers must be accepted into the Apple Developer Program. They must obtain a unique Apple Identity certificate and sign their software with it.
Before Apple admits a software company as an authorized Apple Developer, a thorough check of the corporate identity and its good standing is performed. This is your assurance that the software product you are getting for your Mac comes from a legitimate source verified by Apple.
ValuAdder: secure business valuation software for your Mac
ValuAdder is proud to be an authorized Apple Developer. All ValuAdder for Mac products, including ValuAdder 7 business valuation software and Report Builder 3.0 are signed by a genuine Apple Identity certificate. It is your assurance that your Mac computer is safe and secure when you do your business valuation with ValuAdder products.