The recent article by Mark Cohen in the New York Times titled “Do You Know What Your Business is Worth? You Should” contained a number of relevant insights related to the valuation of privately-held companies – including the “commanding” title itself. Interestingly, the first part of this title happens to be our primary tagline.
Single Most Important Piece of Advice
Cutting to the chase, my analysis led to the conclusion that the primary or single most important sentence in the piece was:
“….it helps to have at least a basic understanding of the valuation process.”
The implication was, it seems that many business owners do NOT have a basic understanding of the valuation process.
Pioneered by experienced entrepreneurs and valuation experts alike, there is now a tool available which can help the business owner to “Optimize, Optimize, Optimize” as Mr. Cohen puts it convincingly in his final comments. Importantly, the employees of BizEquity are devoted to the development and implementation of a comprehensive suite of business valuation methods which will allow the user to generate a credible, reliable and accurate estimate of fair market value on a going concern basis – from the perspective of both an “asset sale” and “stock sale” paradigm.
Why Do Some Online Tools Disappoint?
There are several online valuation tools or calculators which can be located via the internet which run the gamut from extremely basic calculators with 3 or 4 entries to complex discounted cash flow applications based on Excel spreadsheets and the Capital Asset Pricing Model complete with “beta” and a staggering number of assumptions stemming from modern portfolio theory. Neither of these options can truly help the typical small business owner determine value or understand what truly determines business value.
The primary reason why a business broker (such as Barbara Taylor in the Cohen article) using many of the current online tools (calculators are a better description in many cases) would be disappointed in the valuation estimate is their inability to properly gauge cash flows for valuation purposes (whether in the form of “discretionary earnings” or “net cash flows” or “after-tax profits”). Even those tools which fall in between the two extremes just identified are unlikely to “hit the mark” for this key metric.
Unless the valuation algorithm specifically addresses owner or officer compensation in a robust manner, the results will be more than disappointing. More specifically, the earnings stream most suitable for a small company is reflective of a “return on the owner’s labor” as opposed to a “return on investment” perspective. Most specifically, it must reflect the “pretax, cash equivalent financial benefits available to a single owner working on a full-time basis” in order to pass “the smell test”.
Such a tool must also be able to account for other “outliers” so to speak, ranging from a variety of non-recurring or non-operating expenses/revenues to the imputation of a market level rent burden if the subject company happens to own the underlying real estate. Without these adjustments, valuation results based on pretax profits or an unadjusted EBITDA will almost always fall short of what would be deemed a “credible” estimate. Contingent liabilities and net operating loss carryforwards are examples of balance sheet adjustments which must be captured in order to derive a credible estimate of “equity value”.
Through literally years of trial and error, BizEquity has managed to work all of these key valuation elements into their algorithm. By accurately determining the proper earnings/cash flow amount, other key value determinants can be utilized to build the proper valuation multiple or capitalization/discount rate. Factors such as size, expected growth and profit margins, customer concentration, importance of owner-operator to business performance along with other financial statement ratios can be used to assess areas such as liquidity, solvency and activity as compared to industry benchmarks.
Second Most Important Piece of Advice
The second most important piece of advice from Mr. Cohen’s article, in my opinion, reads as follows:
“But some are starting to treat the act of valuing their business as an integral part of running it.”
Naturally, treating the valuation process as part of day to day and strategic planning requires the “basic level of understanding” referred to earlier. BizEquity wants to do more than just provide a bottom line number. The unique and patented user interface allows the user to visually note how a changing variable can impact the final estimate of value – in real time.
In addition, the firm is in the process of publishing a series of blogs which, from start to finish, will educate the owner on key concepts related to business valuation. These blogs will, in part, be incorporated into a new book that Mr. Gabehart and Mr. Carter are currently writing called “Valuation 2.0”. This unique book will be the formal link between business owners and their quest for knowledge in the valuation realm. Beyond providing a user-friendly overview of the business valuation process, this book will also give the readers added insight into how to use the online tool – both in general and with respect to maximizing business value over the long run.
As noted by Mr. Cohen, it is certainly true that small business owners are, almost without exception, extremely preoccupied with “the day-to -day demands” of their companies. And yes, there are many instances when there is “something to be said for having a real person trained at valuations”. As I have duly noted in my blogs, it is clearly the case that “there’s an art to doing a valuation.” Finally, I have no doubt that there are many online tools which would produce different results from what a hands-on and experienced business broker would surmise as being the correct value. Even “reasonable” professional appraisers would admit that a given company’s value can easily range up or down by 10% to 15% around some hypothetical average or probable value.
Despite these admissions, I have seen firsthand that we can assist business owners with efficiently (but steadily) learning about business valuation and how it relates to both their day-to-day operations and long term planning. After four years and literally millions of dollars in invested capital by the former credit card giant Advanta and now the new owner Mr. Michael Carter, we have introduced an “online tool” which we hope will become more of a “way of thinking” than a once in a while application. Our forthcoming book will deal with this in detail as we delineate the finer points of what we term “Enterprise Value Management”. In short, all roads lead to “value”.
Based on my experience as an internal auditor, business broker/middle market specialist, real estate agent, securities agent and certified business appraiser, I have spent most of the past two decades immersed between buyers and sellers of privately-held businesses of all types and sizes. Along the way, I have written two major books (covering business brokerage and business valuation) and developed/taught an MBA level course on private firm valuation for the highest ranked international MBA program in the entire country. All of this experience is being incorporated into the development of BizEquity with the ultimate goal of teaching business owners how to value their most precious assets – and how to “optimize” this value.
About the Author: Scott Gabehart, VP Valuation Services, Bizequity
BA, MIM, CBA certified appraiser. Author, “The Business Valuation Book,” Professor of Valuations at the Thunderbird School. Over 700 valuations completed over twenty years of consulting. You can check out thissimple to use 7-step cloud tool for real time business valuation. www.bizequity.com