In response to this need, there are numerous individuals who stand ready and willing to provide an estimate of value for a fee. They often include business brokers, CPAs, CFPs, business consultants, real estate appraisers, bankers, lawyers, college professors and, perhaps, your partner’s brother-in-law, who reportedly once lived next door to a business appraiser. Some of these individuals may be perfectly capable of providing a reliable estimate of value, depending on the purpose for which the appraisal is needed and size and complexity of the business. For example experienced business brokers can be quite adept at preparing value estimates for their small “main street” clients, especially those who operate in a distinct industry. Therefore, it is reasonable to approach a business broker to assist in the development of an asking price or offer price if you are considering the sale or acquisition of a very small business. But can you rely on this same broker to provide an appraisal for estate tax planning? And what about larger companies with, say, over $1 million in gross revenues? Probably not a good idea. Read on.

First of all, if a valuation is needed for tax purposes, the Internal Revenue Service will expect the appraisal to be performed in accordance with the Uniform Standards of Professional Appraisal Practice and Revenue Ruling 59-60. Although there can be no guarantee that the IRS will not challenge a value estimate, you run a higher risk of finding yourself in tax court if your appraiser is not well-versed in these standards. IRS officials estimate that currently about 50% of all valuations submitted in conjunction with estate or gift tax returns are reviewed and those that are not performed properly will be challenged.

Further, if the purpose of your appraisal involves a third party, such as a minority interest holder or partner, for example, a qualified, independent appraisal may allow the parties to avoid costly litigation. And if litigation is imminent, as is often the case in divorce proceedings, you will want a highly qualified professional to provide expert witness testimony in addition to the initial valuation.

Finally, if your business’s annual gross revenues exceed $500,000 or so, its growth trends, operations and capital structure probably preclude it from being reliably valued with methodologies typically used for small, “main street” businesses. In fact, estimates of value of a business of this size and complexity derived solely from multiples or rules of thumb can easily be hundreds of thousands, or even millions of dollars in error. In short, a business owner must carefully consider the trade-offs between cost, reliability of results, and the independence of the appraiser when selecting a professional to estimate the value his business.

Individuals who are qualified to perform business appraisals will usually have attained a professional designation from a reputable institution in the business valuation industry that attests to the person’s qualifications. There are four senior designations which are highly regarded in the business valuation industry. They include the CBA (Certified Business Appraiser, from the Institute of Business Appraisers), the ASA (Accredited Senior Appraiser for business valuation, from the American Society of Appraisers), the ABV (Accredited for Business Valuation, from the American Institute of Certified Public Accountants), and the CVA (Certified Valuation Analyst, from the National Association of Certified Valuation Analysts). A professional who holds any one of these designations has demonstrated his or her expertise in the field of business appraisal.

There are numerous other designations out there as well, but none of the organizations that provide them require the level of training, expertise and experience required by the institutions that confer these four. If you are in need of a valuation by an independent qualified appraiser, your best bet will be an individual who has earned one of these designations.

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As we all know, there are a number of appraisal methods utilized by business brokers to estimate the value of small “main street” businesses. These include rules of thumb, the multiple of discretionary cash flow method and the fair market pricing method, among others. These methods used in conjunction with good judgment and common sense have served the business brokerage industry well for many years. But under what circumstances might it be appropriate for a broker to recommend to a client that he or she obtain an independent appraisal and what kind of appraisal is appropriate?

If the subject business has less than $750,000 or so in gross revenues and meets certain other criteria, your client may find that a limited scope appraisal will meet his or her needs. A limited scope appraisal invokes the departure rule of The Uniform Standards of Professional Appraisal Practice in order to provide a low cost alternative to those who desire an independent appraisal performed by a Certified Business Appraiser or similarly credentialed professional. This appraisal is often suitable when a client desires an independent valuation to justify an asking price. The resulting certified appraisal report also provides valuable information that can be used in price negotiations and may be especially helpful when neither the seller nor the buyer are particularly knowledgeable about value concepts, which is often the case.

A limited scope appraisal might also be utilized in cases where the seller has an unrealistic expectation of the value of his or her business. Or perhaps the seller perceives the broker, who would like to have his or her listing, to have a conflict of interest and would like to the appraisal to be performed by an independent, third party. Another instance where an appraisal may meet a broker’s needs is in conjunction with Article Eleven of the Code of Ethics of the International Business Brokers Association which states that “The business broker should not undertake to make an appraisal that is outside or beyond the scope of his experience without first obtaining the assistance of an authority of such types of property unless the extent or lack of experience of the business broker is fully disclosed to the client.” Of course, no intermediary cares to be in the position of having to explain to their client that they have a “lack of experience.”

Although a limited scope appraisal may meet the needs of many sellers and buyers of small businesses, there are often situations where a formal valuation should be recommended. The primary indicator should be size. Companies with over $750,000 or so in gross revenues, are typically more complex than main street businesses. To arrive at a reasonable estimate of the fair market value of an business enterprise of this magnitude and complexity both internal as well as external factors that influence value must be taken into careful consideration. These factors are outlined by the IRS in Revenue Ruling 59-60 which states that an appraiser should conduct a careful analysis of: a) the nature of the business and the history of the enterprise; b) the economic outlook in general and the condition and outlook of the specific industry; c) the book value and financial condition of the business; d) the earnings capacity of the company; e) the dividend paying capacity (cash flow) of the company; f) goodwill and intangible value; g) the size of the company, and; h) the market price of similar publicly owned companies that have sold. The analysis of these and other factors, in conjunction with valuation methods which are more rigorous than those typically employed by business brokers, are used to develop a formal estimate of the fair market value of the subject company.

Another indication that a formal valuation should be recommended might be a function of the industry in which the business operates. For example, professional firms, such as those of physicians, engineers and architects have unique financial/accounting issues and practices that must be addressed when developing an estimate of value. In addition, some industries, such as auto and recreational vehicle dealers for example, have developed industry-specific valuation methods that should be included in the analysis. If a broker is not familiar with these methods, a qualified appraiser should be recommended.

Although formal appraisals may be expensive, they can substantially reduce the likelihood that a company is over- or under-priced. This will be of importance to those of your clients who are particularly concerned about leaving money on the table. Further, a prospective buyer of a company with an asking price of over $500,000 or so is likely to be more sophisticated than the typical buyer of a main street business and may well have a formal appraisal of the target company performed on his own behalf before making an offer. A seller who has not engaged a qualified business appraiser could find himself seriously lacking at the negotiating table.

Professional, well-trained business brokers have a long history of providing valuable services to their clients in the development of appropriate asking prices. However, it is important that brokers and associates alike understand that an estimate of the value of a larger, more complex company derived from main street business appraisal methods may be materially different than the company’s true fair market value, which can only be determined through a formal valuation.

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Fast forward to today: your new business has now grown to where you have 10, 20, maybe even 30 or more employees, all of whom seem to be constantly squabbling and coming to you for everything. You’ve never had the time to develop a formal organizational chart, but if you did, it would look like a starburst with everyone reporting to you. Your accounting is a mess and you don’t have the training to use what little financial information you receive. You have your personal finances tangled up with that of the company’s and you’re not sure where all the money goes from month to month. Your accountant tells you the company is profitable, but you never seem to have any cash, and you’re afraid to be away from the office for more than a day or two at a time. In short, you feel as though you are losing control of your company.

As a business owner, hopefully you’re not suffering from all of these symptoms. But the onset of that uncomfortable feeling of losing control is most likely indicative of one thing: the “baby” you have nurtured for so long, is growing into a “teenager” – your business is on the threshold of becoming a mid-sized company.

Regardless of whether you started your business from the ground up, took over operations from a family member or acquired it from a former owner, managing your company through this next level of growth will likely equal or surpass the challenges you faced in any previous stage of operation. Whereas before, your personal ability to produce your product or service was enough to make you successful, you must now become a professional manager, a role for which you may not be fully prepared.

So, what is a manager, anyway? In the broadest terms, a manager is a person who gets work done through other people. Although it may sound simple enough, developing and implementing the systems, procedures and organizational infrastructure required to manage a larger company, while at the same time learning the art and science of delegation, can be difficult for even the most seasoned small business owner.

How do you get your arms around all this? First of all, another dose of hard work and determination will be in order. But this time around you will also need an elixir of additional business education and training coupled with the advice and assistance of other business owners and professional business advisors. Depending on your background and experience, some of the following resources may be helpful:

• Look into attending business management courses provided by local institutions of higher learning. Start with the business programs at Florida Community College and UNF;
• Evaluate the business assistance services provided by the Small Business Development Center, which is located on the campus of UNF;
• Network with other business owners by joining the Jacksonville Regional Chamber of Commerce and participating in local community service organizations such as Rotary and Lions clubs;
• Consider joining a CEO peer group such as The Executive Committee (TEC). Although pricey, some CEO’s find this forum invaluable. A less expensive alternative is the CEO Roundtable sponsored by the Chamber of Commerce.
• Check out the many business computer software programs currently on the market for business plans, budgeting, accounting and other business functions;
• Browse the business management section of your local bookstore for “how-to” and other management books;
• Subscribe to trade journals and business periodicals to learn how other business owners handle issues similar to those which you are experiencing;
• Get direct professional assistance from accountants, lawyers and business advisors who have experience working with larger business organizations.

Making the transition from a small business to a mid-sized company is a daunting task for any business owner. But not unlike the results you experienced from those early years when you were just starting out, the personal pride and financial rewards you will gain from taking your company to the next level will be well worth the effort.

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1. Your debt-to-asset ratio is increasing. It is not uncommon for businesses to borrow money to finance equipment, buildings and other assets, including inventory. However, if your ratio of debt to total assets is increasing, you may be at risk of becoming over-leveraged. Although acceptable debt levels vary from industry to industry, a ratio of 50% or greater is generally an omen of impending trouble.

 

2. Your bank won’t loan you any more money. We have all heard the story that banks only lend money to people who don’t need it. In reality, most banks are not in the business of making high risk loans. Your banker’s reluctance to provide you additional debt is a sign that this outside third party may not think your business is as healthy as you think it is.

 

3. Slowing inventory turnover. If you are in the business of selling products, having inventory on the shelves longer may be an negative indicator.

 

4. Net losses. It’s not uncommon for startups to experience losses in the early stages of a venture. A startup company is typically funded from outside resources until it reaches its breakeven point. In the case of later stage businesses, most owners try to minimize net profit for tax purposes by taking advantage of depreciation and other elements of the tax code. But if your business is routinely losing money in real terms, this is a not-so-subtle indication of trouble.

 

5. Cash flow problems. Chronic cash flow shortages can also signal an ailing business. Indicators include average accounts payable agings that exceed 30 days. In this case, you’re financing your short term cash flow shortfalls on the backs of your vendors. Another sign of cash flow problems is when the practice of writing checks on the due date, and then not mailing them until the bank account is replenished, becomes a routine cash management tool. A working capital ratio, which is the comparison of current assets to current liabilities, of lower than 1 to 1 can also be an indicator of cash flow problems.

 

6. You’re no longer having any fun. Not everyone has the luxury of waking up in the morning and looking forward to going to work. However, if your business has become to feel like a millstone around your neck, it may be time to reassess your career options.

So, what can you do if you find that your business is not performing as well as it should? Your first reaction might be to try to sell it. However, it’s very difficult to sell a weak or failing business and it’s unlikely you will recoup your investment. A better idea would be to conduct a thorough business analysis of the company and develop a plan of action to turn it around. This may well include enlisting the help of outside professionals who have the skills and experience to help you identify and implement changes that can keep your business from getting deeper in trouble. And then, of course, if your company is too far gone to be salvaged, or you simply no longer have the drive to continue, you may find that committing it to “euthanasia” may be the best medicine for your mental health as well as the health of your checkbook.

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The modern version of the three basic financial statements derived from this system include the profit and loss, or income statement, the balance sheet and the cash flow statement. Each of these, or at least the first two, are routinely prepared following the end of each calendar month by countless accountants around the world and, all too often, are then promptly filed away. In fact, these reports, which many business owners use solely for purposes of filing their tax returns, can provide a fountain of information about the operations of a company.

Financial statements measure your business’ economic performance. Obviously, if your accounting system is not competently managed, these measurements will be erroneous, unreliable and of little use to anyone. Therefore, the first step in establishing a system to use this information begins with making sure that the person responsible for maintaining your accounting system is properly trained and experienced.

Once you have established that the financial statements are reliable and accurate, the second step is to learn how to decipher them. This will probably require some training and minimally involves understanding the basic concepts of profit and loss, how various “metrics” or ratios are developed, and most importantly, the actual business activities that affect them. This training may be acquired from a variety of sources including formal educational institutions, books, seminars and business advisors.

The third step is to develop management systems, such as an operating budget, which allow you to establish the standards for these various metrics and provide methods by which they may be compared to actual results. A simple example would be determining through the budgeting process that an annual net profit margin of 10% for your company is desirable and attainable. This standard is then compared to the actual profit margin at the end of each operating period. If you are on or over budget, congratulations are in order. If not, then a review of the numbers that affect this ratio can identify the business activities that caused you to miss your goal.

No single financial ratio can meet the analytical needs of any particular business. In fact, there are four primary groups of ratios that have been developed. They include those related to liquidity, or you ability to pay your bills; activity ratios, which can help manage inventory and trade payables, for example; financial ratios, which focus on your use of leverage; and profitability ratios.

Running a business without the ability to use your financial statements is not unlike driving down the highway in a rain storm with no windshield wipers. Once you turn those wipers on, you’ll never want to be without them again.

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Sooner or later every business owner is faced with the decision of whether or not to sell his/her company. In fact, studies conducted by the International Business Brokers Association reveal that the typical small business changes hands about every five years, on average. So it would seem only prudent for a business owner to manage her business in such a manner as to maximize its value over time. In order to do this, the owner should have an understanding of the basic concepts that drive the value of a business, regardless of its size or industry, in the eyes of a prospective acquirer.

Although qualified business appraisers, as well as astute buyers, often utilize a great deal of research and complex valuation methods to arrive at the fair market value of a business, the two fundamental, underlying concepts that drive the perception of value are straightforward and rely on common sense. So what are these concepts and how can you utilize your understanding of them to maximize the value of your business?

First of all, we need to identify them. They are 1) cash flow, specifically, the estimate of future cash flows that the business can reasonably be expected to generate for a new owner; and 2) the buyer’s perception of risk, or his level of confidence that he will actually receive those cash flows if he buys the business.

The cash flow value driver is a function of both revenues and cost controls. Its affect on value is derived from the current owner’s ability to maintain stable or growing revenues while, at the same time, controlling costs. Doing so over time creates a history of profits to the current owner that will be taken into consideration in developing reasonable estimates of potential future profits that will benefit a new owner.

With regard to the risk driver, we all know buyers are risk averse. So while we work toward establishing that the business can generate a certain level of revenues and profits, our concurrent goal should be to minimize a prospective buyer’s perception of risk with regard to his investment, in which case he will be more likely to pay a higher price for the business. Essentially, this consists of being able to provide compelling evidence to a prospective buyer, ideally in the form of historical financial performance, that he will actually receive those projected cash flows if he acquires your business.

So let’s sum it up: stable or growing revenues and cash flow over the most recent three years or so are not only verifiable proof of your business’s ability to generate a certain level of revenues and profits but also are indicators that those revenues and profits will continue. That’s a good combination.

The manner in which one manages the day-to-day operations of a business can also affect value through its influence on risk. Customer or supplier concentrations tend to increase the perception of risk, whereas contractual sales and a history of return customers, for example, reduces that impression. Also, value may be increased by reducing the business’s dependence on the current owner to generate cash flows. A buyer wants to know that the company can continue to be successful without your presence. Here, then, is a summary of the basic drivers that create value:

• Continuous and stable revenue growth over time
• A history of controlled costs and predictable cash flows
• A stable workforce and management depth
• A diverse customer and supplier base

Managing your company’s financial performance in such a way as to establish a history of stability and growth provides a reasonable basis for the assumption that the prosperity of your business can be transferred to a new owner. This, coupled with sound operations and management depth, can help maximize the value of your business.

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First of all, its important to understand that the value of a going concern is fundamentally a function of the present value of future profits the business is expected to produce for a new owner. In other words, a typical buyer of a business will invest capital only if he believes it will render future earnings at an acceptable rate of return. Therefore, in order for a seller to benefit from his investments in his company, both tangible and intangible, the company must demonstrate financial results and operational attributes that enhance the business’s value drivers in the eyes of a prospective acquirer. Value drivers include a history of steady and predictable sales levels, controlled costs, manageable debt loads and the presence of a well-trained and reliable staff, for example. These and other desirable characteristics result in industry-typical profit performance and risk levels, which in turn translate into value.

If the contribution of sweat equity from the owner and his family and friends has had a positive affect on the financial performance of the business and the perception that it is likely to continue providing acceptable levels of cash flow to the owner, then his efforts will pay off in the form of a higher price. Unfortunately, the value of a business is diminished if it is losing money or only marginally profitable, regardless of one’s contribution of time and treasure.

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