If you've nurtured your business from the ground up and are flirting with the idea of selling, valuing your business accurately is crucial.
Aim too low and you won't get value for money, pitch it too high and you'll have no takers.
John K. Paglia is Associate Dean at the Graziadio School of Business and an award winning researcher within the business community, specializing in all aspects of finance.
BusinessesForSale.com asked him to clarify some of the more complex aspects of valuing a business:
BFS: If a business is losing money, does it immediately lose value?
John K. Paglia: No, every business has some positive value providing it is expecting to operate in the future.
BFS: Are all business valuation reports ultimately the same?
JKP: Absolutely not! Valuation reports vary from appraiser to appraiser and from firm to firm.
We have seen a lot of variability in appraisal reports over the years and have occasionally made corrections to other firms' reports that were, frankly, substandard.
BFS: Can you explain the difference between minority interest and control interest?
JKP: A minority interest is an interest in a company that is non-controlling. For instance, if there are two owners in a company - one with 51% and another with 49% - then the 49% owner is deemed to have a minority interest because he or she presumably does not have voting control rights. In these situations a discount may be applied to the minority interest.
A control interest is an interest in a company that is controlling. In this case, if there are two owners in a company - one with 51% and another with 49% - then the 51% owner is deemed to have a control interest because he or she presumably has voting control rights. A premium may be applied to the control interest.
BFS: What if I only have tax returns to document my financial performance?
JKP: Tax returns are sufficient; in fact, we use them frequently. We can still do the project with your business tax returns.
BFS: What is a 'market approach'?
JKP: A market approach is one of the three common approaches used by business appraisers. As such, it considers what the buyers paid for similar businesses. The other approaches are income and asset.
BFS: One last question, how do you determine earnings in your business appraisal packages?
JKP: We use what is referred to as Seller's Discretionary Earnings (SDE). SDE are those earnings that can be expected by a business owner, without regard to items subject to spending preferences.
For instance, one business owner may prefer debt financing and, therefore, will have an interest expense; while another may not. This affects the reported bottom line.
Also, one may have the business set up as an S-Corporation, which provides pass-through income; while another business owner may elect to be a C-Corporation. Again, this will cause net income to vary between otherwise identical businesses.
These choices affect the amount of money that would be available, on net, to a business owner. Therefore, in order to provide a consistent earnings base, we add back 'discretionary' expenditures to calculate Seller's Discretionary Earnings.
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