How much is your business worth? If you’re selling your company, it’s a question you’ll want to ask long before it’s time to hang out the FOR SALE sign. A business valuation will provide the answer, provided you’re an owner who is willing to hear the truth.

Many owners don’t want to, and probably can’t handle the truth (cue Jack Nicholson). But why? Part of it is because they don’t understand the nuts and bolts of valuations.  The other reason is fear, denial, short-sightedness, ignorance – the list goes on.

For the owners who can handle the truth, and want it ASAP, I’ve decided to take you on a deep dive into the topic. For this, I turned to Darren Mize, an accredited senior appraiser with GCF Valuation, Inc.

Why Get a Valuation?
It’s a question I wish more owners would ask. I’ve seen too many owners ignore the valuation process and put their business up for sale. The marketplace then proceeds to brutally separate fact from fiction, revealing the true value of their company and causing them to scramble for Plan B.

Why do so many owners get their actual value wrong? 

Value is driven from two primary factors: Cash flow (profitability) and risk. Everything else is just a complementary component to one of these two key variables. However, there’s a big difference between knowing this information and interpreting it.

“An owner might think their business is booming. Cash flow is high, operations are running smooth, everything seems great,” says Mize. “However, they might not realize they have a high amount of associated risk – perhaps they rely on one or two customers for most of their business. Suddenly, their value is much lower than expected.”

A valuation can uncover these details, revealing chinks in your business’ armor that you didn’t know existed. If you plan to sell your business, understanding and correcting your shortcomings is crucial for a successful deal.
Before we break down the method appraisers use to create an accurate business valuation, let’s examine two types of appraisals that are most useful for owners looking to sell their business.

Choosing the Right Valuation for Your Needs
The first thing you should do when looking for an appraiser is ensure they are accredited. That means they’re continuing their education, they’re experienced, and they belong to a recognized appraisal associate (there are four of these associations).

Beyond that, both of the following business valuations can accurately determine your company’s value. However, as Mize explains, the levels of detail are vastly different, and each is suitable for a particular situation.

1. Calculation of Value – A calculation of value is a restricted use and less formal valuation estimate for owners who are considering selling their business. The report includes your company’s basic information, a brief financial summary, and a brief summary of valuation methods used to create your final report.

“Although it might not follow every uniform standard or provide the level of detail compared with a more in-depth valuation, such as a Complete Appraisal Summary, it can give you a good sense of a business’s value – and at a reasonable fee,” Mize says.
However, because a calculation of value isn’t as detailed as some other valuations, it’s only intended for one user – generally the owner – though it can assist the owner in particular situations:

• It can help a buyer and broker come to a fair selling price.
• It can reveal areas an owner might need to improve before officially putting his/her business on the market.
• It’s a relatively inexpensive way to gauge the marketplace.

2. Complete Appraisal Summary – A Complete Appraisal Summary is a more in-depth valuation that comes to a conclusion of value and that follows the Uniform Standards of Professional Appraisal Practice (USPAP).
With an extremely high level of detail, some owners look at a complete summary appraisal as overkill. However, according to Mize, certain scenarios might require you to conduct a more thorough valuation.

• It’s ideal for large businesses that generate more than a million dollars of earnings annually, and who plan to sell 100 percent of the business.
• It’s useful when entering a situation with multiple intended users, such as presenting to a board, approaching a partner, or engaging in discussions with a potential buyer or just in those situations that require something more formal.

Mize notes that while both valuations should calculate a similar value for your business, it’s not always the case.

“A Complete Appraisal Summary dives further into your financial and operational information,” Mize says. “If any of that information affects a business’ risk or cash flow, it could result in a different valuation than a calculation report.”

Still, despite providing different levels of detail, the process behind conducting the two valuations is virtually the same.

What’s Included in a Valuation
Creating an appraisal is a multi-step process that requires your full cooperation with an appraiser. As we’ll explain, the more transparent you are with your company’s information, the more accurate the valuation will be.

First, the appraiser will craft an engagement letter that outlines the purpose, scope of work and use of the valuation. This essentially ensures the valuation fulfills your specific requirements.

Then, they’ll begin a process of information gathering. This is the meat and potatoes of the valuation, where the appraiser collects all of your business’s data for analysis. Once the information is collected, they break it down into four categories:

• Financial analysis –  This identifies trends based upon your financial information, including the following: historical financial performance, adjusted income statements to determine adjusted cash flow, profitability and financial risk. “This information is key to determine how your business stacks up financially against your peers,” Mize says. “Perhaps more importantly, it determines your level of financial risk and cash flow, two of the key metrics that determine your company’s value.”
• Operational analysis – The appraiser assesses risk based upon your business’ operational factors. These include the markets you serve, your business’ reliance on you (the owner), and the structure of your staff. The operational analysis and the financial analysis are two of the most crucial components of any valuation, as they help determine the bulk of your business’ total risk.
• Market, industrial and economical analysis – This section focuses on economic and industrial trends relating to your business. To gather this information, Mize says appraisers must rely entirely on published sources of information, such as IBISworld.com, RMA, etc. “It’s the best we can do,” Mize says. “Unfortunately, data is often limited and between six months to a year old.”
• Summary of valuation methods applied – This section summarizes the methods used to conduct your valuation. A Complete Appraisal Summary has quite an extensive summary.  However, in a calculation of value, this section is more brief. 

While every valuation must meet certain standards, there isn’t a specific formula that every appraiser uses to conduct a valuation.
“Creating a valuation is something of an art,” Mize explains. “There’s a lot of subjectivity, and you’ll rarely get the exact same appraisal from two different appraisers.”

For example, one appraiser might determine your company is heavily reliant upon you (the owner), creating a higher amount of risk in your absence. However, a different appraiser might disagree, leading to a lower amount of determined risk and thus, a higher valuation.

The Keys to Receiving an Accurate Valuation
The level of detailed information you provide an appraiser largely impacts the accuracy of your business’s valuation.
“Some owners keep their company’s information very accessible and detailed,” Mize says. “Others don’t keep track of their information at all. From our point of view, the more information you share with us, the better.”

Here are the three pieces of information you’ll need to provide for an accurate appraisal:
1.  Three years of financial statements – These financial statements can come in any form and include your current year’s financial statement as well.

2.  Adjustments to your income statement – This specifically includes expenses that the company pays on your (the owner’s) behalf, such as benefits, perks and travel funds.

3.  A detailed business summary – Finally, an appraiser will require details that give an overview of your business. This information includes the following:

• Description of your products and services
• Markets you serve
• Suppliers you rely upon
• Description of your staff
• Number of management positions
• List of key employees
• Your company’s hard assets
• Specific responsibilities and duties of owner(s)
• Whether or not any family members are staff employees
• Specific plans for growth and expansion
• Condition of the company’s facilities and assets
• Process of marketing/acquiring new business
• Reliance upon specific companies for annual revenue

Can you accurately tell a buyer what your business is worth? Without a valuation, that’s a tall order. But with one, you’ve got a solid, objective piece of data that will provide the foundation for selling your business, or growing it. And that’s the truth everyone should get a handle on.

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Rock LaManna, President and CEO of LaManna Alliance, helps printing owners and CEOs use their company financials to prioritize and choose the proper strategic path. He can be reached at [email protected].