Calculation of Value – Key Terms and Risk Factors
Key Terms & Definitions
When reviewing a Calculation of Value report, you should understand these three (3) terms:
Type of Value: It is important that the user know our definition of “Fair Market Value” – “the price, expressed in terms of cash equivalents, at which property would change hands between a hypothetical willing and able buyer and a hypothetical willing and able seller, acting at arms-length in an open and unrestricted market, when neither is under compulsion to buy or sell, and when both have reasonable knowledge of the relevant facts.
Assets or Equity: It is also important that the user understand the difference between a “value of equity” (stock sale) vs the “value of assets” (asset sale). Most small business transactions are completed as asset sales, which typically include inventory, fixed assets, and intangible assets (goodwill). However, a stock sale is not uncommon and would include all assets and liabilities. In the real world, there are many variations on these basic structures. The Calculation of Value report doesn’t take into consideration a particular type of sale, but what’s included in the sale (or value). For instance, an asset sale can include a certain amount of cash, A/R and assumption of liabilities…..while a stock sale could include just inventory, fixed assets and goodwill.
Control: Lastly, it is important that the user understand the difference between a “control value” and a “non-controlling value”. Control refers to the ability to manage or control the business. A minority interest, by definition, does not have control. Minority interests in a business are typically worth less, often a lot less, than the proportionate share of the entire business. Ask yourself, would you buy a minority interest in a privately held company where you have no control? The value in this calculation report is a 100% controlling value.
The Calculation of Value report uses proprietary software to analyze and compare the subject business to similar businesses in its industry. This software includes technology to isolate the “Critical Value Drivers” in most small businesses ….including returns to shareholders, ratio performance, customer / supplier concentrations, and dependence upon owner, among others. To help develop the discount and capitalization rates in the Calculation of Value report, the following risks are considered in this calculation:
a. Financial: Financial Risk deals primarily with the consistency and overall performance from a financial perspective. Erratic, inconsistent, and below industry average performance would warrant higher risk, while consistency and performance above industry averages would warrant lower risk.
b. Quality of Financial Information: Quality of the financial information is based on the analyst’s confidence level in the accuracy of the financial statements. For instance, a CPA Audited Financial Statement would have much lower risk compared to an internally based financial statement. There could also be risk in the reliance upon an interim statement.
c. Diversification: Diversification risk is based on: (1) diversification of customers (reliance upon 1 or 2 main customers); (2) diversification of suppliers (reliance upon a single supplier); (3) product or service mix diversification (reliance upon a sole product or service); and (4) geographic diversification (significant reliance upon location).
d. Management: Management risk is the reliance upon the current owner(s) of the business and/or key management or another key employee. For instance, the more specialized a professional practice or business, the more likely that business will be reliant upon its owner. There could also be a significant dependence upon a key sales person.
e. Industry: Is the business in an industry that is being buffeted by low-cost foreign labor? Is the industry under financial stress because of low margins? Is the industry insulated from competition because of a high cost to enter – in money and time? Is the industry growing rapidly because of new technology that is quickly being adopted by their customers? Every company is subject to the same forces impacting the overall industry – for good or bad.
f. Competition: If the business is dependent upon its location, it most likely has a high competition risk. Businesses with higher barriers to entry can sometimes have lower risk of competition. Just because a business has no competition, does not mean there is “low” competition risk. What’s the likelihood of a new competitor entering the market?
Price for Calculation of Value
While typical business appraisals often start at $5,000, the cost of our Calculation of Value report is a fraction of this cost. Click HERE to see a sample report. Contact Tom MacPherson, at the Charlotte office, for the cost of a Calculation of Value and what we need to prepare one.
The Summit Acquisitions Group — Business Brokers and M&A Advisors — specializes in the sale, appraisal, and financing of privately owned companies ranging in valuation from $750,000 to $25,000,000. Contact their offices in Atlanta, GA or Charlotte, NC for a free consultation.