Buyer Beware – and Become Informed
A Buyer’s Guide to Business Valuation
You have often heard the term “let the buyer beware.” This statement summarizes the concept that a purchaser must examine, judge, and test a product considered for purchase himself or herself rather than relying on the seller to represent the product.
If you are considering buying a business, it is important to gain an understanding of the value of the business. Part of the process is realizing that the seller of the business has a very different goal that you do as the buyer. The seller may have engaged a business broker to assist in the sale of the business. The business broker acts on behalf of the seller to identify a buyer and bring the buyer and seller together. Business brokers often provide the seller a business valuation as part of the service they are providing. Business brokers work on a commission basis – earning a percentage of the sales price for the transaction. The broker is working for the seller and is not an independent third party to the transaction.
Also consider that any time you purchase real estate (that requires financing), the bank requires a property appraisal. This is true for both commercial and residential real estate. When you purchase a business that does not include real estate, it is unlikely that a loan will be based on the business you are acquiring. More likely it will be based on your personal assets – mainly the equity in your home. Since the banks don’t ask for an independent appraisal on the value of the business you are about to purchase, there is no requirement that you have someone assess what that business is worth. You are free to overpay as long as you have the personal assets to reduce the bankers’ risk.
How can you gain some assurance that you are not overpaying for a business?
As a buyer, you need to have objective information to reduce the risk that you do not overpay for your business. Consider an independent valuation for the business.
Independent business valuations can be performed by a wide range of professionals. There are various certifications including:
- American Society of Appraisers (ASA): Accredited Senior Appraiser (ASA)
- CFA Institute (CFAI): Chartered Financial Analyst (CFA)
- Institute of Business Appraisers (IBA): Certified Business Appraiser (CBA)
- American Institute of Certified Public Accountants (AICPA): Accredited In Business Valuation (ABV)
- National Association of Certified Valuation Analysts (NACVA): Certified Valuation Analyst (CVA)
All of these certifications require experience, coursework, an exam, and a case study to gain the credential and can provide you with an independent opinion as to the value of the business. An independent valuation may align with the valuation of the broker, but not necessarily.
Regardless of the source of the valuation, it is important that you are able to assess the likely cash flows from the business. As part of your due diligence in the purchase process, request at least five years of financial data including profit and loss statements and balance sheets. Build your own projection of future cash flow to gain an understanding of the ability of the business to generate cash for you. Can you earn a return on your investment? Can you pay off any debt associated with the purchase? It is not just the purchase price of the business that matters, but the terms of transaction as well. There are many variables that need to be considered in financing the acquisition of the business. Working out a projection can assist you in gaining an understanding of what will work for you.
Take action so you don’t become another story of a business owner who learns too late that they paid too much for their business. It is challenging to integrate a new owner into a business, to be accepted by customers, by employees, and by suppliers. You can avoid the additional challenge of having paid too much by taking two simple steps before you finalize your purchase.
- Get an independent valuation
- Prepare your own projections of cash flows
Ask your trusted advisor (lawyer, CPA, banker, other) for a referral to someone who can provide support for you