Importance of a 3rd Party Valuation When Acquiring a Business
In most business transfers, a business seller has proactively conducted a business valuation to ensure they are getting a fair, realistic price for their business. This is the smartest thing a business owner can do because it protects them and helps facilitate a smoother transaction.
If, however a seller has not conducted a credible, independent valuation then it is in the buyer’s interest to ask for one or to purchase such a valuation at their own expense as part of due diligence and price justification.
Savvy buyers want to ensure they are acquiring a synergistic business that meets their investment objectives. The buyer also needs to understand the earning potential of the business by examining not only tangible and intangible value, but also the seller’s discretionary cash flow (SDCF). This cash flow would include but is not limited to adding owner’s total compensation, non-operating or one-time expenses benefiting the owner, depreciation and amortization, interest expense and adjusting other owner salaries to market value. Buyers may wish to get a third-party opinion as to the veracity of items that were financially recast as part of seller’s discretionary cash flow. It is common for sellers to recast future benefit into historical performance versus using net present value. The legitimacy of the seller’s financials would be of key concern to the independent valuation expert.
If you are a buyer (individual, strategic, or financial/investment) and are considering a business purchase where you desire an alternate opinion of value, then communicate this to the seller; if they resist, then this is a cause for some concern.
Another reason buyers should conduct a business valuation is to fulfill commercial lending requirements associated with banks and SBA loans. When an individual buyer seeks bank financing to purchase an existing business, some lenders will require a price and consequent loan justification, validated through a qualified third-party business appraisal. If real estate is involved, you can be assured an appraisal is required. In other instances, lenders may require a complete business valuation to justify loan proceeds.
The fees associated with a business valuation may be covered by the seller. Everything is negotiable. When a buyer pro-actively requires that a valuation be conducted, the fees should be paid by the buyer and then adjusted for in the final purchase price – either evenly split or credited in full by the seller. In theory, it is the seller’s responsibility to know the value of their business to preserve fairness to all parties involved in a transaction but that is not a guarantee.
Know your value, know your business.