Business Valuations – Kansas

Business owners often seek valuations when they are considering selling their companies, but there are many other reasons to get a valuation. For example:

• If one owner or shareholder wants to exit the business before others do, a valuation can help establish the buyout price.
• If a business owner is in the process of divorce, a valuation is usually necessary to determine an equitable division of assets.
• When owners need to prioritize capital spending and business improvements, obtaining a valuation can help determine which expenditures would add the most value to the company.

Estate planning is another strong reason for obtaining a business valuation. Whether the business will be passed to the next generation of family owners or sold as part of the estate, its value as a piece of the owner’s estate is an important factor.

• Management buyout & succession planning – Key persons in the business may want to continue the business once an owner decides to retire. A fair price or range of value is determined so that both the buyer and the seller negotiate the price and terms of an actual deal.
• Divorce – A valuation helps determine an equitable division of assets during marital dissolution.
• Estate planning – Knowing your business’ value helps determine whether your estate will be subject to federal or state estate taxes. A valuation allows you to implement strategies to minimize or defer estate taxes, such as gifting shares during your lifetime or setting up trusts.
• Selling a business to a third party – Business valuations help owners sell their businesses with confidence, attract qualified buyers and increase the chances of achieving a best-scenario deal.

Business valuations are typically performed by credentialed professionals such as CPAs with the ABV (Accredited in Business Valuation) credentials, CVAs (Certified Valuation Analysts), ASAs (Accredited Senior Appraisers) or CBAs (Certified Business Appraisers). Working with professionals, like those at Adams Brown CPAs, ensures that the valuation meets industry standards, withstands scrutiny and complies with IRS and legal expectations if required.

The valuation process starts with an in-depth review of the company’s financial records, operations and industry position. A valuation expert will typically use one or more of the three main approaches: the income approach, which looks at future earnings potential; the market approach, which compares your business to similar companies that have been sold; and the asset approach, which is based on the net asset value of the business. The chosen method depends on the nature of the business, its industry and the purpose of the valuation.

1. We first look at the company’s financial history (generally five years) and apply an income approach (using the company’s normalized cash flow).
2. From there, we research comparable company transactions to apply a market approach.
3. We request 5 years of tax returns or financial statements from you to go through our analysis.
4. Once we have reviewed the requested information, we schedule a 45-minute client interview to ask more detailed questions about the financial statements and the company’s operations. We can issue a draft report about 1-2 weeks after the client interview.
5. We request another 30-to-45-minute call to discuss the draft and our findings with you.
6. If there are multiple owners or shareholders, then they generally need to be part of the process.

To produce a comprehensive business valuation that is more than numbers – a valuation that tells the story of your business – a valuation professional will interview you and your key managers to learn about your business and what makes it operate efficiently.

The valuation professional will also learn about your industry, your customer base, how you do business and whether you are operating in a high-risk or low-risk environment.

Before you call a valuation professional:

• Have a working idea of where you see your business in five years. Will you be running it, or are you looking to exit in that timeframe?
• Make sure your financials are in order and your books are clean. Get any personal items such as loans and car leases off the balance sheet. Make sure all adjustments are made and the reporting is consistent.
• Check the accuracy of your operating agreements and other legal documents and bring them up to date.
• Be prepared to walk through the strengths and weaknesses of your business with candor.

 The documentation the valuation professional will need includes:

• Financial statements
• Tax returns
• Operating agreements
• Buy-sell agreements
• Governing documents
• Contracts
• Customer lists

The documentation list may seem overwhelming, but it helps establish important information and intangible factors that impact valuation, such as risk.

Rule of thumb: Goodwill is the “how” a company performs daily operations. It’s an intangible asset, often resembling the “opportunity” identified by a prospective buyer. Common examples of goodwill include:

• Human capital (key executives, sales, operations, etc.)
• Processes and procedures (including use of technology/software)
• Stakeholder relations (customer concentration, key vendors, etc.)
• Company leadership and culture (arguably the most valuable form of goodwill)

The impact of goodwill on a company’s valuation can be significant.

For example: Say a company is valued at $10 million. The real estate, equipment and the working capital are valued separately at $6 million, leaving $4 million allocated to goodwill. In other words, 40% of the company’s value is comprised of goodwill.

Note: This is an example, and the value of goodwill will vary depending on factors including the specific buyer, deal structure and terms of the deal, etc.

Not only can goodwill represent a significant portion of company value, but it’s often a key factor in a company receiving a premium or a discount on its sale price. Or, in other words, price multiples. For example, assume the sale of two companies in the same industry, and of similar size (in terms of revenues). But Company A sells at a seven multiple and Company B sells at a five multiple. Why is there a difference? Probably because Company A has better profitability. But why? Large in part due to goodwill – Company A exhibits:

• Better leadership
• Talented and engaged employees doing jobs they are well suited to perform
• Sound processes and procedures to perform their daily functions in an efficient and effective manner
• An established culture

It’s very likely that Company A is going to show stronger financial performance. This, plus the strength of their goodwill, is going to fetch a higher valuation.

Valuing the Company to determine the estimated goodwill is also a great KPI when measuring a company’s financial performance. We often use market multiples as a strategic planning tool. For example, if a company is valued at a multiple of 6x EBITDA, then in theory, every $1 of incremental EBITDA will result in $6 of incremental value. Pretty simple, until you put it into practice – does this mean revamping operations to improve efficiencies and margins? Does this mean better training to improve your people? Or investing in key employees? Many, many ways exist to drive value. But understanding your Company’s value to measure goodwill is best practice.

Enterprise goodwill is the value generated from some of the factors mentioned above that are owned by the business. Note: Not to be confused with intellectual property. It focuses on the value owned by the company, as opposed to the individual.

Alternatively, personal goodwill is value owned by an individual that either owns or is employed by a company. It is more common within companies that require specific credentials, experience and qualifications (e.g., dental practices, professional service organizations, general contractors, owner/operated companies, etc.) but is also in present in the form of customer relationships, key employees (sales, operations, etc.) or specialized knowledge/skills held by an employee.

When determining the nature of goodwill (enterprise vs. personal), a good rule of thumb is to ask yourself – “If this person were to leave the business, what would happen?”

Why is this important? Personal goodwill has very little, if any, value in the eyes of the buyer, and more importantly, lending institutions, insurance and any other stakeholder with a financial interest in the sale of the company. And for obvious reasons, why would a company pay for value that cannot be transferred into the business?

And to clarify, the presence of personal goodwill, regardless of the form, is not a “deal killer.” And in many cases, it won’t dilute the value of a company, so long as there is an agreed upon plan in place for the transition of personal goodwill into enterprise goodwill. Predominantly in the form of an earnout, i.e., a specified amount of time (months, years, etc.) that the owners of a company are contractually obligated to assist with the transition of ownership after the sale.

Yes. The firm provides valuation services for use in estate, gift and income tax planning purposes.

Yes. Adams Brown offers business valuation services for marital dissolution proceedings.

Yes. Adams Brown offers business valuation services to help business owners and shareholders with mergers, acquisitions, sales and spin-offs.