As practice director for mergers and acquisitions with Ernst and Young, Aroon Sequeira has conducted business valuations – independent assessments of the value of a business – for dozens of companies. He’s crunched numbers and reviewed financial statements enough times to know that the valuation process is based on sound financial and management theory, but he’s learned to trust his gut instincts as well.
“You can kind of tell what the rest of the business is like by the first impression,” says Sequeira. “A disorganized first impression leads to disorder elsewhere.”
If first impressions are anything to judge by, business is thriving at Smith Construction Co. (name has been withheld at owner’s request). The receptionist answers the phone with cheerful efficiency and president Joe Smith (a pseudonym) is willing to discuss the purpose and results of their recent valuation. “It was more detailed than I thought – more in depth – but it didn’t surprise me at all,” he says.
Smith’s company has been a fixture in its industry for more than 40 years and has almost 100 employees. He initiated the valuation to find out what his company was worth with the intention of moving to employee ownership down the road.
What Smith found is that having a strong, well-established business results in a favourable asking price. “You can see it on a financial statement, but to see it valued is different – it gives you a solid indication of what you’ve done,” he says, pride evident in his voice.
It can also give a company an indication of what needs to be done. “A good valuation will also highlight some of the problems in the business,” says Bob McNally, president of McNally Valuations Inc. And while the process involved in conducting the valuation may be highly technical, some of the improvements indicated by a below-par valuation may be relatively straightforward.
“It can be as simple as managing your working capital better, taking better care of your customers or taking better care of your personnel,” says McNally.
The reasons for conducting a valuation vary. Shareholder disagreements are one of the more unpleasant but common reasons, as are divorce proceedings, oppression remedies and fairness opinions. There are also tax and insurance reasons for a valuation and, of course, the need to set a fair price for a business.
Few companies use a valuation process as an annual benchmark, although there can be value in doing so. “It’s definitely something people should look at on a more frequent basis,” says Devin Wagner, senior manager with Grant Thornton.
In a hot market like Alberta, having a good idea of the value of your company can be handy if an opportunity to sell comes up suddenly. With most experts recommending a three- to five-year horizon from planning to closing a sale, it can be hard to take advantage of unanticipated offers unless you have been keeping track of your company’s value.
“Realistically, every business is always for sale,” says Craig Bell, principal of a private equity firm. “It’s just a question of price.”
How business valuators arrive at a final price is based on three main factors: assets, income and market conditions. In some industries – such as real estate, where land is the main value of the business – the assets and the business value are roughly equal. In other industries – such as the service sector – cash flow, estimated rates of return on investment and risk are calculated to arrive at a present value figure. The difference between the value of the assets and the present value is the “going concern” or “goodwill” in the business.
Most owner-managers understand the basic concept of goodwill value but have little idea of how to measure it. Others overemphasize its value, assigning an arbitrary, Austin Powers-ish “one million dollars” figure to what are essentially their personal relationships with clients and suppliers.
In order to have value, goodwill “has to be transferable to another party,” says Chris Lee, a partner at Deloitte & Touche and a chartered business valuator since 1992. If an owner feels the business would fall apart if he or she were to leave, the goodwill will likely have little value to a buyer (see “When Goodwill isn’t so Good” sidebar on next page).