It is a well-known fact within the business brokerage industry that improperly valued small businesses generally benefit no one, often putting both the owner who wants to sell and their broker at a disadvantage.
Sellers need realistic valuations that set and defend the asking price. Business brokers need to avoid time-consuming listings that will not result in sales.
Fortunately, the process of valuing small businesses has gained in sophistication and accuracy in recent years. The growth and refinement of small business transaction databases, with their sorting and statistical functionality, have aided the valuation process. They serve as powerful tool for brokers, adding to the accuracy and professionalism of valuations, as well as supporting pricing recommendations for prospective clients.
Benefits of Using Broker Authored Valuation Reports
Broker Valuations such as Opinions of Value (and Calculations of Value) are widely used for owners contemplating the sale of their business. Such valuation reports are standard products marketed by experienced business brokers and are priced for a fee to provide the broker some compensation for their time in the event the owner is not ready to sell.
These valuations benchmark business health, condition, and location against similar businesses sold in the area to estimate an appropriate asking price. During the process it is common for the broker to make improvement recommendations based on visual inspection of the business. As such, they can be particularly useful for owners deciding whether to sell now or to make improvements prior to listing. Broker valuations also tend to cost less than formal appraisals.
Limitations of Using Broker Authored Valuation Reports
However, Broker Valuations are generally limited in terms of scope, may not incorporate multiple valuation methods, and may omit appropriate premiums and discounts, or other factors influencing a business appraisal.
In addition, it is difficult to set an annual revenue threshold as to when a broker valuation is appropriate and when a third party credentialed expert should be engaged for a business appraisal, as the decision might be driven as much by balance sheet issues as the sales volume.
These reports can also face challenges from potential business buyers and their CPAs who argue that the asking price was not objectively established by an impartial third party credentialed expert. It’s important to note that many business brokers do have valuation expert credentials and their valuations are less likely to be challenged. Broker generated valuations, with or without valuation credentials, are important and appropriate for owners contemplating selling their business.
Furthermore, inexperienced business brokers may appease a seller by providing them with an unrealistically high valuation figure for a business in order to obtain a listing. This is cooperative self-delusion.
How Third-Party Business Appraisals Help Brokers and Owners
Third party business appraisals are independent, objective, and produced by trained valuation professionals. Credentialed valuation experts utilize more detailed and complex processes with different techniques than most broker-generated valuations.
Moreover, professional third-party appraisals start with the data collection and continue- through the reconciliation of values. It is for these reason that increasingly, successful business brokers and their respective sellers set the price and defend it with objective credentialed business appraisals. This is also true when SBA lending is involved.
What are the Different Types of Business Appraisals Authored by Credentialed Valuation Experts?
Appraisals can be categorized as a “Calculation” engagement or an “Opinion of Value.” An Opinion of Value is a more substantial report wherein an analyst must consider all relevant data and apply all relevant valuation procedures to arrive at a value. Conversely, a Calculation engagement is frequently a shorter analysis wherein the client and analyst agree on the approaches and methods used.
Regardless of the type of assignment, the format of the report can differ. The report can be a detailed report (which is often quite lengthy and frequently performed in litigation matters), a summary report which, although substantive, is an abridged version of the detailed report, and in some cases may be delivered verbally.
As a practical matter, brokers will likely find that a summary report is often suitable for their client’s needs.
Benefits of Third Party Credentialed Expert Business Appraisals
- Objectively Determine if the Owner has Realistic Sell Price Objectives. Many experienced business brokers use third party valuations as a qualifying tool with prospects. Getting a neutral opinion – and then gauging the Owner’s reaction – helps with the broker’s decision on investing the time and effort in taking a company to market if the seller has unreasonable expectations.
- Expedite the Business Selling Process. Third party business appraisals reduce wasting time with buyers challenging the price. In some cases, buyers suspect that the price was engineered by seller and broker motivations and not authored by an impartial credentialed expert. The credibility of the business for sale listing (and the broker) is often enhanced when a third-party professional business appraisal supports the price.
- Prevent Deals from Falling Through Due to Inflated Asking Prices Based on Unrealistic Valuations. Third party business appraisals also assist with financing process. However, depending on the transaction price, many lenders will insist that the buyer pay for a third-party appraisal authored by a business appraisal expert approved by the lender’s underwriters. This is an important part of the financing process; a buyer’s offer based on an inflated valuation can kill a deal or end up in a substantial repricing or restructuring. Conversely, an improperly created appraisal may conclude a valuation lower that what is fair market value thereby putting a seller at a disadvantage.Business brokers can potentially sell a higher percentage of listings-and more quickly– when the listings are realistically priced and supported by third party business appraisals.
- Provide High Level of Sophistication, Accuracy, and Professionalism. “As companies get larger and more sophisticated, the level of professionalism and accuracy of the valuation analyst needs to rise as well. Looking to an outside expert who practices exclusively in the realm of valuation is one way to help deliver a high-quality valuation experience to clients,” noted Dan Doran, Founder of Quantive in Washington, D.C.Added Doran, “Private equity groups, investment funds, and home offices are generally more receptive to a third-party business appraisal. Investment committees at private equity groups and funds insist on verifiable and detailed valuations to support their recommendations to their investors.”
Do Business Brokers Participate in Third Party Business Appraisals?
Brokers may either stay outside the process, or selectively assist the valuation firm with the collection of financial statements and other operational information. Should the Broker participate on a limited basis, the broker should not attempt to influence the outcome of the valuation conclusion.
SBA Qualified Sources for Business Valuation
When a valuation is required for obtaining financing, the SBA often requires that a third party ‘Qualified Source’ must author the valuation. These ‘Qualified Source’ designations include:
- Accredited Senior Appraiser (ASA) through the American Society of Appraisers
- Certified Business Appraiser (CBA) Accredited through the Institute of Business Appraisers
- Accredited in Business Valuation (ABV) accredited through the American Institute of Certified Public Accountants
- Certified Valuation Analyst (CVA) accredited through the National Association of Certified Valuators and Analysts
- Accredited Valuation Analyst (AVA) accredited through the National Association of Certified Valuation Analysts
- Business Certified Appraiser (BCA) accredited through the International Society of Business Appraisers
All of the above professional designations require training, passing rigorous tests, and often ongoing professional development. Buyers, sellers, and brokers all benefit from such expertise integrated in the valuation process.
Summary
Setting a fair market value for business and defending it with a business appraisal is critical to a broker properly representing a client or gauging whether or not a broker’s prospect might be a good client. Sellers need realistic and supportable valuations to increase the probability that their business will sell and at a fair price.
Broker-generated valuations have their place in brokering small businesses while the valuations of larger and more complex businesses are likely best left to third party independent valuation experts.
Original Posted at BizBuySell on June 5, 2023