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We are hearing and reading all about artificial intelligence and the role it may play in our lives. Think about how our lives have changed over the years with new things: from radio to television, from horses to automobiles, from writing letters to texting and messaging. It is quite astonishing the transformation technological advances have in our world.

And with such advancements, there are downsides such as the general belief that constantly being on one’s phone or tablet has prevented a generation of young adults from being able to have a conversation.  There always seems to be a trade-off as innovations take effect.

Does AI Threaten Business Valuations as Prepared Today?

It is a fair question given the emphasis on applying artificial intelligence to rapidly produce large amounts of content on any given subject. Given a completed business valuation is typically 100+ pages, it would be logical to think that AI can shorten the timeframe and lower the cost.

So, let’s take a broader view of key elements that are analyzed when preparing a detailed and thorough business valuation of a privately held company:

• Financials (revenue, net income over a period of time)
• Leadership team
• Staff/employees
• Products and services
• History
• Industry
• Local market information
• Customer/client base
• Patents/Trademarks
• Processes
• Assets including equipment, physical properties, real estate

Determining the valuation of a privately held business is not formulaic. There are quantitative components (of course) but also qualitative factors as noted in the above simplified list that a ChatGPT or other AI system cannot accurately account for.

An example: two convenience stores have the same revenue, net income, products, square footage, and foot traffic. It is likely and reasonable to think that by applying AI, the valuations for these two stores would be the same or quite similar. An industry multiple (an average) would be applied to the earnings and a few industry comparatives would be identified to determine a valuation. A lot of general content could be generated via AI to describe the convenience store national market, local market, and recent transactions. Volumes of content could be generated, but the applicability of the content may or may not be relevant to each convenience store.

In reality, each of these stores will have a vastly different valuation based on a thorough analysis of the above list. One will have a significantly higher valuation due to its client base, location and lower business risk factors.

At a quick glance, the challenge for business valuations given the rise of AI will be identifying if the contents of the valuation are ‘junk’. With AI, volume of content can be generated rapidly, but the challenge will be in determining if the content is accurate.

A Test of AI by a Highly Regarded Valuation Professional

A business valuation professional who is highly regarded nationally spoke about AI as it relates to developing business appraisals at the annual NACVA conference (National Association of Certified Valuators and Analysis). He conducted a test using AI to prepare a business valuation. His test showed that the AI tool had fabricated content.

Ask How the Sausage is Made

It may seem difficult to evaluate a business valuation professional other than to rely on the integrity and professionalism of a person you trust who made the referral. There are important factors to consider including their credentials and certifications. First, do your homework online and then when speaking with the recommended business appraiser, ask to describe the process they follow to prepare the valuation. You have every right to ask about process and to listen or ask specifically, if they complete the research, have other staff to do the research, or do they leverage AI. If the latter, move on. 

Business valuations need to stand up to intense scrutiny, which in some cases is handled in court. If the valuation report has been generated by AI, who is testifying to the opinion of value in the business valuation? A system can’t testify.

When a business valuation matters – whether for a tax matter including settlement of an estate, allocating assets as part of a divorce, settling a shareholder dispute, or selling a business – the consequences of the business valuation are important. AI is not where it needs to be as a replacement for a thorough and objective business valuation. I am not convinced it ever will be there, but never say never.

For professionals seeking to cut corners and check out emerging technology, yes, their fees may be less, but their professional reputation is at risk and your time and money is also at risk for an inaccurate valuation.

Stay tuned to the fascinating advancement of artificial intelligence, but do not risk a flawed valuation that has real implications.

When Values Matter.

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So, you have a client who is going through a divorce, and they need a business valuation to settle the allocation of assets. Or you are filing for a divorce and need to hire a business valuation professional.

Whatever the situation, state-specific knowledge is essential.

When it comes to business valuations for settling divorces, every state has its own rules.

Time and money could be lost by hiring a part-time business appraiser who prepares valuations on the side or a full-time appraisal professional who has limited experience.  

Example: New Hampshire and Massachusetts

People drive over these state lines regularly to go to work, go out to dinner, or run errands. But, when it comes to business valuations for divorces, two bases of valuations exist.

In the Commonwealth of Massachusetts, the standard of value is the Fair Value to the Holder rather than Fair Market Value. The Supreme Judicial Court ruled in Bernier vs. Bernier that business valuations assumed each party had 50% ownership in the business and because of a divorce, one party was giving up the 50% interest and the other was walking away with the whole. Rather than a business valuation determined by mimicking a transaction in the open market, valuation would be determined based on fair value to the holder. The income approach using public stock market data, without reductions for lack of marketability is generally preferred while a market approach using transactions of privately held companies is generally not used.

In New Hampshire, valuation of a business in the case of settling a divorce is based on fair market value, considering the actual prices paid for privately held companies in the market.  

When referred to a business appraiser or evaluating a business appraiser, ask them about their experience in valuations in the state that is the venue for your matter. In business valuations for divorce, the venue is determined by the state of the divorce, not where the business operates. The business may be in Salem, MA while the parties live in Salem, NH. New Hampshire rules may govern the preparation of the opinion of value.

Another Nuance: Dates and Business Valuations

It may seem like a pretty straightforward question – what is the date of the business valuation in the matter of a divorce settlement? Well, it depends.

In some states, by law, the valuation date must be the date when the couple filed for divorce.

In Massachusetts, the date of the business valuation is not specific, but most parties want the valuation not to be ‘stale’, therefore updates are typical as the attorneys inform the business appraisal professional of the divorce proceedings with updated timelines as court dates are determined.

Other states including New Hampshire, operate similarly to Massachusetts as there is not a specified date requirement, but being timelier may be less important.

Based on the state laws, it becomes readily apparent how important timing can be. Getting an experienced, credentialed, business valuation professional secured early in the divorce process in order not to elongate a typically lengthy process is recommended.

Conclusion

If you are seeking to refer a client to a business appraisal professional related to a divorce or need to retain such a professional, make sure to ask about their knowledge of state divorce procedures. Anyone going through a divorce has a lot on their mind and the last thing you need is to learn the detailed business valuation that you have paid thousands of dollars for was not prepared applying the correct standard of value for the applicable venue.

When settling a divorce where a privately held business is involved, secure a knowledgeable and experienced business appraiser.

When Values Matter.

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When a business valuation matters, supporting details matter.

The need for a business valuation is triggered by important situations: selling a business, gifting shares of a business, valuation of assets as part of a divorce settlement, tax matters, and settling disputes. No matter the trigger, the valuation is important. And the supporting details matter.

Beware of an Emerging Trend – ‘Skinnied Down’ Business Valuation Reports

There is an emerging trend to offer ‘skinnied-down’ valuation reports. The end report is typically briefer, often in the form of a PowerPoint presentation and does not meet the standards of a USPAP compliant business Appraisal Report (mine are typically 100-150 pages).

Firms, including national and larger regional firms, that prepare business valuations are looking for ways to be more efficient; to take less time preparing business valuations.

The format of the final deliverable matters because the supporting details matter. A business valuation report must present a clear and replicable explanation of how and why the business valuation number was determined. The written explanation supported by charts and graphs is essential to a business valuation report meeting the highest standards for business valuation reporting defined by the IBA (Institute of Business Appraisers).

If you need a business valuation, ask the valuation professionals you speak with about the format of the final deliverable to help you assess if you are getting a thorough report that will stand up to scrutiny.

Lack of Support = Lack of Credibility

Standards were established by USPAP for the business valuation industry to garner public trust in the work being done.

When a business valuation is needed, the interested parties need to be able to understand the valuation determined and be able to understand and trust how and why the valuation was determined. This is precisely where these skinnied-down PowerPoint valuations are lacking support and therefore lacking credibility.

The risk for you as an interested party is that the lacking valuation report may create unrealistic expectations, making the situation worse and contributing to trust among the interested parties breaking down further. A valuation report needs to stand up to rigorous scrutiny: that may be another interested party in the matter, the IRS, or a judge. A report lacking supporting details will not meet that standard.

Cutting corners rarely if ever works out. With Merrimack Business Appraisers, you can be assured our valuation reports will adhere to the highest reporting standards with the valuation presented in an objective and detailed way to present what the valuation is and how and why it was determined. Just like a residential real estate valuation, reasonable comparisons will be included.

An Unnecessary Re-Do

I recently completed a business valuation for a divorce settlement. Unfortunately for the two parties, they had jointly hired a business valuation professional and what they received as a PowerPoint deliverable was expensive and lacking in supporting detail. Neither understood the valuation report nor had any confidence in its contents. So, they hired me and received what they needed. Learn more here.

Avoid losing time and wasting money on brief and insufficient valuations. Get the details you need to ensure the valuation is understandable. With a detailed and thorough business valuation that answers why and how, the reason for the valuation will be solved and the situation that triggered the need will be resolved. Do not risk adding to the problem. At Merrimack Business Appraisers, our valuations solve the matter at hand and our clients move on with confidence in the valuation.

When Values Matter. Supporting Details Matter.

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Do you need an appraisal of a business? Whether for gifting shares of a business, settling a divorce, or buying/selling a business, it is important to evaluate the business valuation professional. That may be difficult to do as this may be your first time needing to hire a business appraiser.

No matter what is triggering your need for an appraisal, it is important to understand the process that the professional follows in developing the valuation.

Why does process matter?

Process matters because it is important that the valuation is thorough and complete. A well-documented opinion of business value is defensible and will stand up to rigorous scrutiny.

We have developed a proven process comprised of a series of logical steps that make our company valuations defensible. Our reports document what was done, why it was done, how it was done, and the conclusions drawn and why those conclusions are reasonable and credible.

To date, when a business valuation has required expert testimony to present clearly and logically how the valuation was prepared and determined, the ruling authority has always ruled in favor of Certified Business Appraiser and President, Lou Pereira.

A Summary of Our Valuation Process

Our valuation reports are developed to conform to the highest and most inclusive of all the applicable standards. Our complete and thorough process is summarized in the below 6 steps:

1. A careful and thorough qualitative and quantitative analysis of the business, including the history, products, markets, customers, management and employees, facilities, capital structure, and competitors. This step includes a site visit, which may be virtual, to tour the operation and interview management.
2. Review important documents including shareholder agreements and by-laws, key customer contracts, and leases.
3. Complete detailed financial analysis of the past 5-7 years of income statements and balance sheets, common-size and industry peer group analysis to identify trends and anomalies.
4. Construct a forecast of expected future operations.
5. Apply the three generally accepted business appraisal approaches:
   • Income Approach – earnings relative to public market returns.
   • Market Approach – research transactions of similar businesses, and develop price to revenue and earnings multiples, which are applied to this business.
   • Asset Approach – analyze the underlying assets and consider value in liquidation.
   Reconcile the indications of value from the three approaches into a conclusion.
6. Document all the relevant research, information collected, analysis, observations, and conclusions in a detailed written Appraisal Report, compliant with USPAP.  The company valuation reports are typically 100 – 150 pages or more depending on the specific facts and circumstances of the case, with all the information needed to understand and agree with the conclusion of value.

If you need a business valuation, be sure to assess the track record of the business valuation professional who will do the work and be comfortable with his/her track record and adherence to a complete and thorough process. Learn more about Lou Pereira.

When Values Matter. Process Matters.

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It is understandable why when evaluating a business valuation professional, some people ask, “Do you specialize in my industry?”

For many services, knowing one’s industry can bring great value. It shortens the learning curve and addresses the nuances of your industry that the service provider will or should readily understand. I get it.

Should this be your focus when evaluating a business appraiser to prepare a business valuation for your business or for you to refer one of your clients?

Franchises: Comparing Valuations of Businesses within the Same Franchise

Franchises are a great example of how valuation can vary greatly from one franchise to another. An example, I have completed numerous business valuations for the same fast food restaurant franchise.

• The industry is the same.
• The restaurant is essentially the same (minimal differences)
• The business model is the same.
• The physical assets are the same.
• The ingredients, recipes, and food provided are the same.

So why has the valuation of each of these franchise restaurants varied considerably?

There are many variables that ultimately affect the valuation of a business, including those within the same industry. Leadership and management have a big effect on value as does location. Is one located in an easy to access location with plentiful parking while another’s location is less desirable in terms of access and parking? The former’s valuation will be higher, all other factors being equal. Each restaurant could be in the same location on different sides of the street and that could result in different values. Other factors driving value include restaurant cleanliness, friendliness of the staff, and compliance with key brand qualities such as freshness rules.

Same industry. Same franchise brand. Significant difference in valuations from one restaurant to another.

Industry experience can be valuable, but experience across industries offers in-depth analysis and breadth of perspective as the business valuation professional is not stuck in a silo.

Breadth of industry experience is a benefit when speaking to and evaluating business appraisers. Breadth of experience contributes to thoroughness. Cross industry experience is naturally tapped into by a business valuation professional when preparing a detailed business valuation. Breadth provides additional insight and takes the blinders off – that is a real risk when choosing an industry-focused appraiser who is stuck in a silo.

Don’t put weight on industry specialization as a criterion for a business valuation professional. Rely on track record, breadth of industry expertise, and one’s certifications and credentials.

When Values Matter. Breadth Matters.

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A question I am asked frequently is: Can this business be valued?

I have written multiple blogs recently on various scenarios including:

• Part 1: Valuation of a business that has been operating for years, but with incomplete or poor financial data.
• Part 2: Valuation of a start-up
• Part 3: Valuation of a nonprofitable business

Then I realized there is another category of business: businesses that are worth more closed than continuing to operate.

This does not necessarily mean the business is not profitable. The business is typically technically viable, generating income and in some instances, profitable. That is why they do not fall into the category of the businesses discussed in Part 3 of this blog series.

So what is going on that makes a business more valuable shut down?

Often the business has been operating for many years. The owner or owners are satisfied with the income derived from the business. In many cases the real estate associated with the business has appreciated significantly over the years. Additionally, for many businesses in this category, other assets, including heavy equipment, have been acquired over the years and the metal itself has value.

An overview of determining value of these businesses

In prior blogs in this series, I emphasized the importance of financial forecasts as an important starting point in the valuation process. In these circumstances, the forecast reveals the business is not viable. Applying the asset approach to valuation, I focus on the underlying assets of the business where real estate and equipment tend to be the business’ most valuable assets. Valuation is determined based on establishing the liquidity value of each asset, including real estate. The result of the detailed valuation analysis is that the business is worth more by closing and liquidating its assets than it is by continuing to operate.

Common triggers for valuing such a business

As one would expect, one trigger for needing a valuation of a business in this category is bankruptcy. The valuation is leveraged to determine payouts to debtors.

Another trigger for needing a valuation of a business that is worth more closed than continuing to operate is when the business is losing money and the situation is not fixable. Like the bankruptcy situation, the viable option is liquidating the business. The business valuation is the sum of the value of the underlying assets of the business.

The other trigger is settling an estate. Usually, the business has operated for many years and the owner or owners were satisfied with the income generated and their modest lifestyle. To settle the estate, the valuation of the business determines that more value would be generated by closing the business and liquidating the assets than continuing to operate.

Conclusion

As these four blogs have described, any business can be valued. The key is to secure a certified business appraiser, a professional who focuses on business valuation, with a proven track record and process so that the valuation is objective, thorough, and defensible should it need to stand up to scrutiny.

Whether selling or buying a business, allocating assets as part of a divorce, settling an estate or settling a shareholder dispute, when you need a business valuation, contact us.

When values matter.

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A common question I am asked is: Can this business be valued?

In the first blog in this series, we focused on determining the value of a business that has been operating for years, but with incomplete or poor financial data. The second in the series focused on valuation of a start-up. And finally, this third blog is how to determine valuation of a nonprofitable business.

How do you determine the value of a business that is not profitable?

Forecasts are an important starting point in the valuation as written about in Part 2 of this series. A forecast is still relevant and an important factor in developing the valuation for a business that is not profitable. The reality is the value may be determined to be zero or negative should debts exceed valuation. In this situation, the seller may be interested in securing the tax benefits of a zero or negative valuation.

Typically, there are two scenarios when determining the valuation of a business that is not profitable. The value is tied to the people, or the business value is largely driven by an idea. Talented people and disruptive ideas are value drivers in a business and the use of public data can support the valuation of people and/or a disruptive idea.

In either situation, the valuation is developed by gathering and analyzing available information. The valuation prepared answers the question: how would a hypothetical buyer evaluate this business?

My thorough process leverages public data about businesses with talented teams and/or valuing an idea before it has been taken to market. Risk is then applied as it is especially important when calculating the value of a non-profitable business, similar to a startup. With expenses exceeding revenues, a higher level of risk will be applied.

Conclusion

Over the decades of developing business valuations that stand up to scrutiny, I have prepared detailed business valuations for firms having zero revenue as well as for business owners having an idea, but no product or service.

Determining the value of a non-profitable business can be done and is done with relative frequency. While not the most common situation I encounter, the steps to preparing a thorough and objective business valuation remain the same. Available public information, market information, and experience all support developing financial models that withstand the reasonable test and apply a risk factor to determine the valuation applying the discounted cash flow method.

If you are wondering if your business can be valued, you now know the answer is yes. Now it is important to secure a certified business appraiser with the knowledge, proven approach, and experience so that the valuation is thorough and defensible.

When values matter.

Contact us.

A common question I am asked is: Can this business be valued?

In the first blog in this series, the focus was on determining the value of a business that has been operating for years, but with incomplete or poor financial data.

The focus of this blog is on valuation of a start-up business.

How do you determine the value of a business in its infancy?

The starting point is the business owner’s forecast. Business owners typically have a forecast of projected revenues, expenses, capital expenditures, and income. The ideal starting point is having an income statement and balance sheet for the next ten years. The reality is the business forecasts I start with vary considerably: some may be a profit and loss statement for the next three years, with no balance sheet forecast. Whatever the owners have is my starting point and the ideal is rarely what I am starting with to prepare the valuation of a start-up business.

Building the Forecast

My next priority is to expand on the forecast from the business owner(s) and work with management to fill in the gaps. Sometimes capital expenditure planning is scant, or assumptions for market penetration, number of clients, or average revenue per client are needed for me to further expand the forecast.

Building and expanding the financial forecast is the foundation for developing the business valuation. While rudimentary valuation approaches may simply average the last three years of revenues and net income, venture capital firms and prospective buyers of a business are unlikely to accept this simplified calculation. Given the pandemic and its far-reaching effect on industries and businesses, an average of the past three years of revenue and net income is unlikely to represent a future business’ performance. The financial model I build looks forward, documenting key inputs and assumptions to pass the reasonableness test.

Factoring in Public Data & Risk

After working with management to augment the forecast, I turn to analyze public data. Useful public data includes price to earnings ratios as well as public information to incorporate into a regression model regarding returns based on the business’ financing stage.

Risk is applied when determining the value of any business. It is especially important when calculating the value of a start-up business. There may be no revenues and no history to support the forecast. That is where a higher level of risk will be applied.

Accounting for risk is factored into the discounted cash flow analysis. We have long embraced the discounted cash flow method, an approach that more business valuation professionals now utilize. This is the most accurate method. Once the forecasted financials have been expanded/developed in the above-described steps, now we factor in risk. The higher the level of uncertainty, the higher the rate used to discount the projected earnings.

Public data enables me to analyze rates used in valuing companies based on financing stage. A company with two to three rounds of financing will have a lower risk factor than a company at the seed level stage for financing. For self-funded start-ups, the financing stage is irrelevant, so risk excludes public financing data, but accounts for market and business risk inherent to the business.

Conclusion

Over the decades of developing business valuations that stand up to scrutiny, I have prepared detailed business valuations for firms having zero revenue as well as for business owners having an idea, but no product or service.

Determining the value of a start-up business can be done and is done frequently. Available public information, market information, and experience all support developing financial models that withstand the reasonable test and apply a risk factor to determine the valuation applying the discounted cash flow method.

If you are wondering if your start-up business can be valued, you now know the answer is yes. Now it is important to secure a certified business appraiser with the knowledge, proven approach, and experience so that the valuation is thorough and defensible. You have put a lot of time and effort into your start-up, do not sell the business short with an overly simple calculation.

When values matter.

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It’s that time of year when taxes are top of mind. No one wants to pay more than is required. Business valuations can have a significant impact on tax liability and IRS compliance. Read a few examples below of the importance experience and expertise have in achieving the desired outcome.

1. The Risk of Double Taxation

Eight owners of a C-corporation were preparing to sell the business. The transaction was at risk as its structure as an asset-based sale put the owners at risk of significant tax liability in the form of double taxation.

The owners needed a business valuation to determine fair market value and total goodwill to restructure the deal and minimize tax liability. Lou Pereira developed the business valuation and then built a multi-variate model to calculate each owner’s goodwill. With the valuation, modelling, and analysis completed by Merrimack Business Appraisers, the deal was restructured, and double taxation was avoided.

Read the case study.

2. Compliance with IRS Section 409 and Reducing Tax Liability

Like many businesses, attracting and retaining talent was a priority for this rapidly growing company on the west coast. This company was experiencing hypergrowth and included in its compensation package stock grants to attract professional executive managers.

The firm’s owners contacted Lou Pereira to develop a business valuation of the stock to comply with IRS Section 409A. Lou’s methodical and thorough valuation substantiated the value determination, satisfying the stringent requirements for Section 409A compliance.

Please read more about how the tax liability for the company was reduced.

3. A Sale & Donating Shares to Charity to Minimize Tax Liability

Two owners of a business decided to sell their business. One of the owners wanted to donate proceeds from the sale to charity to minimize his tax liability. To the average person, this may appear straightforward, but Lou Pereira was fully aware of the IRS requirements for charitable contributions. Incorrect sequencing and timing of actions could result in the IRS disallowing the charitable donation as part of the sale.

Lou Pereira prepared the business valuation, including determining the value associated with the shares donated to charity. The sale was completed and all actions were executed for the seller to achieve his goal of securing the tax deduction, minimizing tax liability and supporting the charity of his choice.

Please read more about this case.

Contact a proven certified business appraiser to prepare a thorough and objective business valuation that can stand up to scrutiny, including the IRS.

When Values Matter. Expertise Matters.

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I am regularly asked if this business can be valued. This blog is the first in a series of blogs to explain how value is determined, with the focus being on valuing a business that has been operating for years, but has incomplete or poor data.

This situation is quite common. In fact, it is the nature of small businesses. The owner runs the business with most of the information in their head. For purposes of this blog, the owner passes away and I am contacted to develop the valuation of the business to settle the estate.

In reviewing the available financial information (e.g., P&Ls, balance sheets), it is clear the financials are incomplete. Given the business had been successfully operating for many years, I have a higher degree of confidence in the functioning of the business, but I will have to recreate the financials and in many cases restate the financials. My focus is to first assess what is available that I can leverage and then to leverage other available information that would fill in the missing components. A guide to how this is done is to ask, ‘what information would be available to a hypothetical buyer of this business?’

Determining the valuation of a business with an operating history is possible and not as uncommon as you may be led to believe. Many family businesses and privately owned businesses may not have consistent and complete financial records over the course of operating. That does not mean your business can’t be valued. It can.

My work is guided by the same process that I follow for a business with well documented financial statements. The difference is applying a risk factor based on what information is available and what information I have had to determine to the best I could. In the case of very poor data, the risk factor will be higher as I have less confidence in the available data to determine the valuation. But, for businesses successfully operating for at least 5-7 years, there is typically sufficient evidence and available information to confidently determine the value.

So if you are wondering, can my business be valued? The short answer is yes. The methodology I follow remains the same, but when information is poor or incomplete, research and analysis is important to leverage any available data to recast, recreate, and build the valuation model to ensure the determined value will stand up to scrutiny.

When values matter.

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