CPA Certified in Business Valuations
While Greg's business valuation practice usually involves litigation or mediation, he also does valuations for business owners for other purposes. He has valued hundreds of businesses in various industries from early stage to one as large as $500 million in revenue, which was a personal loan company. Greg charges a fixed fee based on the revenue of the business. Though there are online business valuators who charge substantially less, their report may not be as comprehensive or may not comply with the business valuation standards. Nevertheless, a less expensive report may be adequate for your purpose. However, if your business valuation is an investment instead of a cost, then you will know exactly which business valuator to select.
Los Angeles Business Valuation Services
Business valuations have purposes apart from property division in a divorce action or economic damages in civil litigation. They are also used for buying and selling businesses, planning gift and estate taxes, and complying with buy-sell agreements in corporate bylaws. No matter the purpose, the first question seems to be "What is the value of my business?" While Greg may give you a quick impression of the value of your small business in Los Angeles as part of his free telephone consultation, he believes that the first and maybe better question must be “How is my business valued?”
Valuing Small Businesses in Orange County
According to the Small Business Administration (SBA), small businesses employ half our country's workers and contribute 50% to its Gross Domestic Product (GDP). While many small businesses are just the owner or two partners, it is not unusual for a small business in Orange County to have revenues in the millions with ten to a hundred employees. Therefore, business valuations can be straightforward, sophisticated or somewhere in between. A business valuation is the process of converting the income of a business into the value of a business. In essence, the value is its ability to produce (and protect) future income, which is called goodwill. The value is as of a point in time much like a company traded in the stock market. Each day the value of a publicly traded company moves up or down based on its intrinsic value relative to its market value. While the value of a privately held company fluctuates, it is more stable over several months. Therefore, its value six months ago may still be meaningful today.
Business Valuation Approaches & Methods
There are three business valuation approaches: market, asset, and income. Each approach has its methods. Also, each approach is distinct and will produce a different value. It is up to the certified business valuator to select the most appropriate approach based on the valuation standard and premise and the type of business. The fair market value (FMV) standard and the going concern premise are commonly used and are always for a hypothetical financial buyer. The other valuation standards are related to specific buyers (synergistic or investment) or defined by law or regulation. You cannot average the three approaches. However, you may use a valuation approach as a floor value (lowest value) for reference. Lastly, the value of any business - large, small, public, or private - is based on its profit, risk and growth. Higher profit, lower risk and higher growth always means higher value.
Market Approach: Market Data Method
The market approach is based on reasonably comparable businesses that have sold. The market data method is like valuing a home, which has a value relative to other homes. Real estate appraisers use sales of comparable homes nearby (called "comps"). The homes closer to yours are often the best comps. This method is used for asset sales, where seller keeps their liabilities, although it can be adjusted for stock sales. Many business valuators make the mistake of using the market data method to value the equity of the business without making the proper adjustments. Business brokers often provide their closed or sold transactions to the databases; however, unlike public company disclosures, the transactions are never independently verified. The data usually include the selling price and its relationship to income and assets (called multipliers). The income includes revenue, earnings before interest, depreciation, and amortization (EBITDA), and seller’s discretionary cash flow (SDCF). SDCF is generally EBITDA plus the business owner's salary and perks. The tangible or physical assets are generally inventory and equipment. Cash is never included in an asset sale since nobody buys cash. Accounts receivable are usually excluded included since the buyer does not want to assume the collection risk. The market data method is often used to value businesses under $1 million in sales. In some cases, the market data over time produces rules of thumb for certain types of business. Unfortunately, the comparable transactions of private businesses with revenue of $1 million or more are often insufficient because there are more small businesses under $1 million in revenue. Therefore, this valuation approach may not always have a comparable sale. The multiplier, whether its price to sales or price to SDCF for example, must be adjusted for the size, risk and growth of the business since it is only the starting point. If the value of the equity is higher than its tangible book value, then there is goodwill (or some specfically identifiable intangible asset).
Rules of Thumb are Deceptively Simple
Rules of thumb in business valuations are often reliable for popular businesses like liquor stores, laundromats, and restaurants because the market data of comparable businesses have been reasonably consistent over time. If the business is profitable, then the market data method should produce a value greater than its tangible assets, which implies the business has goodwill. If it is unprofitable or marginally profitable, then the value of the business should be closer to its tangible assets. As simple as it sounds, a rule of thumb is only a starting point and must be adjusted for the size, risk and growth of the business.
Market Approach: Public Company Acquisitions
Public companies often acquire private companies. These acquisitions are disclosed in their 10K or 10Q filings to the Securities and Exchange Commission (SEC). The public companies either buy the stock or assets of closely-held company. It is how they grow their business or achieve economies of scale when their profits margins are decreasing. In most cases, you are lucky to find a comparable private company acquisition over the last several years. In some cases, public companies make several acquisitions over a three to five-year period. From this data, you may calculate the valuation multiplier of large private companies based on the price the public company paid for their assets and future income. Much like a rule of thumb, the multiplier is only a starting point and must be adjusted for size, risk and growth. This method must only be used for larger businesses.
Asset Approach: Floor Value (Maybe)
The asset or cost approach is based on the book value or net asset value. You begin by adjusting the assets of a business (up or down) to their fair value or fair market value. The liabilities are then subtracted from the adjusted assets. The difference is the book value. This approach is more common in stock sales of unprofitable business with little or no equity. It is the floor value of a business and rarely has goodwill. A variation of this method is used to value distressed businesses, where the seller just wants the buyer to assume their lease in exchange for deeply discounted assets in place. A restaurant is a common example.
Income Approach: Cash Flow and Minority Interests
The discounted cash flow (DCF) method of the income approach is usually based on the free cash flow available (FCF) to the shareholders of the business. It is forward looking. FCF is the discounted future cash flow available for dividends or distributions after the business considers all its anticipated uses of cash. Many business valuators incorrectly use the DCF method with FCF to value control interests. They use the opportunity cost of a minority shareholder to develop the cost of equity (build-up or CAPM methods). Though some business valuation experts would argue that you can add a control premium to the DCF, it is better to begin your valuation with earnings before interest, taxes, depreciation, and amortization (EBITDA) or another future income stream that accrues to the invested capital of the business. DCF is rarely used to value small businesses under $1 million. It may be used to value larger businesses but, as mentioned, you need to use EBITDA or some other controlling interest cash flow. DCF and FCF are complex concepts and calculations since there are many assumptions about future profits, working capital, capital expenditures, and costs of equity and debt (WACC or weighted average cost of capital).
Hybrid Method: Divorce Valuation in LA & OC
The hybrid method is often used in divorce cases. It combines the income and asset approaches. It is technically called the capitalized excess earnings (or cash flow) method. The IRS calls it the formula method. The Family Law Courts in Los Angeles and Orange Counties have generally accepted this business valuation formula. The formula has three basic elements: income (usually SDCF adjusted for reasonable or replacement salary), rate of return on tangible equity and a goodwill capitalization factor. Basically, the income in excess of the return on tangible equity is capitalized and then added to the tangible equity. This calculation produces the combined tangible and goodwill value of the equity of the business, which is the subject of the property division in a divorce. Many divorce business valuators incorrectly use the cost of equity (build-up method) in the discounted cash flow (DCF) method as the goodwill capitalization factor. Though they may be the same by coincidence, these valuators may not understand their technical differences.
Family Law: Pereira Van Camp
The most common case law specific to dividing a separate property business is Pereira Van Camp. Most separate property businesses are generally acquired before marriage. The Marriages of Pereira and Van Camp are two distinguishable cases but are often referred as one. They are only relevant if the business appreciated during marriage. You use Pereira to apportion the separate property business wherein the residual is community property. On the other hand, you use Van Camp to apportion the community property wherein the residual is separate property.