Preface

My father was the CEO of a $750,000,000 revenue general contracting firm when he retired 25 years ago. With 20 jobsites under construction, he was king of just knowing where the problem was--and getting someone to solve it--before it became a threat to the company. After all, large general contractors work on 5% or less gross profit. One "bad" job can wipe out a year's profits. Excelling in this environment, one of his favorite maxims was: "I would rather be approximately right than perfectly wrong."1

His maxim came out of jobsites full of technical engineers who each solved their system problems perfectly but with no regard for how the building as a whole would work. All too typical were pipes that were shown running through the structural steel that held the building up. What made this more difficult was the fact that often there was nowhere else for the pipes to go. This was offset by the more practical guys in the field who had to make it all work.

This tension between technical perfection and seeing the big picture still exists today in construction and it also exists in business valuation. It is all too easy to get lost in technical details. After all, business valuators tend to be technical people with extensive technical training. Being able to work between these two worlds--the technical and the practical--is the art of contracting for my father and the Art of Business Valuation for us.

In most approaches to business valuation, an equation or model is created where a company being valued is compared to other similarly known data. In the asset approach, it is other asset sales. In the market approach, it is sales of other businesses. In the income approach, it is investment options of investors.

The problem with small and very small businesses is that there is an information gap on both sides of the equation. Small businesses tend to have poor data collection. Compilations of the collected data are based on the suspected data. Yet, that is all there will ever be. Small businesses will not be expected to provide GAAP-based audited statements. Therefore, much of this book is about how to work with suspicious company data and other relevant information to close the gap.

Yet most businesses are small and very small businesses. Using 2012 data with $10 million of revenues as an upper limit, 96% of the businesses with payroll are very small. In fact, revenues of $5 million and below cover 93% of the total businesses and revenues under $1 million cover 75% of the firms in the United States.2

Even with imperfect data, these owners are still engaged in planning for the future. They are taking out loans. They are adding and eliminating partners who often are lifelong friends or family members, adding volatility to the mix. They are getting divorced. Some are even eventually selling. All of these common activities require an accurate business valuation.

That is the genesis of this book.

HOW DOES ONE ACCURATELY VALUE SMALL BUSINESSES?

How do we as business valuators, business brokers, accountants, lawyers, owners, and other interested parties prepare, review, evaluate, or use an accurate business valuation for small and very small businesses in a clearly difficult environment?

The answer in just a few words may be: "I'd rather be approximately right rather than perfectly wrong."

After all, we are never going to accurately predict the future. But we can accurately value a business. Accurately valuing a business is using credible cash flows and methods properly based on professional judgment as to material matters. Accurate does not mean with the advantages of hindsight that we predicted the future precisely. It means we performed our work to high ethical and professional standards based on what is known and knowable, as of the valuation date.

The book is not about how to value mid-sized or large businesses. Much has already been written on that. Even though the methods are the same, valuing larger businesses involves focusing on different specific analyses, different parts of the data, and different risks than valuing small and very small businesses.

A few key elements that both continue through the entire book and should always remain part of the focus when preparing or using a business valuation are:

• Does this make sense?
• What are we valuing?
• What method provides the best comparisons?
• How can we improve one or both sides of the valuation equation?
• How can we tie our value found into a price as a sanity check?
• Does this make sense?

Note the circular effect of these key areas of focus. "Does this make sense?" is listed twice. That question should be listed after every other area of focus and after every question asked, document reviewed, assumption made, and so forth "Does this make sense?" is the essence of the art of business valuation. "Does this make sense?" is the most interesting and most infuriating thing about business valuation.

At its heart, a business valuation is a mix of facts and assumptions to estimate a value based on future results, as of a given day. Integral to the process is the addition of assumptions-after all, we are looking to the FUTURE. It is said the stock market is valued on the future 18 months. So are private businesses. This brings in assumptions. Layers of assumptions.

The future will rarely be the same as an accurate business valuation. But, by following a systematic process filled with plenty of "Does that make sense?" questions, we can build and document and report accurate business valuations even when any one piece of the puzzle does not quite fit. We can master our art.

Improving the Art of Business Valuation should be the goal of every valuator. Hopefully this book will assist valuators and other users in that endeavor.

HOW TO USE THIS BOOK

Depending on who you are and what you want to accomplish, there are different ways to use this book. This book is more than a book. It also includes a related website with links to a business broker-level estimate of value, a sample annotated calculation report, a sample annotated summary conclusion/opinion report, various checklists and Excel files for many of the calculations and methods shown in the book.

Some suggestions on how different readers could use this book are:

• New valuation analyst. The book, along with the sample reports, and using Statements for Standards for Valuation Services (SSVS) No. 1 as a checklist, is a great way to prepare your first few business valuations, assuming they are for typical companies under $10 million in revenues. Keep in mind every valuation is different, so assume you are 85% complete if following these suggestions. Hitchner, Pratt, Mercer, Trugman, and others have written or contributed to more encyclopedic and technical area books. Use them for reference liberally. Do find someone to review your work if you are on your own.
• Experienced business valuator. You will find most of this book VERY basic. But many valuators are not familiar with more up-to-date small business market methods. For most businesses and situations under $1.5 million to $3 million in value, this is the most reliable methodology. In addition, an attempt has been made to present current positions on current income method matters, such as multiple sources of capitalization rate buildup method data, tax affecting, and a review of projections.
• Certified public accountant (CPA), analyst, or other advisor to a business owner or business buyer. There are chapters on working with business brokers, transactions, due diligence, increasing business value, the sales process, listening, negotiation, and, of course, business valuation. These are all to the point yet comprehensive enough for many small and very small business situations.
• Business owner. Read the chapters on increasing business value, how to sell or buy a business, negotiation, and listening, which are all likely to be helpful and well worth your time. Do hire competent experts. Use this to have a working knowledge and be able to manage your experts.
• Business broker. Depending on your level of interest in business valuation, you might want to read how to apply the market method and how to best work with small business financial statements. This was my initial level of interest and work in business valuation. You will also find helpful chapters on asking questions and listening, the business brokerage process, negotiation, Small Business Administration (SBA) loans, and due diligence. Great summaries and checklists are provided. Finally, as you progress and want to have better tools and estimates, you may find the whole book helpful.
• Attorney. If you primarily work with small business owners in litigation, growth, or exit planning, this book will provide helpful background. Chapter 14, How to Review a Business Valuation, provides insight into how valuations might be tilted to favor one side or another, either inadvertently or intentionally.

DISCLAIMER

This is a book about business valuation. Business valuation is a curious mix of facts, assumptions, comparisons, methodologies, and theories, used to estimate a value to set standards, as of a specific date. If any part of the mix varies even a small amount, the suggested solution and the calculated result are likely to...