What is a Business Appraisal and When a Small Business Owner Might Need One
A business appraisal is a process involving a professional appraiser assessing a business's fair market value. It is a widely recognized method used to determine the worth of a business for various reasons, including mergers and acquisitions, buy-sell agreements, selling a business, lender financing, and business investments. While larger corporations typically undergo regular business appraisals, small business owners may also significantly benefit from obtaining an independent business appraisal, as it gives them an accurate understanding of their business's value.
This article aims to provide an overview of the fundamentals of business appraisals. We will explore why small business owners may require a business appraisal, the various methods used to calculate a business's value, and the benefits of obtaining an independent appraisal.
Additionally, we will discuss the cost of hiring a certified appraiser and provide guidance on selecting the right appraiser to assess your business's worth thoroughly. By the end of this article, you will better understand the importance of business appraisals and how they can help small business owners make more informed decisions.
Business Appraisal Fundamentals
When conducting a business appraisal, professional appraisers use three primary approaches to evaluate a business's value: the market approach, the income approach, and the asset approach. The market approach uses market data to compare the subject business to similar businesses sold in the past. This method considers various factors, such as the subject business's size, performance, industry, and trends, to determine its value.
The income approach uses the current value of expected future cash flows the subject business generates as the basis for its valuation. This method focuses on the business's financial performance and considers the risks associated with its future cash flow projections to determine its worth.
On the other hand, the asset approach uses the sum of all tangible and intangible assets owned by the subject business to determine its value. This approach assesses the business's balance sheet to arrive at its value.
Each valuation method is suitable for different types of transactions. For instance, when valuing a business for sale, an appraiser may use a combination of all three approaches to ensure a more comprehensive and accurate assessment of the business's worth. By understanding these different methods and when to apply them, business owners can make informed decisions about their value and how to maximize it.
Do You Need a Business Appraisal?
Small business owners can benefit from obtaining an independent business appraisal in several situations, including buy-sell agreements, business mergers, selling a business, lender financing, and business investments.
In the case of buy-sell agreements, an independent appraisal is used to determine the fair market value of a company to buy out some portion of an owner’s stake in the business. Such an agreement outlines how ownership will be transferred in specific scenarios, such as death or disability, and having a clear and accurate assessment of the company's worth is crucial.
If two companies are considering a merger, an independent appraisal can be used to determine both companies' fair market value for an equitable exchange ratio. This assessment ensures that both parties receive a fair share of the merged entity's value.
When selling a business, an independent appraisal provides an objective analysis of the company's fair market value. This valuation helps the owner price the business appropriately to ensure a successful sale.
For lender financing, an independent appraisal can be used to determine the collateral value of the company so the lender can adequately determine the amount of funding. This assessment helps the lender minimize the risk of taking a loss if the company cannot repay them.
Lastly, business investments involve investors investing capital in a company in exchange for equity or other types of compensation. Therefore, an independent appraisal of the company's fair market value can provide investors with an informed assessment of its worth, enabling them to make sound investment decisions.
Certified Business Appraisals
In some cases, such as when dealing with taxes or litigation, it may be necessary to get a certified appraisal from a qualified certified public accountant accredited in business valuation (ABV). A certified appraisal is a valuation based on accepted standards and methods that have been reviewed and approved by a third party. In addition, a certified appraiser must have experience in business valuation and adhere to ethical standards set forth by professional organizations such as the American Society of Appraisers (ASA).
When is it recommended to get a certified appraisal? Generally speaking, getting a certified appraisal when dealing with taxes or litigation is recommended, since these require higher levels of accuracy and expertise than other types of transactions.
How to find a certified appraiser? You can find qualified appraisers through professional organizations such as ASA or online directories of accredited appraisers.
Cost of Hiring a Business Appraiser
The cost of hiring a business appraiser varies depending on several factors, including the size and complexity of the company, the type of transaction, and the experience and reputation of the appraiser. Larger and more complex businesses typically require a more comprehensive valuation process, which can result in higher appraisal fees.
One can imagine the level of difficulty involved in valuing a business with multiple business units or product lines that operates across several geographies relative to a small, one-location, one-product business.
The type of transaction is also a factor in the cost of hiring an appraiser. Different transactions have unique valuation requirements, and the appraiser's scope of work will depend on the transaction type. For example, the valuation requirements for a merger or acquisition will differ from those of a buy-sell agreement, which will impact the appraiser's fees.
Finally, the experience level of the appraiser can also meaningfully impact the cost. Experienced appraisers with a proven track record of delivering high-quality work will typically charge higher fees for their services. On average, you can expect to pay anywhere from $3,000-$35,000 for a valuation report from an experienced appraiser.
However, remember that the fees for a comprehensive valuation can go much higher, particularly for large and complex businesses or unique transaction types. Ultimately, the cost of hiring an appraiser should be viewed as an investment in obtaining a fair and accurate assessment of a business's worth.
Benefit of Independent Valuation
As a small business owner, it's crucial to know the actual value of your business, especially when preparing your business for sale and engaging in critical transactions. A business appraisal is an independent valuation of your business based on accepted standards and methods. This provides an accurate value of your business that can be used for various types of transactions.
Ultimately, an independent business appraisal is essential for any small business owner who wants to make informed business decisions. Feel free to reach out to a certified appraiser to gain a better understanding of your business's value so you're prepared for any important transaction.