Why Should I Buy A Business Rather Than Start One?
An existing business has a track record. The failure rate in small business is largely in the start-up phase. The existing business has demonstrated that there is a need for that product or service in a particular locale. Financial records are available along with other information on the business. Most sellers will stay and train a new owner and most will also supply financing. Finding someone who will teach you the intricacies of running a business and who is also willing to finance the sale can make all the difference.
What Is The Real Reason People Go Into Business For Themselves?
There have been many surveys taken in an attempt to answer this question. Most surveys reveal the same responses, in almost the same identical order of priority. Here are the results of a typical survey, listed in order of importance:
To do my own thing, control my own destiny.
Don't want to work for someone else.
To better utilize my skills and abilities.
To make money.
*It is interesting to note that money is not at the top of the list, but comes in fourth.
Why Should I Buy A Business Rather Than Start One?
An existing business has a track record. The failure rate in small business is largely in the start-up phase. The existing business has demonstrated that there is a need for that product or service in a particular locale. Financial records are available along with other information on the business. Most sellers will stay and train a new owner and most will also supply financing. Finding someone who will teach you the intricacies of running a business and who is also willing to finance the sale can make all the difference.
How Are Businesses Priced?
PRINCIPLES OF VALUATION Fundamentals, Techniques & Theory
Similar to the value of many items or possessions, the value of an interest in a closely held business is typically considered to be equal to the future benefits that will be received from the business, discounted to the present, at an appropriate discount rate.
This seemingly simple definition of value raises several problems, some of which are:
1. Whose definition of benefits applies?
2. Future projections are extremely difficult to make (absent a crystal ball), and also very difficult to get two opposing parties to agree to.
3. What is an appropriate discount rate?
4. How long of a stream of benefits should be included in this determination of value?
THEORETICAL BASIS OF VALUE
Almost everyone has an opinion of value, be it of a business, a tangible asset, or an intangible asset. Unfortunately, the term value means different things to different people. This presents problems for the valuation analyst who has the extremely important task of working with clients and other parties to come up with an appropriate definition of value for a specific valuation. As defined by Webster's dictionary, value is:
A fair return or equivalent in goods, services, or money for something exchanged; the monetary worth of something; marketable price; relative worth, utility, or importance; something intrinsically valuable or desirable.
THREE STANDARDS OF VALUE
a. Fair Market Value ("FMV")
The IRS has defined FMV in Revenue Ruling 59-60 as follows:
The price at which the property would change hands between a willing buyer and a willing seller, when the former is not under any compulsion to buy and the latter is not under any compulsion to sell, both parties having reasonable knowledge of relevant facts.
However, Fair Market Value has this common definition:
Fair Market Value the price, expressed in terms of cash equivalents, at which property would change hands between a hypothetical willing and able buyer and a hypothetical willing and able seller, acting at arms length in an open and unrestricted market, when neither is under compulsion to buy or sell and when both have reasonable knowledge of the relevant facts. (NOTE: In Canada, the term "price" should be replaced with the term "highest price")
b. Fair Value
To understand what the expression fair value means, you have to know the context of its use. In business valuation, the term fair value is a legally created standard of value that applies to certain specific transactions.
In most states, fair value is the statutory standard of value applicable in cases of dissenting stockholders valuation rights. In these states, if a corporation merges, sells out, or takes certain other major actions, and the owner of a minority interest believes that he is being forced to receive less than adequate consideration for his stock, he has the right to have his shares appraised and to receive fair value in cash. In states that have adopted the Uniform Business Corporation Act, the definition of fair value is as follows:
Fair value, with respect to a dissenters shares, means the value of the shares immediately before the effectuation of the corporate action to which the dissenter objects, excluding any appreciation or depreciation in anticipation of the corporate action unless exclusion would be inequitable.
Fair value may also relate to value for generally accepted accounting principles, and value in divorce. Many states have specific definitions of fair value with regard to marital dissolution.
The differences in the definitions used for Fair Value are, at present, irreconcilable.
c. Strategic/Investment Value
Investment value the value to a particular investor based on individual investment requirements and expectations. (NOTE: in Canada, the term used is "Value to the Owner"). (International Glossary of Business Valuation Terms)
Types of Value
Any discussion of value must begin with the realization that there are many different types of value. For example:
a. Social value
b. Ethical value
c. Moral value
d. Religious value
e. Sentimental value
f. Economic value
g. Commercial value
In valuing a closely held business, the theoretical basis of value is as follows:
A valuation is based on a hypothetical arms length sale of a business between a buyer and a seller, usually for cash.
Premise of Value
In the valuation context, once the standard of value is determined, the appropriate premise of value must then be selected. Premise of value can be further broken down into various subsets, including:
a. Book value
Book value is synonymous with shareholders equity, net worth, and net book value. It is essentially the difference between total recorded cost of assets and the total liabilities of a company. Assets are generally recorded at historical cost, net of any accumulated depreciation and/or value allowances, and liabilities are generally recorded at face value. Because of the potential for unrecorded intangible assets and/or understated value of the tangible assets, book value of the company is not an appropriate measure of business value. The longer a particular asset or liability is carried on the books, the greater the potential for differences between book value and fair market value.
b. Replacement value
The current cost of a similar new property having the nearest equivalent utility to the property being valued.
c. Liquidation value
Value, at which the asset or assets are sold as quickly as possible, such as at an auction.
d. Going concern value
Going concern value is the value of a business enterprise that is expected to continue to operate into the future. The intangible elements of going concern value result from factors such as having a trained work force, an operational plant, and the necessary licenses, systems, and procedures in place.
A trained and assembled work force is a valuable intangible asset for many businesses because of the substantial costs involved with developing a new work force.
Going concern value can be particularly relevant to service firms, such as medical practices. The American Medical Association refers to going concern value as in place value and states the following relative to practice valuation:
Some advisers give an in place value to assets because they are assembled into a working system and they help to produce income. For example, a physician may have purchased a piece of equipment for $10,000 and depreciated it over a period of five years at $2,000 per year. At the end of those five years, when the physician decides to sell the practice, the balance sheet shows the value of the equipment as zero because it has been written off in the intervening years. But to a buyer the equipment has value, because it is in place and functioning.
e. Loan value
f. Insurable value
g. Appraised value
h. Face value
i. Intrinsic value
HOW VALUATION PURPOSES AFFECT THE ESTIMATE OF VALUE
Before a valuation analyst proceeds in valuing a business, he/she must recognize the purpose for which the valuation is needed. Different purposes will require the use of different methods and approaches, thus generate different values.
No single valuation method is universally applicable to all appraisal purposes. The context in which the appraisal is to be used is a critical factor. Many business appraisals fail to reach a number representing the appropriate definition of value because the appraiser failed to match the valuation methods to the purpose for which it was being performed. The result of a particular appraisal can also be inappropriate if the client attempts to use the valuation conclusion for some purpose other than the intended one.
There are two main reasons for valuations. They are:
A. TAX VALUATIONS
1. Estate tax
2. Gift tax
3. ESOPs
4. Allocation of lump sum purchase price (Code Section 338 and 1060 allocations)
5. Charitable contributions
B. NON TAX VALUATIONS
1. Purchase
2. Sale
3. Merger
4. Buy/sell agreements
5. Regulatory valuations: asset allocation/valuation under FAS 141 and 142
6. Litigation support
a. Partner/shareholder disputes: There is a growing need for valuation services in this area. b. Divorce actions: State law governs disputed property settlements. Most states have failed to establish standards of value.
c. Other
d. Damage/economic loss cases
1) Breach of contract
2) Lost business opportunity
3) Antitrust |
