Stick To What You're Good At Doing

Everyone has their expertise. The key for any buyer is identifying what that skill is, and marrying it to the right business. In a prior post, I alluded to the fact that good businesspeople know their strengths while great ones know their weaknesses. A situation arose this week that not only reinforces how critical it is to buy a business that can leverage your strengths, but also, how you need to have the right experts on your team doing what they are good at, and not what they think they are capable of contributing.

Why is it that some professionals feel this need to step completely outside their area of alleged expertise, and offer opinions on subjects which they are in no way qualified to do?

Let me tell you what the catalyst was for the prior paragraph.

This past week, a client emailed me because she and the seller ran into a major roadblock. They had previously agreed on a valuation for the business, and were working out the final deal terms. Their basis was a multiple of the Owner Benefits which is the proper way to value the business, and I fundamentally agreed with the valuation they had mutually agreed upon. So far, so good - but not for long.

In comes the buyer's accountant and derails the entire deal.

Why?

Because according to the CPA: “that is not the way to do a business valuation”. In the opinion of this genius, you need to strictly take the Net Income plus the value of the assets and any excessive personal perks and bingo, that is what the company is worth. End of story. He further suggested that depreciation should never be added back, no matter what, and moreover, the buyer needs to further reduce the amount by the cost to hire a manager.

Wrong! Wrong! Wrong!

This stuff makes my blood boil.

There is no doubt that depreciation cannot be an automatic add-back without a corresponding reduction for future capital expenditures in many cases and clearly, this is not how many businesses are often represented which is misleading.

However, the concept of reducing the basis of the valuation by the cost to hire a manager is completely ridiculous. Yes, it is an exercise a buyer should do strictly to measure their potential return versus other investment opportunities, but not to determine the valuation of an owner-operated business that the buyer will be running.

Additionally, while I hate to use the word “typical”, it is exactly that for an accountant to suggest that the assets of the business play such a robust role in the valuation – they don’t. Assets are a means to drive revenue. They are a vehicle to obtain financing. They play a role only as it relates to adjusting the valuation to accommodate their replacement as I mentioned earlier. That’s it. That’s all.

The issue of assets should be taken in this light: Is a business with new assets that is not making any money worth more than a highly profitable business with older assets? I think not. If your accountant has a different opinion, send them over to me any time - I welcome the debate. 

I am the biggest proponent of using a number of different valuation methods to get a general parameter of a valuation and a sanity check because this is not an exact science. But, I simply cannot grasp the idea of trying to apply an archaic textbook theory to a very different real-world.

It reminds me of when I ask someone what is it specifically that qualifies them to run a particular business they may be considering and they tell me: "Because I have an MBA". Well that’s great I tell them; a degree like that is impressive and it certainly helps to get a job; but I have no idea what it has to do with the skills necessary to successfully operate a business is beyond me. At that point, I like to remind them that Bill Gates, Richard Branson, Rachael Ray, Russell Simmons and Barry Diller to name a few, never even graduated from college. Or that Michael Eisner had no idea how to even read a financial statement when he first took over the helm at Disney.

The point is that acedemia and the real-world do not always mix.

While I have the utmost respect for the accounting community and they clearly play a very important role in the buying process, they are not trained, nor are most of them experienced, to perform the valuation of a small business in the real world. They generally pay too much attention to the balance sheet, while it is the income statement that drives small business valuations.

I do not want to paint the entire accounting profession with the same brush of course. But as a buyer, for goodness sake, learn what is involved to properly and accurately value a business, and let your accountant focus on the due diligence, financial and tax issues for you.

Comments

[David E. Coffman CPA/ABV, CVA]

I am a CPA that specializes in business valuation. One of my biggest problems is competing with CPAs, tax preparers and accountants, that are not qualified to do valuations. They have little or no valuation education and experience yet they take advantage of their 'trusted advisor' status with their clients to provide sub-standard valuations. As of January 1, 2008, the American Institute of CPAs requires all CPAs that perform valuation engagements to meet their Statements on Standards for Valuation Services which contain competency standards. I hope this will reduce this problem, but I urge anyone seeking a business valuation to make sure the person or firm they engage has at least one major valuation certification and adequate valuation experience. Do not assume they are qualified simply because they are CPAs.

[Richard Parker]

Mr. Coffman: I have only one word about your comment - "Amen".

[Salvatore Urso]

Richard,

I found your article very interesting. I would like to ask the CPA the following question- Which data base of comps is he using? This is the key. If he uses comps that do not add-back depreciation, etc., he may have a point. I like to use bizcomps which clearly looks at EBITDA plus 100% of one owner working full time. Period. Now you have apple-to-apples; he has apples-to-nuts!

[Richard]

Salvatore - excellent point about the comps and certainly your comment about making an apples-to-apples analysis is so important. Often, people involved in the buying process on both sides of the table will randomly throw out a multiple by stating "it's a 4x multiple" - great, but a multiple of what number? In the example I discussed, the CPA wasn't using any comps and moreover, it seems to me he wasn't using any rational nor acceptable means to arrive at what he espoused to be "the only way" to do a valuation.

[Dylan Garland]

I agree, especially with the key point you make that buyers must educate themselves as much as they can, rather than merely relying on outside "experts", and ultimately buyers must be prepared to make tough decisions on their own. And during the process of buying the business is a good time to develop that habit, as the tough decisions will not be any fewer once you own the business!

[Michael Pfeffer]

Richard:
As a Certified Business Appraiser for eight years and a business broker for the last two, I can assure you there is no "one way" to value a business. It is often said if ten appraisers work with the same information they will produce eleven results. It is critical to understand the purpose of the valuation and the standard of value to be applied. The value to a hypothetical buyer (fair market value) is quite different than the value to a particular buyer (investment value). If the buyer and seller agree on a price, utilize the skills of the CPA to help structure the deal for tax purposes, not to establish a fair price. The price for that particular transaction has already been established by the parties to it. If a valuation is necessary, rely on a professional business appraiser.

[Greg]

I think that the CPA might have a good point. In "assets heavy" industries one should probably include assets as part of business valuation.
For example, you have Corp A which makes $100K in NI/owners benefit w/$0 in assets & Corp B which makes $0 in NI/owners w/$100K in assets (at market value). I do not think it makes sense to say Corp B is worthless. It worth at least $100K & Corp A is multiple of $100K.

[Richard Parker]

MY COMMENTS TO MICHAEL AND GREG POSTS:

Michael - Great points. Yes indeed when a buyer and seller agree on a price then everyone else should stay the heck out of any further valuations. There is no "one way only" for valuations - well put - it's an art; not a science.

Greg - While assets can be, in some cases, included in a valuation in order to obtain a range through a variety of methods, the example you cite can actually prove to be a danger zone. Assets drive revenue. If a company allegedly has $100,000 of assets but zero profits, try selling those assets in the open market. If someone will pay $100k for them then yes, the assets, NOT the business, is worth $100k. The buyer pool is generally miniscule, if any, and typically, in an asset-only sale, they are worth far less than what the seller believes someone should pay for them. However, I do see your point, and I certainly agree that Company A should generate a multiple of the $100k in NI as you state.

[Dustin Sigall]

Regardless of the valuation method being used, a business is ultimately worth what a buyer is willing to pay for it. Because most buyers are unfamiliar with the "going rate" for a business in a particular industry, they turn to their trusted advisors for input. As much as I would like to blame CPAs and Attorneys for throwing curve balls at my deals, I can't really fault them for wanting to sustain client retention. The last thing they want is the finger pointed at them for subjecting their client into making a poor decision. As long as CPAs and Attorneys remain conservative, they know their clients will feel the comforts of having their “big brother” looking after them.

[Richard Parker]

Dustin - I agree with you that a business is worth what a buyer will pay. And certainly, a buyer should trust their own legal and financial advisors before any others. The issue being raised however goes beyond that - trusted advisors should be sticking to the disciplines in which they are trained. All parties should welcome the discussion and input from any attorney or CPA in a deal. Healthy discussion and debate ultimately pays dividends for the buyer and seller. But when any party begins to dispense advice on matters which they are not qualified for, then they are in fact doing a grave disservice to the people who are paying their fees.