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Getting Third-Party Valuation of Business Has Pros, Cons
Second Article in a Two-Part Series on Business Valuation for Pallet Companies

By Rick LeBlanc
Date Posted: 4/1/2002

(Editor’s Note: This is the second article in a two-part series on business valuation for pallet companies; part one was published in the March issue.

Part one noted that placing a value on a business is a low priority for most owners. However, when it becomes time to sell, take on new investors, end a partnership, or make some other major organizational or ownership change, knowing the value of the business is critical. Understanding the valuation processes can also help business owners make decisions more likely to enhance the value of their companies.

There are many different methods to determine the value of a business. One of the most common rules of thumb for valuing a pallet business is to use a multiplier of net operating cash flow.

Part one warned about proceeding with caution when offered a ‘free’ service to determine the value of your business; such services may include up-front fees for marketing services. Companies may receive an offer for a ‘free’ business valuation coupled with a suggestion that the business may be worth more than the owner realized. A related pitfall is paying a business broker a large up-front fee for a valuation.

In part one, Patrick Seitz of Sunbelt Business Brokers was incorrectly identified as a pallet broker; he is a business broker and has experience brokering pallet companies. Part two, which follows, examines the pros and cons of third-party business valuations.)

Patrick Seitz, a business broker with Sunbelt Business Brokers in Chattanooga, Tenn. believes that getting an independent valuation is an important first step in selling a pallet company. "The approach we like to use is to recommend the client to go to a third-party certified valuation firm," said Pat, who has experience brokering businesses in the pallet industry. "Put it (valuation) in the hands of someone who is removed from the process, who is properly credentialed."

Without an independent valuation, a business owner may tend to over-price his company because he often is emotionally attached to the enterprise, Pat observed. Over-pricing obviously could hinder a sale.

"We take a properly researched approach," said Pat. "Here’s a 50-page document that’s bankable. It justifies the asking price. That helps us clean the mud out of the water. It’s not our opinion or the seller’s opinion. It’s a third-party evaluation. Also, it is bankable."

Vance Maultsby, former chief executive officer of PalEx, agreed that when there is a wide difference of opinion between potential buyer and seller on valuation, it is more difficult to complete a deal. He recalled some of the acquisitions he was involved with at PalEx. "Some times it was a deal stopper," said Vance, who now operates a CPA consulting firm that specializes in business finance, planning and strategy. "Some times people just had different views. An interesting thing we found was that when people have an experienced intermediary involved, an investment banker or a broker, we were able to reach a meeting of the minds on value. It was not always 100 percent, but we got close, and then we would start negotiating. Someone who is dispassionate helps."

Bernie Kamps, owner of Michigan-based Kamps Pallets, has been involved in acquisitions, and he has found that using outside valuation professionals can help in negotiations. "We have used outside accountants in two of our transactions to sit down and work through it three of four different ways," said Bernie, "and sometimes they can bring a lot of credibility to the process."

Brokers an Option

During negotiations to acquire another company, both Bernie and owner of the company that was selling used outside accountants; the result was a similar range of valuation estimates from both. Although the two valuations were close, the deal with Bernie was derailed when a larger company came along and offered the seller a higher price based on a valuation that was tied to sales. Another factor was that the new buyer also offered stock while Bernie was seeking a strictly cash sale. "The buyer has to also weigh what is best for him," Bernie said. If the buyer has an over-inflated perspective of how the company will perform in the future, a portion of the payment may be structured as a bonus if the company performs to that level.

For many smaller businesses, a professional business broker is perfectly capable of a performing an acceptable valuation, according to Tom West, author of The Business Reference Guide. In fact, he suggested that a broker might have a better understanding of the local market or the particular industry than a valuation specialist.

"It is acceptable for a broker to offer a seller a market analysis which is an evaluation based on like-kind sales, an income approach to value and asset value" said Jacqueline Kittrell, CAGA, a business broker at Kittrell Auctions Business Brokers. "However, if the seller is not happy or comfortable with that, I say go get a third opinion. Most sellers value my opinion and we are normally very close on evaluation of the business."

"Should we find a buyer for the business," Jacqueline added, "then it is very appropriate for another independent appraiser to do the appraisal. The bank that the buyer will use will provide one or suggest one. Or we can provide a list of appraisers who are certified and have some specialization in this type of machinery." According to an industry code of ethics, she noted, the seller's representative and the appraiser for the buyer should not be the same person. However, the seller’s representative may perform a valuation if their relationship is disclosed and the buyer is agreeable to the arrangement, she added.

Computer Software

Off-the-shelf computer software is available to help perform a business valuation, although Pat warned that even this process may be prone to bias. The programs still depend on data about the business. "Garbage in, garbage out," Pat said. "There are umpteen ways to affect the output, whichever way you wish to slant it."

Small companies may be able to dispense with a valuation, according to Tom. "My argument is that businesses that sell for under $1 million don’t really need a valuation," he said. "You’re just looking for, ‘What will the market pay for my business?’ When you get into the larger ones, valuation is appropriate. If it is just for sale purposes, a broker is good, third-party evaluation is good, and there is even some pretty good software if you want to do it yourself. If it is for legal purposes, such as setting up an employee stock ownership plan, estate planning, forming or changing a partnership or dissolving a business, then I think a third-party valuation is certainly appropriate."

According to Pat, selling a business has nothing in common with real estate sales, other than there is still a buyer and seller. "Variables are multiple," he said. "Automation, assets, environmental issues, historical demonstration of cash flows, trends, customer base -- all of these factors and others affect perceptions about the value of a business."

One reason to use an independent valuation consultant is to get a better grasp of actual cash flow, said Pat. "Among smaller privately held companies, profitability may be more difficult to determine," he said. The reason is that the owner may use an accounting strategy to minimize profit -- and taxes. This approach may have the unwanted result of lowering the company’s value. Pat’s advice for owners who are thinking about selling at some point is to report profits "straight up." He said, "It’s pay me now or pay me later, and we see it every day."

While professionals may use more sophisticated methods to determine the value of a business, those professional services come at a cost, of course. Pat recommends consultants that can provide valuation services in a price range of $3,000-$7,500 packages. In Maine, for example, business valuations commonly cost $5,000-$10,000.

In The Small Business Valuation Book, Lawrence Tuller wrote that financial ratios can provide a "preliminary valuation" but should never be interpreted as a quantification of the fair market value of a business. In the final analysis, the value of a business is in the eye of the beholder and can "…be satisfactorily determined only by negotiations between interested parties."

Whether or not you plan to sell your business in the near future, having a basic knowledge of valuation methods can be an important tool in your managerial toolbox.

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