Preface: Anyone with a keen interest in history is familiar with the Tulip Mania in Holland. We can learn much from business history looking at enterprises during the Tulip Mania with regards to keeping business valuations in perspective for privately owned businesses today, and further elicit gems for consideration in accurate appraisal values from a proper perspective.
Profitability and Business Valuation: Appraisals Are a Prophecy of an Enterprise’s Future Cash Flow Value
Credit: Donald J. Sauder, CPA | CVA
As a process and set of procedures used to estimate the economic value of a (business) owner’s interest in an enterprise, business valuation is both an art and science. It is governed with models for financial market participants to determine the price(s) they are willing to pay or receive as a value to achieve a transaction of an enterprise at a set price. Yes, those financial market participants can be independent certified appraisers; and opinions are entitled to non-accredited business owners too.
Euphoric business valuations like euphoric investments, are as realistically permanent as the Dutch Tulip Mania. During the Dutch Golden Age the people of Netherlands had money up and down the social class. It was the richest country in Europe from the country’s great success in commerce and global trade. The aristocrats figuratively had money burning holes in their pockets, and so did the middle-class merchants, artisans, and tradesmen. With that extra cash, they had richer door man opportunities to enjoy both leisure and investments.
At that time in the Netherlands, as has been for millennium, neighbors talked to neighbors, shopkeepers with candlestick makers, and dentists with booksellers. Tulip speculation was one such drawing conversation topic. Anyone with a keen interest in history is familiar with the rest of the story of the Tulip Mania in Holland. The point is that we can learn much from business history in Holland during the Tulip Mania with regards to keeping business valuations in perspective for privately owned businesses today, and further elicit gems for consideration in accurate appraisal values.
Few would counter argue this fact– we are in a business Golden Age. Since the long forgotten 2008 economic malaise, many entrepreneurs in management positions have minimal if any experience guiding an organization during monsoon conditions in the economic climate. Yes, it is the “Good old Days”.
Is the Question a matter of Goodwill?
Often, the most controversial feature of business valuation is goodwill. Many business owners have a realistic assessment of what their business assets are worth as tangibles, e.g., the computers, equipment and machinery you can see, but business goodwill is subjective. As the cherry on top of business value, goodwill is always a subjective value given to the intangible assets of a for-profit enterprise. Further, the true value is only verified with an exact balance at sale of a business interest.
Goodwill has multiple factors in a business appraisal. Let’s first look at Factor A: the going concern value of the goodwill. That is, the probability of the business continuing to produce net income effectively following the transferring of ownership in the capital of tangible assets , employees, and management.
This going concern factor assesses the appraisal value with the business continuing as a successful going concern after the transaction. The greater the probability of the going concern success feature in the business from systems , processes, location(s), name recognition, web reviews, customer loyalty, and transition guidance, the higher this component of goodwill.
Unfortunately, too many businesses have not invested in developing standard operating procedures or developing seamless transition plans years in advance to maximize this Factor. Their businesses are managed will less than optimal efficiency and hence resulting in reduced goodwill appraisals. Yet, the enterprises that have invested appropriately, should expect a premium valuation appraisal. An experienced valuator can assess this rather effectively and efficiently from accurate cash flows, narrative, and analytical procedures.
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