Chapter 9

Overview of business valuation

No matter how you plan to transfer your business, there’s a key piece of information you must know: How much is the company worth? You need a business valuation. The value of a business often involves more than tangible – or real – assets of the company, such as your trucks, trailers, land and buildings. These assets generate income and create a value that can be much higher than the value of the tangible assets alone. A number of other factors play into the value of your business, making the process of valuing your business that much more complicated.

Business valuations may be performed for any number of reasons, including sale of the business, a merger or acquisition, estate and gift planning, succession planning and employee benefit programs. When you sell your trucking company to a third party, you obviously need to determine its value. The same is true in the case of a merger, as you must determine a fair allocation of ownership in the combined enterprise.

Valuations are important – and mandated by the Internal Revenue Service – in estate and gift planning. An accurate valuation for estate and gift planning can help you to lower your potential estate taxes. In addition, employee benefit programs usually require that an annual business valuation be performed to determine the value of the company stock.

Taking the company public requires an initial public offering, which makes a business valuation necessary in order to determine the stock price at the IPO. Finally, a business owner would need a business valuation when closing a business to establish the liquidation value of the business, or the value the owner would get from selling off tangible assets individually.

The complexities of business valuation demand the services of a professional. Valuation analysts are individuals who specialize in valuing businesses and are certified in this field. Certified valuation analysts have been trained and tested on their valuation knowledge by a professional valuation organization, such as the National Association of Certified Valuation Analysts, the Institute of Business Appraisers and the American Society of Appraisers. A valuation analyst can help you through the process of valuing your business and give you reassurance that the value determined is sound. It also helps to check into an analyst’s trucking experience. All industries are not created equal.

Steps of a valuation
While individual business valuations may vary due to differences in how companies operate and are structured, the process generally can be summarized in five steps:

• Define the valuation engagement.
• Gather the necessary information.
• Analyze the information gathered.
• Estimate the value of the business.
• Prepare and issue the valuation report.

Define the engagement. The valuation analyst most often begins by conducting an initial meeting with the business owner. In this meeting, the valuation analyst will discuss why you want to value your trucking company. The analyst will also gain an overall understanding of your company and its operations and discuss, in general terms, the state of the trucking industry from your perspective. This meeting helps the analyst define the valuation engagement.

Gather information. Following this meeting, the valuation analyst will ask that you sign an engagement letter that spells out the terms of your arrangement and will provide you with a document request list. A document request list assists the analyst in gathering the necessary information by detailing the information that the valuation analyst will need from you to perform the valuation. The document request list can be a lengthy document and includes such requests as five years of company financial statements and tax returns, details of owners’ compensation, and details of any stock transactions. This abundance of information is necessary in order for the valuation analyst to fully understand your company. See Exhibit 1 for a copy of a sample document request list used for trucking companies.

Analyze and adjust the financial picture. Following the receipt of your documents, the valuation analyst dives into your financial statements to identify trends and unusual items. For example, are repairs and maintenance relatively consistent from year to year? Are there any one-time expenses? Next, the analyst will compare your financial performance results to other similar companies in the trucking industry to get an idea of your position in the industry. This review will reveal the strengths and weaknesses of your operations. A more in-depth research of the trucking industry and perhaps the markets represented by your customer base will help in projecting future business prospects. The analyst also will study the national, state and local economies to understand the conditions in which your company is operating.

Based on the results of these analyses, the valuation analyst may adjust your historical financial statements. These valuation or normalization adjustments aim to present a better picture of economic value. Often the adjustments are expenses on the profit-and-loss statements. One example is a non-recurring expense that should be spread over several years or removed from the financial statements. Suppose that following a Department of Transportation audit you have to spend several thousand dollars to upgrade your compliance systems. A valuation analyst likely would adjust the financials to spread these expenses over several consecutive periods based on the assumption that you would not have had such a large expense in the current year had you been in conformity with the DOT regulations prior to the audit.

Valuation adjustments may also be based on the comparison of your company to the industry. Suppose you maintain a large cash reserve on the books while other companies in your industry keep a much smaller reserve. The valuation analyst might determine that your cash reserve is excessive and make an adjustment to remove the cash balance above the industry level in order to reflect a more comparable balance sheet.

Estimate value. With a comprehensive understanding of your industry and financial situation, the analyst now estimates your company’s value. To do so, he must determine:

• The appropriate valuation method (Discussed in Chapter 10)
• The appropriate benefit stream to use in the valuation (Discussed in Chapter 11)
• The rate of return required (Discussed in Chapter 12); and
• Which discounts to use and at what level (Discussed in Chapter 13)

Prepare the report. The final step of the valuation process is to prepare and issue the valuation report, which explains the purpose of the valuation, information about the company, details of the industry and the state of the economy. The report also describes the method utilized, the discounts taken, justification of these discounts, and the conclusion of value. There is no standard length or presentation, although certified valuation analysts are bound by the standards of the certifying organization to which they belong.

It may seem odd at first, but business owners don’t always want the appraisal of their businesses to be high. Obviously, you want the valuation to be high if you are selling the business or using it for borrowing purposes. On the other hand, divorce usually triggers a business valuation, and the owner typically wants to avoid paying a large settlement to his soon-to-be-ex spouse. Or in the case of estate planning and gifts, lower valuations reduce tax bill.

Business valuations can often take months to complete and can be quite costly. Due to this commitment of time and resources, most valuation analysts require a retainer before beginning work. But don’t expect your sizable fee to buy the valuation you desire. In fact, the valuation analyst must indicate in the valuation report that his or her fees are based on stated rates and are not contingent on the conclusion of value. In addition, standards usually require that evaluators include a statement indicating their independence – or lack thereof – in the valuation report.

Next we will consider in more detail the bases on which valuation analysts determine value.