A business appraisal is a professional valuation of a business to determine its overall value. Appraisals are necessary for various reasons – selling a business, obtaining financing, litigation, mergers and acquisitions, estate planning, buying into a business, accounting and compliance, damages assessment, and more. 

This comprehensive guide will outline everything you need to know about business appraisals, including reasons to get one, how they work, what impacts your business value, choosing an appraiser, appraisal report options, cost and timelines, and tips for maximizing your valuation.

What is a Business Appraisal?

A business appraisal, also called a business valuation, is a professional analysis done to determine the economic value of a commercial entity. It is conducted by a qualified, certified appraiser and results in a detailed report assessing all aspects of the business – assets, liabilities, financials, operations, industry standing, growth potential, and more.

Appraisals require an in-depth analysis of both quantitative and qualitative factors. The appraiser will review all provided documents, conduct competitor analysis, analyze financial records, assess assets, interview management, and apply appraisal methodologies. 

The resulting fair market value determination is an objective, standards-based, and well-documented estimate for the price a business would sell for. Lenders, investors, courts, and government agencies rely on appraisals for major business decisions involving mergers, acquisitions, taxation, and litigation.

Reasons to Get a Business Appraisal

There are many scenarios which warrant a professional appraisal to determine your company’s fair market value:

Selling Your Business

One of the most common reasons for a business valuation is selling your company. Both buyers and sellers need an objective price assessment when preparing for a sale. It allows you to realistically price your business, negotiate effectively, minimize taxes, and comply with accounting and legal requirements.

Obtaining Financing

Banks and investors will almost always require a formal appraisal before approving financing. It allows them to assess risk, determine appropriate loan amounts, and ensure correct collateral value. Appraisals help owners obtain optimal financing terms and provide assurance to lenders.

Litigation 

Valuations play a key role in legal proceedings involving shareholder disputes, bankruptcy filings, divorce cases, insurance claims, dissenting shareholder rights, and damage quantifications. Courts rely on appraiser expertise as unbiased testimony.

Estate Planning

Proper estate planning requires knowing the value of your total assets. Appraisals allow you to make fair decisions regarding inheritance, trusts, gifting, charitable donations, and taxes. It also ensures smooth business transitions to heirs.

Mergers and Acquisitions

Whether participating in a merger, acquiring another company, or offering your business for sale, valuations help buyers and sellers agree on a fair acquisition price and transaction terms. It provides the business intelligence needed for appropriate negotiations.

Buying Into a Business  

Purchasing partial ownership in a business, such as buying out a partner’s share, necessitates determining the total enterprise value. This allows for a fair allocation of equity and the right purchase price.

Expanding Your Business

Appraisals may be required when substantially expanding your operations, acquiring new equipment, purchasing a facility, restructuring, or branching into new markets. It provides assurance of proper investment and optimal resource allocation.

Damages Assessment

Quantifying business damages due to accidents, disasters, theft, patent infringement, breach of contract, or eminent domain seizure involves identifying appropriate appraisal methodologies. Experts can determine fair damages estimates.

Accounting and Compliance

Valuations are necessary for certain regulatory reporting like purchase price allocation after acquisitions. They also provide business intelligence for assessing goodwill, ensuring book value accuracy, and identifying intangible assets for accounting purposes.

How Business Appraisals Work

Professional appraisers utilize accepted standard methodologies endorsed by accounting and appraisal organizations. The three main approaches are:

Asset Approach

This focuses on the company’s balance sheet, with adjustments made to the stated book value of assets and liabilities to reflect their fair market value. All assets – tangible property, financial holdings, inventory, intangibles, goodwill etc. – are valued individually. Liabilities are deducted to derive a net asset value.

Income Approach 

This analyzes the company’s ability to generate revenue and profits. Discounted cash flow models are applied based on revenue projections and expected growth. This results in a net present business value based on future earning capacity.

Market Approach

Recent sales of comparable businesses are used to derive valuation multiples like price to earnings ratios. These are applied to the subject company’s financial metrics to determine an indication of value. Adjustments are made for differences between comparables and the appraised business.

In finalizing their opinion of value, appraisers consider the results of all approaches. The individual business circumstances will determine which methodology carries the most weight. Most reports provide a reconciliation of the varying values derived from each approach to reach a final conclusion.

What Impacts the Value of Your Business

Many internal and external factors influence a business’s fair market value during an appraisal:

Financial Records

Historical financial statements like income statements, balance sheets and cash flow reports are analyzed in depth. Revenue growth trends, profit/loss levels, changes in key accounts, debt structure, working capital, capital investments and other metrics inform the valuation.

Business Assets  

The fair market value of all assets – facilities, equipment, vehicles, inventory, furniture, supplies, intellectual property etc. – will significantly impact the overall worth. Asset conditions, transferability, remaining useful life and potential liabilities are considered.

Market Conditions

The overall economic climate, industry health, growth projections, competitiveness, regulatory issues, access to capital and other market factors affect valuations. Buyers consider future profit potential, risks, and investment return. 

Competition

Direct and indirect competitor analysis informs market share, growth potential, risks, substitution threats, and competitive advantages or disadvantages. These impact financial projections relied on in the income approach.

Revenue and Profits

Current and historical revenue levels, growth rates, profit margins and earning trends inform valuation potential. Strong bottom lines allow buyers to pay higher premiums. Declining profits or losses decrease value.

Location

Facilities in economically depressed areas lower valuations, while prime locations boost value. Proximity to customers, transportation access, qualified workforce populations, incentives and costs factor in.

Size and Capacity

Larger companies with excess capacity for growth and economies of scale often achieve higher valuations and sale prices than small, niche businesses. Potential to expand increases value.

Customer Base

A diverse, long-standing, reputable customer base with recurring revenue, high retention and growth potential increases valuations. Reliance on few customers creates risk for a buyer.

Management and Employees

Strength of management team usually increases value, as buyers want assurance of continued success after acquisition. Key employee skills and depth of talent also factor positively into appraisals.

Intellectual Property 

Patents, trademarks, copyrights, proprietary processes and trade secrets can greatly increase valuation. However, values depend on IP exclusivity, legal protections, shelf life and transferability.

Choosing an Appraiser

Selecting a qualified, experienced business appraiser is critical for an accurate, usable valuation. Key considerations include:

– Credentials – Minimum designations like Accredited in Business Valuation (ABV), Certified Business Appraiser (CBA) or Certified Valuation Analyst (CVA) should be required. Additional certifications like Accredited Senior Appraiser (ASA) indicate greater expertise. Accounting degrees are preferred.

– Experience – Seek appraisers who have personally conducted a substantial number of business valuations for a variety of purposes over many years. Check client references to confirm satisfactory outcomes.

– Specialization – Find appraisers focused specifically on business valuations, not just a side service. They should have in-depth experience in your industry for the most relevant insight. 

– Independence – An independent, third-party appraiser ensures objectivity versus using someone affiliated with the buyer or seller. Lenders and courts typically require independence.

– Methodology – The appraiser should follow Uniform Standards of Professional Appraisal Practice (USPAP) and methodologies endorsed by The Appraisal Foundation (TAF) and other valuation organizations.

– Reporting – A detailed report conforming to industry standards is vital. Review sample reports to assess clarity, depth of analysis, reasoning and compliance.

– Fees – Rates will vary based on appraiser experience, project scope, geographic region and other factors. However, significant deviations from average industry rates could signal issues.

– Reputation – Search online reviews and complaints, client testimonials, professional affiliations and profiles. Also request references to contact on past work quality and ethics. 

Appraisal Report Options

Appraisal reports range from brief letters to comprehensive written reports:

– Letter Opinions – Short document stating the appraiser’s value conclusion without details. Used for limited purposes like divorce cases.

– Calculation Reports – Summarize the valuation with limited description of methodologies used. Provide the minimum data courts require.

– Self-Contained Reports – Include moderately detailed descriptions of the business, valuation methods used, financial statement summaries, and analysis and reasoning. For most financing and sale purposes.  

– Full Narrative Reports – Comprehensively detail the business operations, financials, assets, valuation methods, adjustments, analysis, conclusions, certifications and other factors considered. Provide full support for appraiser’s value opinions.

Ensure you obtain the necessary report type for your situation. Lenders, courts and regulatory bodies may require self-contained or full reports. While narrative reports cost more, they provide maximum transparency and back up appeal challenges.

Appraisal Rules and Regulations

Business appraisers must adhere to uniform standards and ethics oversight according to their certifying boards. Key regulations include:

– Uniform Standards of Professional Appraisal Practice (USPAP) – Ensure proper methodology, ethical conduct, and report transparency. Developed by The Appraisal Foundation (TAF).

– AICPA Statement on Standards for Valuation Service Number 1 (SSVS 1) – Accounting industry standards for CPAs conducting appraisals. Issued by American Institute of CPAs.

– Business Valuation Standards – American Society of Appraisers standards covering development, reporting, ethic and disclosure requirements.

– Professional Code of Ethics – Mandate integrity, objectivity, competence, confidentiality and professionalism by all certified appraisers. Enforced by issuing boards. 

Using properly credentialed appraisers who follow federal and industry valuation standards ensures compliance and maximizes credibility.

Cost of a Business Appraisal

Appraisal costs vary substantially based on the size of business, complexity of the valuation, level of detail required, geographic location and appraiser qualifications. Typical range averages include:

Small Businesses – $3,000 – $7,000+ 

Mid-Size Companies – $7,000 – $15,000+

Large Firms – $15,000 – $50,000+

Extremely Complex – $100,000+

Many factors like business type, revenue, assets, financial history, number of locations, and specialization influence costs. Request fee quotes from several credentialed appraisers in your industry and geographic area.

Be wary of quotes well below average rates, as appraisers may cut corners threatening quality. Reports not meeting standards may require revisions or totally new valuations. Paying a premium for top expertise is wise for high value businesses.

How Long Does it Take?

Another consideration is the timeframe required to produce a report. Some factors affecting turnaround time include:

– Size of business 

– Complexity 

– Purpose of appraisal

– Appraiser workload and resources

– Timing and quality of records provided

– Report scope and detail

Typical appraisal timeframes range from two weeks for basic reports to two months for detailed, high value business reports.

Working with appraisers in less demand and providing organized quality documentation can help expedite the process. Allow sufficient time even for rushed valuations, as cutting corners threatens accuracy.

For transactions like selling a business or securing urgent financing, using larger established firms with ample personnel speeds reliable appraisal completion versus sole practitioners.

Maximizing Your Business Value 

Business owners influence appraisal outcomes by positioning their company favorably ahead of time:

– Improve cash flow – Increase revenues and margins to demonstrate maximum profit potential. Eliminate unnecessary expenses.

– Resolve outstanding liabilities – Clear debts and settle lawsuits to improve net worth. Remove potential buyer concerns.

– Formalize intellectual property – File patents and trademarks to protect intangible assets. Update copyrights. Establish clear ownership.

– Upgrade key assets – Make capital investments to modernize facilities, technology, equipment, and other infrastructure. Boost productivity.

– Document strengths – Track metrics like customer statistics, retention rates, repeat sales, efficiency gains, quality ratings and other differentiators.

– Clean up accounts – Review financial statements for irregularities. Write off bad debts. Dispose of obsolete inventory and assets.

– Establish continuity – Implement policies, procedures, systems and management succession plans. Reduce reliance on owner.

Presenting a healthy, profitable, sustainable business with strong fundamentals results in maximum appraised value.

FAQs

Why can’t I just estimate my business value myself?

Relying on unsubstantiated assumptions or outdated rules of thumb risks undervaluing your company or overpricing it. Valuations are based on many complex factors requiring professional judgment. Qualified appraisers also provide credibility.

When selecting an appraiser, is lowest cost best?

No, cheaper does not necessarily mean better value. In fact, unusually low fees can indicate appraisers who cut corners undermining quality. Balance cost with expertise, experience, qualifications, and methodology.

What documentation will the appraiser need from me?

At minimum, you’ll need to provide historical financial statements, tax returns, lists of assets, equipment schedules, inventory details, customer lists, organizational charts, contracts, intellectual property registers, ownership agreements, articles of incorporation, and other pertinent business records.

Should I use book value or cash flow to value my business?

Neither alone reliably indicates fair market value. Professional appraisals synthesize booked assets, earnings, cash flow, qualitative metrics, economic conditions, growth potential, risk, and industry practices. Leave the final value determination to certified experts.

How can I get financing without an up-to-date appraisal?

Most traditional lenders will require a current third-party appraisal before approving major financing. Alternative lenders may be more flexible, but charge higher interest rates to offset risk. An appraisal protects owners too by verifying adequate collateral.

Conclusion

Having a qualified, independent appraiser professionally assess your business value provides peace of mind and credibility during sales, acquisitions, ownership changes, financing, compliance, dispute resolution and estate planning. 

While appraisals require time and money, they help maximize outcomes, minimize taxes, and avoid undervaluing your company after years of hard work building it. Relying on unsubstantiated estimations during major transactions can lead to financial loss and discord.

This guide reviewed when appraisals are prudent, how they work, factors impacting value, choosing an appraiser, report options, and tips to maximize your valuation. With proper planning and reasonable expectations, a formal appraisal provides both buyers and sellers appropriate business intelligence to reach fair deals and optimal terms.