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A Business Valuation is Not Just In the Numbers

As a professional business appraiser, we are called to provide our best estimate of fair value.

On its face, it would seem relatively straightforward to assume that most of it has to do with the

financial well-being of the company, which it does. However, it is also very easy to overlook

some of the more salient issues in the ongoing operations of a business which subtract

meaningful dollars from its value. In our experience, the issues most prevalent impacting

potential valuations can be found in the following areas: financial operations, sales function,

operations, leadership and culture, as well as owner psychology. This article will outline a few

of the key issues within these areas.


First and foremost, however, is the quality of the financials. It is critical for a business to have

strong financial and internal controls. I have seen too many businesses fall flat on their face

because they were still being operated much like they were when they first started out.

Operational infrastructure must evolve with the growth of the business, and the evolution of the

financial function is one of, if not the most, critical components of a successful business. Not

having a strong bookkeeping or accounting function is perhaps the most important reason why

valuations fall short of expectations, and why sellers often feel unsatisfied after the transition

or sale. In addition, poor financial management will often show itself in the financial

statements and footnotes, which can reflect improper capitalization and/or cash flow management. Each of these on their face would receive due scrutiny from a qualified appraiser

in their analysis.

A good bookkeeper or CPA can help you set up a clear, concise chart of accounts and establish

strong internal controls for the handling, measurement and access to funds. Easy to follow,

consistently applied procedures following generally accepted accounting principles is essential

for an appraiser to gain an accurate assessment of the financial well-being of a business. A

business lacking in this critical area could face meaningful haircuts to value in an appraisal.

Budgeting and financial forecasting are two other key pieces of the financial function which are

commonly overlooked by business owners. Surprising to some, but most small business owners

do not establish thoughtful and useful budgets. These are the roadmaps used by effective

managers in carrying out the annual action plan which typically forms the basis of a strategic

plan, which most business owners generally do not take the time to do.

Multi-year forecasts are indeed useful for qualified appraisers who can incorporate these

forecasts into their assessment, even if the weights assigned to these projections are less than

the ones assigned to the historical data they can see. Suffice it to say, a business appraiser will

be able to paint a much more complete and holistic picture with this depth of information, which

can also add meaningful value to a company. In other words, the more complete and insightful information available to an appraiser, the more value can likely be recognized.


Sales is the lifeblood of a business – the mother’s milk so to speak. It is certainly obvious, but

you can’t have profits and value if you don’t have the throughput at the top of the financial

statement. Of course, a business owner is focused on generating sales, but a good appraiser will

want to more deeply understand the source and consistency of that revenue. An appraiser will

also be concerned with whether the business has established leadership for the sales function,

and whether that leadership has created and articulated a strategy surrounding revenue. Far

too often, we see businesses that start as order takers from a few key clients, but never evolve

their marketing, advertising and client relationship management functions in tandem with

overall growth.

Many businesses are adversely impacted by high customer or client concentration. It is easy to

assume these great relationships will persist into the future, but I’ve seen far too often where

the law of the unknown takes over and the environment changes overnight. Often, the

landscape can change due to the shift in the business or ownership of the client, a falling out

over service or capabilities, or even as simple as a dispute over price. Large clients usually

know when they have some leverage over the seller, and will try to use that to their advantage,

especially when substitutes are available. It is admittedly hard to know when and if a

substantial change in customer mix may occur, but it is a meaningful risk that any good

appraiser will take into account when applying the approaches to value.


The income approach to value depends in substantial measure on the ability of a business to

generate consistent profitability, especially for its industry group. Profitability comes from

operating leverage; in other words, the ability to grow expenses at a rate less than sales.

Underperforming businesses relative to their industry code cohort will usually get valuation

markdowns from qualified appraisers doing their homework.

An appraiser will also look at the management of the operation itself. This includes not only the

efficiency of the operations, but also the management of human capital. Often, we see business

lacking in some of the most basic human resources functions, including compliance and required

training. Sometimes, it is as simple as not even having a formal HR function at al. Businesses

really are as strong as their weakest link when it comes to human resources, meaning that a

shortfall in this area could lead to considerable financial impact and embarrassment for the

business, as well as a potential valuation discount.

From an operational perspective, an appraiser will be interested in both the data and so-called soft items. These include an analysis of financial ratios, operating margins, as well as trends in the data. In addition, an appraisal should consider whether a company maintains proper

oversight and management over facilities and equipment, purchasing, vendor management,

suppliers, and even such things as intellectual property. We are surprised by the number of

small businesses which fail to effectively plan for such things as equipment utilization, repair

and replacement, not to mention effectively negotiate and maintain contracts with business

partners and vendors.

Leadership & Culture

The culture of an enterprise may be hard to measure, but it nevertheless very important to the

worth and value of a business. Employee retention and turnover is one important variable that

appraisers will want to understand, as well as some of the underlying drivers. Companies with

weaker benefits and compensation programs will likely face more competitive employment

pressures and increased turnover, which in turn creates increased discounts to value when

analyzed by a qualified appraiser.

Another issue many businesses face is key person risk. We have enjoyed a strong economy over

the last decade, which has led to strong new business formation and also to labor shortages in

many markets. With tight labor comes increased competition for talent, especially experienced

talent in key areas such as sales, operations or finance.

The risk of losing a key employee is certainly real, and can with some effort, be quantified by a

business appraiser in terms of its impact on a business value. There are several good rhetorical

questions which stem from this, not the least of which is the cost to hire and train replacements.

Also, what is the revenue and operational disruption should they lose one or more of these so

called “key” employees...?

For example, a business may have an employee who represents a key sales relationship, sales

channel or has skill in developing strategy. Some businesses have people who possess critical

knowledge of the products or services or a proprietary process. The adverse financial impact to

the business of the loss of this type of person can be significant, and a good appraiser will

certainly take that into account during their assessment. The ability for a company to find

ways to retain that key talent, through advanced compensation and retention programs,

retirement plans and the like, can add meaningful value to a business in an appraisal.

Another aspect of key person risk is the exposure that a key person loss will have on the

efficiency and productivity of the staff or leadership. As difficult as it is to assess culture, an

experienced appraiser will be able to discern whether the loss of key employees will disrupt the

team esprit de corps, or perhaps remove a key personality or psychological attribute from a high

performing team.

Sometimes, the loss of a key employee might be good thing, if that person was deemed

influential but toxic to team balance or efficiency. A comprehensive appraisal should be able to

look past the adjustment or transition period to account for the long-term gain in this case.

Owner Psychology and Readiness

Going beyond the application of control premiums and minority discounts, another important

yet difficult to measure component of a qualified appraisal is the mindset of the ownership

team. What are their goals, aspirations and motivations? If there is a single owner, how long

have they been in the business? Are they happy, motivated, and satisfied? What would make

them stay in the business longer (or leave earlier), and what does the future look like for them?

If there are multiple owners, what is the relationship between the owners? Does the distribution of ownership adversely impact operations, satisfaction levels, or efficiency in anyway? Also, what is the view of the ownership team of how they define “exit”, and what does that future look like for each of them?

A valuation performed as part of an effective exit planning process will certainly consider the

existence and vitality of a succession plan. Most owners do not go through the exit planning

process, however, and fail to create either a plan of succession or fail to cultivate and train the

future leadership identified in the plan if it exists. Each of these issues on their own would lead

to a discounted valuation by a qualified appraiser. In the case of family-owned businesses,

oftentimes so-called “anointed” family members actually do not wish to carry on the legacy,

leaving a void in succession which usually does not bear itself out until the eve of the transition

or shortly thereafter.

A valuation performed as part of a transaction will want to assess why the owner(s) seeks to

exit the business, sell or transition the business, as well as assess their view of the business

legacy they are leaving behind. Sometimes, owners become frustrated by the tedious nature of

running a growing business, especially if they were not effective in delegating or advancing the

operating infrastructure noted above. Sometimes, it is due to business or personal divorce,

where sale is the only possible solution to a difficult problem. Seller motivations are far and

wide, but it is important for an appraiser to incorporate anything which might lie below the

surface, as seen through the eyes of the owner.


In conclusion, an appraiser’s job in valuing a business, on its face, can be fairly straightforward.

The conventional wisdom suggests that a simple review of the published financial data, coupled

with an assessment of industry multiples, should suffice in determining value. However,

business appraisal is as much an art as it is a science, and it is important to note just how

important and influential the “soft” data and details can be in arriving at the final calculated


A skilled appraiser will want to understand the various components described in this article,

because it helps to paint a more relevant picture and a deeper profile of the company being

valued. The output from this important exercise can lead to adjustments in the risk and

attribute weightings that are applied within the valuation approaches, which in turn can have a

meaningful impact on the valuation. The end result should be a better, more complete

valuation encompassing both available information and accessible feedback

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