Drysdale: I’ve done valuations of raw startups and main street retailers to companies with up to $1.5 billion in annual sales and even bigger. I’ve got the Accredited in Business Valuation credential, too. An accounting background is helpful, but some people think that CPAs are too rigid for the nuances of business valuation. CPAs like following strict accounting rules and filling in IRS boxes, and business valuation isn’t about that.
For one thing, business values are actually a range, not a specific number. You are using the history of a company’s operations and then basing valuation on a forecast of what will happen going forward. You are looking at the cash-flow stream and estimated growth and then discounting all that by assessing risk and coming to a fair market value. CPAs are often uncomfortable in assessing risk. In the end, you need to find someone with an acumen for this work. People with engineering and mathematics backgrounds often do well.
Should a business owner seek a valuation from somebody with experience in his/her industry?
Industry expertise is generally less important than people believe. It’s necessary in a health care-related business where there are lots of rules and regulations that need to be understood. Also important in banks, which are also in a regulatory environment. One expertise I have is in construction, where percentage-completion ratios of projects underway are rather difficult to assess. By comparison, valuing companies in service industries and retailing and wholesaling is pretty straightforward.
The assumption is that you are looking at an entire industry to find comparable companies, often publicly traded, to judge valuations against.
Public company comparisons can be very useful. But public companies have often bulked up so much with acquisitions in recent years that they’ve become diverse in product lines and geography and are vertically integrated. Private companies rarely are that diverse.
With my specialty in construction, I can’t find a pure play on the public markets anymore in just construction. These public companies do engineering and design/build and architecture and lots of other things now. In using public companies as a guide, valuators have to be prepared to make adjustments. As an alternative, we try to find data in private company databases like DealStat, which tracks the sale of private companies. But such data is often incomplete.
Does experience count for a lot?
Yes. Beyond the simple math in business statements there are subjective judgments that need to be made. We are looking at current economic conditions and how they impact the business. I’m looking at the bylaws and articles of incorporation and bringing business law into the calculations. I need to understand the cost of capital and how that impacts value, too. You are bringing everything you know about business in general into play.
So how do you assess the current outlook?
Right now we have inflation, with plenty of indicators that a recession is coming. I might, therefore, say we need to bump up the risk, which can bring the valuation down. But another analyst might say no, a recession is unlikely and not add in so much risk. At the end, two valuations can come in 15 or 20% apart, and even much more.
There are lots of arbitrary decisions that come into play and there is plenty of room for disagreement. In divorce cases involving the split of a family business, this can be very frustrating for both lawyers and judges. You have to realize that valuing a business is not a science or an art—it’s a craft.
Why have you been so busy lately?
When Joe Biden and Democrats were voted into office in 2020, there were warnings that the threshold for paying inheritance taxes—set at about $11.7 million under Trump—would be lowered, maybe by a lot. This put high-net-worth individuals at real risk, and suddenly they were reaching out to people like me to value their businesses as part of a program to shift their assets to heirs. I have a client who owns a ranch of more than 50,000 acres in Montana with lots of sheep and cattle, and he faces an estate tax that could gobble up 40% of his net worth.
As it happens, the war in Ukraine and worries about inflation have monopolized politicians’ attention and they haven’t moved to change the estate tax. But people are still on guard.