At least weekly we are asked to look through a valuation report, and find ourselves saying, “what in the world…?” Most often, the document supplied to us for review, cites earnings before interest, taxes, depreciation and amortization (EBITDA) with adjustments to historical financial information.
Adjustments can be perfectly acceptable, as owners run excess personal expenses through their business that would not be assumed if the business was operated in a prudent manner. Sometimes, family members are paid above-average wages and will not continue when a transfer occurs.
Regarding justifiable adjustments, you will hear no objections from us. However, just because adjustments are justified, that doesn’t mean they are always reasonable. We recently were asked to review a report completed by a real estate appraiser (with limited knowledge of business valuation) who placed a value on the business. He decided to add-back all historical interest and depreciation expenses, citing his reason as the real estate is owned by a related entity of the business. He arrived at annual EBITDA of $1.0 million and applied a seven-times valuation multiple to the adjusted EBITDA amount to arrive at a value of $7.0 million for the business.
His real estate report stated reasonable rent should be $480,000 per year. What the real estate appraiser forgot to do in his adjustment of EBITDA was to account for reasonable rent expense, which would have reduced EBITDA to $520,000. Meaning, in this case, his lack of business valuation education and experience created a serious problem for the lender. A $3,360,000 problem.
How can American Business Appraisers Help?
The best advice on creating a list of adjustments, is to be honest and conservative, as these adjustments will have to be supported by documentation. Business valuation require a significant amount of careful consideration and judgment. Our experienced staff recognizes and quantifies a business’ risk factors and value drivers. The more risk factors a business has, value is driven downward. On the other hand, identifying value drivers will increase the value of a business.
With our initial consultation, there is no cost or obligation to you. We promise you two things; first, to invest a reasonable amount of time to gain an understanding of your specific requirements, and second, our communication will be kept confidential.