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Sweet marketing music

Tanner Montague came to town from Seattle having never owned his own music venue before. He’s a musician himself, so he has a pretty good sense of good music, but he also wandered into a crowded music scene filled with concert venues large and small.But the owner of Green Room thinks he found a void in the market. It’s lacking, he says, in places serving between 200 and 500 people, a sweet spot he thinks could be a draw for both some national acts not quite big enough yet for arena gigs and local acts looking for a launching pad.“I felt that size would do well in the city to offer more options,” he says. “My goal was to A, bring another option for national acts but then, B, have a great spot for local bands to start.”Right or wrong, something seems to be working, he says. He’s got a full calendar of concerts booked out several months. How did he, as a newcomer to the market in an industry filled with competition, get the attention of the local concertgoer?

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by Don Keysser
April 2003

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Business valuations

What’s it worth?
There is value in
business valuations

Business owners often question the value of business valuation. And for good reason. Their view is that business valuation does nothing more than establish a questionable number, as of a date in the past, with no relevance to the future, at a cost of many thousands of dollars. That combination does not push business valuation to the top of one’s list.

There are other reasons why business owners fail to value business valuation. One reason is that people have a natural tendency to jump ahead to the end of a story. For a business valuation, the end of the story is a number. “Don’t bore me with the details, all I care about is the number.” Then, when a number has been established, the validity of the number is called into question. “That’s way too high.” Or, “That’s way too low.” Or, “The number means nothing. I’ll know the true value when someone writes me a check.”

These responses are legitimate when the focus is only on a number.

But does business valuation result in more than a number? And can a business derive value from business valuation?

The definition of business valuation provides a clue: Business valuation is a systematic and analytical process of applying income, market and asset-based approaches to determine the value of a business. In other words, what a valuation professional does is to uncover and weigh the factors that contribute to the value of an enterprise. That process requires experience and a combination of both science and art.

There are many situations when knowing the value of your business is important if not essential. Here are some of them. If you are selling your firm (or part of it), you want to know the highest realistic value, as a negotiating tool; if you are a buyer, you want a valuation that your investors or bank will accept and so that you don’t pay too much. There are other situations: if you are buying out a partner’s interest, if you are raising equity, if you are going public, if you want to recapitalize your balance sheet, if you need to value assets in a divorce, if you are making a gift, or if you are planning the transfer of your company to your heirs.

In these situations, the primary goal is to establish a number. However, there is a way for you to get far more value from a business valuation. The value is in looking beyond the number to the report that is the basis for the number.

A good report will reveal a wealth of information about the factors that contribute to the value of the business. The savvy business owner uses that information to focus attention and resources on those issues that will have the biggest impact on value. When used in that way, the valuation process and report becomes a tool to help guide the business going forward, rather than a static number with little value.

Periodically valuing your company helps you to identify and focus on issues that can enhance your firm’s value, and to recognize the value drivers in your business. Since one of the primary tools of valuation is the “income approach,” which is essentially a cash-flow pro forma, a continually updated pro forma, compared to past pro formas and actual figures, will help in analyzing profitability patterns, variable and fixed expenses, and growth opportunities.

Developing business valuations

There are four common valuation approaches. Sometimes only one method is employed, and sometimes two or more are used together.These methods are called: asset-based, replacement cost, market approach, and cash-flow (or income) approach.

The asset-based approach, often used in a liquidation situation, looks at the for-sale value (assuming an orderly liquidation) of all of the hard assets of the firm – buildings, land, equipment, patents, technology, inventory, A/R – and subtracts all of the company’s liabilities, to arrive at a net equity position. Because this approach excludes goodwill (goodwill value is the value of intangible assets including the name, reputation, customer loyalty, employee expertise, locations, products, services, history and logo), it omits what can be an important component of value.

In a replacement-cost analysis, the focus is on the cost that it would take to replace, or replicate, the existing assets. This may be appropriate for valuing hard assets like buildings and equipment, especially for insurance purposes. However, if the firm’s hard assets are relatively obsolete (a steel mill), the replacement cost may exceed the fair market value of the company. Note that the replacement cost approach ignores goodwill, and may therefore undervalue a company that has relatively modest hard assets but considerable intellectual assets (an architectural firm).

The market approach establishes value based on recent sales of comparable firms. Or if those are not available, an approximate value can be derived by looking at the value of publicly traded companies that are similar in size and industry (something that is determined every day on the stock exchange), and using that value as a benchmark, adjusting up or down for unique factors.

The most powerful method, and the one that is most commonly used for valuing companies that are going concerns, is the cash-flow, or income, approach. This approach projects the company’s future net cash flow that is available to service debt and provide a return on equity, and discounts that back to the present using a discount rate that reflects market interest rates. However, since this approach is in part a prophecy of the future, this is also the most complicated method, and the one most subject to disagreement, especially for companies that have volatile earnings histories, or a relatively short history, or are going through massive changes due to technology, mergers or industry shifts.

Finally, who does business valuation? An entire industry of valuation experts has emerged over the years. To get the valuation help you need, begin by talking with your CPA, lawyer and financial consultant. It is likely that none of them is a certified valuation consultant, but they can lead you to experts who are. Look for someone who is a member of, and certified by, the American Society of Appraisers, the National Association of Certified Valuation Analysts, or the Institute of Business Appraisers.

Contact
Don Keysser, formerly a senior investment banker at Dain Rauscher and Miller & Schroeder Financial, is a principal of Hannover Ltd. in Minneapolis, which offers business financial consulting services and capital market services: 612.710.0995; HannoverLtd@aol.com. Scott Moen is an attorney with Best & Flanagan in Minneapolis: 612.349.5659; smoen@bestlaw.com.