Business valuations provide an individualized economic forecast that can help entrepreneurs determine how best to get their ideas off the ground.
Economic growth does not occur without effort. Business leaders must work to start, expand or acquire businesses. Such activities are not without risks, and traditional borrowing opportunities may not present themselves to entrepreneurs looking to face the challenges of business development head-on. In these cases, entrepreneurs can help mitigate risk and aid in the procurement of necessary capital by seeking the assistance of the business valuation community. This article discusses three of these instances.
Great ideas can lead to great businesses. However, some individuals do not have the financial means to turn that great idea into a successful business. Most startup companies will be initially financed from the pockets of their owners (and family members), but once those funds have been exhausted, the company will have to turn to outside sources for additional cash. The first inclination may be for the owners to borrow money from a financial institution, yet banks will be hesitant to lend money to an unproven business with no history of profitability.
A non-traditional avenue for raising additional capital is in the form of angel investors, or an angel network. An angel investor provides capital to the business in exchange for an ownership interest. When a group of angels pool their capital together, they form an angel network. There is one located in our own backyard, the Central Illinois Angels, which has invested over $2.7 million in local businesses. Additionally, ABC’s reality series Shark Tank provides an entertaining perspective if you are interested in gaining a broad understanding of an angel investment.
The first question likely to come to mind when seeking to raise capital from angels is, “How much of my company will I have to give to them in order to raise a certain sum of cash?” This is where a business valuation can prove valuable. The business valuation professional will utilize financial projections and forecasts, as well as non-financial information and industry, economic and market data to validate a reasonable per-share value of the company. This will provide the owner with pertinent information regarding the number of shares the company will need to issue in order to raise the necessary capital. Additionally, the owner can evaluate whether he or she will maintain a controlling interest in the company after the new shares are issued.
The Small Business Administration provides a number of financial assistance programs for small businesses that have been specifically designed to meet key financing needs, including debt financing, surety bonds and equity financing, the most common of which is debt financing. The SBA does not make direct loans to small businesses. Rather, it sets the guidelines for loans, which are then made by its partners (lenders, community development organizations and microlending institutions). The SBA guarantees that these loans will be repaid, thus eliminating some of the risk to the partners. So when a business applies for an SBA loan, it is actually applying for a commercial loan, structured according to SBA requirements with an SBA guaranty.
SBA-guaranteed loans may not be made to a small business if the borrower has access to other financing on reasonable terms. The SBA does not extend financial assistance to businesses when the financial strength of the individual owners or the company itself is sufficient to provide all or part of the financing. Both business and personal financial resources are reviewed as part of the eligibility criteria. If these resources are found to be excessive, the business will be required to use those resources in lieu of part or all of the requested loan proceeds.
Individuals seeking to acquire or start a business may view an SBA loan as their best form of financing. The SBA may require additional documents compared to a financial institution during the application process. Refer to sba.gov for information on the documents required for an SBA loan application. In cases where an applicant is seeking to acquire a business, a business valuation report regarding the acquisition target is likely to be required to support the amount of the purchase price to be financed.
Purchase Price Allocations
One way that a company may pursue growth is through a strategic acquisition. An acquiring company may view specific customers, product lines or brand names of a target company as attractive assets that will promote growth and profitability.
The value of each identifiable asset acquired, or purchase price allocation, can have several implications for an acquiring company. The specific assets that may be acquired include not only tangible assets (accounts receivables, inventory, property, equipment, etc.), but also identifiable intangible assets (brand names, customer lists, etc.). An acquiring company may pay for more than the tangible assets and identifiable intangible assets of a target company, in which case the acquiring company has purchased goodwill.
Lenders generally prefer that tangible assets serve as collateral, so high levels of intangible assets and goodwill will likely cause increased scrutiny. The value of acquired assets has important implications from an income tax standpoint as well, as future depreciation expense and taxable income is influenced by the allocation of value among acquired assets. Companies who have their financial statements audited often comply with generally accepted accounting principles (GAAP). To remain in compliance with GAAP, an acquiring company must record all of the specific assets that it purchases at “fair value.”
Intangible assets and goodwill are often among the most challenging assets to value, and a business valuation professional is well suited to assist with such a determination. Business valuation professionals can determine the value of acquired intangibles and provide assurance that the allocation of value among purchased assets is reasonably stated. Auditors of GAAP financial statements often look for a professional’s independent valuation report to support the purchase price allocation reflected in the acquiring company’s financial statements. Furthermore, lenders may gain additional assurance regarding the value of assets that serve as collateral for their loans if they are provided with an analysis of the purchase price allocation.
These various financing methods provide business owners with numerous options when seeking to increase or fund their invested capital (equity and debt financing). However, the lender or investor may require a business valuation report prior to his or her investment. Most entrepreneurs and business owners see the value of retaining a business valuation professional when they are seeking to sell their business, but the valuation process can be just as significant when starting or acquiring a business. Seek the advice of your legal counsel, lender or accountant for a referral to a qualified valuation specialist if the need arises. iBi
Nathan Isenberg and Brent Sauder are senior accountants at Heinold-Banwart, Ltd. They can be reached at (309) 694-4251, [email protected] or [email protected].