1407: Determining Fair Market Value: What Is That Business Worth? by Vincenzo Camporeale with LenPenzo.com

[00:00:00] [SPEAKER_00]: This is Optimal Work Daily, Episode 1407, Determining Fair Market Value. What Is That Business Worth?

[00:00:07] [SPEAKER_00]: By Vincenzo Camporeale with LenPenzo.com. And I'm Dan, your host of the show, and I am here with you

[00:00:14] [SPEAKER_00]: every single day reading posts from some of the best work and productivity blogs around,

[00:00:19] [SPEAKER_00]: and let's get to it now as we start optimizing your life. Determining Fair Market Value.

[00:00:28] [SPEAKER_00]: What Is That Business Worth? By Vincenzo Camporeale with LenPenzo.com

[00:00:34] [SPEAKER_00]: Whether you're planning to buy or sell a business, the starting point is to determine the fair market

[00:00:39] [SPEAKER_00]: value, or FMV. FMV is always a range, never a specific number. Obstacles to a buyer and seller

[00:00:46] [SPEAKER_00]: agreeing on value are numerous. Owners generally have invested so much of their lives into their

[00:00:51] [SPEAKER_00]: business they believe FMV is too high. Buyers may have never owned a business and never

[00:00:55] [SPEAKER_00]: run a business, so they don't know where to begin to determine FMV. And sometimes both buyers and

[00:01:01] [SPEAKER_00]: sellers can have a very different perspective as to business FMV. Additionally, FMV is different

[00:01:06] [SPEAKER_00]: for different purposes. Different norms can result in different values for divorce court

[00:01:11] [SPEAKER_00]: versus for a business sale versus for a buy-sell agreement between existing business partners.

[00:01:17] [SPEAKER_00]: The Science of Business Valuation. Business valuation is a complex field.

[00:01:21] [SPEAKER_00]: Business valuation is a discipline of its own and no one article can cover all of the

[00:01:26] [SPEAKER_00]: considerations that go into the FMV calculation. What follows is a summary of some of the major

[00:01:31] [SPEAKER_00]: considerations experienced CPAs and attorneys will review when assisting a client in buying or selling

[00:01:37] [SPEAKER_00]: a business. Value is generally determined after examining a number of considerations.

[00:01:42] [SPEAKER_00]: For example, 1. Is the business a high or low-risk business? Risk is not only a

[00:01:48] [SPEAKER_00]: function of what industry the business is in, like sporting goods, computers, etc., but also a

[00:01:53] [SPEAKER_00]: function of the competition. For instance, local competition, online competition, etc.

[00:01:59] [SPEAKER_00]: For example, savvy buyers would not want to compete with Starbucks,

[00:02:02] [SPEAKER_00]: nor would they compete with online computer retailers. Bottom line? The higher the business

[00:02:07] [SPEAKER_00]: risk, the less the business is worth and vice versa for lower-risk businesses.

[00:02:12] [SPEAKER_00]: 2. Are there excess earnings or EE in your business?

[00:02:16] [SPEAKER_00]: This is generally the biggest driver of business valuation. Buyers pay for excess earnings.

[00:02:22] [SPEAKER_00]: To keep it as simple as possible, EE can be explained in the following example.

[00:02:27] [SPEAKER_00]: A specialty manufacturer is selling. The records show the family is earning $480,000 per year made

[00:02:32] [SPEAKER_00]: up of the following. $80,000 net income. Mom and dad receive annual pay of $75,000 for full-time

[00:02:39] [SPEAKER_00]: management, plus $25,000 for part-time admin tasks, and the six adult children each receive $50,000

[00:02:46] [SPEAKER_00]: annually including perks. Buyers or sellers first step is to determine whether this business creates EE.

[00:02:54] [SPEAKER_00]: To do this, the fair market value of the owner's efforts must be determined.

[00:02:58] [SPEAKER_00]: Due diligence reveals the two older owners work a combined 80 hours per week,

[00:03:02] [SPEAKER_00]: and their six children each work 55 plus hours per week. A buyer then looks at

[00:03:07] [SPEAKER_00]: the local area to determine the cost of wages they must pay to third parties to replace the

[00:03:11] [SPEAKER_00]: family's efforts. Research indicates hiring employees to cover the family's efforts would

[00:03:16] [SPEAKER_00]: have an annual cost of $465,000, that is $80,000 for a manager, $25,000 for an admin worker,

[00:03:23] [SPEAKER_00]: and $360,000 to hire nine other 40-hour per week positions to cover the 330 hours per week

[00:03:30] [SPEAKER_00]: of the six other family members. In this scenario, the business generates

[00:03:34] [SPEAKER_00]: excess earnings of $15,000 per year, that is $480,000 minus the replacement cost of $465,000.

[00:03:42] [SPEAKER_00]: Buyers then must decide what they will pay to purchase that $15,000 of excess earnings income

[00:03:47] [SPEAKER_00]: stream. Answer? Not much. 3. Buyers will also pay the fair market value of business assets

[00:03:54] [SPEAKER_00]: acquired. This includes tangible assets such as equipment and delivery vehicles

[00:03:59] [SPEAKER_00]: and intangible assets such as long-term leases at below market rates and patents.

[00:04:05] [SPEAKER_00]: All of these components must be valued in the purchase or sale process. For tangible assets,

[00:04:10] [SPEAKER_00]: it is generally easy to determine FMV for each component. On the other hand, intangible and

[00:04:15] [SPEAKER_00]: other assets are more difficult to value. Regardless of the agreed upon value of the

[00:04:20] [SPEAKER_00]: total purchase price allocated to assets, the buyer is still limited to paying a total

[00:04:24] [SPEAKER_00]: price based upon EE. 4. Buyers want to purchase organizations that aren't dependent upon the

[00:04:31] [SPEAKER_00]: personality or skills of a specific person or family. An example of this might be to compare

[00:04:36] [SPEAKER_00]: buying a restaurant franchise with buying a local restaurant that finds its popularity tied

[00:04:41] [SPEAKER_00]: primarily to the personality of the husband and wife sellers of the restaurant. If a buyer

[00:04:46] [SPEAKER_00]: acquires a franchise, nothing will be different for their customers. After sale, the product

[00:04:50] [SPEAKER_00]: will be the same, the workers may stay or be easily replaced, and none of the customers know

[00:04:56] [SPEAKER_00]: who owns the franchise. On the other hand, consider a popular local restaurant, let's

[00:05:00] [SPEAKER_00]: call it Maria's Italian Restaurant, that drives its customer base through the entertaining

[00:05:05] [SPEAKER_00]: high-touch personality of Maria. Maria is out on the floor every hour entertaining

[00:05:10] [SPEAKER_00]: customers with her personality, treating customers like family, and humorously directing

[00:05:15] [SPEAKER_00]: her husband Mario who does the cooking. The customer base loves the environment,

[00:05:19] [SPEAKER_00]: and the food is great too. In the case of Maria's Italian Restaurant, most potential buyers should

[00:05:24] [SPEAKER_00]: know that many of those customers will move on quickly after the sale as the restaurant would

[00:05:28] [SPEAKER_00]: no longer be Maria-centric. The buyer might replicate the recipes but they can't replicate

[00:05:33] [SPEAKER_00]: Maria. Unique local restaurants, small boutique consulting firms, and small service firms

[00:05:39] [SPEAKER_00]: are usually Maria or somebody-centric, and as a result they don't command a high value

[00:05:45] [SPEAKER_00]: regardless of their excess earnings. And five, obstacles to entry. Regulations and licensing

[00:05:52] [SPEAKER_00]: or ease of entry will impact FMV. How should one initiate the process of buying or selling a business?

[00:05:59] [SPEAKER_00]: A business owner should begin the process of increasing the FMV of their business at least

[00:06:03] [SPEAKER_00]: five years ahead of their target sale date if not the moment the business has created.

[00:06:08] [SPEAKER_00]: Business sellers and buyers should hire experienced business sale valuation

[00:06:12] [SPEAKER_00]: attorneys and CPAs. These advisors can hold owners accountable to themselves and can assist

[00:06:17] [SPEAKER_00]: them in not only successfully running their business but assist them each year in increasing

[00:06:22] [SPEAKER_00]: the value of their business. These same advisors will assist buyers in determining FMV,

[00:06:27] [SPEAKER_00]: including conducting due diligence when reviewing a seller's financial records.

[00:06:32] [SPEAKER_00]: Conclusion In summary, many complex components may

[00:06:36] [SPEAKER_00]: impact the FMV of a business. The most important component is likely going to be access

[00:06:40] [SPEAKER_00]: earnings. Business owners utilize the help of experienced professionals and should continually

[00:06:45] [SPEAKER_00]: think long term when running their businesses, focusing not only on paying the bills and earning

[00:06:50] [SPEAKER_00]: a profit, but also continually making decisions with an eye toward enhancing business FMV

[00:06:56] [SPEAKER_00]: for the day they may eventually sell. You just listened to the post titled

[00:07:04] [SPEAKER_00]: Determining Fair Market Value. What is that business worth?

[00:07:09] [SPEAKER_00]: Vincenzo Camporiale with Lenpenzo.com

[00:07:12] [SPEAKER_00]: This show is sponsored by BetterHelp. We all have non-negotiables. Maybe you never skip leg day

[00:07:18] [SPEAKER_00]: or have to take your morning walks, but when your schedule is packed with kids' activities,

[00:07:23] [SPEAKER_00]: big work projects and more, it's easy to let your priorities slip. Even when we know what

[00:07:28] [SPEAKER_00]: makes us happy, it's hard to make time for it. Therapy can help you reclaim control of

[00:07:33] [SPEAKER_00]: your time and values. And make no mistake, therapy is for everyone. Whether or not you've

[00:07:39] [SPEAKER_00]: been through significant trauma, therapy can be a great tool for setting boundaries,

[00:07:43] [SPEAKER_00]: learning positive coping skills, and ultimately becoming the best version of yourself.

[00:07:48] [SPEAKER_00]: If you're thinking of starting therapy, give BetterHelp a try. It's entirely online,

[00:07:52] [SPEAKER_00]: designed to be convenient, flexible and suited to your schedule. Just fill out

[00:07:56] [SPEAKER_00]: a brief questionnaire to get matched with a licensed therapist and switch therapists

[00:08:00] [SPEAKER_00]: anytime for no additional charge. Never skip therapy day with BetterHelp.

[00:08:05] [SPEAKER_00]: Visit BetterHelp.com-work-daily today to get 10% off your first month. That's BetterHelp,

[00:08:11] [SPEAKER_00]: H-E-L-P.com-slash-work-daily. And I want to thank Vincenzo, who has a degree in economics and is

[00:08:19] [SPEAKER_00]: the retired owner of a CPA firm in the Eastern U.S., with over 25 years' experience assisting

[00:08:24] [SPEAKER_00]: closely held businesses with 1 million to over 40 million in annual sales.

[00:08:30] [SPEAKER_00]: And we also have to say thanks of course to Len, who is the owner of the site.

[00:08:34] [SPEAKER_00]: Len Penzo writes about personal finance and macroeconomics on his eponymous

[00:08:38] [SPEAKER_00]: Personal Finance blog, which has been twice honored as a Kiplinger Best Money blog

[00:08:42] [SPEAKER_00]: and honored with two Plutus awards for Best Personal Finance blog.

[00:08:46] [SPEAKER_00]: Len's personal finance articles have been featured in publications like The New York Times, MSN,

[00:08:51] [SPEAKER_00]: Business Insider, Money, Forbes, Yahoo Finance, and many more.

[00:08:55] [SPEAKER_00]: And his focus is on the importance of personal responsibility, not just for our

[00:08:59] [SPEAKER_00]: personal finances, but also for everything else we do in life.

[00:09:02] [SPEAKER_00]: For more from Len, come by lenpenzo.com. That's L-E-N-P-E-N-Z-O.com.

[00:09:09] [SPEAKER_00]: And that's going to wrap up our episode of OWD today. I hope you enjoyed the post

[00:09:13] [SPEAKER_00]: and that you'll join me again tomorrow, where your optimal life awaits.