Business Appraisal in New Zealand

A business appraisal is a simplified business valuation, often done by business brokers rather than than professional business valuation analysts.

Often it is just the market approach method that is used, not the asset or income approaches. For this reason it is sometimes called a ‘market appraisal’. The market approach uses similar business sales transactions in the ‘market’, calculates the similar business sales ratios and applies them to the subject company. 

Business Appraisal Earnings

Part of the market approach is to calculate a form of earnings. In the case of New Zealand small business this is called Sellers Discretionary Earnings or Earnings Before Proprietors Wages Interest Tax Depreciation Amortisation (EBPITDA). This is EBITDA with one shareholders wage added back. This represents all the earnings available to pay to debt and equity holders. Most importantly, it is used by BizStats, the small business sales transaction database.

For mid-market businesses, standard EBITDA is used, that is no shareholder’s salary is added back.

It is earnings that is adjusted for one-off and discretionary expenses. For example, there may be legal costs in one year only, which would be added back. Or a golf club membership in every year which is really personal expense, this too would be added back.

Business Appraisal Enterprise Value

An appraisal often stops at the enterprise value (or Market Value of Invested Capital), the value of both debt and equity. The total value is calculated and then the debt is subtracted to arrive at the equity value. Again this is a simplified view as it assumes a share sale, where the shares in the business are transacted, not an asset sale where assets are purchased and placed into a new company owned by the new owner.

Business Appraisal Issues

An appraisal won’t discuss the balance sheet, that goes beyond the simple parameters of an appraisal report. There are two issues with this: 1) what is sold to a buyer in an asset sale 2) what working capital is included in a share sale.

What is sold to a buyer in an asset sale?

In New Zealand, we use BizStats for small companies, my estimate is 95% of these sales are asset sales. An appraisal will give you the sales price which is the enterprise value using the market approach (the methods in the private market are called the Direct Market Method, Private Comparables or Private Company Transactions). Remember the enterprise value is the value of debt and equity.

• From your market approach analysis you have the asset value, here are the steps to calculate how much equity the shareholders have on a certain date.
• Asset Value from analysis
• Remove any long term debt.
• Add the current assets (but not some items like shareholder’s current account which is just equity).
• BizStats includes inventory in the sale prices to subtract that.
• Subtract current liabilities. In an Asset sale the seller keeps working capital.
• Subtract fixed assets and goodwill, probably all of Non-Current Assets. This is becuase these are included in the sales price.
• Subtract non-operating assets e.g. a holiday home or boat, these are not relevant to the business (but are added back as a ‘postscript’ at the end).
• This equals the equity value, what the seller can expect in cash for the business.

It’s not the enterprise value, nor asset value. Yet, an appraisal will not do this calculation. A business valuation report will.

To be fair, the business broker is usually asked for the advice on the sales price, not the total cash the buyer will get on settlement date.

What working capital is included in a share sale?

Smaller businesses tend to be asset sales, mid-market businesses can be either asset or share sales. This may mean you use a different business sales transaction database, not BizStats (or you search public company results looking for similar business transactions). These databases have different rules as to what is included in a sale, you need to check their notes.

In a share sale the business is sold with its working capital. Then, for the purposes business valuation of the equity, we still remove the debt. This is all as at the valuation date, a historical date.

Note for an actual transaction the sale would be ‘debt-free, cash-free’, so you remove the debt and add back the cash to calculate total equity. The working capital for payment on settlement date is estimated because the accounts won’t be finalised for weeks. This estimate is called a ‘peg’ and once the true working capital is known then you subtract/add the difference.

How about the other approaches!?

Firstly, outside of a few industries (e.g. hospitality) there are often no or insufficient similar sales transactions to use the market approach. In which case you are left with dodgy data driving valuation decisions.

Secondly, if profits are low then use of this method could give a low valuation. If there are losses then the method arguably cannot be used.

Lastly, and most importantly, there are three approaches to valuation and about nine methods that sit underneath them. Each method may at times appear more justified in its use than others. The soundness of a particular method is entirely based on the relative circumstances involved in each individual case. Just assuming one approach and one method is ignoring other more suitable methods.

Summary

A business appraisal is a poor cousin to a business valuation. It doesn’t consider all of the equity in the balance sheet, the market approach often has insufficient data, and lastly it tells such a small part of the valuation story it could well be misleading.