Why Values Can Be Different

The value of a business is judged differently as a going concern than as a potential acquisition by another firm.

The value of an agency that is being considered for sale to an outside entity must eliminate unusual expenses that would not be encountered in the buyer’s company. It must also discount revenues that would not be continued or replicated if the agency were not in the current owners’ hands. While these are subjective decisions, they can certainly be analyzed on a line-by-line basis.

The “Going Concern” value of an entity is its value to its current owners under the assumption that any ownership change in the business would not affect its current structure, location, staffing, revenue stream or expense categories and size. The best example of going concern values is for internal perpetuation, estate planning for multiple owner agencies and for ESOP (Employee Stock Ownership Plans).

The question of when to use pro-forma revenues and expenses and when to “purify” general ledger lines is best answered by asking what would change if an owner were added, eliminated or ownership interest would change? If the answer is, “very little,” or “none”, then adjustments are not prudent in that case. An example is an agency whose owners take most of the agency’s net income in compensation, bonuses or perquisites. There is nothing wrong with that. However, you can not spend all of the money you earn and simultaneously build the asset value of the business – IF THE BUSINESS IS TO BE CONTINUED AS A GOING CONCERN! If the agency grows each year and throws off all of its profits to owners, it can still be worth more each year. However, the circumstances under which the agency is valuable is in the event of sale to another company who would take advantage of the profits now distributed to the agency’s owners in ways that would be advantageous to the new owners. If the agency stock ownership transitions internally, the assumption must be made that the new owners would continue the spending patterns of the pre-existing owners.

Every agency owner must make a choice – spend or save. If they choose to spend their profits on themselves, they have become enriched at the expense of the business. The benefits of ownership accrue personally, but not through enhanced value of the business. If they compensate themselves similarly to other businesses of their size and type and invest the balance in their agencies, they build asset value in their businesses.