About five years ago I decided to consider getting into business appraisals since I get calls for that all of the time. I purchased a couple of books on the subject, studied up on it, but thought better of it for this reason: Take Terrell’s example above of hard assets plus 20 to 40% of annual gross. This gives no consideration to highest and best use of the property or the feasibility of the enterprise. You could conceivably buy the hard assets and business enterprise goodwill and not have enough net return to pay the debt service on the hard assets. The same goes for any kind of ratio valuation rule of thumb. I remember many years ago when the biggest motel owner in the area told me that he purchased and sold motels for 3.5 times the gross. Well, suppose the real estate as though vacant is worth 4 times the gross, or suppose the debt service on the loan is more than the net income, etc. It seems to me that using ratios to value business value flies in the face of sound appraisal methods and theory as it relates to H & BU and feasilibity.
A couple of years ago I took an AI-CE class on appraising nursing homes and the instructor was an MAI considered to be the authority on this subject. We had some interesting conservation. I asked him how he complied with USPAP when he gave a going concern value including real estate, personal property, and enterprise value in one report. Under USPAP this includes three areas of development and reporting: real estate, personal property, and business appraisal with consulting being a gray area. He would not answer my question because he obviously was not doing USPAP compliant appraisals because to do so requires three separate developments and reporting standards all tied together with a consulting report.
Here is the Austin method of doing any kind of business appraisal, which I have never used because it has never been used which puts it in the shadows of USPAP compliance. First: Take a highest and best use approach. Take a look at the net operating income of the enterprise and do a highest and best use analysis and valuation of each component starting with the hard assets. Value the hard assets including real estate and inventory. Will the enterprise NOI service the return on and return of these assets? If the answer is yes, then estimate the value of the residual NOI, which can be attributed to the enterprise value. This would depend on the nature of the business generally related to the time it would take to establish that type of goodwill. If you estimate it would take five years to establish goodwill, then capitalize the NOI attributable to goodwill at 20% for return of and 8% for return on capital, cap rate of 28%, and add that to the hard asset value. This way you have the bases covered and know that the highest and best use has been addressed and the new owner is getting what he paid for with the ability to may the debt service. Also, you have complied with USPAP development and reporting requirements.
