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Enterprise Value Includes Asset Value

“It doesn’t work that way. You don’t value a business then add asset values to it. The market value of your assets is embedded in your business’ valuation.”

Henry (not his real name) was one disappointed guy. But our conversation didn’t start that way. We were talking about his interest in taking his business to market in early 2023. As we walked through his manufacturing plant, I surmised most of his equipment was fully depreciated, but I also noticed the plant floor was clean and the place seemed to run with impressive efficiency.

I had reviewed the five years of financial data Henry had sent prior to my visit, so by the time we sat down after the plant tour, I was ready to be specific. I explained how buyers evaluate quantitative and qualitative factors to reach a market valuation. Based on my knowledge of the market and review of his business, I told Henry his company was worth $12 million to $15 million.  He said “Hmm, that sounds about what I expected,” but then he dropped this on me, “But what about my assets? I have over $3 million worth of equipment out there” as he pointed toward the factory floor.

At first, I wasn’t sure what he was getting at, so I asked Henry to clarify. That’s when he said he was expecting to get a valuation for his business and the assets.  As we dug into the conversation, I realized he either received bad advice or hadn’t fully understood the advice he was given. Henry told me his CPA said goodwill was what a buyer bought in addition to the business assets. I quickly pointed out that that was not right, but in fairness, how that concept is explained can lead to it being misunderstood. That’s why I told Henry the business value (a/k/a, enterprise value) is the combination of assets and goodwill.

Reality check: a buyer sets an enterprise valuation for a business based on how it has performed and its potential future performance. The proposed valuation might be expressed as an asset sale or a stock sale (the hows & whys of that decision are for another blog post). But either way, once the transaction is completed, federal tax law considerations require the buyer and seller to mutually agree on how much of the purchase price will be allocated to asset value and how much of the purchase will be allocated to goodwill (the hows & whys of that allocation are also for another blog post). But to be clear, the allocation does not change the enterprise valuation.

Once explained, Henry understood that his $3 million worth of assets was part of the engine that drove the business valuation of $12 to $15 million. “I was probably not paying attention when it was being described to me,” Henry said.  “After all, my CPA and I were on a golf retreat at Pinehurst, so I wasn’t fully plugged into the business at that moment” he added with a smile, to which I replied, “Well let’s get the business on the market and get you a lot more time for uninterrupted golf.”  With a wink Henry said, “That’s a concept I fully understand.”

Entrepreneurs really do say the darnedest things.

JIM CUMBEE is President of Tennessee Valley Group, Inc. a retainer-based business brokerage and transition mediation firm in Franklin, TN. Cumbee is an attorney and has an MBA from Harvard Business School. Jim is the author of Home Run, A Pro’s Guide to Selling a Business. .  He has a wide range of corporate and entrepreneurial experiences that make him one of the most sought-after business transition advisors in the state of Tennessee. The principles above are true, but the names and fact patterns are changed to preserve the parties’ identities.

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Tennessee Valley Group

Jim Cumbee established Tennessee Valley Group to help business owners fulfill their dreams for life after business ownership. It’s a mission that his 30+ year career history had prepared him well for—in addition to being an attorney, transition mediator and business broker, Jim has been a buyer, seller, and entrepreneur. His broad range of experience gives him unique insight into how business buyers and sellers can achieve their goals.

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