How Do I Get My Money Back?
In 2004, I earned my CVA professional designation (Certified Valuation Analyst) from NACVA (The National Association of Certified Valuators and Analysts). In addition to meeting certain academic and professional standards, the process encompasses a week of on-site training, certification exam, and follow-up submission of a sample valuation report for a hypothetical company.
In addition to NACVA, there are other bodies that credential valuation professionals such as the AICPA (American Institute of Certified Public Accountants ), ASA (American Society of Appraisers), and the IBA, (Institute of Business Appraisers). However, NACVA’s CVA designation is the only valuation credential accredited by the National Commission for Certifying Agencies (that’s NCCA, not the NCAA!).
Why do I share all this with you? Despite all our expertise and credentials, typical valuation reports feature the following disclaimer: “valuation of closely held companies is an imprecise science, with value being a question of fact, and reasonable people can differ in their opinions of value.”
Back to the question of the day, “HOW DO I GET MY MONEY BACK?” Fans of ABC's The SHARK TANK will recognize that question as panelist-Shark Kevin O’Leary’s favorite question. Let’s change that question to, “WHEN WILL I GET MY MONEY BACK?”, which is what we call the PAYBACK PERIOD. Mathematically, the payback period is the Investment Made divided by the Annual Profit; it provides a reliable check and balance on the purchase price or valuation.
Let's use a simple example: If a buyer purchases a company for $2 million and it has annual profits of $500,000, the payback period is 4 years ($2 million Investment /$500,000 Profit). If the company was valued at $3,000,000, the payback period would actually be 6 years. This assumes that the yearly profit will not decline or at least hold steady, which may or may not be a “big assumption”, depending on the circumstances.
Another good “sanity check” in valuing a business is calculation of the RETURN ON INVESTMENT (ROI). In the first example above, the ROI is 25% ($500K Profit / $2 million Investment), and, in the second case, 17% ($500K / $3 million). ROI as a number taken in isolation is not very useful. The rate of return should reflect the amount of risk taken and /or be compared to alternate uses of the funds.
In conclusion, when considering the value of businesses, you don’t need to be a business valuation expert. Thankfully, we have a prime time TV show about business valuation that we can learn from. Bottom line, consider these two basic, yet fundamental questions: 1) How long will it take to get my money back? 2) What is the rate of return on investment?