At the beginning of any sale negotiation, the most important question to address is how much is my business worth? For lenders, we need to understand the valuation to provide potential financing solutions. Lenders tend to put a lot of weight on the strength of the balance sheet and primarily appraise tangible assets to make our balance sheet flow. This helps to set sale prices and make lending work. Simply put, we determine the asset-based value of a business by subtracting the total liabilities from the total book value of a company’s assets.
Tangible assets form the core of balance sheets from most farm businesses. Asset-based valuations include real property – land, buildings and improvements – and personal property – machinery, equipment, breeding livestock, feed, etc. The market value of the hard asset is what we are typically going to use and, at least in the dairy industry, we don’t need to go much beyond that.
But what about intangible assets? Is the business profitable and will it continue to be profitable into the future? Is the dairy a concentrated animal feeding operation (CAFO-permitted), and what is that worth to a prospective buyer? Is the technology in place on the operation new or outdated? What is the profitability of the business worth to a potential buyer and is there a standard to determine that value? Should we put a value on that and what would that look like? Should we try to sell that value in some way?
In many industries outside of production agriculture, sellers may attempt to add a salable value of the business’s goodwill itself. What is the current earnings before interest, taxes, depreciation and amortization? What factor should be multiplied by earnings to determine a buyout value? These will vary by business and industry, but in the end, it gives us a value above and beyond the asset-based value and is deemed as the business valuation. This method is highly preferred when valuing strong businesses with substantial goodwill. Typical examples include businesses that offer professional services such as law firms, engineering and medical services. Business valuation can also be useful during valuation of manufacturing companies and well-established technology enterprises.
So why don’t we talk about business value very often as part of agricultural lending? When we look at other industries, we can develop a pretty reliable range of future income expectations from the business operations. Not every car dealership, for example, is managed exactly the same, but we can draw reliable comparisons in the industry to determine business income potential. If a car dealership were to carry two brands and have enough room for X amount of inventory, we would be able to compare that to a similar dealership nearby doing the same thing. We could then take gross revenue multiplied by a predetermined value to obtain a potential business value to be used for a sale or even to determine financing.
Production agriculture is much different. Future income is much less predictable due to the immense number of variables that come into play on each and every operation. As dairy lenders, we often discuss the differences we see between similar-sized operations. Cow numbers can be similar for neighboring dairies, but minor management differences will cause stark differences in financial returns. Land base and quality make a huge difference. Payment price paid by milk or grain buyers can vary a great deal within a similar geographic region, not to mention nationwide. These are just a few examples of variations that occur within our industry, making business valuation unviable in most cases. As the industry consolidates, however, this could come into play.
The value of a business and its selling price are not the same thing. The reason why many businesses conduct asset-based valuation is to find out what an entity would go for, in theory. So, while there are several methods that can be used to value a business, asset-based valuation is often preferred because of its applicability in most instances regardless of industry.
