Is a Third-Party Business Appraisal Needed to Sell My Business?
A third-party appraisal refers to an assessment conducted by an independent entity. In this scenario, you directly compensate the broker, who then subcontracts the business appraisal to an external appraiser with whom you may never interact.
In larger establishments, appraisals are often outsourced to third parties and are marked up by 100% to 500%. This additional cost is on top of other fees that might be charged for selling your business. We priced a third-party appraisal at $4,950, even though the actual cost was approximately $750. This markup amounted to an astonishing 660%.
Advocates of third-party appraisals assert that an unbiased third party can instill more trust in a buyer regarding the valuation’s authenticity. However, questions emerge: Is the appraiser genuinely impartial? Is an external business appraisal imperative while selling your business? Why do brokers opt for third-party evaluations rather than conducting them in-house? When you opt for a third-party appraisal, can you communicate directly with the appraiser, or are interactions limited to the broker? These inquiries are both common and intricate.
Valuation is an intricate discipline demanding years of experience to master. High turnover rates in most establishments necessitate outsourcing technical processes, such as appraisals, as new recruits often lack the requisite skills and knowledge.
Outsourcing simplifies the process and minimizes the need for extensive agent training. Crafting a comprehensive business appraisal mandates extensive expertise spanning various domains. Given the structure of business brokers’ agreements, their fee models, and office arrangements, outsourcing appraisals aligns logically.
Why Do Firms Offer Third-Party Business Appraisals?
The rationale is straightforward: It benefits both parties — the business and the broker. In a landscape marked by high turnover, many offices opt to outsource technical processes, including valuations and appraisals, owing to the limited skills and knowledge new recruits possess. These skills are often a rare find; those who do possess them are unlikely to join an established office, often choosing the path of entrepreneurship.
Third-party appraisals primarily favor one party — the broker. In this role, there’s no requirement for firsthand appraisal experience, as the broker need not conduct the appraisal personally. Remarkably, they can sell these appraisals at a markup ranging from five to 10 times the cost. For instance, if the appraisal expense amounts to $750, they can sell it for $3,500 to $7,500. Thus, a business broker could dive into the field without prior industry exposure or financial investment, swiftly selling third-party appraisals at a substantial margin to unsuspecting clients.
For those who own a business brokerage office, the prospects are even rosier. Hiring novice associates with minimal knowledge becomes an option, enabling them to initiate the sale of business appraisals. Comprehensive broker training becomes obsolete. No experience prerequisites exist; backgrounds matter little. Selling third-party appraisals requires neither specialized know-how, experience, nor certification, for both the broker and their associates.
Outsourcing these intricate processes effectively lowers the bar, reducing barriers to entry and facilitating the expansion of business broker franchises or the inclusion of new brokers. After all, recruiting new brokers or franchising becomes notably more streamlined with lower entry prerequisites.
The lesson here is unequivocal: Collaborate with brokers who possess the expertise to accurately value your business.
Why not approach the appraiser directly, cutting costs by 10% to 20%? The next time a broker proposes a third-party appraisal, inquire about the appraisal provider’s identity. Further, seek direct interaction with the appraiser. Some brokers may claim the appraiser solely partners with brokers, but this explanation seems questionable. Moreover, inquire about the broker’s markup, if applicable. Concealing such costs is unwarranted. If transparency falters, or if the broker hesitates to divulge the markup, consider this a sign: Explore alternatives.
On a separate note, a reasonable practice involves marking up “managed services,” akin to attorneys outsourcing some tasks to third parties. However, transparency and value must coexist. Disclosure and added value for the fee charged should be evident in cases where services are outsourced and managed by an intermediary, such as in legal transcription or research services.
Do Third-Party Appraisals Eliminate Conflicts of Interest?
Is it a conflict of interest when a broker conducts a valuation for a business they’re marketing for sale? Is it more prudent to engage an impartial, third-party appraiser when contemplating the sale of your business?
Undoubtedly, a conflict of interest arises when business appraisers rely on referrals from brokers.
If the premise of hiring an independent entity holds true, then no broker should ever offer a valuation opinion — this principle extends to residential real estate agents, commercial real estate agents, fine art brokers, yacht brokers, and their counterparts. Consider this: Would you trust the valuation of your fine art collection to an individual who exclusively sells art or to someone with no practical experience in art sales?
Pursuing the argument of a “neutral, independent, third party” would paradoxically exclude the very experts most adept at rendering assessments — the professionals actively negotiating in the real-world marketplace. After all, who possesses the most comprehensive understanding of actual business values in the midst of transactions?
The conflict of interest becomes glaring when a broker endorses a specific third-party appraiser to evaluate your business, all the while receiving a referral fee for directing you to that appraiser. In such cases, brokers refer you to appraisers within their network, reaping compensation for the referral. Subsequently, they inflate the appraisal cost you bear, capitalizing on financial gain from both parties involved.
To clarify, there are brokers of integrity amidst the industry. With a discerning approach to interactions, you can distinguish the trustworthy from the dubious. A forthright professional will furnish a list of potential appraisers, encouraging you to directly contact, hire, and compensate one.
The Major Downsides to Third-Party Appraisals
The notable drawback lies in the business owner’s limited ability to directly engage with the appraiser. Essentially, the owner receives a value figure (representing the appraiser’s business valuation) enclosed in a metaphorical black box, devoid of explanation or rationale. While an accompanying written report exists, comprehending its contents proves challenging for many business owners. Additionally, few brokers vending these reports possess the proficiency to succinctly elucidate the appraiser’s reasoning. It’s worth noting that seasoned brokers seldom peddle third-party valuations, leaving the primary group of sellers inexperienced and ill-equipped to lucidly convey report specifics to business owners.
Typically situated out of state and unfamiliar with business sales, the appraiser’s specialization centers solely on business appraisals. In-depth familiarity with a business’s strengths and prospects often eludes them, leading to value definitions primarily centered on fair market value (FMV). Frequently, brokers are unable to expound on the methods utilized by the appraiser to establish business value due to a lack of knowledge or understanding. Reflecting on my own experiences over a decade ago when I offered third-party valuations (lessons have been learned since then), communication with appraisers was scarce. Both business owners and I were recipients of numbers from an enigmatic void, exacerbating the disconnect.
Engaging with appraisers seldom yielded informative exchanges; responses were often terse at best. Business owners expressed dissatisfaction with this breakdown in communication, a sentiment I shared. Presently, my discussions on valuation with business owners traverse intricate terrain, delving into numerous interconnected factors influencing business value. Such intricate conversations are incompatible with the linear exchange of messages, particularly concerning the intricate multi-variable nature of valuing small to mid-sized businesses.
For those seeking a figure devoid of context within a black box, this approach might suffice. However, if understanding the rationale behind your business’s valuation, the factors shaping its value, and avenues for value enhancement are paramount, a third-party appraisal is unlikely to satisfy these inquiries. Essentially, substantial queries concerning the appraisal are apt to remain unanswered.
Buyers face the same predicament. If a buyer seeks clarification on appraisal aspects — such as the rationale for employing a 3.5 multiple, when industry norms suggest 2.5 to 3.0 — direct communication with the appraiser is improbable. Even if such communication were feasible, the appraiser’s limited grasp of the business undermines buyer confidence. Consequently, buyers are less inclined to place trust in the appraisal.
Take Control of the Process & Get Your Questions Addressed
Do you truly desire an appraiser evaluating your business without any direct interaction or understanding beyond your financial statements? What if queries arise regarding the appraisal? It’s logical that the appraiser who crafted the report should be the one addressing these inquiries, not a broker lacking appraisal expertise.
The prevailing industry approach that spotlights the advantages of appraisals for brokers, rather than their benefits for business sellers, displays a backward perspective. The primary focus should be on serving the client’s interests, not the broker’s. Often, prospective clients at conventional brokerage firms are presented with a skewed representation of appraisal costs and procedures, aimed at justifying the purported advantages of employing a third party. This narrative often masks the broker’s underlying agenda — a steep markup of appraisal costs, followed by pocketing the surplus.
To be unequivocal, I’m averse to criticizing others in our industry, but this practice is unequivocally disingenuous and warrants cessation. Consequently, I hold no reservations about condemning this pervasive practice across the industry, especially when it contradicts the best interests of the clients.
You Deserve an Honest Relationship
Your business stands as one of your most valuable assets, warranting trust and respect in your broker. Can you genuinely put your trust in a broker who inflates a third-party service’s cost by five to ten times, all while delivering minimal to no actual value? In certain sectors like law, it’s common to apply markups to third-party services. However, these markups typically range from 10% to 50%, not an astonishing 500% to 1,000%. Moreover, they should come with tangible value attached.
If the service’s role is purely administrative, a markup of 10% to 20% might be reasonable. When value is genuinely added, as seen in “value-added reseller” (VAR) scenarios, a markup exceeding 50% could potentially be justifiable. Regardless, transparency is key. If a broker conceals the extent of their markup, it’s a sign of dishonesty. And if a broker isn’t forthright, can you entrust them with the pivotal transaction of your lifetime?
Appraisers Depend on Volume
Around twelve years ago, I reached out to an appraiser I was collaborating with to raise a question about one of their methods. Given their busy schedule, the appraiser opted to modify the report to address my concern without any discussion. From their perspective, no conversation was necessary. This appraiser was a well-established, nationwide professional frequently engaged by extensive business broker networks. The company I was associated with directed a significant amount of business their way. In response to my query, the appraiser made a few adjustments to bolster the company’s value in the appraisal, solely to ensure my satisfaction.
Why the need to dismiss my concern? Because their business model thrives on volume. With likely thousands of appraisals conducted each year at a lower cost, they simply lack the capacity for in-depth discussions about their appraisal methods.
Should you find yourself conversing with a broker who proposes a third-party appraisal, I strongly recommend seeking an alternative broker. Should you decide to continue the dialogue, I urge you to pose the following questions to the broker:
- What is the name of the firm you collaborate with?
- Is there a markup on the appraisal cost?
- To what extent is the appraisal marked up?
- Can I engage the appraiser directly?
- Is it possible to communicate with the appraiser prior to payment for the appraisal?
- What is your knowledge and experience in preparing business valuations or appraisals?
- Can I directly communicate with the appraiser for queries?
- Why do you not personally conduct valuations?
- Which methods does the appraiser employ?
- How many years of appraisal experience does the appraiser possess?
- What certifications does the appraiser hold?
- How many businesses has the appraiser overseen the sale of?
You should be able to discern that opting for a third-party appraisal isn’t a prudent choice.
What are You Paying For?
Let’s approach it from this perspective: What exactly are you investing in? It’s not merely a figure; it’s the appraiser’s wealth of knowledge, experience, and guidance. What justifies the value of your business? How can you enhance its worth? What alterations in strategy will impact your company’s valuation in terms of x, y, or z?
The most valuable counsel I offer to business owners goes beyond the numerical outcome. It’s the combined expertise that underlies the rationale for their business’s valuation and the actionable steps to influence that figure. In my case, this advice is rooted in over two decades of practical involvement in the realm of buying and selling businesses, rather than confined to spreadsheets and distant ivory towers.
Should a broker promote a third-party appraisal, inquire if they receive compensation or commissions for “referring” the appraiser. You can also request the appraiser’s contact details and express your preference for a direct engagement. You might hear that the appraiser solely operates on a “wholesale basis” through brokers. This assertion holds little weight.
The essence of any worthwhile appraisal necessitates direct interaction with the business owner. The reason behind the appraiser’s avoidance of direct interaction relates to the method of preparation and the economics of the referral relationship. These appraisals are orchestrated through data entry, where inputs are fed into a computer program. Following this process, a comprehensive report materializes, creating the illusion of extended labor. The report’s complexity is often intentional—it serves to intimidate, making you less likely to scrutinize and question its contents.
The survival of these appraisers depends on generating a high volume of these reports through data entry, akin to an assembly line process. Unfortunately, human error can infiltrate number punching. Additionally, direct interaction with the business owner is perceived as time-consuming. Thus, if ample time was allocated, the economic structure would need revision (i.e., the appraiser would need to charge more than $750 to the broker). In this scenario, you’re not receiving your money’s worth. Regrettably, you’re getting what the broker has invested in, which could be significantly less than your initial payment.
Experience Makes a Difference
In the realm of brokers offering third-party appraisals, a general trend emerges: those who engage in this practice tend to have less experience compared to their counterparts who do not. This phenomenon is a prime example of selection bias in action. Experienced experts, as a rule, are unlikely to seek the advice of other seasoned professionals who lack hands-on knowledge in their field. The rationale is clear: the truly experienced seek expertise on par with their own. Consequently, the brokers primarily involved in selling third-party appraisals are often those lacking the proficiency to conduct appraisals independently.
Seasoned brokers with substantial expertise generally prefer to conduct appraisals in-house. This approach enables them to engage in meaningful discussions with business owners regarding appraisal outcomes. Moreover, they find it uncomfortable to inflate service costs by an exorbitant 500%. Many of these seasoned brokers have shared their underwhelming impressions of the quality and applicability of appraisals sourced from third-party appraisers.
Applicability carries significant weight, particularly considering that most “business appraisals” are executed for legal purposes, such as divorce proceedings, tax planning, and partner conflicts. The methodologies employed in courtroom appraisals markedly differ from those applied in the real-world business context. Potential buyers are astute enough to recognize this distinction, and if they cannot readily comprehend the content of a business appraisal, they are prone to disregard it.
Publicly available software caters to business valuation needs, yet my personal experience with various appraisal software versions has left me unsatisfied with the results. Most software tools are designed for legal valuation purposes and inadequately address factors beyond the software’s rigid framework. While the allure of generating extensive reports is tempting, the lack of practical relevance in these reports remains a persistent issue.
For instance, consider the relevance of liquidity ratios to small businesses. Are these ratios genuinely pertinent? Irrespective of their relevance, standardized reports often include them as potential considerations. Customizing these reports proves challenging, and the software necessitates accommodating the highest conceivable complexity users might encounter.
As a consequence, users are compelled to input data for numerous irrelevant fields. This influx of irrelevant data convolutes the report, obscuring the valuable insights. Consequently, the report becomes needlessly extensive, teeming with extraneous information, and incapable of accommodating factors beyond the software’s predetermined scope.
The Difference Between Using Standardized Reports and a Customized Approach
As an illustration, I recently concluded an in-depth assessment call with a prospective client who owns a service company within the aerospace sector. Throughout our conversation, we delved into the intricate elements that could potentially shape the value of his business. Given the complexity of his business, there were numerous interdependent factors to consider that might impact its valuation. As we peeled away layers of complexity and delved deeper into the business, our comprehension of its nuances evolved, and the valuation evolved in tandem.
During such discussions with potential clients, I guide business owners through the ramifications of these factors on the valuation as we explore them. I rely on a streamlined proprietary spreadsheet for these calls, allowing clients to witness real-time changes to the model on their computer screen as we fine-tune our analysis. Through this approach, we scrutinized the likely profile of the future buyer. Would it be an aircraft maintenance company or a company from a related industry seeking a horizontal acquisition? In dissecting potential buyer scenarios, we assessed how different buyer types could influence the business’s financial performance and, consequently, its valuation. This dynamic cannot be replicated in isolation; it hinges on owner input. Real-time modifications enable a clear understanding of how key value drivers impact the business’s overall value.
Consider the scenario where the business is acquired by a company in a related industry offering similar services. In this case, numerous duplicated expenses would likely be eliminated, leading to a cumulative reduction ranging from $200,000 to $250,000 annually. This exerted a multiplier effect—4.0—translating to an impact on valuation between $800,000 and $1,000,000. However, envision a sale to an aircraft maintenance company; while a comparable expense reduction might not apply, revenue synergies could emerge. Precisely quantifying revenue synergies posed a challenge, so we reverse-engineered various scenarios to gauge their potential influence on valuation. The introduction of the aircraft maintenance company to a wide array of new clients could lead to the offering of additional services, but quantifying their exact value proved intricate. To address this, we formulated a spectrum of assumptions, ranging from conservative to optimistic, to grasp their potential valuation impact.
All of this transpired within a brief ten-minute window during our phone conversation. Throughout our dialogue, we meticulously scrutinized numerous other factors and their corresponding influence on the valuation. This type of conversation is standard practice for us during our valuation process. For the average client, we meticulously evaluate a multitude of factors that hold the potential to significantly sway the valuation of their business.
Frequently, business owners stand at a crossroads, compelled to choose between divergent paths with far-reaching implications for valuation. This is precisely why a valuation cannot be isolated from its context. From my perspective, conducting a valuation necessitates two critical components: 1) a wealth of real-world experience in buying and selling businesses, and 2) the direct involvement of the business owner. Unfortunately, third-party appraisals lack both of these pivotal elements.
A profound comprehension of the actual marketplace is pivotal in both gauging a business’s value and effectively conveying that value to you, the business owner. In the realm of small- to mid-sized businesses, a plethora of strategies exist to potentially facilitate a company’s sale, each with the potential to exert a substantial impact on its valuation.
Are Third-Party Appraisers Really Unbiased?
A dynamic unfolds wherein the broker maintains an ongoing affiliation with the appraiser. In this scenario, a pertinent question arises: What transpires if the appraiser assesses the business at a lower value than expected? Does the rapport between the broker and appraiser remain unaltered? In one instance, during my tenure of selling third-party appraisals more than a decade ago, I contacted an appraiser to inquire about the rationale behind a specific valuation multiple assigned to a recently appraised business. To my astonishment, the appraiser swiftly escalated the multiple without hesitation, and promptly reissued the report, seemingly striving to expediently conclude our interaction.
Is it True There is a Correlation Between Businesses That Have Been Appraised and the Percentage of Asking Price Received?
Certain brokers have asserted statistics like, “We achieve a 97% asking price for businesses that obtained a third-party appraisal,” or “Businesses with third-party appraisals sell at an accelerated pace.” While a correlation might exist, the question of causation arises. Could it be that owners willing to invest in a third-party appraisal are inherently more committed, prepared, or serious? Alternatively, could the influence of the appraiser lead to more realistic pricing? Furthermore, could similar outcomes be achieved without third-party appraisals? There is no conclusive evidence of causation, rendering such claims questionable at best.
Our suggestion is to collaborate exclusively with brokers who conduct valuations in-house. If a broker proposes a third-party appraisal, insist on engaging directly with the appraiser and covering their fee. Nevertheless, it’s wiser to seek guidance from a seasoned broker with hands-on market experience. Invest only in advice from someone truly acquainted with real-world dynamics.
The specific appraisal format matters less than the advisor’s experience. Greater experience leads to better results. Remember the adage, “You get what you pay for.” In the case of third-party appraisals, you receive what your broker invests in. Your journey to this point has been hard-earned. Don’t squander value by outsourcing a crucial process to a third party with no market expertise and no direct interaction.