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The importance of "paper" in business valuation The contents of your file cabinets can radically affect the value of your business When owners try to conduct a do-it-yourself business valuation, their inventory of assets often excludes the contents of their file cabinets, home to two significant types of assets: contracts and proprietary lists. Some contracts, such as affiliation agreements, generate direct income, while others (e.g., advertising) might not generate income per se but contribute to profit via cost savings. In addition, customer, subscription and other specialized lists have value and should be considered in any valuation of the business. Non-compete covenants. Agreements not to compete are unique in that their value lies not in adding to income or cutting costs, but rather in protecting existing revenue sources, cost savings or employment relationships. The importance of a noncompete agreement generally fades over time as the new owner gains goodwill. A valuator typically needs to account for the declining value of a noncompete agreement on a year-by-year forecasted basis, totaling the value of the savings or the value of the reduced loss of customers for each year. Sales or purchasing contracts. If you sell a product or service at a higher price to your contractual customers than to your non-contractual customers, the contracts have measurable value. Similarly, if you contract to purchase or lease a product or service at a lower price than you would have to pay without the contract, the resulting savings also have value. In acquisitions where a tax step-up is applicable, the value of such a contract can usually be amortized over the length of the contract. Employment contracts. Certain employment contracts, especially those that bind key employees to your company for a specified period of time, have significant value and can be essential to the new company’s future success. Valuation professionals base the value of such contracts on the cost to replace that person plus the time required for the new person to achieve the predecessor’s level of effectiveness. The valuator must determine how much each function the key person performs contributes to the value of the contract. Specialized mailing lists. Businesses often create highly specialized lists to advertise in particular niches or markets. A valuator might determine the value of such a list by a cost-to-replace approach or by an income approach based on the incremental income generated. The valuator also will determine how long the list took to create and how much research time the business expends each year to update the list. Customer lists. Customer lists are even more valuable than specialized mailing lists. Not only do they represent a quantifiable future revenue stream, they can be used as referral sources for new customers. Listed customers may also be valuable as potential advertisers or endorsers of the business’s products and services. To determine how valuable a customer list is, a valuator might conduct a historical study of customer retention to derive an annual attrition rate. The list gains value the longer the business is able to retain its customers. Subscription lists. Some businesses have subscription lists for their publications. Subscriber lists have some of the same advantages as customer lists and have the added advantage of potentially being sold or rented to other firms. Generally, market data is available to help quantify typical prices paid to rent or purchase such lists. Value enhancement. Depending on the nature of the company’s business, the worth of "paper" assets can radically affect the ultimate value. The fact that many business owners ignore or underestimate the contents of their files reaffirms the importance of involving a qualified professional and not settling for a home-grown valuation. Based in Mesa, Arizona, and serving closely held businesses in the East Valley, the Phoenix area and throughout Arizona, Schmidt Westergard & Company, PLLC, is an independent full-service tax, audit, accounting and business advisory firm focusing on the middle market. |
