Business Appraisal - A Profits Method of Valuation

A business appraisal is called for when the business is to be sold, business ownership interest is gifted or transferred as part of an estate, addition or departure of business partners, legal separation of business owners, or for business financing purposes.

Typical business appraisal recipients are business owners and buyers, commercial lenders, investors, tax authorities, legal professionals and courts.

Certain properties are bought and sold on the basis of their trading potential and in such circumstances, it can be appropriate to use a profits method of valuation. Examples (whilst not an exhaustive list) include hotels, pubs and bars, restaurants, nightclubs, petrol stations, care homes, casinos, cinemas and theatres, and various other forms of leisure property. The essential characteristic of these types of property is that they have been designed or adapted for a specific use. In many instances, there is also some form of licence, certificate or statutory consent registered against the premises that distinguish it from more mainstream commercial property. The value of the property interest is intrinsically linked to the returns that an owner can generate from that use and thus the value reflects the trading potential of the property.

The profits method of valuation involves the following steps:

• An assessment of the fair maintainable trade (FMT) and fair maintainable operating profit (FMOP) that could be achieved at the property. This is ascertained by making reference to recent trading information for the business (ideally profit and loss accounts for the last 3 years).
• When assessing future trading potential, the valuer should exclude any turnover and costs that are attributable solely to the personal circumstances, or skill, expertise, reputation and/or brand name of the existing operator (i.e. personal goodwill). However, the valuer should reflect additional trading potential.
• To assess the market value of the property the FMOP is capitalised at an appropriate rate of return reflecting the risk and rewards of the property and its trading potential. Evidence of relevant comparable market transactions should be analysed and applied.

It is important that the valuer is regularly involved in the relevant market for the class of property, as practical knowledge of the factors affecting the particular market is required. This assist in the analysis and review of trading performance.

The valuer’s assessment of FMT and FMOP may be above or below the recent trading history of the property. It reflects a range of factors (such as the location, design and character, level of adaptation and trading history of the property within the market conditions prevailing) that are inherent to the property asset.

 If the valuer decides that an incoming operator would expect to improve the trading potential by undertaking alterations or improvements this will be implicit within the estimate of FMT. In such instances, an appropriate allowance should be made to reflect the costs of completing the alterations or improvements and the delay in achieving FMT.