Worth Its Weight in Gold

Valuing your business to get top dollar

By F. Daniel Pharr, CPA/ABV, CVA

(Originally Published by MJSA September 2024)

In the distant past, jewelry manufacturers, suppliers to the industry, wholesalers, distributors, and retailers generally did not have to be concerned about selling the family business. The key term in the previous sentence is “family.”

The business typically would be hand-ed down or sold to the children or, in some cases, the nieces and nephews of the owners, just as would have been done for generations.

However, for the last generation or two, the children and other relatives have chosen not to be in the family business. They wanted to do something else.

When this happens Mom and Dad have to look at other alternatives. While owners have options—selling it to an employee or to another company interested in expanding, for example—they first need to find out how much the business is worth. They may think they know their business’s worth, but having it analyzed and valued by an independent third party is the best way to arrive at a fair (and realistic) selling price.

Valuing Your Jewelry Business

If you find yourself in this situation and decide to sell your business, the first step is to have it professionally valued. A business valuation is an unbiased and independent appraisal of a business or business interest. While you may not sell your business for the exact value given in the final business valuation report, it provides a starting point and helps you understand whether you are getting a fair price.

The valuation should be performed by a person with business valuation credentials, such as the Accredited in Business Valuation (ABV) (awarded by the American Institute of Certified Public Accountants) or the Certified Valuation Analyst (CVA) (a certification awarded by the National Association of Certified Valuators and Analysts).

Ideally, you should work with an analyst experienced in valuing jewelry companies. Although hiring a professional can be expensive, if you follow their advice, you should get your money’s worth.

Once you’ve selected a valuation professional, they will conduct a thorough and detailed examination of the business with you and request documents such as financial statements, tax returns, and other pertinent data.

Determining the Standard of Value

The analyst will determine the standard of value; fair market value and strategic value are the most common standards of value I use with my jewelry industry clients.

Fair Market Value: This is the price, expressed in terms of cash or cash equivalents, at which property would change hands between a hypothetical willing and able buyer and a hypothetical willing and able seller, acting at arm’s length in an open and unrestricted market, when neither is under compulsion to buy or sell and when both have reasonable knowledge of the relevant facts. In addition, the hypothetical seller and the hypothetical buyer must be in a pool that has the ability to exercise the right.

This method considers valuation discounts such as a marketability discount and others. Closely held and family-owned businesses, by definition, are non-marketable. Public companies such as Signet Jewelers, the stock for which is traded on the New York Stock Exchange, are considered marketable. When selling shares of stock on a stock exchange, you have a good idea of how much you will receive and what the transaction costs will be, and the funds will be in your brokerage account within three days.

In a family-owned or closely held business, you do not know what the business will sell for or what the transaction costs will be. Finding a buyer, agreeing to terms, and getting the deal closed and the money in the bank can easily take from three months to a year. This discount accounts for costs, unknown time, and other variables. The marketability discount is an approximately 12 to 25 percent subtraction from the total value.

This approach is often used when seeking a buyer through a broker of other entities. (While not discussed in this article, fair market value is required by the Internal Revenue Service in connection with business valuations being prepared for gift and estate tax matters.)

Strategic Value: This is similar to fair market value except it involves a specific buyer instead of a hypothetical one. Generally, valuation discounts do not apply. This method is used when selling to someone like an employee, who has a thorough working knowledge of the business, or others who have approached you to buy the business.

Valuation Approaches and Methods

After determining the standard of value, the valuation professional selects the best approach and related method.

The Asset Approach

This approach uses the adjusted net asset method, which adjusts the values of the assets to their real value rather than their book value. For example, inventory that is new to less than a year old will be valued at cost, while older inventory will be discounted based on its age, with old inventory being given a higher discount and newer inventory given a lower discount. A buyer will not pay full price for old inventory. The other assets would be valued and discounted based on the type of asset. Liabilities would be reviewed, although liabilities generally do not need to be adjusted.

The adjusted net asset method determines the value by subtracting adjusted assets from liabilities. This method is generally considered a “floor” value for a company.

(There are two other methods for an asset approach: the net asset method, where no adjustments are made, and the liquidation method, where the assets are valued at liquidation value. These two methods are generally not used.)

The Income Approach

This approach determines the value based on anticipated cash flows, using one or more methods whereby a value is determined by converting anticipated cash flows into a value of the company. Valuation methods under the income approach generally contain common characteristics such as benefit streams, discount rates, and/or capitalization rates. The methods most commonly used by business valuation professionals when valuing small- to medium-sized companies include the capitalization of earnings method and the discounted cash flow method.

• Capitalization of Earnings Method: This method uses adjusted cash flows over the previous five-year period and applies a capitalization rate to each year’s cash flow, giving more weight to recent years. The values are added together, and then any appropriate valuation discounts (such as a marketability discount) would be applied to arrive at a conclusion of value.

• Discounted Cash Flow Method: This method estimates projected cash flows for five years, based on discussions with the owner or owners, industry research, and database information supplied from various research companies. A discount rate is applied to each year’s cash flow, with more weight given to recent years. A terminal value, which is the long-term component, is calculated and added to the five-year calculated values. The appropriate valuation discounts are then applied to arrive at a conclusion of value.

The Market Approach

Based on the principle of substitution, this approach values a business based on how similar businesses are valued in the market by looking at comparable sales in the general area, which may be as small as a city or region of the country or as large as the whole United States. This depends on the number of similar transactions that can be found. This approach looks at the sale prices, size, and other attributes of companies of similar sizes, industries, markets, and so on and uses those to estimate the value of your business. Due to the variations in company size, makeup, location, and lack of timely, sufficient, and appropriate data, this approach is less commonly used for jewelry businesses.

Combining Methods for Accurate Valuation

The determination of the company’s value is based on the values derived using the above methods. Ideally, the valuation analyst will select the method deemed most appropriate. However, for jewelry industry businesses, using a combination of two methods often provides the most accurate value.

For example, using the adjusted net asset method generally returns a value less than the company is worth. The capitalization of earnings and discounted cash flow methods often give values that are too high. Weighting the adjusted net asset value and one of the income approaches gives the most appropriate value. I generally give each method a weight of 50 percent, but depending on market conditions, the economy, and the company’s attributes, I may use between a 60/40 percent weight to a 40/60 percent weight.

Once the value has been determined, you will have a reliable reference point for setting a realistic selling price for your company. Selling your family business that you have worked in for many years, and possibly many generations, will be difficult and stressful, so start early, choose trusted professionals, and remain as objective as possible.