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Factors to consider in purchasing or selling an appraisal business.

An appraiser may have spent a lifetime building a business and reputation to be proud of, and then decided it was time to sell. Another appraiser may have planned and saved to buy an appraisal practice after obtaining a designation. How is an appraisal business priced? What should a buyer pay? How can a deal be structured to minimize risk and maximize reward? Is buying a business like buying property? Is bank financing available?

Appraisers earn their living as experts on value. But technical training in estimating the value of real property has not necessarily provided appraisers with experience or expertise in pricing a business for sale or in arranging the purchase of a practice.

Over the past few years the authors have represented several clients as well as themselves in the purchase or sale of existing service-related businesses. Some of the more important considerations that should be a part of every negotiated contract relating to the sale and purchase of an appraisal business are discussed here. The first half of the article addresses the pertinent issues as they relate to valuation: prices paid for appraisal businesses, typical financing arrangements, and factors that make an appraisal practice particularly valuable. The second part of the article focuses on the legal issues to be considered by all concerned parties, centering on 15 provisions typically included in all contracts ranging from selecting a purchase price to establishing noncompete agreements. The article should help appraisers negotiate a business opportunity into a "win-win" transaction for both buyer and seller.


Purchase price

"You can name the price, if I can name the terms," said the wheeler-dealer. It is important to note that almost all small businesses sell for terms that are "soft" compared with real estate deals. There are a couple of reasons for this. One is that businesses are not easily financed by a third party, so most financing is undertaken by the seller, resulting in leveraged buyouts (as occurred in the 1980s).

The cash flow of a business amortizes a seller's loan. Most buyout terms do not extend beyond three to five years. Thus a significant aspect of a prospective buyer's negotiations is to model a payout from projected cash flow with which the buyer can live. If payments cannot be met after designating a living wage for a buyer, a basis is provided for downward adjustment of the purchase price.

The best terms are often flexible ones that create a win-win situation. Such terms may take the form of a minimum payment after 30% to 40% down against an earn-out as a percent of the gross for a period of time, or until a maximum price is met. This "flex" in the terms could be important if there is a serious business downturn, as occurred in several cities beginning in late 1989.

Another reason that terms often are advantageous to a buyer is that sometimes businesses are misrepresented. It is not possible to simply call in a property inspector before buying and be certain of what is being sold. If misrepresentation occurs, a term agreement provides leverage to a buyer to force renegotiation of the terms.

Buying or selling a service business involves pricing. Although a larger survey would be useful, we do have some data on prices paid for practices. According to this information, prices range from .25 multiplied by annual revenues to 1.4 multiplied by revenues. One of the lower prices of .5 multiplied by revenues was reportedly paid for American Appraisal, the nation's largest appraisal company, which sold several years ago and was reported to have $30 million in revenues at the time. The highest price was paid for the practice of one of the authors. The circumstances involved in the latter sale illustrate the wide price range and the crude revenue multiplier that is the usual measure used.

Most practices that sell are in the revenue range of $100,000 to $500,000, and the motive is usually retirement. The purchasers usually fall into one of two groups: associates of the owner or outside appraisers seeking to relocate in the first half of their careers.

A high-revenue practice will sell for proportionately less or sell on soft terms. It is simply not possible for most motivated buyers to afford to pay over $300,000 under any terms for a practice. When a price becomes that high, the principle of substitution suggests that a buyer has the means to "tough it out," build goodwill, and spend heavily on marketing. The best situation for an owner of a high-revenue practice is to have more than one qualified associate so the purchase obligation can be shared.

Financing and terms

Small businesses almost always sell for seller-financed terms. A typical arrangement is 25% to 40% down, with the seller carrying back a note for three to five years. This is a small-scale leveraged buyout financed by cash flow. The terms and the price will likely be modeled by a discounted future earnings in which a purchaser must decide what personal draw is required while the business is bought. Deals in which the terms are rigid sometimes run into trouble. We have been involved in renegotiating deals that became impossible for the buyer to fulfill. The better deals may include some fixed note payments and a percentage of gross future revenues with a cap and a time limit in the form of an earn-out provision.

What makes a practice valuable?

The question of what makes a practice valuable touches on the nature of goodwill and its preservation and nourishment. Service businesses have clients, files, databases, furniture, and computers. The biggest assets of a business, its employees and subcontractors, go home for dinner and can find another job before a sale contract can be drawn up. A large portion of what is sold is a reputation with the users of a business's services. Generally, commercial real estate appraisal practices are more valuable than residential practices, because residential lenders are a notoriously fickle lot and losing old clients or gaining new ones is easier.

The city in which a business is located will affect its value. If there are a lot of appraisers and the location is desirable (e.g., Hawaii, San Diego), then buying an established practice may be the preferred option because barriers to entry will be high. In some areas of the country, however, it is possible to simply get a business phone number and hang out a shingle. There is no need to pay someone else.

Good files and documentation increase a practice's value. If an owner has not already done so, some ways to "dress up a company for sale" are to cross-reference files, have an employee policy manual, have a good subcontractor contract, and include written forms and procedures to help a buyer truncate the learning curve and start making money right away. A good internal accounting system is also a must.

Discussion of typical financial ratios in an appraisal practice and how they can be used to increase the profitability of a business is beyond the scope of this article. It should be noted, however, that a major reason appraisal practices are sold by gross revenues as opposed to net profits is that the expense item ratios can vary widely. If a seller shows more favorable ratios it is possible to command a higher price.

A final point to consider is the noncompete agreement that is almost always a part of every small business sale. The goodwill of a service business is partly professional goodwill that accrues to the business and the name. A significant part of the goodwill of a professional practice, however, is personal goodwill. To get a good price for a practice it is necessary to transfer as much personal goodwill as possible. A buyer will not pay much if a seller is going to continue competing. Most practice sales require a seller to continue on some sort of contract arrangement for several months part- or full-time in the business to facilitate goodwill transfer. A seller should give careful thought to a noncompete clause. While there may be a way to hold onto a small part of the business or a few named clients, every concession a buyer makes in this area creates risk and means a lower price.


The following provisions and comments should be considered as part of any negotiated agreement and contract in the purchase and sale of an appraisal business. In the next section, 15 of the most common provisions Howard Berkson has used in his client contracts are outlined. Although this guide is not a substitute for legal advice, it forewarns appraisers of important issues.

Sale and purchase of assets

In legal terms, what is being sold is all the trade and other fixtures, furnishings, furniture, equipment, accessories, signage, and other personal property owned by the seller and used in connection with the operation of the business, including but not limited to those items attached here.

* Detailed list of computer equipment including the number and type of computers, software, and manuals; photocopiers; printers; telephone system; desks, chairs, filing cabinets, and office supplies; customer lists, customer files, supplier lists, supplier files, data, and records relating to the business; telephone numbers and telephone directory listings; unfilled orders and work in progress; all warranties enforceable by the seller, made by the manufacturer, supplier, and/or the vendor of any and all equipment and supplies.

* Dollar allocation of each asset (tangible and intangible). Proper allocation will provide a tax shelter (i.e., depreciation on equipment and amortization of covenant not to compete). It should be noted that goodwill is not depreciable.

1. Tangible: Includes value attributable to FF&E, unfilled orders and work in progress, receivables, and so on.

2. Intangible: Includes provisions for telephone numbers, covenant not to compete, nonsolicitation, goodwill, and so on.

3. Example:
Furniture, fixtures,
equipment $ 40,000
 agreement $100,000
Goodwill $ 35,000
Client list, data,
 and research
 material $ 40,000
Telephone numbers $ 10,000
Receivables $ 15,000

Total purchase price $240,000

* List of excluded personal property

Purchase price

The purchase price includes:

* All cash or installment (e.g., down payment, terms, prepayment, default)

* Earn-out provision (i.e., payment based on gross earnings over a period of time)

* Uniform Commercial Code (UCC) financing statement and security interest in the purchased assets

* Personal guarantee if promissory note involved

* Possible nonrefundable option period to properly observe the business

An earn-out represents a flexible way to pay for a business and can be a win-win situation for both parties. It is a form of leveraged buyout because the future cash flow of the business is used to buy a substantial part of the business.

This provision is favorable to a buyer because if he or she is caught in a recession, a big customer is lost, or the goodwill is not as good as it was touted to be there is some protection. Instead of paying a fixed high sum a buyer pays a percent of the future revenues for a period of three to five years, typically. Thus if a buyer has a few bad months of cash flow, he or she will pay a lot less for the business.

This provision can also be favorable to a seller in the form of a higher price. A seller's incentive should be to work together with the buyer to help the business grow. If it is a good business and a skilled, ambitious buyer, the seller may reap premiums above the asking price.

For example, assume a buyer purchases a business and pays 15% down and an earn-out of 10% of monthly revenues. There is a maximum earn-out period of four years and also a maximum amount for total payment for the business. Assume further that the business grew four times in two years, causing the business to be paid for in under three years. The seller gets his or her price, and the buyer finds out that the goodwill was worth paying for. Although there may have been some lean months, the purchaser was not hurt because the payments to the seller were smaller. Of course, if the purchaser had kept the revenues the same as they were when he or she took over the seller would have been paid less than half of the final price. The reality is, however, that buyers protect themselves from any downside of the business, and everyone shares in the positive outcome--a purchaser has a better business and a seller who accommodated a purchaser reaps a bigger profit. In the current volatile business climate, an earn-out provision is highly recommended.

Assumption of liabilities

In the assumption of liabilities, the question of what liens, obligations claims, and liabilities a seller is assuming as well as what the buyer is assuming must be asked. Typically, the assets rather than the stock are purchased to avoid liabilities associated with the corporation. A purchaser may want to consider a license to use a trade name. Whether the name is something of value (i.e., is it an asset with enough professional goodwill or is it mainly personal) should be considered.

Even when a purchaser buys assets he or she will probably assume some liabilities, such as an office lease, equipment maintenance agreements, and yellow page ad costs. A purchaser should therefore be aware of the details of these liabilities and specify which are being assumed.

Closing date

In terms of a closing date, when and where it is to take place must be determined as well as when possession and control transfer (e.g., before closing date?). In addition, prorations (e.g., work in progress, rent, utilities, service contracts, insurance, permits, licenses for operation of business) must be considered.

Special agreements

In a special agreement, the following points must be taken into account:

* Availability of the seller: Is the seller to stay on in the office for a period of time and as a consultant after leaving the office? The purchaser in such a case should be introduced through a letter by the seller and be introduced to the seller's clients through personal interviews.

* Access of the seller to appraisal reports held by the purchaser (limit to five years).

* Use of computer programs and files.

* Use of secretary and general office space.

* If certain clients insist on using the seller for certain assignments, it should be ascertained that there is an agreement to share in any revenue paid directly to the seller, and such revenue should flow directly through the company.

Representations and warranties

Representations and warranties should comply with the following conditions:

* They should be free and clear of all liens, encumbrances, and restrictions of every kind and description.

* The equipment sold should be in good working condition and order at the time of closing. The risk of loss, damage, or destruction prior to actual delivery and possession is usually incurred by the seller.

* It should be ascertained whether there are any judgments of record or any litigation proceedings either pending or to the knowledge of the seller threatened against or relating to the seller, the business, or the purchased assets, or any other matter pending that would adversely affect the purchaser.

* The financial representations made to the purchaser concerning the business, including the balance sheets, income statements, and tax returns delivered by the seller, should be true, accurate, and correct.

* The seller should not be in violation of any relevant federal, state, local, or other applicable laws or regulations related to tax matters, labor and employment relations, or real property appraisal.

* The seller shall attempt to preserve the seller's present relationships with suppliers, customers, and other parties having business relationships with the seller, including but not limited to the employees/independent contractors of the seller.

A seller of a business should take a year or more to ensure that everything is shipshape and that any sloppy accounting is straightened out. If a seller has ever taken cash out or paid expenses "off the books," this is the time to get a true accounting. If an owner assures a buyer there is unreported cash, the buyer is going to discount it heavily. If expenses are overstated because of owner "perks," now is the time to economize and show what cash flow the business can generate. If expenses are underreported, a seller could be accused of misrepresentation and the deal to sell could unravel--or worse, the seller could be sued.

Relationships that add value to a business, such as relations with associates and subcontractors, should be strengthened if possible. Seller and buyer should sit down with each employee and contractor and discuss their concerns and needs. Informal relationships should be delineated in written form.

A CPA should prepare professional financial statements. A comprehensive historical perspective should be included. A purchaser will be concerned with allocations of all gross income, operating expenses, the number of jobs from any one client, and the number of jobs performed each month, among other things.

Operation of business prior to closing

In the operation of a business prior to closing, the following procedures are necessary:

* The business should be operated in accordance with current business practices and all purchased assets must be maintained in their present condition and in good working order or repair.

* Salaries should not be raised, additional employees or independent contractors should not be hired, and bonuses or other benefits should not be granted to or for any of a business's employees, officers, or agents without the prior written consent of the purchaser.

* No sales of purchased assets should be undertaken.

* All of the insurance covering the purchased assets should be maintained in force.

* The strengths and weaknesses of the seller and key employees or independent contractors should be analyzed. Employment contracts may be considered to ensure a smooth transition. Every person involved in the business should be personally interviewed as to their future plans.

* Lease should be secured by purchaser (the effect of assignment or subleasing should be considered).

* Necessary permits and licenses must be secured.

* Premises should be inspected prior to closing.

In addition, a letter should be sent to all past and present clients and other associates and friends of the seller to introduce the purchaser. Personal appointments should be scheduled on an as-needed basis.

Destruction or damage

If, prior to closing, purchased assets are destroyed or materially damaged (i.e., damage fairly estimated to cost $500 or more to repair), then the seller must repair them so that their condition is the same as at the date of the agreement. If damages cost less than $500 to repair, the transaction will still close, and the purchaser shall be entitled to settle any loss with insurance carriers and to receive the proceeds of all insurance applicable to such a loss. The seller must also pay the amount of any deductible portion on demand by the purchaser.


Notice of default should be given and the type of default should be disclosed. With a notice to cure, a nondefaulting party shall have the right to terminate the agreement and the right to pursue all remedies available to it at law or equity.

Brokerage commissions

The parties should represent and warrant to each other that they have not dealt with brokers in connection with the sale and purchase of the business, if this is the case.

Covenant not to compete

A covenant not to compete should entail a reasonable time period and geographic scope, and penalties should be itemized (i.e., first-year payback 100%; second-year payback 80%; third-year payback 60%). A typical covenant is five years with defined geographic boundaries.

In a service business the covenant not to compete is critical. In some cases, sellers remain for two to six months to ensure a smooth transition and transfer of as much of the personal and professional goodwill as possible--then depart. In many successful transitions, however, the seller stays for years, often gradually easing off to a part-time advisory or consultant role.

It is important for a buyer and a seller to carefully work through this part of the sale. Often this is psychologically wrenching for a seller. Some think they can sell their businesses for good prices and continue to do what they have been doing. A sale will not work unless a seller is willing to transfer the work relationship that has been built with clients. If a seller still wants to work it will be necessary to carve out a new customer base and a new niche--and the buyer will have the upper hand in determining what that different role will be.

Payments over the life of a covenant not to compete are ordinary income to a seller and tax deductible expenses to a buyer.

Nonsolicitation agreement

A seller should not directly or indirectly divert, solicit, take away, or interfere with any customers or clients of the purchaser or the seller for which the seller performed work or solicited during the time and within the agreed on geographic scope.

The business should be defined. If it is defined as the performance of real estate appraisals, does this mean that a seller can continue to consult for clients in varying capacities (e.g., negotiate loans for them, do feasibility studies, do expert testimony work)?


A purchaser and a seller should agree to indemnify, defend, and hold each other harmless from and against any and all loss, liability, damage, cost, and expense (including reasonable attorney fees and costs) each may suffer, sustain, or incur by or in connection with any misrepresentation or breach of warranty or agreement by each other relating to business relationships, activities of business, or purchased assets.


An agreement should be binding upon, and inure to the benefit of, the parties and their respective heirs, executors, administrators, successors, and assigns. No party should be able to assign any of its rights or obligations under an agreement without the express written consent of the other party.

Howard C. Berkson, MAI, is president of Real Property Appraisers & Consultants, Inc., a full-service appraisal firm in San Diego, California. Mr. Berkson received a BS in business administration, with a major in real estate, from Indiana University, and a JD from California Western School of Law, San Diego, California. He is a licensed attorney in the State of Illinois and District of Columbia Bars.

Margaret N. Singleton, MAI, is president of G.R. Bill Co., a full-service appraisal company. A member of the American Society of Appraisers, she teaches both for that organization and for the Appraisal Institute. Ms. Singleton has been a columnist on business valuation for Inc. magazine. She is continuing research on the expense and profit ratios of all appraisal firms as well as transaction terms for firms that sell. If you are willing to participate in a confidential survey on your ratios, please call her collect at 619-497-6000.
COPYRIGHT 1993 The Appraisal Institute
No portion of this article can be reproduced without the express written permission from the copyright holder.
Copyright 1993 Gale, Cengage Learning. All rights reserved.

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Author:Berkson, Howard C.; Singleton, Margaret N.
Publication:Appraisal Journal
Date:Jul 1, 1993
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