Mind the gap – shaping valuation expectations
Machinery and equipment (M&E) appraisers, like all appraisers, expect that most business owners will be disappointed with our valuations.
Many times, however, the gap between the appraiser’s valuation and the business owner's expectation of that valuation is due to a misunderstanding – and miscommunication – of what is actually being included in a given assignment.
What the business owner sees
Understandably, business owners tend to view machines as investments or financial calculations: “I spend $X on a machine and gain $Y in output capacity.” As such, they view all costs associated with purchasing a machine as part of its value.
Consider this hypothetical investment breakdown for a new CNC machine:
$250,000 – base machine
$40,000 – custom fixtures and tooling
$40,000 – standard fixtures, tool holders, machine accessories, etc.
$10,000 – concrete and room improvements
$10,000 – electrical and water/air plumbing improvements and hookups
$10,000 – rooftop exhaust and HVAC improvements
$10,000 – software program and order tracking integration
$10,000 – part-loading jib crane
$10,000 – OEM service contract
$10,000 – freight, rigging, millwrighting, calibration
Based on this, the business owner expects the starting point for appraising the CNC machine to be $400,000.
What the appraiser sees
As we often discuss, every appraisal has unique parameters based on the intended users and uses of the results:
If appraising for a business acquisition where the intent is to utilize the assets in-place, for example, all costs could be considered as a starting point for valuation. The buyer would benefit by not having to re-incur any of the original costs. In this scenario, the appraiser's starting point for valuation would be $400,000.
If appraising for a business acquisition where the intent is to relocate the assets to another existing operation, the physical installation costs will not be included. Costs such as concrete improvements, utility hookups, and calibration are one-time expenditures. They will all need to be re-incurred by the buyer, so the seller will not receive any credit for them. In this scenario, the starting point for valuation is $360,000.
If appraising for collateral value for a loan, then the physical installation and the intangible costs are both excluded. If a bank seizes and liquidates M&E assets, they will typically be sold piecemeal for removal by outside parties. As such, the physical installation costs noted in the previous example are excluded once again. In addition, custom fixtures and tooling are usually not credited, or at least not for much. These assets were specially designed for one company and are probably scrap to most other companies. Integration software is not credited; it is custom and licensed and will not transfer to an outside business. Service contracts would likely need re-engaged or renegotiated by the asset buyer; they may even be more expensive since the buyer is not the original purchaser. In this scenario, the starting point for valuation is just $300,000.
Starting and finishing
When there is a misunderstanding of the starting point for a valuation, the natural gap in value perception between the appraiser and the business owner will be compounded at the finish line.
In the example above, the appraiser and business owner could face a 25% discrepancy before the appraisal even begins. After the usual differences in perception of asset condition and marketability, the final valuation may be so far below expectations that the business owner loses trust in the appraiser altogether.
This is why it’s critical for the appraiser to educate the appraisal client and intended users regarding key valuation factors. These topics can be addressed twice: initially in the pre-assignment proposal and scoping communications, and again in the appraisal report.
Open and up-front discussion about valuation factors such as M&E cost inclusion will help ensure that both parties start the process on the same page – and therefore help minimize how far apart they finish.