Minimizing the Gap

Machinery and equipment (M&E) appraisers, like all appraisers, expect that most business owners will be disappointed with our valuations. I discussed in a previous article the way in which most of us tend to overvalue the things we own.

 Many times, however, the gap between the business owner's expectation and the appraiser's valuation is due to a misunderstanding of what is actually being included as “M&E” in a given assignment.

What the Business Owner Sees

Business owners tend to view machines as investments or financial calculations: “I spend $X on a machine and gain $Y in output capacity.” They view all costs associated with purchasing a machine as part of its value.

Consider this fictional-but-plausible 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

$400,000 – total cost / investment

The business owner expects the starting point for appraising the CNC machine to be $400,000.

What the Appraiser Sees

Every appraisal has unique parameters based on the intended users and uses of the results. Here are a few common appraisal scenarios for the CNC machine:

-         If appraising for a business acquisition where the intent is to utilize the assets in-place, 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.

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 integrate them with 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.

Removing these costs leaves the starting point for valuation at $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.

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 also licensed and will not transfer to an outside business.

Service contracts would need re-engaged by the asset buyer; they may even be more expensive since the buyer is not the original purchaser.

Removing these costs leaves the starting point for valuation at 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 here, 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.

It is the appraiser’s job to educate the appraisal client and intended users regarding key valuation factors. These topics can be addressed twice: first in the pre-assignment proposal and scoping communications; and again in the appraisal report.

Open discussion about valuation factors such as M&E cost inclusion will help ensure that both parties start together, and therefore help minimize how far apart they finish.