Why You Should, and When you Shouldn't, Pay for an M&E Appraisal Before Liquidating

Many small business owners may be contemplating liquidation in 2020, either independently (perhaps they want to retire and can’t find a buyer), or as compelled by creditors (perhaps they can’t service debts after losing revenue during the COVID-19 lockdowns).

Common sense dictates that if your business owns substantial machinery and equipment (M&E) assets, you need to understand the market value of them before deciding whether to liquidate. What’s not so clear is whether you should pay an appraiser or if you should save your cash and assess your M&E value in-house.

Human Nature

Appraisers and liquidators are very familiar (in practice if not in name) with the Endowment Effect, which is the tendency for us to overvalue our own possessions.

The Endowment Effect is what makes me think my stuff is better than your stuff even though it’s the same stuff. Everybody thinks their baby is the cutest baby; everybody thinks their house is worth a little more than their neighbor’s.

We experience this every day when buying and selling personal goods, but the risk of seller overvaluation is generally low: if your car sits in your driveway for too long without any offers, you can simply lower the asking price.

However, when deciding whether to liquidate a business, the risk of overvaluing your own M&E assets may be unacceptably high.

The Risk of M&E Overvaluation

Consider a small business with considerable M&E assets which is struggling to service its debts. Perhaps the business owner and/or primary creditor believe the best course of action is to liquidate the M&E and settle the debt for the cash raised, as opposed to refinancing the debt and continuing the struggle.

This decision is based on an estimate of the market value of their own assets (for the owner) or the assets of a borrower with whom they have a relationship (for the creditor). But what happens if their estimate is too high?

Unlike selling your car, liquidating your M&E is a one-way street. If the liquidation falls below expectations, you cannot simply reverse course and reopen your business. Your cash-generating assets may already be sold; clients will seek more stable vendors; suppliers will shorten payment terms; good employees will have found other work.

The best way to mitigate some of the decision risk - that is, to circumvent the Endowment Effect - is to engage an unrelated party. You must recognize that co-owners, creditors, and liquidators all have an interest in your business and/or your decision whether or not to liquidate.

It may be painful, but you need somebody to honestly assess and report on the cuteness of your baby. Independent appraisers have no stake in your business or your decision to liquidate; they can be truly objective.

When You Can Save Your Money

Clients frequently call and say, “I have to liquidate my M&E, so I need an appraisal.” While liquidation and appraisal often occur in tandem, the decision to engage either service is independent of the other.

If the SBA or another creditor requires an appraisal prior to liquidation, we are certainly happy to offer our services. But if you are not required by such parties to engage an appraiser, and you have already decided with certainty that you need to liquidate, an appraiser may or may not be needed.

Here are a few questions to help determine if you need to call an appraiser before beginning liquidation:

1. Do I have time flexibility?

If so, an appraiser may help you decide the most beneficial means of liquidation. Should you have an auction? Sell it yourself? Consign with a dealer? Some combination?

But if you have to liquidate now, the answer is auction or perhaps a short-term orderly liquidation, and the same firms can conduct either of these. You don’t need to pay an appraiser to tell you that.

2. Do I have a relationship with a liquidator whom I trust?

If not, an independent appraiser can give you informal referrals or advise you formally in the selection of a firm. Or, if you feel that your chosen liquidator’s pre-sale estimates are too conservative or aggressive, an appraiser can review them for reasonableness.

But if you have a reputable firm in mind whom you trust and you find their estimates reasonable, there is no reason not to work with them directly. You can always seek out competitive proposals from similar firms to ensure you are getting a fair deal – but make sure you’re comparing apples to apples in terms of service, professionalism, and marketing.

3. Are there potential disputes from other stakeholders?

If you are a sole proprietor, your attorney will likely have satisfied all settlement arrangements prior to the decision to liquidate. A UCC search should have been conducted to give you confidence that unexpected creditor claims won’t be coming down the road.

However, if you are going through a divorce or have absentee co-owners or other parties you fear will accuse you of intentionally selling assets for less than market value, you may want independent documentation of asset values from a party other than the liquidator.

(It's not uncommon for sellers to seek out unethical liquidators and request limited exposure with the intention of buying back business assets below market value.)

An independent appraiser can verify – and, if needed, testify – that your results were in line with the marketplace.

And As Always, If You Aren’t Sure…

Don't hesitate to call and discuss the situation with us or another independent M&E appraiser. Have a list of your major M&E assets handy, including makes, models, ages, and your original costs – a depreciation schedule with a little detail will suffice. The appraiser should be happy to give you and/or your advisors some free high-level feedback to guide your decision-making.

Tim Roy, ASA, Senior M&E Appraiser

Capitale Analytics

[email protected]