Business valuation under calculation and valuation engagements

If you are interested in getting a high quality business appraisal but want the flexibility of choosing how it is to be done, then the recent AICPA SSVS No 1 standard is a good starting point.

In addition to offering you a number of guidelines on how to value a business or professional practice, the standard offers several ways to get the job done. Not all business appraisals need to be prepared using all the available valuation methods and procedures. In some cases, such as a management advisory for business expansion or outside financing, business owners can opt for a simplified format that includes specific valuation methods while keeping the resulting valuation report concise and easily accessible for laypeople.

Two ways to value a business under AICPA SSVS No 1 Standard

The AICPA SSVS No 1 standard helps you make such decisions at the outset. There are two main formats you can choose from:

• valuation engagement.
• calculation engagement.

Valuation engagement: all decisions made by the appraiser

The valuation engagement takes place when the professional adviser is in charge of selecting all the valuation methods and procedures deemed appropriate. The client does not have a say in which ones are picked or why. The appraiser prepares the valuation and reports the conclusions in a formal business appraisal report that is then presented to the client. The report is usually lengthy and includes an explanation of the choices the appraiser has made.

Calculation engagement: appraiser and client work as a decision making team

Things are different if you decide to follow the calculation engagement framework. Here, the appraiser and the client agree on a certain number of methods to calculate the company value. What these choices are and why they have been made can be put into the agreement between the client and the appraiser. This gives the client an idea of what to expect and limits the scope and cost of the work.

In a sense, the client and appraiser work as a team to customize the business valuation. For example, you may feel that your own knowledge of the market is sufficiently deep to be accepted as a given. No need to expend the appraiser time on extensive market research. Here a full scope valuation may be an overkill. You can settle for a concise analysis of business value based on your knowledge of the market that the appraiser takes as an input.

This flexibility in choosing the best way to go about your business valuation is a major boon to both the client and the appraiser. With key points agreed on up front, you know what to expect. The appraiser has fewer choices to make especially in the areas where the client’s knowledge is much more extensive.

You can expect the time and cost of preparing a calculation engagement appraisal to be considerably lower than what a full scope valuation would call for.

Report your business valuation as a single number or a range of values

Regardless of which approach you choose, the resulting business value can be reported either as a single number or a range of values. This is yet another point the SSVS No 1 standard makes clear – business value is not a mathematical certainty, but an educated guess. The actual business value may be somewhere in the range depending upon the ever changing market conditions, or circumstances of a particular business sale.

Valuing a business with intangible assets but no income

It goes without saying that the best way to value a business is based on its earnings. But what about companies that currently do not generate income, e.g. due to a temporary closure? Surely, there is some value in all those assets the company controls?

This is indeed the case. If the income stream is insufficient or stops for some reason, you may want to review the values of business assets.

Consider a restaurant that has been closed by its current owners temporarily. Even without income, there are some assets that may prove highly valuable once the business re-opens its doors. Among the most common are the liquor license, conditional use permits, special entertainment licenses and the like. Given the limited number of liquor licenses granted, such an asset is very valuable, especially to a prospective business buyer who will not need to struggle in order to obtain a new license.

But what is the best way to value such assets and how does this differ from valuing an entire company? When an operating business is being appraised, you would usually be less concerned about the values of individual assets. After all, all these assets are used to generate business income. So by focusing on the income stream and business risk, you can determine the overall business value. This, of course, would include the values of all the assets together.

This is the example of valuing a business with its assets in use, committed to produce the income for the owners. If the business income cannot be readily assessed, then you need to resort to valuing assets piece meal.

One way to do this is to estimate the replacement costs for the assets in place. What would it cost the owners to go out and procure that liquor license? You should consider both up-front cost and time, i.e. lost business earnings. If you don’t have the license already, you may need to pay a premium to get one. Plus the time it takes to get a license is the time you can’t serve the customers. You can discount the income stream from such lost earnings to figure out the additional value the existing license represents.

The same argument holds for all the other valuable assets. It takes time and money to rebuild the assets needed to open a business and start generating income. One way to estimate the replacement costs is check the market in your area. Brokers usually have a good idea of the prices for each type of intangible asset as well as the time and effort needed to obtain one.

Once you have this information gathered together, you can estimate the total value of the assets in place and attached to an existing business. With that figure in hand, you can decide whether the non-operating business is more valuable than rebuilding the asset base from scratch.