If you ask a business appraiser why clients show up, you will hear that there is some type of business transaction that drives the need for business valuation.
Rarely do business people spend money on a business valuation just out of curiosity. The situation is similar to getting your personal or real property appraised.
Why appraisals are essential – avoiding asset overpricing or underpricing
If you are looking to buy or refinance your house, you would need to appraise the property to get the loan or make sure the asking price is realistic. Your lender would want to know that the house offered as a collateral for the loan is worth the money. As well, you would want to know that the asking price for a house you are considering is in line with the market rates.
If the price is right, you can feel good about making a fair offer. If not, especially in the case of for sale by owner or FISBO sellers, you may need to resort to negotiating the price if you still want the house. Your ability to convince the seller to come to a reasonable compromise can make or break the deal.
Either way, there is tension in the air as the buyer and seller come from two opposite directions. The buyer wants to pay the lowest price possible. The seller looks for the highest selling price the market will bear. It can get quite intense in the heat of negotiations.
Overshooting the asking price can land the seller in trouble as the house languishes on the market with no serious offers. Buyers get a sticker shock and look elsewhere. The overpriced house does not sell, until the seller comes around and lowers the price.
On the other hand, the valuable asset that is seriously under priced may fly off the shelf, but leave sour taste in the seller’s mouth. Just consider all that money left on the table.
The situation gets even more serious with business valuations. For one thing, businesses do not sell nearly as often as homes or cars. In addition, no two companies are the same. Just finding the right buyer for a business is a major project.
Dumb money in business buying – how to wreck successful companies
Anybody with money can in theory buy a house and occupy it without difficulty. But assuming that any buyer with money is a good candidate to buy your business is a bad idea. Whether the buyer is capable of taking over the company is by no means obvious. You may see your life’s work driven into the ground by an incompetent new owner shortly after the business sale.
Reserve seller financing for qualified business buyers
This concern over the future prospects of the business is one key reason business owners are reluctant to offer seller financing. A chunk of the business selling price may depend upon the new owner’s ability to run the business successfully after the purchase. If they fail, the seller is out of money and often needs to regain control of a failing company.
So in addition to business valuation, transactions often require due diligence to maximize the chances of successful ownership transition.
A solid business appraisal is very helpful here. In your business valuation report, you describe your company, its value drivers, competitive position, and future prospects. Your buyer candidates need to understand what they are up against if they decide to move forward with an offer.
No 1 reason for business failure – under-capitalization
The business selling price and terms are key to a successful sale. One important question that must be addressed is whether the new owners have sufficient capital on hand to both fund the purchase and cover the cash flow needs for operating the business. Under-capitalization is perhaps the greatest danger the new business owner faces.
If you want your business appraisal to be taken seriously, you should consider compliance with a major appraisal standard, such as the USPAP. The Uniform Standards of Professional Appraisal Practice govern valuations of all kinds of property – including real estate, business personal property, and business enterprises.
Creating trustworthy business valuations
The reason USPAP exists is to promote public trust in business valuation results. If your appraisal follows the guidelines of this venerable standard, chances are your clients and anyone else reading your valuation report would feel comfortable that the conclusions of value are based on sound, well reasoned thinking.
While some jurisdictions may require that your business valuation comply with USPAP, the standard by itself is not enforced by law. Business valuation experts and seasoned business people may opt for a USPAP compliant business valuation whenever they anticipate challenges to their conclusions, or feel the added credibility of a professionally done business appraisal is called for.
In some situations, compliance with a standard may be mandatory. Examples include business valuations required by lenders, courts, or tax authorities.
So what does it mean to create a business valuation that measures up to the USPAP requirements? Here is the list:
- The appraiser must be prepared by an independent party who is competent in valuing businesses.
- The appraiser must gather and maintain all the supporting information used in business valuation.
- Your valuation must be done in accordance with the major USPAP Rules: Ethics Rule, Competency Rule, Scope of Work Rule, and Record Keeping Rule.
Rules of the game: Ethics, Competence, Scope of Work, Accurate Record Keeping
The Ethics Rule is made up of three parts: conduct, management and confidentiality.
Your business valuation should be done in an impartial, objective way, and be independent of any personal interest. For example, you should not stand to benefit from a certain business valuation result, such as a higher or lower valuation.
If you are hired to do an appraisal by a client, you should disclose that you are paid to do the work. In addition, you should seek to protect your client’s confidentiality by not disclosing the business valuation data or results to anyone other than the intended parties.
Reselling client data violates the USPAP Ethics Rule
Be sure you or your service providers do not try to profit from reselling the client’s data. This is strictly in violation of the USPAP Ethics Rule! If you are using Web-based software vendors, check to make sure they don’t resell your client’s data without permission.
Under the Competency Rule, the business appraiser must possess the necessary skill and experience to take on a business valuation assignment. Business appraisal calls for serious financial analysis. If you do not have the know-how, you should bow out.
To meet the Scope of Work Rule, you should clearly state what you intend to do in your business appraisal. The amount of information gathering, research, and analysis you do should be clearly stated in your business valuation report.
The Record Keeping Rule requires that you keep the complete records of what has been done in the course of your business valuation engagement. Some elements your records must include:
- Identity of your client and anyone else who will be receiving the business valuation report.
- Copies of written reports.
- Synopsis of any oral communications with your client.
- All data you have gathered in the course of your business valuation engagement.
It is a good idea to retain the documents for some time. USPAP Record Keeping Rule calls for a 5 year retention on all completed appraisals. Watch out – mishandling the documents or failing to produce copies on demand could invalidate your business appraisal and put you in violation of the USPAP Ethics Rule.