Valuation engagement vs calculation engagement – what’s in the name?
If you are preparing a high quality business valuation, standard compliance is very useful indeed. Business appraisals are governed by a number of professional standards with one of the most detailed being the AICPA Statement on Standards for Valuation Services or SSVS No 1 for short.
SSVS is a relatively new standard, at least when compared with the venerable USPAP that is well known not just in business valuation but in the real estate appraisal industry.
Authors of the SSVS standard studied the needs of clients and CPAs alike and came up with some new ideas. One such notion is the different formats of business valuation known as the valuation and calculation engagements.
Many business appraisers know that the scope and cost of a valuation project can vary dramatically depending on the needs of an individual client.
Does the client management team need to have a general idea of business value to file away for future reference? Or do business owners require a serious study of business value in order to raise essential capital for business expansion? Is legal challenge on the horizon? Do business partners consider buying out a retiring team member and need to know a fair market value of the partners’s ownership share?
All these reasons for business appraisal are very different and often call for a highly specialized valuation.
In many cases business owners approach their professional advisors with questions about business value but do now need a formal business appraisal. Imagine a meeting in your CPA’s office talking about your business value drivers and what you can do to increase your business worth going forward. Odds are you can hash out a very focused project with your CPA in order to get to the bottom of this question.
To save time and money, you may be willing to agree on a specific set of valuation methods your CPA will use to estimate the company’s worth. This may be enough for your purposes and has the big advantage of reduced complexity and cost savings.
On the other hand, some business owners may feel uncomfortable getting involved in choosing the valuation methods. Perhaps they would be concerned that some proverbial stones would be left unturned and important details missed if the owners roll up their sleeves on valuation. In such situations, the business appraiser is best left to make the right choices in order to determine the business value.
SSVS standard lets you make such decisions at the outset of your valuation project. Calculation engagement is defined as the limited scope appraisal where you agree with your advisor on the choice of valuation techniques to be used. Remember that there are three fundamental business valuation approaches, each offering you a number of methods.
Excluding any of the valuation approaches from your appraisal should not be taken lightly. Indeed, the USPAP standard frowns on such restrictions because a business appraisal could be too limiting and miss important insights. The standard requires that you explain why any one of the approaches is omitted from your analysis.
There are situations where it may be justified. Consider, for example, valuing an emerging technology company that is blazing a new path in the industry. There may not be any real competitors just yet to compare this company against. Hence, it makes little sense to use the market approach when valuing such a business. You can state in your business valuation that the market approach is not suitable and your appraisal would focus on the income and asset approach valuation instead.
The alternative is to let your CPA choose the methods used in valuation of the company. This is the essence of the valuation engagement under the SSVS No 1 standard. This hands-off handling of the project has its benefits – you provide the needed input in the form of business information to your professional advisor who uses his or her knowledge to structure the appraisal in the best way possible.
When in doubt as to which way to go, consider using the letters of engagement to outline your appraisal project. This way there are no surprises down the road, and the choices made early on help you manage expectations for both the client and the professional advisor.