Take a look at a professional quality business appraisal, and you will notice that business value analysis is done three ways. These are called business valuation approaches: asset, income, and market.
In addition, you will spot a number of methods each valuation approach offers. Business appraisers include a number of such methods into their business value analysis.
You would hope that the results of all these valuation methods would come close. They usually do, but the numbers are not identical. Some differences are to be expected, but if one or two of the methods produce results that are way out of line with the rest, you should view it as a red flag. An error in business valuation is often lurking somewhere in the details.
While it is permissible to report business values as a range of numbers, most business people still prefer to see a single value. You can see in our business valuation report sample how the results of several methods are reconciled to produce a single opinion of business value.
You might say that a well considered conclusion of business value is why an appraiser gets paid the big bucks. Valuations that are well supported and carefully thought through should fall within a close value range of each other. A rule of thumb in the industry is that most business appraisers would come to within 10% of each other.
That 10% is still enough to encourage some business people to push for a result at one or the other end of the range. In this regard the overly aggressive clients should be admonished against getting carried away. If you push the appraiser to come up with a number and it gets challenged by an adverse party such as the tax authority or the court, you may be looking at a failed business valuation that loses all credibility.
The key business valuation standard, USPAP (Uniform Standards of Professional Appraisal Practice) states that appraisers must be independent of their client and the business being appraised. Your appraiser cannot have any financial interest in your company and try to benefit himself or herself by coming up with a specific figure.
Think about it, would you or your partners trust a business valuation prepared by the appraiser who also happens to own part of the company? There is a major incentive to overstate the value and reap the benefits of selling such a business at an inflated price. Truly, caveat emptor!
USPAP standard requires that the business appraiser disclose any interest in the company being valued. If the appraiser fails to do so, it would be seen as a serious violation as the business valuation report readers are not made aware of a potential bias.
Unsurprisingly, the ethical standards under the USPAP preclude any such interest on the part of the business appraiser. When preparing a business valuation for a client, you should clearly state in your report if any such interest or other concerns that could influence your conclusion exist.
Another tricky element to watch out for is contingent compensation of an appraiser. The question here is: does the business appraiser get paid for the time spent on the engagement? Or is there an additional compensation incentive based on the business value conclusion? While many other professional advisors take on projects on a contingency fee basis, this is unacceptable for business valuations.
The reason is the objectivity required of business appraisals. While a lawyer is expected to act as the client’s advocate, business appraiser must stick to the facts and come up with an unbiased opinion of business value. In other words, your business valuation should not be influenced ahead of time to achieve a specific outcome.
Unlike a business broker, the appraiser cannot be paid based on the success of the deal. If it was the case, no reasonable business person would believe the business appraisal. The whole premise of coming up with a credible estimation of what a business is worth would go right out the window.
Business people need to know if they can rely upon business valuation in making strategic decisions such as buying or selling a company, approaching a lender or talking with the tax authorities.
Business appraisers must earn credibility. This rules out a sales pitch or a biased opinion aimed to deceive. Used car sales tactics may work well at a dealership, but have no place in professional business appraisals.
If you consult the USPAP Standard, you will notice that the appraiser’s fees must be based solely on the time spent on the engagement. Contingent payments or compensation based on the business value result are strictly prohibited.