There is a big difference between a casual check on business value and a professionally prepared business appraisal. Out of curiosity business people may run a quick and dirty calculation to ball park the value of their ownership interests.
But when business people approach their professional advisors for help, business valuation takes on a whole new meaning. If you take your client’s money and promise to come up with a reliable opinion of business value, you got to walk the talk. In a close working relationship, the client expects a reliable, accurate result from their trusted professional advisors.
Reasons for professional business valuation
Why would business people seek professional help with their business valuation? Usually they face a challenge and the stakes are high. Some common scenarios:
- M&A transaction such as business sale, purchase or merger with another company.
- Divorce or other legal disputes.
- Tax issues including gift and estate taxes.
- Partner buyout or buy-sell agreement.
- Management transitions such as ESOPs (employee stock ownership plans).
- Equity financing by venture capital or private equity groups.
- Lender financing for business expansion.
- Strategic management decision making.
In these types of situations business owners and managers expect to rely upon the business valuation results to make critical decisions. Needless to say, they expect nothing short of perfection from their business appraisers.
Credibility and business appraisal accuracy
Business valuation is a pretty well mapped out field with established principles behind the process of getting a business appraised. Ways of measuring business value in a free market economy are well defined by now and known among the professional community of appraisers, courts, and tax authorities.
If you ask two different appraisers to value a given company, they are likely to come up with the results that fall within a narrow range of each other. Why such accuracy? Because the appraisers are quite familiar with the methodologies that stood the test of time. Professionals apply them to the problem at hand with amazing consistency. You are unlikely to see differences in excess of 10% between well run business valuations.
Standards compliance – passing muster in the business valuation industry
The business appraisal profession has adopted a set of standards to ensure this remarkable consistency of results and enhance their credibility. The central standards everybody in the field knows about are these:
- USPAP (Uniform standards of professional appraisal practice).
- AICPA SSVS No 1 (Statement on standards for valuation services).
- IVS (International valuation standards).
These standards are pretty detailed and cover the accepted valuation methodology, ethical rules of conduct, formats for reporting the valuation results, and just about everything else. Yet the frameworks the standards define are quite flexible. Things like the purpose of business appraisal and intended audience can make quite a difference to what the finished valuation report looks like.
A level of detail sufficient for the business owners with deep understanding of the company’s fundamentals may not work if the valuation report is put in front of an outside investor or business buyer.
There is always tension between the scope of work and the amount of money the clients are willing to spend to get the most accurate result. The standards require full disclosure to the clients of what was done and even encourage the appraisers to forgo a project they believe cannot be accomplished on a client suggested budget.
Custom tailoring your business valuation – approaches and methods
There is a reason business valuations usually involve the use of multiple methods under the asset, income, and market approaches. Each method tells a different story of what drives business value. So using several methods in your analysis gives you a systematic way to cross check your results. If your calculations generate numbers that are all over the place, it is time to review your assumptions for errors and omissions.
In addition, choosing the best set of valuation methods is a great way to customize your valuation to each project. For example, imagine that the subject company is a pioneer in an emerging market segment and has no real competitors at the moment. Running a market comparables valuation is not likely to be helpful in this case. Your valuation should focus on the intrinsic value analysis of the company under the income and asset approaches.
The asset accumulation method is an excellent choice when valuing asset-rich manufacturing or distribution companies. It is not as compelling when it comes to appraising a professional practice with few tangible assets and considerable business goodwill.
Here the capitalized excess earnings method is probably a better choice. You could help the business owners determine how to structure an earnout arrangement in the event of a practice sale. Transfer of business goodwill is often a challenge in professional practice sales and requires an understanding of the difference between the institutional and personal factors involved.