You may wonder how a casual check on business value differs from a professionally prepared business appraisal. For instance, out of curiosity business people may run a quick and dirty calculation to ball park the value of their company.
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? Because 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 need valuation results they can use to make critical decisions. Needless to say, they expect nothing short of perfection from their business appraisers.
Credibility and business appraisal accuracy
Business valuation covers a pretty well mapped out field. Importantly, you need to follow established principles behind the process of getting a business appraised. Moreover, you have well defined ways of measuring business value in a free market economy. And the professional community of appraisers, courts, and tax authorities expect nothing less.
Let’s say you ask two different appraisers to value a given company. They will likely 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) now VS Section 100.
- 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. But the frameworks the standards define are quite flexible. For example, things like the purpose of business appraisal and intended audience can make quite a difference to what the finished valuation report looks like.
A brief description may suffice for the business owners with deep understanding of the company’s fundamentals. However, it will likely not work if you put the valuation report 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. The standards require full disclosure to the clients of what was done. Interestingly, they even encourage the appraisers to forgo a project they believe cannot be done on a scanty budget the client suggests.
Custom tailoring your business valuation – approaches and methods
There is a reason why business valuations usually call for 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 way to cross check your results. If your calculations produce 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 value analysis of the company itself. And the best tools for this are the income and asset approaches.
Consider the asset accumulation method for valuing asset-rich manufacturing or distribution companies. However, this method is not a good fit when it comes to appraising a professional practice with few tangible assets and considerable business goodwill.
Instead, take a look at the capitalized excess earnings method. For example, professional practice owners often need help on how to structure an earnout arrangement in the event of a practice sale. So you could assist your clients with measuring the value of the practice goodwill they can transfer to the buyer.