Business Valuations

INDEX (Click on a Category for Additional Information)

What is Value?
Control and Marketability Issues
Selecting a Business Appraiser
Reasons to Get a Business Appraisal
Commonly Used Business Appraisal Methods
Types of Valuations and Reports
Contents of a Comprehensive Business Appraisal Report
Litigation Support
Seminars
Frequently Asked Questions
Revenue Ruling 59-60 ("the Bible")

What is Value?

The word "Value" by itself is not very helpful. In business appraisal work, a number of different standards of value are often employed depending on the purpose and use of the appraisal. The following standards of value are the most common:

· Book Value is not really a standard of value. It is an accounting concept used to compute the difference between a company’s total assets and total liabilities. Due to the nature of the accounting process, book value would equal the value of a business only by coincidence. Intangible assets are usually not included in book value.

· Fair Market Value is defined as the price at which a business would change hands between a willing buyer and a willing seller when the former is under no compulsion to buy and the latter is not under any compulsion to sell, both parties having reasonable knowledge of relevant facts. It is generally also understood that the parties have has the ability to buy or to sell and the transaction will be in cash or cash equivalents.  In the United States, this value is the most widely recognized and accepted value related to business valuations. 

· Fair Value is the statutory standard of value usually used in court cases involving dissenting shareholders and other similar types of litigation.

· Liquidation Value is the expected amount that could be obtained from the piecemeal sale of business assets on either an orderly or forced liquidation basis.

· Investment Value is the value to a specific buyer or investor often based on perceived synergies when the business is combined with another business. This standard of value is often used in merger and acquisitions.

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Control and Marketability Issues

As part of the appraisal process, the business appraiser has to determine if a control premium, lack of control discount or lack of marketability discount is appropriate.  Many factors will effect whether or not a control premium, lack of control discount or lack of marketability discount are appropriate to apply to the business ownership interest being valued such as the standard of value, the valuation methods used, the purpose for the valuation, the nature and history of the company with respect to dividends and shareholders’ compensation, among others.

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Selecting a Business Appraiser

Most professionals, such as doctors, attorneys, engineers, dentists, etc. have clearly defined career paths that must be followed to enter their profession. Typically, a specific college program must be completed followed by some examination for licensing or other certification.

Unfortunately, the business valuation profession does not have a clearly defined path. No specific college major exists for business valuation, nor are there any governmental licensing requirements to prove minimum competency. Because of this lack of a specific career path and licensing requirements, many individuals with different backgrounds claim expertise and perform business appraisals often with poor results.

Business appraisers typically come from one of the following groups: certified public accountants (CPAs), business brokers, college professors, and stockbrokers. Without special training and business valuation credentials, none of the individuals from these groups are competent to do business appraisals. Very few individuals actually performing business appraisals have earned a professional designation from a recognized professional organization certifying business appraisers.

For years many assumed CPAs were competent in valuing businesses. In 1997 the American Institute of Certified Public Accountants (AICPA) established a special credential for business valuation called Accredited in Business Valuation (ABV) to demonstrate competence in business appraisal. This seems to indicate that the vast majority of CPAs nationwide have little or no training or expertise in business valuation. Another problem for CPA's is potential conflicts of interest.  In 1991, another organization called the National Association of Certified Valuation Analysts (NACVA), exclusively for CPAs, was also formed to give CPAs some training and a credential in business valuation called Certified Valuation Analyst (CVA).  However, only approximately "one percent" of the CPA's across the nation currently hold either of these two credentials in business valuation.

Business brokers sell businesses, but most have no training in business valuation. Often business brokers use generic rules of thumb to list and sell businesses. Also, many business brokers lack the financial expertise necessary to properly analyze a company’s financial statements.

College professors typically have expertise in financial theory and may be able to analyze financial statements, but they often try to apply sophisticated financial techniques designed for very large companies to small privately held companies. They also often lack the "real world" experience necessary to properly value most privately held companies.

Stockbrokers and stock analysts usually have the ability to analyze financial statements and understand public markets. However, they typically have no experience dealing with privately held companies.

In order to meet the need of demonstrating competence in business valuation, several professional organizations have evolved that certify business appraisers. Additionally, often a business appraisal is done because of some type of litigation. Historically, it was fairly easy to qualify an individual with a business background as an "expert witness." In 1993, this began to change. Now, trial judges are deemed to be "gatekeepers." Meaning that the trial judge has the ability to exclude experts if they do not meet appropriate standards. It is now more important than ever to ensure that an expert witness has the credentials and experience to survive a challenge. Otherwise, their testimony might be excluded in court, or perhaps, admitted but given little or no weight.

The four organizations in the United States that certify business appraisers are: 1) The Institute of Business Appraisers, Inc.; 2) the American Society of Appraisers; 3) the National Association of Certified Valuation Analysts; and 4) the American Institute of Certified Public Accountants. The table shown below compares and contrasts the requirements to obtain credentials from each of these professional organizations. Before you select a business appraiser, carefully review his or her credentials and experience. Generally, those who have obtained the more difficult credentials, such as the Certified Business Appraiser (CBA) from the Institute of Business Appraisers or the Accredited Senior Appraiser (ASA) in business valuation from the American Society of Appraisers, will do high quality work and be well regarded in court.

In summary, the Certified Business Appraiser (CBA) and the Accredited Senior Appraiser (ASA) in business valuation designations are the two most difficult designations to achieve in the business appraisal profession due to the rigorous peer review report requirements.

Our group views the report review requirement as the most important component of professional certification.  All members of the National Business Valuation Group have either the Certified Business Appraiser (CBA) and/or the Accredited Senior Appraiser/Accredited Member (ASA/AM) designation. 

Another professional designation exists specifically geared towards litigation support and expert witness testimony.  This designation is called Business Valuator Accredited for Litigation (BVAL).  It is awarded by The Institute of Business Appraisers after an applicant has taken a seven day class, passed a proctored examination, and submitted proof of two successful expert witness engagements or the equivalent.  A number of professionals in the National Business Valuation Group hold this designation. 

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Reasons to Get a Business Appraisal

There are many reasons why a business may need to be appraised. Here are the most common reasons. Click on a Reason for a More Detailed Explanation.

Mergers and Acquisitions

Other Reasons

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Buying or Selling a Business

Occasionally, a seller or buyer of a business wants to know the actual fair market value of the business. In cases such as these, a business valuation is performed.

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Partnership or Shareholder Agreements

Agreements between partners or shareholders, often a buy-sell agreement, should be based on a business appraisal rather than some simple formula. Often, an appraisal is performed when a shareholder, such as a professional, is buying into a business or professional practice or when they want to sell out and move on.

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Marital Dissolution (Divorce)

During a divorce, a closely held business is usually a significant marital asset. Often, an appraisal is done by an appraiser hired by each spouse however, in some cases, one appraiser is retained by both parties to prepare an objective value acceptable to both parties. Each appraisal should be totally objective regardless of which side has retained the appraiser—however, in practice this is often not the case.

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Estate Planning for Gifts or Inheritance

Interests in closely held businesses can be transferred during the lifetime of the owners to minimize the estate taxes that will be due on the death of the owners. Business appraisals are typically required and must be filed with the Internal Revenue Service along with the gift or estate tax returns. Often, these reports are closely scrutinized by the Internal Revenue Service. For this reason, it is important to retain a highly qualified and experienced business appraiser to prepare the needed valuation.

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Family Limited Partnerships or Limited Liability Companies

These entities are often used as estate planning devices for owners of closely held businesses including farms and ranches. Minority interests in the company or farm can be gifted to relatives or others while the owners still maintain control of the company or farm. Typically, discounts apply to the minority interests that are gifted thus saving gift and/or estate taxes. Your attorney can help you structure the entity that is appropriate for your situation. We can do the business valuation needed to quantify the appropriate discounts.

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Employee Benefit Plans

Transferring a portion or all of the ownership of a business to employees is a complex area. Typically, called Employee Stock Ownership Plans (ESOP), employer stock is contributed to the plan instead of cash. Department of Labor rules and regulations apply to ESOPs. The stock must be valued by an independent appraiser annually.

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Litigation Issues involving Lost Profits or Economic Damages

These types of cases need a business appraisal to establish the amount of damages that occurred. Often, the business must be valued twice. Once, at the present time and the other as if the action that resulted in the problem had never taken place. The difference represents the amount of damages.

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Dissenting & Oppressed Shareholder Litigation

Stockholder disputes arise from a variety of reasons. Often, the problem is a minority shareholder that is not receiving any dividends or other return on their investment in a closely held company but watches the majority owner take huge amounts of money and benefits out of the company. In this type of litigation, a competent business appraiser and a comprehensive valuation is a necessity.

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Mergers and Acquisitions

Business valuations are often performed when one company wants to acquire another. Typically, each business is valued as a stand alone. Then, the two businesses are valued as if combined using anticipated synergies from the merger. This process gives each firm guidance on how much can and should be paid for or by the other.

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Other Reasons

There are many other reasons for a business appraisal. Some of these include: Allocation of Purchase Price, Liquidation or Reorganization of a Business, Conversion of a "C" corporation to an "S" or SubChapter S corporation, Financing, Ad Valorem Taxes, Incentive Stock Options, Initial Public Offerings, Insurance Claims, Charitable Contributions, Eminent Domain Actions, etc.

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 Commonly Used Business Appraisal Methods

A company’s historical financial statements cannot be used by themselves to determine the value of a business. Financial statements are prepared according to generally accepted accounting principles (GAAP). GAAP relies on the historical cost of assets or the price paid for them at the time of acquisition. Additionally, depreciation, amortization, and some other expenses are applied based on accounting rules not on economic realities. Historical financial statements do not show any goodwill or other intangible asset value that may be in place due to the successful operation of the business over a number of years. Other intangible assets that may not be reflected on company financial statements include such things as proprietary lists, beneficial contracts, below market leases, patents and applications for patents, copyrights, trademarks and brand names, subscriptions and service contracts, franchise agreements, and in-house developed software.

When appraising a company, historical financial statements are used to help assess risk and to project likely future returns. 

Valuation methods typically fall under one of three basic appraisal approaches: the asset approach, the market approach, or the income approach.

The asset approach uses appraisal methods that consist of a review of the individual assets of the company. The most commonly used asset approach method is called the adjusted book value method. In this method, assets and liabilities are adjusted to the standard of value, for example fair market value. The major weakness of this method is that the intangible asset value of a going-concern business is not measurable. Occasionally, an appraiser may use an asset approach method in combination with a hybrid-method, the excess earnings method, used to value the intangible assets of a company. 

The market approach uses businesses in the same or similar industry to develop valuation multiples that can be used to determine a value for the business in question. Several methods may be used—some use information from the sale of private companies, others use the sale of public companies or the price of stock as of the date of valuation for comparable public companies in the same or similar industry.

The income approach consists of two primary methods: the capitalization of cash flow method and the discounted cash flow method. These two methods are mutually exclusive. The basic difference between the two is based on the stability or lack thereof of expected future income. The most difficult part of the income approach is the determination of the appropriate discount or capitalization rate to be used. A discount or capitalization rate measures the risk associated with achieving the projected income or cash flow.

Some formulas exist to give businesses in a particular industry an easy, quick way to estimate a value. These formulas are generally referred to as rules of thumb. Rules of thumb usually provide a range of values—often a wide range of possible values. They are best used as checks for reasonableness instead of appraisal methods.

The appraiser must reconcile the various values determined from each appraisal method to determine a final value for the company.

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Types of Valuations and Reports

The most common types of reports typically issued are described below:

Comprehensive Report: This is a formal presentation of the value of the business in a written format. If a valuation has the potential to go to court, this is the type of report that is usually needed. Also, if the report needs to be reviewed by others, such as the IRS for tax implications, this type of report best explains what was done and how the value was derived. 

Limited "Abbreviated" Report: This type of report does not include much of what is in a comprehensive report. It is appropriate for some occasions when a case is not going to court; for example, to assist with structuring a buy-sell agreement between two partners, a limited "abbreviated" report may be all that is necessary.

"Letter Report" or Calculations:  This type of report is typically a one page letter with supporting calculations.  This type of valuation is often performed to assist an owner develop an "asking" price for the sale of the business or a buyer an "offering" price.

Oral Report:  This type of report can be anything from a quick phone call to lengthy meetings.  Some attorneys prefer oral reports in litigation.

Fairness Opinion: A fairness opinion is issued when a company has received an offer to be acquired by another firm. The opinion does not express a specific value; rather it states whether or not the appraiser feels the offer received is fair for the shareholders.

Review of an Appraisal: Often, we are asked to review and critique a report issued by another appraiser. A letter describing the review and critique is typically issued.

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A well written business appraisal report should contain the following:

· An introduction, including the purpose and use, the standard of value, description of what is being appraised, and limiting conditions.

· An economic analysis and industry section.

· An analysis and description of the subject business including its history and future prospects.

· A financial analysis of the subject company.

· A financial forecast including assumptions used.

· A discussion of the valuation process and methods used including a detailed explanation of how each method utilized was applied.

· A description of any applicable discounts or premiums applied including justification for amounts selected.

· A reconciliation of indicated values developed from the various business appraisal methods utilized. 

· The professional qualifications of the appraiser showing that the appraiser has the qualifications and experience necessary to perform business appraisals.

· Exhibits showing historical financial information, projections, and other information used in preparing the business appraisal.

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Litigation Support

A valuation professional often serves as either an expert witness or as a consultant.  Expert witnesses are often used in situations such as the following:

Things to check before hiring an expert witness or consultant include:

A business appraiser also may work as a consultant to assist with such things as:

As a consultant, a valuation professional is free to act as an advocate for the attorney.  In a business appraiser and expert witness role, the appraiser must not be an advocate for either side.

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Seminars

We have presented several business appraisal seminars typically for attorneys and CPAs. Seminars are available from one hour to four hours or longer on a variety of issues including Understanding Business Appraisals, Discounts and Premiums, Mergers and Acquisitions, and other topics.  Please call us to discuss your needs.

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Frequently Asked Questions

How long is a business appraisal good for?

A properly done appraisal—an assessment of a business’s intrinsic value based on characteristics such as earnings and assets—is valid as long as its underlying assumptions remain valid. Some of these assumptions change rapidly, some more slowly: external factors such as world events, economic trends and competition as well as internal factors such as management, markets and finances.

Some valuations, like those for Employee Stock Ownership Plans, are legally obsolete after a year and must then be updated. Others are contractually outdated; prudent buy-sell agreements should stipulate annual reviews. Estate tax returns, litigation appraisals, merger and acquisition reviews and transaction fairness opinions are normally one-time engagements.

Most valuations are open-ended because their underlying purposes are long-term. A typical example occurs when families sell or transfer minority business interests each year as part of their estate and business succession planning.

Valuations depend on many factors, all of which can change. These include critical assumptions (such as management continuity), the industry outlook, historical financial performance, assumptions about and projections of future results, prices of guideline (comparable) companies, the price/earnings multiple and the company’s normal earnings.  Typically, chances are 4 in 5 that a valuation will be good for at least a year.

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If public companies are trading at price to earnings multiples of 10, 15, or higher, shouldn’t my business be valued based on the same multiples?

In a word, no. Public companies with access to public markets are typically worth more than most closely held businesses. Choosing the correct multiples requires an in-depth analysis by a qualified business appraiser.

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I recently had my house appraised and it cost me $350. How much is a business appraisal going to cost?

A business appraisal is much more complex and takes a lot longer to complete than an appraisal of a house. Each assignment is different, and each appraiser has a different fee schedule.  However, typically you will have to spend several thousand dollars to get a full, comprehensive appraisal report.

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I am thinking about selling either part or all of my business. Do I have to get a business appraisal?

We are often help people derive an appropriate asking price for their business without an appraisal. We also provide limited appraisals or computations for less cost than a full business appraisal.

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If I give my son or daughter stock in my company, do I need a business appraisal?

We recommend that a business appraisal be done whenever a potential gift tax is involved. If the Internal Revenue Service audits the gift, the burden of supporting the value of the gift given is on the taxpayer. A properly done business valuation should help establish the value of the gift and demonstrate to the IRS that everything was done properly.

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Why can’t I have my CPA appraise my business?

CPAs are great at what they do: help you prepare financial statements and tax returns, and assist with many financial decisions. However, very few CPAs have been trained to perform business valuations. Unless your CPA is accredited in business valuation, you should use a valuation expert to appraise your business. Also, your CPA can not be independent since they do your accounting work, even if they are accredited in business valuation. Most CPAs are not willing to appraise their own client’s business even if they are qualified to do so.

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Will you be able to testify in court about the value of my business?

Yes, we have business appraisers that are qualified and experienced in providing expert witness testimony. We will work with your attorney and support our appraisal in court.

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Revenue Ruling 59-60 ("the Bible")

Revenue Ruling 59-60 is considered the "Bible" of business appraisers. It is quoted more often by business appraisers than any other document. In order to review a copy of the Revenue Ruling, click on it below:

View Revenue Ruling 59-60

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