After a written understanding called an engagement letter or retainer is signed, you will be asked to provide documents and to fill out a management questionnaire. This information forms the basis for understanding business issues that impact value. A site visit of the facility is often performed although not a requirement. The site visit gives the appraiser a chance to see the assets of the organization and perform any inventory or other testing deemed necessary.
Valuation analyses begin once the appraiser synthesizes the documentation provided and does independent research to determine how these factors impact the value of the entity. Facts and circumstance subsequent to the valuation date are not considered unless they are known or knowable at the valuation date. The appraiser will evaluate the economy, industry and management, as well as utilizing three appraisal approaches: asset, income and market. We also consider the marketability and control of the business interest being valued. The appraiser will use his/her experience and judgment to reconcile any disparate indications of value to arrive at a final conclusion.
Finally, the appraiser will document and report on the findings and methods used in the analysis. The conclusion can be reported as a total value, per share value or value for a certain percentage interest. The level of reporting was agreed upon in the engagement letter. A signed, certified and bound report is issued. Typically, this step will also include a follow-up discussion with the client and their advisors to address any questions they may have about the appraisal report.
The time taken to complete an appraisal depends largely on the availability of financial and nonfinancial information, the client and the clients advisors. Anywhere between 30 and 60 days is fairly normal. Faster turnaround times are possible depending on the size and scope of the work product.
Under certain statutory requirements, a business appraiser must be “qualified.” There are a number of professional organizations that offer business valuation credentials. Some designations are more difficult to obtain and more respected than others. Seek out those with experience and credentials from more than one professional organization. Specialization in certain industries can also be an important determinant. A full-time commitment to the profession can also help provide confidence in the valuation you receive.
Yes, a business valuation is required on a transfer of ownership even if money is not exchanged. You must establish the value of your business so that the Internal Revenue Service can evaluate the gift. The burden of support for the value of the gifted interest lies with the taxpayer. An independent valuation can provide such support.
We typically need five years of tax returns and/or financial statements to start the valuation process. Other information that is generally requested includes an aged receivables report and any stock holder agreements or other contracts for the entity. Additional information may be required or requested depending on the type of business being valued. In addition, a management questionnaire will be completed or management/owner interviews conducted.
Business valuations are performed as of a specific date and for a specific purpose. Generally, if there are no material changes in the operations of the business or its capital structure, annual updates may satisfy the same use of the appraisal report. If substantial changes have occurred, or market conditions dictate, a valuation done yesterday could be out of date. The best course of action is to contact a valuation professional to determine the appropriateness of a given report for a given purpose.
Presumably, all risk factors are considered when performing a business valuation. The most relevant factors affect changes in earnings, growth rates and volatility. Appraisers generally categorize the risks into external and internal risks. External risks include the economy, industry and regulation by governmental authority. They may also include political, social, demographic and risks specific to the exit market for the business interest. Liquidity risk relates to the uncertainty associated with the disposal of a closely-held business at fair market value.
Internal risk factors include operational risks, balance sheet risks and income statement risks. Examples include management and their ability to respond to external changes, manage and create value and forecast future earnings. The types of assets and liabilities held, workforce, corporate governance policy and overall business model all contribute to the internal risk framework. For certain business interests, the degree of control in the interest is also considered.
It is important to have methods and techniques to evaluate these risks in the context of the engagement assignment and methods used. Otherwise, it is easy to double count, ignore or otherwise misstate the overall risk in the business interest.
The cost of a business appraisal is tied to the amount of time it takes to complete the valuation assignment pursuant to our professional standards of practice. An accredited business valuation professional should determine the complexity of the business being valued before making an estimate. Many factors must be considered to accurately estimate the scope of work. Of course it is in violation of ethics and standards of practice to receive payment based on the outcome of the valuation. If you’re not asked any questions, be suspect about the quality of the appraisal you’re about to receive. Here a few factors which can impact the cost of an appraisal.
Purpose of the appraisal
Appraisals used to support litigation or marital dissolution require more intensive documentation, which result in higher costs. An appraisal used to obtain financing is more time consuming to perform than estimating the value of a business for insurance purposes. As a result, a financing appraisal is more expensive.
Complex capital structures add to the cost of an appraisal. When convertible preferred securities or outstanding stock options exist they must be valued separately and taken into consideration when reporting equity values. In addition, if voting and non-voting stock exists, analysts must identify and evaluate the distinction and allocate the resulting value accordingly.
Pending or threatening lawsuits, environmental issues or taxing authority issues can all add time and cost to the valuation.
Sources of Revenue
Analysts are required to evaluate the economy and markets for each material business revenue stream. So when income is derived from multiple states or countries, additional time is required. An understanding of the markets, competition and cost structure is key to producing reliable results.
Reporting requirements drive the cost of the appraisal. Summary reports are less expensive than detailed appraisal reports. The sophistication of the end user is one consideration when selecting the report format.
Fortunately, Baden, Gage & Schroeder has a process and the knowledge to address any of these complex issues. Through a series of questions in the initial stage of the engagement we evaluate your needs and the entity’s characteristics to provide you an estimate of the valuation service fees.
Typically, valuations are performed when an independent opinion of value is needed. The reasons for obtaining an independent value are many. Some people simply like the confidence provided by a having a trusted accredited valuation professional involved when commencing a transaction. Here are a few other reasons when an independent business valuation performed by an accredited valuation professional is critical.
While rules of thumb exist, their usefulness is questionable. It is not ethical, nor in your best interest, to use a rule of thumb to value a business. The valuation process is complex, and every business is unique with specific risks that just cannot be captured in a generic multiple. It would be like valuing a house from the curb. Deferred maintenance, unfinished basements and low quality materials can substantially change the value.
Guidance provided by ASC 805 formally, Statement of Financial Accounting Standards No. 141 (SFAS 141) FASB Codification is a good place to start identifying areas of intangible assets. Examples of potential intangible assets include but certainly not limited to:
An assembled work force, patient records and in process research and development can also be a significant source of intangible asset value for certain entities. Traditional income approach valuation methods account for these assets in the cash flows they generate. However, often the assets are non-income producing and are not recorded on the balance sheet. In these instances, they should be given consideration relative to the overall value of the entity.
Simply put, goodwill is an accounting term used to define value above tangible value. In other words, any value a business has above hard assets is considered goodwill. However, accounting terms can also have different meaning depending on the context. The Financial Standards Accounting Board (FASB) views goodwill as the amount paid in excess of the fair value of all purchased assets tangible and intangible.
Family law courts tend to view the term from a different perspective in valuation engagements. The distinction comes from the need to separate marital assets from personal assets. The courts generally view goodwill as the difference between the value of the business and the value of the tangible assets, but go further to separate the character of the goodwill.
The appraisal profession has adopted “personal” goodwill and “enterprise” goodwill as a means to distinguish between the goodwill value of the business and the non-transferable goodwill value created by an individual.
A landmark Indiana court case, Yoon v. Yoon (1999), defined personal goodwill as:
“In contrast, the goodwill that depends on the continued presence of particular individual is a personal asset, and any value that attaches to a business as a result of this ‘personal goodwill’ represents nothing more than future earnings capacity of the individual and is not divisible.”
Goodwill value can become a contentious issue when understanding the value of a business for martial dissolution purposes, particularly with small professional practices. Measurement of enterprise or personal goodwill is complex, particularly when defining a benefit stream using an income approach. Workforce in place, intellectual capital in processes and brand are all transferable assets producing cash flow for the enterprise. Experience and personal reputation are not transferable.
When confronted with determining the value of a business entity with the potential of personal goodwill, it’s important to find a professional that is not only familiar with the concepts, but also has the experience and know how to exact a measurement of personal and enterprise goodwill.
Generally, the purpose of the valuation will determine a “standard of value.” State statutes and other sources can have slightly different variations on the fair market value standard. According to the Internal Revenue Service in Revenue Ruling 59-60, fair market value is the amount at which a property would change hands between a willing buyer and a willing seller, when neither is under compulsion to buy or sell and both have reasonable knowledge of all relevant facts.
There are several fundamental premises of values that could affect reporting the conclusion of value for an entity. The premises of value used in the valuation engagement include one of the following assumptions:
One cannot expect to receive the same value for assets that are forced “under the hammer” in liquidation at auction compared to those assets valued as a going concern.
While not having current cash flow is certainly an impediment to some income approaches, methods exist that can be used to evaluate expected future benefits. For example, what is the value of a coin toss today if you receive $1 or nothing on a toss of a fair two-sided coin? Using probability theory based on statistical analysis, a model is developed to express the expected return for the event. In this case, the expected return is $0.50. A savvy buyer shouldn’t pay more for a chance at this event. New products or contingent assets have payoffs that may well be far into the future, but they have an expected value at any point in time.
Many assets have asymmetric payoffs that are predicable with a degree of certainty. The uncertainty is the risk. Baden Gage & Schroeder has models, methods and the expertise to evaluate complex business scenarios or contingent assets and determine value.
In business valuation, a discount is a way of dealing with a particular characteristic of the interest being valued. Several “discounts” can be taken in a valuation engagement. Two of the most typical valuation discounts are: Marketability and Minority Interest.
Marketability discounts are generally taken when the method of determining value is derived from the public stock markets where an interest can be sold and settled in two days. An interest may also be difficult to market, either because of legal impediments or a lack of actual demand from potential purchasers or because of the lack of an organized marketplace which makes the transfer of ownership more difficult and more expensive. Usually the marketability discount is expressed as a percentage discount from the total value.
Minority Interest discounts are often called discounts for lack of control because they address the issue of a minority shareholder not having the ability to control the operations of the entity. Generally, it has been observed that typical investors tend to pay less for non-controlling interests since they have little or no influence over the management of their underlying investment.
Usually holding a minority interest <50% is not a bad thing. For example, most people hold non-controlling minority interests in public companies. Public companies have SEC regulators, outside boards and typically higher standards of internal controls when compared to small privately held investors. When one shareholder has a controlling position, a minority shareholder is at the discretion of the majority shareholder with regard to how the Entity operates and more importantly distributes wealth. The risk to a minority shareholder under this position is much greater than the public company counterpart.
Practically speaking your business is worth what two people agree it is worth in an arm’s length transaction. No more and no less. But before formal negotiations begin for selling a business interest, market participants engage in what is known as price discovery. The purchaser will announce a price he/she is willing to pay (determined the "bid" or "offer"), while sellers will announce a price they would be willing to accept (determined the "ask" or the "reserve" price in auctions). The difference creates a gap or "spread," which hopefully will close as negotiations proceed. Performing due diligence is part of the price discovery process. Only after due diligence is complete and negotiations close is the price gap eliminated and a transaction or "trade" occurs. Ideally, a great deal of investigation and discussion occurs before a transaction is consummated.
We generally bill at our standard hourly rates, which vary depending on the level of the person working on the assignment. Some of our services are quoted as a flat fee. Pension calculations and the Succession Snapshot™ are two examples. Our standard billing practice is to bill monthly for services rendered. We require payment of all fees prior to any testimony. Typically, fees for expert witness testimony, depositions, etc. are billed on an hourly basis. The hourly rate includes travel from portal to portal.