March 4, 2016

Business valuation can seem to be as simple as a multiple paid against your last year’s earnings.

But the truth is, valuation is an ever-evolving field, and recent advances continue to affect how valuations are performed. The goals are still to determine “What is the right multiple?” and “What discounts or premiums apply?”

Recent changes in the “how of getting there” are going to have a direct effect on business owners and investors.

For those actively involved in acquiring companies, significant advances are being discussed and taught regarding the way that acquired intangible assets are valued and tested for impairment. The impact of these changes on financial statements cannot be ignored.

How much amortization expense is recordable, how financial ratios that are relied on by investors and other third parties are computed – all are affected by these changes. Even how much time is expected of CFOs and audit teams focusing on what is often the last set of entries before accounting books can be closed is changing.

The interaction of debt at a parent/holding company and its acquired subsidiary is also changing, introducing new uncertainty over how inventive, highly structured deals will play out on the financial statements prepared for outside parties.

There is some good news, however. A recent announcement gives a break to small nonpublic companies concerning the level of initial testing to check for impairment of certain intangibles.

For those more concerned about using stock and options as compensation and as sweeteners in financing arrangements, the analysis is becoming more advanced and complex. This isn’t as terrible as it first sounds. One benefit comes from the standardization of the models and techniques that are being taught. The uncertainty over how much difference in opinion might arise between your valuation expert and an adversarial expert (from the IRS, for example) should diminish as the tools to value complex securities become more commonly applied.

In the past, the lack of clarity over how much the securities were worth created a barrier to their utilization. As analysis of them becomes more consistent, complex securities become a more viable tool to better match the incentives and payoffs for executives to reach for the hurdles and thresholds that make businesses succeed.

Also, as the understanding improves of how volatility affects complex securities’ values, so does the judgment and advice of when to use them and how to structure them.

In the world of valuations for wealth transfer, the age-old debate over marketability and control discounts continues, but more emphasis than ever is being placed on tying the analysis to specific, relevant data.

Tax Court cases, and the experts testifying in them, generally have moved beyond qualitative judgments over discounts and have embraced thinking about shareholder-level returns and considering the kinds of information that real investors find relevant in buying and selling securities.

New studies and databases are cropping up that specifically address issues that, in the past, were purely the realm of “appraisal judgment,” and in which the older and more experienced appraiser was given more deference and credibility. These new stores of information are altering the arguments, much like new weaponry changes how battles are fought.

What used to pass for good enough – even a few years ago – is unlikely to stand up to the rigor expected nowadays. This doesn’t necessarily mean that valuation discounts or results have changed drastically, but it does mean that – if challenged – an analysis submitted to audit and headed for Tax Court had better be prepared to reconcile against this new wealth of information that the court is aware of and expects to hear about.

At the same time, a well-prepared analysis, relying on good information, improves its intangible value of “That report looks thorough and well done. Find a weaker one to challenge.”

Like many professions, valuation continues to evolve, creating the need for more specialized knowledge to properly help clients meet their needs. Advances in valuation theory and practice are increasing the complexity of the valuation models and analyses routinely performed, which does create concern over how many new ways errors can find their way into such analyses.

On the other hand, improved valuation models and better data are helping fine-tune value estimates. This will lead to more tailored solutions for business owners and for investors in all types of securities.

Be sure to ask how your valuation adviser is staying up to speed with these changes.

© 2016