November 2, 2015
Whether dealing with estates, divorces or business law, owners often face the issue of valuing their business.
For millions of self-employed people, a business represents their largest asset as well as their future livelihood. For partners to be bought out, heirs to sign off or spouses to settle, a value must be identified and agreed upon.
Valuing a business is often less than straightforward. Unlike a house or commercial rental building, in which apples can be compared to apples, there are many factors that influence value. These include:
- Business sector – Performance measures such as ratios and expected cash flow differ for each sector.
- Industry outlook – At any given time, the value of the business might be increasing, decreasing or flat due to the status of the industry.
- Business life cycle – If a business is new, growing or mature affects its value.
- Asset mix – Each business has its own mix of tangible and intangible assets. Tangible assets include buildings, inventory, equipment and vehicles. Intangible assets may include goodwill, assembled workforce and intellectual property. Ownership of intellectual property is a key area to establish because it may be essential to the business.
- Effect of the proposed stockholder action – How much will business value change after the proposed stockholder settlement? If key partners are leaving, this can greatly diminish future prospects.
Finding a valuation expert with the right sector and industry experience is a primary requirement. The expert should demonstrate awareness of the specific factors that influence value in the subject business.
How a valuation expert can help
Professional services offered by valuation experts aren’t limited to full-blown appraisals. Their opinions and analysis might be valuable early on, during a discovery phase. This is where business records and financials are examined to get a full picture of the company and what has been occurring.
Initial discovery can set the groundwork for a full appraisal by identifying critical strengths and weaknesses, relative contributions of stockholders and partners (if applicable) and soundness of financial statements.
If litigation is involved, depositions are another area of assistance. Appraisers can help attorneys develop the right questions to ask and areas of interest to probe. If the other party has retained a valuations expert, then the work of that expert should be examined closely for accuracy and validity of the approach used.
In some cases, a strategy and approach might need to be developed. Trained professionals can provide insights and experience that sheds light on the best route and approach to be taken.
Finally, appraisers can offer expert witness testimony in court. It is vital to qualify any expert witnesses to ensure that a challenge to their credentials can be satisfied. Since 80 percent of civil cases call upon expert witnesses, attempting to discredit the one chosen by the other side is a ploy used to stall proceedings.
Choosing a valuation expert
The first threshold in choosing an expert is the qualifications they hold.
There are no less than seven certifying bodies licensing or approving business appraisers. These include the American Society of Appraisers, Institute of Business Appraisers and the American Institute of Certified Public Accountants. Each has requirements that range from completing none to 10 appraisals to five years of experience.
Education minimums are all similar – requiring a college degree or equivalent – and a test, but ongoing certification education requirements vary.
Some appraisers hold several designations as well as a Certified Public Accountant (CPA) or Certified Business Intermediary (CBI) designation.
After identifying candidates with the correct qualifications, other factors come into play. Primary is the depth of understanding they have in the subject area business, both industry-wise and in the type of case.
Those dealing with divorces need an understanding of family law, for example. And those weighing in on stockholder splits need to understand equity position, ownership structure and the implications related to division of assets or buyouts. Possible litigation pitfalls should be identified and avoided to prevent problems down the road.
Good communications skills are necessary, both written and verbal. To be effective, the business appraiser must be able to answer questions in laymen’s terms and present a cogent and defensible case for the determined value of the business or other information required.
Communication between appraiser and attorney is also important as well as meeting timelines and informing other parties of any delays or issues that arise.
The last area considered is fee amount and type. Many appraisers bill on an hourly basis, but there is some movement to project billing. In either case, there must be a thorough agreed-upon understanding of the scope of work the appraiser will prepare.
The right appraiser will probably not be the least expensive, but the expert assistance will ensure the best outcome for the client.
This article was originally posted on November 2, 2015 and the information may no longer be current. For questions, please contact GRF CPAs & Advisors at firstname.lastname@example.org.