Having performed business valuations for a variety of
purposes , I have been asked a number of questions from
clients. The following top ten business valuation
questions have been compiled in an effort to briefly
address some of the most frequent concerns clients have
regarding a business appraisal.
1. What approaches do you consider in valuing the business?
Income Approach-The Income Approach derives an indication
of value based on the sum of the present value of expected
economic benefits associated with the company. Under the
Income Approach, the appraiser may select a multi-period
discounted future income method or a single period
capitalization method.
Market Approach-The market approach derives an indication
of value by comparing the company to other similar
companies that have been sold in the past. Under the
market approach, the appraiser may utilize the guideline
publicly traded company method or the direct market data
method.
Asset Approach-The Asset Approach adjusts a company's
assets and liabilities to their fair market values and adds
to the value of intangible assets and any contingent
liabilities.
2. What discounts may be applicable?
The discounts typically used in the valuation of a closely
held business interest include a discount for lack of
control, discount for lack of marketability, discount for
lack of voting rights, blockage discount, portfolio
discount, and key person discount. The most common
discounts applied in business valuations are discounts for
lack of control and discounts for lack of marketability.
3. What are the standards of value?
For most operating businesses, the standard of value will
likely be fair market value, fair value, or investment
value.
Fair Market Value is the price, expressed in terms of cash
equivalents, at which property would change hands between a
hypothetical willing and able buyer and a hypothetical
willing and able seller, acting at arms length in an open
and unrestricted market, when neither is under compulsion
to buy or sell and when both have reasonable knowledge of
the relevant fact.
Fair Value is a legal standard of value that has been
established by the courts for use in issues ranging from
marital dissolution to dissenting shareholder suits.
Investment Value is the value to a particular investor
based on individual investment requirements and
expectations. Investment value is typically used for
transactional purposes when an acquirer is assessing the
value of the target company, including the potential
synergies of the deal.
4. What is the difference between an appraisal and a
fairness opinion?
Full/formal business valuations typically consider all
relevant approaches and methods that the appraiser
considers appropriate in determining a value. These
valuation reports typically include research on the subject
company's industry, economic conditions, trends, etc.
Fairness opinions provide the expert's opinion of whether
the proposed value of the transaction is "fair" for the
shareholders. Fairness opinions do not typically provide
an estimate of value or value range.
5. What are the main credentialing bodies for business
valuation, what designations do they offer, and what
designations have you earned?
The four main credentialing bodies in the business
valuation profession are the National Association of
Certified Valuation Analysts (NACVA), the Institute of
Business Appraisers (IBA), the American Society of
Appraisers (ASA), and the American Institute of Certified
Public Accountants (AICPA).
NACVA offers the Certified Valuation Analyst (CVA)
designation (for Certified Public Accountants only) and the
Accredited Valuation Analyst (AVA) designation.
The IBA offers the Master Certified Business Appraiser
(MCBA), the Certified Business Appraisers (CBA), Accredited
by IBA (AIBA), Business Valuator Accredited for Litigation
(BVAL), and Accredited in Business Appraisal Review (ABAR)
designations.
The ASA offers the Accredited Member (AM), the Accredited
Senior Appraiser (ASA), and the Fellow Accredited Senior
Appraiser (FASA).
The AICPA offers the Accredited in Business Valuation (ABV)
designation.
6. Why should a business have an annual valuation?
The most common benefits of an annual business valuation
policy include:
Accountability and Performance-An annual business valuation
enables the shareholders to see the value that is being
consistently created or destroyed by the management of the
firm.
Estate Planning Purposes-Many shareholders have on-going
estate planning strategies aimed at protecting wealth for
heirs.
Buy-sell situations-For those firms that do not have
buy-sell agreements in place, annual business valuations
are a good way of avoiding disputes that may arise when a
shareholder seeks to sell his shares to the other
shareholders.
Facilitate Banking-Many firms effectively utilize leverage
to invest in value-creating projects. The ability of a
firm to borrow based on the value of the goodwill or the
value of the company's shares may expand the universe of
value-creating investment options available.
Expands the Investment Options-Closely held firms suffer
from a lack of liquidity and the inability to use the
company's shares as currency when seeking acquisitions. An
annual business valuation may enable the management of the
company to use the shares as acquisition currenc.
7. What is the difference between enterprise value and
equity value?
Enterprise value is often referred to as the value of the
invested capital of the business which includes the value
of the equity and the value of the firm's liabilities.
This value represents the total funding of the asset side
of the balance sheet for all fixed assets, cash,
receivables, inventory, and the goodwill of the business.
Equity Value is the enterprise value less all liabilities
of the business and represents the value that has accrued
to the shareholders through retained earnings, etc.
As various professionals may define these levels of value
differently, it is important to understand exactly what a
definition of a level of value includes or excludes under
the specific circumstances.
8. Do you use rules of thumb when valuing the business?
Rules of thumb are simple pricing techniques that business
brokers typically use to approximate the market value of a
business. Rules of thumb typically come in the form of a
percentage of revenues or a multiple of a level of
earnings, such as seller's discretionary cash flow. For
example, a rule of thumb for pricing a widget manufacturer
may be 40% of annual revenues plus inventory or two times
seller's discretionary earnings. Rules of thumb fail to
consider the specific characteristics of a company as
compared to the industry or other similar companies. In
addition, rules of thumb do not reflect changes in
economic, industry, or competitive factors over time.
Widely-accepted business appraisal theory and practice does
not include specific methodology for rules of thumb in
developing a value estimate. However, rules of thumb can
be useful in testing the value conclusion arrived through
the appraiser's selected approaches and methods.
9. What role do court rulings have in developing an
indication of value?
While Tax Court rulings may reflect the proclivity of
certain courts to accept various discounts or levels of
discounts in case-specific circumstances, these rulings may
or may not play a role in the business appraiser's analysis
and value conclusion. The business appraiser must consider
the relevant facts in the subject valuation and make a
reasoned, informed decision regarding the discounts and
level of discounts in developing an indication of value.
With respect to case law, business appraisers should be
aware of general issues that may impact a valuation. Often
times, the business appraiser consults the client's legal
counsel for their position on specific case law issues.
Again, the business appraiser must use reasoned, informed
judgment in developing an indication of value, considering
the case-specific facts relevant to the valuation.
10. What are the main factors that impact the value of a
business?
The value of a business interest is impacted by a number of
factors, many of which may change from year to year,
including:
• Financial performance-If a business has poor earnings
capacity, the value of the business imay be negatively
impacted.
• Growth prospects-Just as too high a rate of growth may
lead to negative operational and financial consequences,
too low a growth rate may also have a negative impact upon
the business and its ability to achieve profitability.
Revenue growth drives all opportunities for the business to
expand.
• Competitive nature of industry-If the industry in which
the business is operating has become more competitive due
to the entrance of new competitors, the value of a business
may be impacted as a result of lost market share, lower
revenue growth, shrinking margins, and lower profitability.
• Management-Management of a business influences the value
of the firm. A highly experienced management team and an
organization with managerial depth is more highly valued by
a willing buyer than an organization with only one manager
or key executive.
• Economic and industry condition-The strength of the
economy impacts all businesses in one way or another. If
adverse economic conditions translate into long-term lower
growth and profitability for a business, the value may be
negatively impacted. Industry conditions are also impacted
by the state of the economy but are also influenced by
various other factors such as competition, technological
change, trends, etc.
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Robert M. Clinger III has strong experience in the fields
of business valuation and financial analysis, having earned
the Accredited Valuation Analyst (AVA) designation from the
NACVA and the Certified Business Appraiser (CBA) More
information on business valuations/appraisals may be
obtained by visiting Highland Global's website
http://www.HighlandGlobal.com .
