Value Blog

I constantly get requests and questions about “informal” valuations or rough estimates of value.  In some cases, individuals are deciding whether to buy a business and they want a sanity check that they are not overpaying for the business.  In other cases, most often divorce, the parties are trying to settle a case at mediation, so they do not have the same requirements that they would to prove value if they went to trial.

Regardless of the purpose, an appraiser who follows standards of any of the generally accepted organizations will have to perform a valuation in compliance with those standards if they are determining value.  In other words, there are no shortcuts if the client wants a number from the appraiser.

The definition of a valuation is very broad.  It includes the use of valuation approaches and methodology as well as the application of the appraiser’s judgment.  The standards all indicate how the appraiser develops the value.  A number of the appraisal organizations refer to the section of the standards dealing with this as developmental standards.

So while a client looking to purchase a business may not see the “number” that he requests as being a valuation, it most likely is.

In situations of litigation, there is often confusion about the applicability of standards.  This arises because of a reporting exception in some of the standards.  The reporting exception provides that appraisers do not have to present his or her findings in compliance with the reporting standards.  The thought behind this is that in a litigation or controversy matter, the opposing party or trier of fact will adequately question the appraiser so that the relevant elements are disclosed, making the format of the report less important.

If you think about it, the reason to hire an appraiser to provide you with a value is for you to have something that you can rely upon.  If you do not need the number to rely upon, then you do not need the appraiser.  When you are relying on a value provided by an appraiser, it should be developed in accordance with applicable standards.  To perform a valuation requires a minimum amount of time, and that time translates to money.  While some situations may not seem to warrant the cost, if an independent appraisal is necessary, there is no other option.

© 2009 Florida Business Valuation Group

There are many people qualified to value a business.  A number of professional societies offer certifications to professionals who meet the organization’s criteria.  In selecting an appraiser, you want to understand the differences between the certifications as well as the necessary skills to value a business.

The following organizations offer valuation designations:

• American Institute of Certified Public Accountants offers the ABV (www.aicpa.org)
• American Society of Appraisers offers the ASA (www.appraisers.org)
• Institute of Business Appraisers offers the CBA (www.go-iba.org)
• National Association of Certified Valuation Analysts (NACVA) offers the CVA and the AVA (www.nacva.com)

Each of the designations demonstrates that an individual has completed certain educational requirements, experience requirement and demonstrated some level of competency through testing and/or submitting sample reports.   You can visit each organization’s website for a list of the requirements for certification.  Additionally, the different groups also have searchable directories of credentialed appraisers.

However, it is important to understand an appraiser’s actual experience, not just the letters after their name.  Some good questions to ask a prospective appraiser are:

• How much of your practice is devoted to business valuation? While it is not necessary that a practitioner do business appraisal work full-time, it is necessary that he or she devote enough time to the work to be proficient.  Someone that does two or three valuations a year may not be the appraiser that you are looking for.
• What type of continuing education have you completed? There are many courses and conferences available to appraisers.  You want an appraiser who regularly participates in continuing education.  An appraiser who attends different courses and conferences each year is more likely to know the current developments in the industry, compared to someone who gets all of his or her hours in once every three years by attending a single conference.
• What type of valuations have you worked on in the past? Not all valuations are the same.  Someone who has only done appraisals for divorce litigation may not be the best fit for a client who needs an valuation for estate purposes. It is also important that you know what type of appraisal you need.
• Will you be the one responsible for valuing my business? You want to know who will be doing the work to appraise your business.  Some firms use staff or outsource some of the work.  This is not necessarily a bad thing.  Depending upon the purpose of the report, you may want to speak to the person actually doing the work to make sure that you are comfortable with his or her credentials and experience.
• What standards do you comply with? Each of the organizations mentioned above have appraisal standards which its members agree to comply with.  If your appraiser is a CPA, he or she may be required to comply with the AICPA business valuation standards.

These are some of the things to consider in selecting an appraiser.  If you have additional questions, please post a question.

 © 2009 Florida Business Valuation Group

There are terms that are frequently used in valuation that have specific meanings.  A group of the appraisal organizations got together and created a glossary defining various terms, the International Glossary of Business Valuation Terms.  Definitions below are taken from the Glossary.

An appraisal is the same as a valuation, which is defined as “the act or process of determining the value of a business, business ownership interest, security or intangible asset.”

The three approaches to valuation are the asset approach, the income approach and the market approach.  Within each approach are various methodologies used in the process of business valuation.

The asset approach is “a general way of determining a value indication of a business, business ownership interest or security using one or more methods based on the value of the assets net of liabilities.”

The income approach is “a general way of determining a value indication of a business, business ownership interest, security or intangible asset using one or more methods that covert anticipated economic benefits into a present single amount.”

The market approach is “a general way of determining a value indication of a business, business ownership interest, security or intangible asset by using one or more methods that compare the subject to similar businesses, business ownership interests, securities or intangible assets that have been sold.”

Discounted cash flow method is “a method within the income approach whereby the present value of expected economic benefits is calculated using a discount rate.”

Discount rate is “a rate of return used to covert a future monetary sum into a present value.” The discount rate converts future net income, earnings or cash flow to a present value.  The rate is used in a formula which takes into consideration the point in time in the future when the benefit is expected to be received.

Capitalization rate or cap rate is “any divisor (usually expressed as a percentage) used to convert anticipated economic benefits of a single period into value.”  In simple terms is a rate that is divided in an estimate of net income, earnings or cash flow for a single period to arrive at a value of a business or business interest under the income approach.  The higher the rate, the lower the value.

A multiple is “the inverse of a capitalization rate.”

These definitions are a start to understanding the terminology used by appraisers.  In future postings I will discuss the application of different approaches and methodology.

© 2009 Florida Business Valuation Group

An appraisal is the same as a valuation, which is defined as “the act or process of determining the value of a business, business ownership interest, security or intangible asset” according to the International Glossary of Business Valuation Terms.  Appraisal organizations have standards that apply to the performance of valuation services.  These different standards provide for different levels of services to be reported in different kinds of reports.

Valuation engagements result in either conclusions of value (also referred to as opinions) or calculations of values.  In general, conclusions of value can be reported in detailed or summary reports and calculations of values are reported in calculation reports.

Typically, if you are valuing the business for compliance purposes a conclusion of valuation is necessary.  Examples of compliance purposes are for gifting an interest, filing an estate tax return, ESOP reporting or valuing charitable contributions.  Typically a conclusion of value is also used for litigation purposes.

The valuation process to reach a conclusion of value may take between four and eight weeks.  Fees may vary depending upon the circumstances.  Some practitioners will quote a fixed fee for valuation engagements, while others charge hourly.  Fees may not include database fees which can be charged separately.

Calculations of value may be used in situations where the parties agree to certain limitations of scope, usually for budgetary purposes.  These lower level engagements are not suitable for all purposes.

(For a more detailed discussion of the types of valuations and types of reports click here.)

© 2009 Florida Business Valuation Group

There are many different types of value. Below are a number of the types of value and examples of when they may apply.

• Fair Market Value: This type of value is used for estate and
gift tax reporting purposes, valuations for contributions to charities, valuation of ESOPs and other compliance purposes. Revenue Ruling 59-60, which is the definition used by the IRS, defines fair market value as “the amount at which the property would change hands between a willing buyer and a willing seller, when the former is not under any compulsion to buy, and the latter is not under any compulsion to sell, both parties having reasonable knowledge of relevant facts.”

• Fair Value: There are two different types of fair value, one
for litigation purposes and one for financial accounting reporting purposes.

•• Statement on Standards for Valuation Services issued by the AICPA
defines fair value for financial reporting as “the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date.” This is the type of value used by companies when adjusting their assets or liabilities to fair value on their balance sheets under Generally Accepted Accounting Principles.

•• Fair value for litigation purposes is defined in each state either
by statute or through case law. This type of value is used to value interests in legal disputes between shareholders, partners or members.

• Intrinsic Value: This type of value is defined by the
International Glossary of Business Valuation Terms as “what an investor considers, on the basis of an evaluation of facts, to be the ‘true’ or ‘real’ value that will become the market value when other investors reach the same conclusion. Investors and analysts use this type of value to determine if stocks are selling at their true value.

• Investment Value: This type of value is defined by the
International Glossary of Business Valuation Terms as “the value to a particular investor based on individual investment requirements and expectations.” Each buyer and seller has his or her own value based on specific investment objectives.

• Net Book Value: Net book value is synonymous with the net
worth (or shareholders’ equity) of the business. It is the total net assets less the total liabilities as stated on the balance sheet of the business. The assets and liabilities are stated at historical cost, which may not be reflective of their current values.

There are other types of value as well. Rob Slee in his book Private Capital Markets, defines other types of value including economic value, insurable value, collateral value, owner value, and market value to name some others.

Sometimes the type of value is not as clear would seem. For example, in a divorce, some states use fair market value, while others may lean
towards the litigation type of fair value.

For more information on standards of value and the valuation process, please click here.

© 2009 Florida Business Valuation Group

The first step in the valuation process is to understand the concept of value. Value is often thought of as a definite number. This is a common misconception. Not only can value be expressed in terms of a range, different types of value create a range of values.

Each person’s perspective, goals and objectives can lead him or her to arrive at a different value. There are different types of value, which valuators refer to as standards of value. Depending upon the purpose of the valuation, different types of value may be relevant.

Most people are familiar with the term fair market value. This type of value is defined as what a willing buyer will pay a willing selling, both being reasonably informed of all relevant facts and entering into the transaction freely. Fair market value is used for estate and gift tax valuations. Value for litigation purposes can be either based on fair market value or fair value. There are other types of value as well.

One of the first steps in the valuation process is identifying the appropriate type of value for the intended purposes. Florida Business Valuation Group is available to assist you in determining the appropriate type of value for your circumstances. For more information on standards of value and the valuation process, please click here.

© 2009 Florida Business Valuation Group

Welcome to ValueBlog. Potential clients and clients often ask the same questions regarding value and the valuation process. The purpose of this blog is to help you by offering some answers to frequently asked questions on an ongoing basis.

As will be discussed further, all value is not the same and correspondingly the valuation process may be different depending upon the purpose of your valuation.  ValueBlog will address general issues.  Please consult a valuation professional regarding the specific circumstances of your situation.  If you have general questions regarding valuation, please post them here and we will answer those on ValueBlog that are of general interest.  Questions of a specific nature will be addressed off-line.

You can also visit our website www.floridabizval.com for additional information.

© 2009 Florida Business Valuation Group