Frequently Asked Questions
While business and personal circumstances vary, it is important to consider the value of your business as part of your overall strategy and decision-making process. It is necessary to identify and recognize the need that fits your plans and purpose, and conduct the valuation accordingly. Defensible opinions of value are necessary for many reasons and each reason may require a different approach and utilize different assumptions. These include tax, litigation, financial reporting, strategic planning, mergers and acquisitions, among many others. Examples of situations where a business valuation is needed are outlined in our list of services.
A shareholder group needs an independent opinion of value to comply with the provisions in their shareholder agreement pertaining to ongoing purchase and sale of company shares.
- A business owner is in the process of formulating an exit plan and needs to understand the range of values attributable to the company.
- A shareholder is gifting shares to his or her heirs, or is selling shares of the company’s stock.
- A business owner has passed away and a valuation is required to settle the estate.
- A business owner needs to manage his or her largest investment – the private company – and wants to understand value drivers and enhance company value.
- Management is looking to sell the company or acquire another company, and needs an objective opinion or estimate of value to set and negotiate a price.
- A company with stock-based compensation needing to comply with IRC 409A and ASC 718.
- A company (public or private) has acquired another company and needs to allocate the purchase price to all the tangible and intangible assets for financial reporting purposes in accordance with ASC 805.
- A company has goodwill on its balance sheet and needs to test it for impairment so that its financial statements are issued in accordance with Generally Accepted Accounting Principles (GAAP).
- Company shareholders are looking to part ways and need to determine a buyout price, or have filed a dissenting shareholder suit.
- A company owner or his/her spouse is getting divorced and needs to have the business interest valued to settle the marital estate.
- Company shareholders have suffered damages due to the loss of business value.
- A business is recapitalizing or reorganizing.
- Company shareholders are putting together a buy-sell agreement or purchasing life insurance.
- A company has an employee stock ownership plan (ESOP) or incentive stock options.
- Any other situation where the value of a business or ownership interest is in question.
Our clients include accountants, attorneys, boards of directors, business owners, CFOs, controllers, divorcing spouses, estate executors, exit planning professionals, financial planners, private equity groups, and venture capital groups.
For tax related valuations, such as gift or estate tax, we often work directly with the client’s trusts and estates (T&E) attorney to begin the process of identifying what is being appraised, the date of the valuation, and the purpose. We then work directly with the company’s owner/accountant/CFO and controller.
Valuations for financial reporting purposes, such as ASC Topics 820, 805, 350 or 718 are often identified as necessary by a company’s auditor or CFO. We work closely with management, including the CFO and controller, to define the nature of the engagement and what needs to be valued. We appreciate when the auditor is involved at the start of the engagement to ensure our process is acceptable and we work closely with them through their review process.
For litigation-related projects we are retained either by the client’s attorney or directly by the divorcing spouse, company, or shareholders.
Nothing. The terms are used interchangeably. In a business valuation context, an appraisal or a valuation is the act or process of determining the value of a business, business ownership interest, security, or intangible asset.
Professional designations are one of the most important factors to consider in selecting a business appraiser. Appraisers who have earned top-quality designations through testing and rigorous peer review of their work product have decisively established their competence. Most members of the business community do not understand the differences in the rigor of and difficulty of obtaining various designations available to business appraisers. However, they are aware of the proliferation of “professional” designations in many fields of specialization, and the ease with which many of them can be obtained. What is even more confusing is when various professional societies (read business brokers, finance societies, and accountants) award designations that involve activities peripheral to a profession (read business valuation). Four professional societies currently offer designations in business valuation:
- American Society of Appraisers: ASA’s senior designation is the ASA (Accredited Senior Appraiser) which requires that appraisers have a minimum of five years of full-time equivalent appraisal experience (10,000 hours of business valuation experience) and a college degree or equivalent, pass up to four levels of exams, pass a standards exam and an ethics exam, and submit an actual appraisal report for peer review. As such, it is perhaps the most difficult to obtain. Once accredited, 100 credit hours in continuing education every five years are required. ASA also offers an Intangible Asset (IA) Appraisal Specialty for ASAs which requires the completion of two courses and exams and the submission of an intangible asset valuation report for peer review. ASA generally focuses on the valuation of mid-sized and larger businesses.
- National Association of Certified Valuators and Analysts: NACVA members can qualify for the CVA (Certified Valuation Analyst) designation by holding an active CPA license or holding an undergraduate business degree, MBA, or higher business degree from an accredited college or university, as well as demonstrating substantial experience in business valuations. The CVA designation requires passing an examination, submitting a case study appraisal report or actual appraisal report for peer review, and submitting three personal and three business references. Recertification requires 60 hours of coursework every three years. The ABAR (Accredited in Business Valuation Appraisal Review) designation is specific to the review of business appraisal reports, requires a professional valuation designation, completion of a five-day course, submission of four professional references, and passing a comprehensive exam.
- Institute of Business Appraisers: Owned by NACVA, IBA’s primary designation is the CBA (Certified Business Appraiser), which requires appraisers to submit two professional references, pass one examination, attend two course series, submit two actual appraisal reports for rigorous peer review, and have a four-year college degree or equivalent. The course and exam requirements may be waived for holders of certain credentials. An MCBA (Master Certified Business Appraiser) is an individual who has been a CBA for over ten years, has over fifteen years of business valuation experience, has a two-year post graduate degree or equivalent, holds a professional designation by one or more peer professional business appraisal societies, and has been endorsed by his/her peers as a leading contributor to the profession’s body of knowledge. Recertification requires 36 hours of coursework every three years. IBA generally focuses on the valuation of small to medium-sized businesses.
- American Institute of Certified Public Accountants: The AICPA has recognized business valuation as a separate profession and acknowledges that a CPA requires separate training and experience to value businesses. CPAs can qualify for the ABV (Accredited in Business Valuation) designation by passing a rigorous exam, demonstrating involvement in at least six appraisals or 150 hours that show substantial experience and competence, and having completed 75 hours of business valuation courses. Continued certification requires 60 hours of coursework every three years.
Some professional designations are more difficult to obtain than others. The consuming public, however, is unaware of differences from one designation to another, and will therefore tend to assume that one professional designation is about as meaningful as any other. In summary, while all have recertification requirements, only an ASA or CBA has undergone a stringent peer review process of their appraisal work product; only an ASA, CBA or ABV is required to have a specified level of business valuation experience. So this may suggest, for example, that if you are considering hiring an appraiser who is not an ASA and/or a CBA, you may want to ask for a sample report to assess work product, since that work product is unlikely to have undergone peer review. While these designations are important in selecting a business appraiser, the amount of experience in the profession and the amount of time spent doing valuation work must also be considered. Nonetheless, given the opportunities to earn a designation in business valuation, the consumer should question the appraiser who has not earned one.
To understand more about designations within the business valuation profession, please request our “Appraising Business Appraisal Designations” issue of our internal quarterly publication, The Valuation E-Column.
If your CPA has received formal training in business valuation (including the particular situation at hand) and there will be no perceived conflict of interest in the situation for which you are getting your business appraised, sure.
However, while most CPAs have achieved a high level of competence in accounting and/or tax matters, the vast majority of CPAs do not have the necessary expertise and training to value a business. In fact, as an illustration, only about 4,200 (as of January 2015) of approximately 400,000 CPAs in the country (about 1%) have earned the Accredited Business Valuator (ABV) designation (discussed above in the response to the preceding question) awarded to members of the AICPA who have passed a rigorous exam and have demonstrated involvement in at least ten appraisals.
Accounting and appraisal skills, although overlapping, are fundamentally different. Accountants are trained to focus on historical information. In addition to that, appraisers look sideways at comparable businesses in the marketplace, and forward at expected future performance.
In terms of a perceived conflict of interest, little else needs to be said given events several years ago with Enron and other companies.
Throughout most valuation engagements, we work closely with our clients’ CPAs (as well as attorneys and other trusted advisors) to ensure a complete and thorough appraisal of your business.
The appraisal process and experience necessary to value real estate and other hard assets is specific to the asset being appraised. While we do not perform appraisals of real estate or other fixed assets, we have strong relationships with many excellent appraisers who specialize in these areas and we work in concert with these appraisers to complete the necessary analysis.
Depending on need, scheduling, availability of information, cooperation of management of the company being valued, type of report required, it typically takes about 4 to 8 weeks to render an opinion of value, and less to complete a limited appraisal.
Most appraisers quote a range of fees or cite a straight hourly rate. Expenses are billed separately. It is a direct violation of ethics and professional standards to be paid on contingency (outcome of the valuation). All professionals will give consideration to the time they will spend on an engagement. To properly value a business, the appraiser must do an extensive qualitative and quantitative assessment of the business. That means, among other things:
- analyzing the current economic environment and how it impacts the company being valued and the industry in which it operates;
- analyzing the industry in which the company operates;
- interviewing company management and interacting with management and their advisors throughout the valuation engagement;
- understanding the history and current and future prospects of the company, its competitive environment, its customer base, its management, its strengths, weaknesses, opportunities, and threats, its suppliers, its possible contingencies, etc.;
- conducting a full financial analysis of the company’s liquidity, activity, profitability, and solvency position;
- understanding future prospects, including a financial forecast of the company’s expected future performance;
- researching guideline public company multiples as well as guideline M&A transaction multiples;
- conducting sensitivity analysis and sanity checks; and
- writing a report.
As such, the business valuation process is a time-consuming one, of which the use of computer software programs comprises a relatively small portion. Professionals expect to be well compensated for their time. If a quote seems low, you might want to consider whether your appraiser is doing everything s/he needs to in order to provide a well-thought out and defensible opinion of value.
“It is unwise to pay too much, but it is worse to pay too little. When you pay too much, you may lose a little money — that is all. But when you pay too little, you stand to lose everything, because the thing you bought was incapable of doing the thing it was bought to do. If you deal with the lowest bidder, it is well to add something for the risk you run; and if you do that, you will have enough to pay for something better.” (John Ruskin)
Perhaps, but that is akin to a residential real estate appraiser driving by a house rather than looking inside. Two identical and adjacent homes could have materially different values if one is in relatively poor condition on the inside and the other has undergone several renovations and additions that are not visible from the outside. The business valuation process is far more sensitive and complex than just plugging numbers into a computer software package or spreadsheet, requiring material professional judgment. The numbers in a business (for example, the pre-tax profits) may need to be adjusted for certain factors such as excess compensation, fair market rent, etc. These numbers may not necessarily reflect certain risks (e.g., dependence on a key person or on one customer) that would need to be factored in valuing a business.
There is no single method for determining the fair market value of a business or individual interests in its equity; the method depends upon the circumstances surrounding the business and its individual characteristics. Traditionally, the development of a fair market value opinion of a business enterprise and corresponding equity interest is based on the consideration of three basic approaches to value, after a full qualitative and quantitative assessment of the underlying business. Value indications derived through one or more of these approaches are then analyzed in order to formulate an objective opinion as to the fair market value of the equity interest under valuation. A brief description of the three approaches follows:
The Income Approach
measures the value of a business based on the expected stream of monetary benefits attributable to the subject company. Generally, the present value of the income stream to be generated for the benefit of the shareholders over the business’ remaining economic life is determined. This approach assumes that the income derived from the business will, to a large extent, control its value.
The Market Approach
arrives at an indication of value by comparing the company being appraised to comparable publicly traded companies or to comparable businesses which have been recently acquired in arm’s-length transactions. The market data is then adjusted for any significant differences, to the extent known, between the guideline companies and the company being valued.
The Asset Based (or Cost) Approach
is a general way of determining a value indication of a business’s assets and/or equity interest using one or more methods based directly on the value of the assets of the business, less liabilities.
Within the income, market and cost approaches are several methods, and within those methods are several procedures. The most commonly applied include:
The Multiple Period Discounting Method
within the Income Approach involves projecting all expected future economic benefits (e.g., net cash flow, net income, etc.) and discounting each expected benefit back to a present value at a discount rate which represents the time value of money plus risk. Two examples of procedures within this method are discounted cash flow (“DCF”) and discounted future earnings (“DFE”).
The Single Period Capitalization Method
within the Income Approach involves dividing a single historical or projected economic benefit by a capitalization rate that represents the discount rate for that variable less the expected sustainable long-term growth rate in that variable. An example of a procedure within this method is the capitalization of cash flows.
The Guideline Publicly Traded Company Method
(a/k/a the Market Multiple Method) within the Market Approach relates market value multiples for public company stocks to fundamental financial variables for the subject company (e.g., P/E, EBIT multiples, etc.).
The Guideline Merger & Acquisition Method
(a/k/a the Transaction Multiple Method) within the Market Approach relates value multiples from sales of entire companies or controlling interests to fundamental financial variables for the subject company (e.g., P/E, EBIT multiples, etc.).
The Direct Market Data Method
within the Market Approach is a broader market based valuation method whereby all transactions for which market data is available are considered as a statistical ensemble that defines the market for businesses of the same general type (e.g., SIC category) as the target business.
within the Market Approach relate ways to reach value based on prior transactions in the subject company’s stock to current data for the subject company.
within the Asset Based Approach involves individually adjusting all assets and liabilities (including those off balance sheet, intangibles, and contingencies) to current values and computing a resulting net asset value.
The Excess Earnings Method
a hybrid between the Income and Asset Based Approaches, involves a collective valuation of all intangible assets as a group by capitalizing returns over and above a reasonable rate of return on tangible assets and adding the capitalized value of intangibles thus estimated to the value of tangible assets. It was originally created for valuing the intangible component of a business, not for valuing the company as a whole, and is not considered appropriate, according to the IRS, except if there is no better basis available for making the determination.
A business is valued either on the basis of what it owns less what it owes, or on the basis of the benefits it generates. Assets are valued the same way. Your equipment is essential to generate the sales and profits an appraiser uses to value the business, and its value is included on that basis. Assets like extra cash, idle equipment, or a vacation condo that are not necessary to support operations and generate those benefits are added to the value.
Fair market value is typically defined based on the definition prescribed under Internal Revenue Service (IRS) Revenue Ruling 59-60, several other pronouncements, and a large body of case law as follows: The price 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. Court decisions frequently state in addition that the hypothetical buyer and seller are assumed to be able, as well as willing, to trade and to be well informed about the property and concerning the market for such property. In other words, in applying the standard of fair market value, we assume that:
- the equivalent of cash is being paid for the subject being appraised as of the Valuation Date;
- it refers to ‘price’ rather than the proceeds of the sale of a property;
- the company (interest) being valued has been placed on the open market for a reasonable amount of time enough for all potential purchasers to be aware of its availability;
- the hypothetical buyer is prudent but without synergistic benefit (i.e., potentially very different from investment or strategic value) — as such, it reflects the consensus of rational pricing, rather than the highest price that might be obtained;
- a seller is not forced to sell (i.e., accept an offer that represents a “distress sale”) and a buyer is not compelled to buy (i.e., necessary to earn a living); and
- the business will continue as a going concern and not be liquidated.
Revenue Ruling 59–60 is an official pronouncement of the national office of the IRS, written in 1959, regarding the valuation of closely held common stock. It is the most widely referenced IRS revenue ruling in a business valuation context, and is also often referenced for non tax valuations.
Within 59–60, the standard of fair market value is defined and the following eight basic factors to consider in a business valuation are outlined:
- the nature of the business and the history of the enterprise from its inception;
- the economic outlook in general and the condition and outlook of the specific industry in particular;
- the book value of the stock and the financial condition of the business;
- the earning capacity of the business;
- the dividend-paying capacity of the company;
- whether or not the business has goodwill or other intangible value;
- prior sales of the stock and the size of the block to be valued; and
- the market prices of stocks of corporations engaged in the same or a similar line of business as the subject company and whose stocks are actively traded in a free and open market, either on an exchange or over-the-counter.
View Revenue Ruling 59-60 (113k PDF).
A valuation is valid as long as its methodology is sound and its assumptions hold firm. It could be a day, a week, a month, a year, or any time period, depending on the facts and circumstances of the situation. As a practical matter, this extends to a maximum of a year (in more certain times), when an appraisal must be updated to reflect subsequent company performance and current economic/industry conditions. The old adage, “timing is everything,” very much applies to business valuation. In the extreme case, given 9/11, in 2001, the valuation of a hotel or an airline company was significantly different on September 10th as compared to September 15th.
If the IRS audits the gift or challenges the value for any reason, the burden of supporting the value of the business or business interest rests with the taxpayer. Without a well-reasoned valuation from a qualified appraiser, the taxpayer has virtually no basis to dispute what may prove to be an unrealistic IRS valuation claim. If a qualified appraisal has not been obtained before filing the tax return, the taxpayer will ultimately have to pay for such a valuation when the valuation dispute arises. The existence of a well-reasoned valuation from a qualified analyst can sometimes prevent a valuation challenge. When faced with a taxpayer valuation based on the opinion of a well-respected, independent analyst, the IRS is essentially forced to hire an equally qualified analyst who can credibly attack the valuation opinion of the taxpayer’s analyst and who can produce an opinion of value different enough to generate a tax revenue advantage for the government. The IRS will only allocate resources to pay for valuations if there is an expectation that the allocation will be more than reimbursed. It is difficult for the IRS to justify spending money to challenge a reasonable valuation from a qualified expert that is based upon widely used valuation methods.
In a 2007 Second Circuit Court decision for Thompson v. Commissioner, the Court held that the decedent’s minority interest in a closely held family business was severely undervalued (the estate claimed the interest was valued at $1.75 million; the Court held that the proper value of the interest was $13.5 million), and reprimanded the executors of the estate who chose to obtain an appraisal from an attorney and an accountant, neither of whom had experience in valuing interests in closely held family companies, thus underscoring the importance of obtaining a qualified appraisal performed by an independent valuation professional.
If the IRS does challenge the value reported on an estate or gift tax return, and determines that the value was underestimated, not only can a larger tax be assessed on the value the IRS feels is more accurate (substantiated by a qualified appraisal obtained by the IRS), but an underpayment penalty of 40 percent of the total tax owed can be assessed if the value claimed on the return is 50 percent or less of the correct value of the asset. Costs of such added taxes and penalties are likely to be significantly higher than the cost of obtaining a qualified appraisal.
Yes. We have the specialized knowledge, skills, experience, training, and education to testify and assist the court in coming to a decision, and have been qualified as business valuation experts in court proceedings. It is important to note that even valuations in a non-litigation matter may end up in legal dispute.
If your financial statements are issued in accordance with Generally Accepted Accounting Principles (“GAAP”), you have goodwill on your balance sheet, and/or you plan to make acquisitions in the future, the answer is “YES.” These Statements require more explicit disclosure of the fair value of past and future acquisitions in relation to their actual cost. This means companies (both publicly and privately owned) will no longer have the option to leave overvalued goodwill assets on their balance sheets.
20. Our firm will be needing a valuation of its common stock in connection with IRC Section 409A and ASC 718. Given that we have both preferred and common stock, how will you approach the valuation of our common stock?
The exact manner in which we value the common stock of a company with a complex capital structure consisting of multiple classes of stock and different rights and claims on its equity will depend on its stage of development and history in terms of rounds of financing. While there are many ways to value the common stock in such situations, the AICPA has published a Practice Aid titled the Valuation of Privately-Held Company Equity Securities Issued as Compensation, which presents three methods intended to cover a range of different scenarios. Brief descriptions of these three methods that are commonly used to allocate the total equity value of a company to the components of its capital structure follow:
- The current value method — This method is appropriate when a liquidity event is anticipated in the near future. It determines the value of the common shares by relying on the assumption that 100 percent of the equity of the subject company is sold. That equity value is reduced by the senior claims of preferred shares, and the remaining balance is allocated to the common shares. In situations in which the senior claims exceed the value of 100 percent of the equity, the common stock is deemed to be worthless. This method is generally considered appropriate to use in the following two circumstances: Companies with an imminent liquidation or acquisition event; or When an enterprise is at such an early stage of development that: i.) No material progress has been made on the enterprise’s business plan; ii.) No significant common equity value has been created in the business above the liquidation preference on the preferred shares; and iii.) There is no reasonable basis for estimating the amount and timing of any such common equity value above the liquidation preference that might be created in the future.
- The option-pricing method (“OPM”) — This method treats common stock and preferred stock as call options on the equity value of the subject company. Essentially, the common stock is treated as a call option that gives the owner a right, but not an obligation, to buy the underlying enterprise at a predetermined exercise price. This method is sensitive to certain key assumptions, including the expected volatility, or the standard deviation of expected returns on the equity of a company, which can be difficult to estimate. This method may be appropriate when a liquidity event is not anticipated in the near future, as the method recognizes that common stock may have little or no value if the subject were to be sold in its entirety on the Valuation Date, but has a claim on future values of the company in excess of the senior claims of the preferred stock.
- The probability-weighted expected return method (“PWERM”) — Under this method, an analysis of future values of a company is performed for several likely liquidity scenarios. Those scenarios may include a strategic sale or merger, an initial public offering, the dissolution of the company in which the preferred shares receive all of the proceeds and the common shares are worthless, as well as the company’s private enterprise value (no liquidity event). The value of the common stock is determined for each scenario at the time of each future liquidity event and discounted back to the present using a risk-adjusted discount rate. The present values of the common stock under each scenario are then weighted based upon the probability of each occurring to determine an indication of the value of the common stock. This method is generally considered appropriate to use when there are several distinct liquidity scenarios to be considered.