Elements of a Credible Business Valuation

By Apex Valuation Consulting LLC

The owner of a full or partial interest in a business or asset-holding company must seek out the professional opinion of a business appraiser only a handful of times in a career. But the significant financial and legal implications inherent in the need for valuation services make the selection of the right valuation expert very important. How can an attorney, accountant or business owner distinguish a credible valuation from that which should be viewed with skepticism?

Whether it is for a transaction, litigation, tax compliance or some other purpose, a business valuation that meets the criteria described in this article is likely one to be counted on:

• Competence – the appraiser should have considerable training, knowledge and experience in performing business appraisals. This should be evidenced by a leading business valuation credential, such as the ASA, ABV or CBA.
• Disinterestedness – the appraiser should and have no interest in the business being appraised.
• Non-advocacy – the appraiser should exercise independent judgment and must not act as an advocate for any party involved. The appraiser must only be an advocate for his or her opinion.
• Support – the appraiser’s analyses, methodologies and opinions should be well supported.
• Replicability – the appraiser’s analyses, methodologies and opinions should be presented in sufficient detail so as to permit the reader to understand and follow the appraisal process.
• Coherence – the appraiser’s report should be well organized, well written and lead the reader to a logical conclusion.
• Qualifications of the appraiser – the appraiser should present their education, experience and credentials in sufficient detail so as to allow the reader to evaluate his or her qualifications.
• Compliance with professional standards – the appraiser should adhere to the appropriate professional standards and ethics, and should attest that they have done so within the text of the report.

The elements discussed above speak to the credibility of the appraisal process. In terms of content, a quality business valuation should consider the following:

• Economic factors – a discussion of the local, national and/or global economic issues that affect the business and its future prospects.
• Industry factors – an assessment of the industry in which the business operates, its recent trends and outlook for the future.
• The business’ operations – a review of the company’s history, products and/or services, organizational structure, management, customer and/or supplier base, and competition.
• Legal issues – a discussion of any laws or contractual arrangements that impact an ownership interest in the business. This includes an analysis of any restrictions on alienation such as those often found in buy-sell, partnership, operating and franchise agreements.
• The business’ financial condition and performance – an evaluation of the business’ capital structure, liquidity, efficiency and profitability and an analysis of key financial ratios in comparison to industry norms.
• Valuation methodologies – an analysis of the methodologies used and rejected. This discussion usually will include the theoretical basis for the methodology, the reasons for the application or rejection of the methodology and the steps and calculations inherent in it as it relates to the subject company.
• Valuation discounts – an assessment of the level of value indicated by each methodology and any adjustments (i.e. discounts) that may be required. This should include a discussion of the relevant empirical data and the specific facts and circumstances affecting the degree of discount for the ownership interest.
• Final opinion of value – a synthesis of all economic, industry, and company-specific factors impacting value. It should reconcile the values indicated by each of the applicable valuation methodologies according to the appraiser’s level of confidence in each methodology.

A credible valuation should also be “certified” and signed by everyone who had a material involvement in its preparation. The certification should include explicit statements that:

• To the best of the appraiser’s knowledge, the statements of fact are true and correct.
• The reported analyses, opinions, and conclusions are the appraiser’s personal, unbiased professional analyses, opinions, and conclusions.
• The appraiser has no present or contemplated interest in the property that is the subject of the appraisal, and has no personal interest or bias with respect to the parties involved.
• The appraiser’s compensation is not contingent upon any action or event resulting from the analyses, opinions, or conclusions in, or the use of, the report.
• The appraiser’s analyses, opinions, and conclusions are developed and that the report is prepared in conformity with the applicable business valuation standards.
• No one provided significant professional assistance to the individual(s) signing the report.

The combination of the factors discussed above boils down to this – the essence of a credible valuation is a thoughtful, well-supported analysis that has been performed by a competent, independent professional applying well-accepted methods.