The business valuation process can be broken down into four parts.
1) The engagement process
2) Research and data gathering
3) Analysis and development of the business value
4) Reporting engagement results
There are several items that need to be considered at the start.
- What legal interest is to be valued – (e.g., 100% of the company’s common stock but partial interests can be valued too)
- Valuation date – the exact date the company’s value is to be calculated
- The valuation purpose (e.g., tax, business sale, litigation support, business planning and so on)
- Define the standard of value, which can be:
Fair market value – the value in an exchange between a willing buyer and a willing seller with a reasonable understanding and access to all the facts. Fair market value is the most common standard of value and is what the IRS requires;
Investment value – the value to a particular investor based on individual investment situation. This standard is often used in merger & acquisitions. - What is the premise of value:
Value as a going concern – this is the value of a business assuming it will continue to operate as a going concern. This is by far the most common premise;
Liquidation value – the value of a business that is not a going concern, but has commenced an orderly disposition of its assets. Situations where the premise is liquidation value is not very common. - The form and content of the report, but that depends on the purpose, and the other items listed above.
Prior to the valuation process the client will need to sign an engagement letter that states, the terms of the engagement and that everything that the client will and has supplied to the valuator is true and accurate to the best of the client’s knowledge and abilities.
Research & Data Collection
After being engaged, the valuator will request information from the client. The exact information requested can vary depending on the purpose of the valuation but may include the following.
- Company history
- Legal ownership information, including documentation of such
- Financial statements
- Tax returns
- Accounts receivable, accounts payable and inventory detail
- Contracts/leases
- Budgets/forecasts
- Board of directors minutes, if any
- Organization chart
- Marketing material/price lists
- Customer lists
- Description of the competition in the trade area
- Whatever else is relevant and helpful in understanding the business.
The valuator will also conduct an interview of the company’s management, to better understand the unique requirements of the business.
While this information is being gathered the valuator will be performing industry and comparable company research.
Analysis of Value
During this part of the valuation, the valuator analyzes all of the internal company information in conjunction with industry and comparable company research. This analysis will then enable the valuator to come to a conclusion or indication of value. (Those are technical valuation terms with specific meanings, that we will not discuss here). This part of the process requires working with financial information, and other data. The client will be contacted to answer questions that arise as needed.
Reporting
In the reporting phase the valuator will issue his or her report. There are three basic types of reports.
- Oral report – issued when time does not permit a written report to be issued. This is not adequate for tax (IRS) and litigation purposes as, among other things, it is easily challenged.
- Limited report – provides a well-documented estimate of value that can be used for many purposes, while taking into consideration the cost of the report preparation. For example, the Alteris Market Compass is a limited scope report.
- Full report rendering an opinion of value – the most detailed and costly valuation. This is often used for litigation or tax purposes or where the results will be highly scrutinized.
Role of the Valuator
Unlike legal counsel who is ethically obligated to be the client’s advocate, the valuator is independent. In the past valuators were often hired by legal counsel to support a particular preconceived position. Although this practice still exists it occurs less frequently today. In the long run, the advocacy bias creates tension between parties trying to reach a good faith agreement on the value of a business. Even if the valuator has to provide expert testimony in a court proceeding the valuator’s ultimate responsibility is to document and support the estimate of value. The IRS, various Courts, SEC and other government entities all have rules regarding independence and the advocacy position of the valuator.
Role of the Client
The key to a successful valuation is establishing a relationship of trust between the valuator, the client and the client’s professional advisors. It is in the client’s best interest to be open and forthcoming with the valuator in order to avoid errors and reduce costs.
What a Valuation is not
A valuation is not an audit or accounting review. Financial information is accepted from management or the business owner as-is, without checking for accuracy. The valuator is not providing any form of assurance, as defined by the AICPA on his or her opinion or calculation of value. The valuation is also not a strategic plan or a long-term financial forecast. The valuation analysis and report cannot and will not detect errors or omissions or fraud.
