Answers to Common Business Valuation Questions
When should I have my business appraised?
In brief, whenever you need to make an important decision involving value. Assuming an incorrect value can lead to a failed sale, acquisition, buy-out, ESOP or resolution of a dispute, or an incorrect tax filing. See business valuation uses.
What is the difference between a business valuation and a business appraisal?
Nothing. Valuation professionals use these two terms interchangeably. They are both opinions of value. Be sure to understand the scope of analysis and level of report that the analyst is proposing, regardless of what they call it.
What types of value are used in business valuation?
Yes. The word “value” by itself is not specific enough when it comes to business valuation. Different standards of value are used, depending on the intended use of the business valuation, and even sometimes the applicable legal jurisdiction. The following standards of value are commonly used to establish the economic value of privately held business interests:
- Fair Market Value is usually defined as the price at which a business would change hands between a willing buyer and a willing seller when the former is under no compulsion to buy and the latter is not under any compulsion to sell, both parties having reasonable knowledge of relevant facts. FMV is used for income and estate tax purposes. In the U.S., FMV is the most widely recognized and used standard of value in business valuations.
- Fair Value is a statutory standard, usually used in court cases involving dissenting shareholders, shareholder oppression, divorce and other litigation. Its definition and application varies by type of case and jurisdiction.
- Investment Value is value to a particular buyer or investor, based on their specific investment requirements and expectations, and may consider expected synergies when the businesses are combined. Investment value is often used in mergers and acquisitions.
Book Value is not a standard of value. It is an accounting concept. Due to the nature of the accounting process, book value would equal economic value only by chance!
Before an appraiser can value a business, the appropriate standard of value must be ascertained. In a dispute setting, for example, an incorrect standard of value would cause a valuation result to be dismissed altogether.
Can I rely on Exit Strategies for confidentiality?
Yes, it is our policy to never divulge anything about our engagements unless we’re officially directed otherwise. We can be retained by your attorney to provide client-attorney privilege.
Can I count on Exit Strategies’ appraisers to be objective?
Absolutely, with no vested interests and no hidden agendas.
For what types of businesses does Exit Strategies provide business appraisals?
- Stand alone businesses, subsidiaries, divisions, profit centers and reporting units
- C Corporations, S Corporations, sole proprietorships, general and limited partnerships and LLCs
- Entire companies and fractional interests
- Operating and holding companies
Does Exit Strategies value intangible assets?
Yes. Common intangible assets are customer and supplier contracts, license agreements, franchises, covenants-not-to-compete, copyrights, designs, goodwill, technology, software, trade names, intellectual property, trademarks, patents, copyrights, trade secrets and proprietary methods or technology. Intangibles assets are non-physical assets (as distinguished from physical assets) that grant rights and privileges, and have economic benefits for the owner.
If I give my son or daughter stock in my company, do I need a business appraisal?
Usually. If the IRS audits a gift, the burden of supporting the value of the gift is on the taxpayer. A qualified business appraisal demonstrates to the IRS that shares are properly valued. See your CPA for advice.
What is a family limited partnership?
A family limited partnership (FLP) is an entity established to hold business or financial assets of a family. FLPs provide a number of advantages including centralized management, protection from creditors, and the ability to apply valuation discounts to the partnership interests for estate and gift tax purposes.
My partner wants to buy me out. Can you value my ownership interest?
Yes. We will need review your buy-sell or shareholder agreement, if you have one. A buy-sell agreement controls how ownership interests in a company are transferred. It is important that private companies with multiple owners have written buy-sell agreements! If you don’t have one, we can still value your interest, but the appropriate standard of value will need to be agreed upon.
What is meant by equity?
We usually value either an invested capital or equity interest in a business. Generally speaking, equity means net worth, or assets minus liabilities. The value of invested capital (sometimes called enterprise value or asset value), is the debt free value of an enterprise. A simple example of invested capital value is when a real estate appraiser values a residential property at, say, $500,000. The appraiser is not concerned with how much is owed on the property, thus the $500,000 is equivalent to invested capital. If we subtract the mortgage owed on the home (interest-bearing debt in the case of a business), let’s say $275,000 in this example, its equity value is $225,000.
What is a business valuation approach?
An approach is a general way of determining value for a business, business ownership interest, security or intangible asset; using one or more business valuation methods.
What is the Asset Approach to business valuation?
The Asset Approach, also called the cost approach, is based on the value of a company’s underlying assets and liabilities, and is generally an indication of the value that has accumulated over time. Generally speaking the cost of duplicating or replacing each component is determined, sometimes using specialist appraisers (e.g. real estate, machinery and equipment). Common asset-based methods are a) Adjusted Book Value Method (sometimes augmented by the Excess Earnings Method to value intangibles), b) Replacement Cost Method, and c) Liquidation Value Method. Liquidation value is the amount that could be obtained from a piecemeal sale of business assets, after expenses, when carried out in either an orderly or forced manner.
What is the Market Approach to business valuation?
The Market Approach is based on the principle of substitution, meaning that for any investment an investor considers, there exist other investments with similar characteristics that are acceptable substitutes. Prudent investors will not pay more for something than they can pay for an equally desirable substitute. Since the objective of an appraisal assignment is usually to arrive at an opinion of market value, it is logical to examine values determined and tested in the marketplace. Two common methods within the market approach are: a) Guideline Public Company Method; and b) Direct Market Data Method.
What is the Income Approach to business valuation?
The Income Approach considers the earnings capacity of a company. It operates on the theory that investors invest in businesses with similar investment characteristics, though not necessarily of the same business type. It values a business based on the present worth of the expected future benefit stream, adjusted for risk. Because estimating the future financial performance of a business is speculative, historical data is considered (though not entirely relied upon), on the premise that history often repeats itself. Two common methods within this approach are the Single Period Capitalization Method and Multi-Period Discount Method (discounted future cash flows method).
What is a premise of value?
Similar to the preceding discussion concerning standard of value, selecting a premise of value has a substantial effect. There are two basic premises: a) value as a going concern and b) value in liquidation. A premise is normally chosen based on the highest and best use of the business, given the circumstances and market conditions on the date of business valuation. A going concern premise usually assumes that a company will continue in business in a similar manner as conducted in the past, and is based on a company’s ability to generate earnings. According to USPAP, Standards Rule 9-3, in developing an appraisal of an equity interest in a business enterprise with the ability to cause liquidation, an appraiser must investigate the possibility that the business enterprise may have a higher value by liquidation of all or part of the enterprise than by continued operation as is.
Are minority interests less valuable than majority interests?
A minority interest in a company may be considered less valuable than a non-controlling interest because the minority interest holder can’t control policy setting, payment of dividends, compensation, investment in and disposition of assets, strategic direction and operational aspects of the company. Investors generally pay more for the rights, liberties and benefits afforded a controlling interest, versus a non-controlling interest. A Discount for Lack of Control (DLOC) is a percentage deducted from the pro rata value of a one hundred percent (100%) equity interest in a business to reflect the absence of some or all of the powers of control.
What is a Discount for Lack of Marketability?
Valuing stock in a private company requires assessing the degree of marketability (liquidity) of the shares in question. Unlike public company securities that have an organized marketplace and are convertible to cash within a few days, most closely held stock is more difficult to sell. A lack of liquidity increases an investor’s required rate of return because it either increases the holding period of the investment (and therefore exposure to changing market conditions) or the cost to convert it to cash or both. Research supports the view that lack of liquidity of privately held securities has a significant impact on value. An ownership interest is not simply marketable or non-marketable (liquid or illiquid). There are degrees of marketability and the appropriate Discount for Lack of Marketability (DLOM) will depend on the facts and circumstances affecting the specific interest being valued and requires careful study.
Does Exit Strategies appraise real estate?
No. However we can direct you to qualified real estate appraisers or contract out real estate appraisals when a business that we’re appraising owns real estate or leases it from a related party. We do appraise holding companies (often FLPs) that hold real estate assets. We also value fractional equity interests in those entities using appropriate discounts, but we do not value fractional undivided interests in real estate directly. Call us for more information.
Can my CPA appraise my business?
Maybe. We have the utmost respect for the accounting profession and most CPA’s do an excellent job with taxes and accounting; however very few (<2%) have the expertise and credentials to value businesses. Most CPA's won't appraise their own clients' businesses even if qualified to do so because they have an inherent conflict of interest. More often, CPA's ask us to appraise their clients' businesses, and supply us with the quality financial reporting we need to do the valuation.
Does Exit Strategies provide tax advice?
No! We are not CPA’s and we do not prepare tax returns. Our focus is on the expert valuation and transfer of private business interests.
Will any business valuation expert that I hire produce the same result?
No. Some people wrongly perceive business valuation services as a commodity that yields identical results regardless of the valuation provider. However, training and experience matter a great deal, as does the scope of analysis and depth of research conducted, among other factors, and all business valuation outcomes are not identical.
Do business valuation credentials matter?
Value is an opinion not a fact. Whether or not a business valuation withstands the scrutiny of a partner, investor, regulator, lender or judge, as the case may be, depends on the credibility and skill of the individual offering the opinion. Selecting a certified professional increases the likelihood that a valuation will be accepted by your intended users. Before you hire a business appraiser, understand his or her credentials and experience.
Major business valuation credentials in the U.S. are (alphabetically):
- ABV – Accredited in Business Valuation, from the American Institute of Certified Public Accountants (AICPA)
- ASA – Accredited Senior Appraiser, from the American Society of Appraisers (ASA)
- CBA – Certified Business Appraiser, from the Institute of Business Appraisers (IBA)
- CVA – Certified Valuation Analyst, from the National Association of Certified Valuators and Analysts (NACVA)
How much does a business valuation cost?
The cost of a business valuation depends on the appraiser’s time and expenses. Factors include (1) your intended use and users, (2) the scope of analysis performed, (3) the type of report required, (4) the nature and complexity of the business and make up of its assets, (5) the specific business interest being valued, and (6) access to information and the quality of your records. It takes many hours to compile information, fully analyze a company, develop a financial forecast, apply valuation methods within each required approach and make a final determination of value, and prepare a comprehensive valuation report. When appropriate, we can provide limited scope value calculations for much lower cost. The appropriate level of service and fees can usually be determined after an initial phone conversation with one of our appraisers. That initial consultation is free — please give us a call.
How much business valuation do I need?
When you only need an estimate of value for internal use, a limited scope calculation analysis and letter report may be adequate. For IRS purposes and shareholder disputes, a full analysis and summary or full report are generally needed. When a third party investor will rely on the report, a summary report is usually appropriate. We will recommend the appropriate level of service after our initial conversation. That initial consultation is free of charge and confidential.
How long does a business valuation usually take?
Full scope business valuations generally take 3-4 weeks from our receipt of the information we need from you. Actual time-frame depends on the scope of work, the complexity of the business, the accuracy and completeness of information, workload and other factors. We can often deliver reports on accelerated time frames when required.
How do I get started?
Any of Exit Strategies’ business appraisers would be pleased to discuss your valuation needs, confidentially and at no cost, to quote the appropriate level of service. Please contact us, or see business valuation process for more information.