Common Business Valuation Questions

When should I have my business appraised?
Most of us rely on expert unbiased opinions when we make important decisions involving major assets. Assuming the wrong value can have serious consequences. Situations in which businesses are appraised usually boil down to ownership transfers, tax, compliance and disputes over value.  See valuation uses.

What is the difference between a valuation and an appraisal?
None; financial professionals use these terms interchangeably.  They are both opinions of value. Be sure to understand the level of analysis and report that the analyst will provide, regardless of whether they call it a valuation or an appraisal.

Can I count on Exit Strategies for confidentiality?
Yes, we take confidentiality extremely seriously. It is our policy to never divulge anything about our clients unless we’re officially directed otherwise. We can be retained by your attorney to assure client-attorney privilege.
Can I count on Exit Strategies to be independent?
Absolutely, with no vested interests and no hidden agendas. Independence is necessary for a valuation to stand up to investor and regulator scrutiny.
What types of businesses does Exit Strategies appraise?  
We have a broad base of experience, resources and data for almost any industry and type of firm. We generally value closely-held companies up to $40M revenue. We commonly appraise businesses in the manufacturing, distribution, professional practice and service, retail, construction and transportation sectors.
If I give my son or daughter stock in my company, do I need an appraisal?  
Yes, an appraisal should be done whenever a potential gift tax is involved. 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.
My partner wants to buy me out.  Can you value my ownership interest?
Yes. We will need to 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 privately-held 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 defined and agreed upon.

What is meant by equity and invested capital?  
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 reported on an invested capital basis. If we subtract the debt owed on the home (debt in the case of a business), let’s say $275,000 in this example, its equity value is $225,000.

What is a 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 valuation methods.
What is the Asset Approach to 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. This approach is useful when a firm’s asset values are greater than values derived from income and market approaches. Liquidation value is the expected amount that could be obtained from the piecemeal sale of business assets, after expenses, when carried out in either an orderly or forced manner
What are intangible assets?  
Intangibles assets are non-physical assets (such as franchises, trademarks, patents, copyrights, goodwill, equities, mineral rights, securities and contracts as distinguished from physical assets) that grant rights and privileges, and have economic benefits for the owner.
What is the Market Approach to 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. Some people consider “Rules of thumb” a third market approach method, however there are several disadvantages to this and it should never be relied on by itself for the valuation. Rules of thumb, when available, can be useful as a sanity check on valuation results.
What is the Income Approach to 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). A method called the Multiple of Discretionary Earnings (DE) method is often used in valuing small owner-operated businesses where potential buyers are often concerned with buying a job in addition to getting a return on invested capital.
What standards of value are there?  
The word “value” by itself is not specific enough when it comes to valuation. Different standards of value are used, depending on the purpose and intended use of an appraisal. The following standards of value are commonly used in valuing 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. It is generally also understood that the parties have the ability to buy or to sell and the transaction will be in cash or cash equivalents.  In the U.S., this is the most widely recognized and used standard of value in business valuations.
  • Fair Value is a statutory standard of value, usually used in court cases involving dissenting shareholders, shareholder oppression, divorce and other types of litigation.  Its definition and application can vary from state to state. Fair Value usually doesn’t allow for minority discounts, and may not allow a marketability discount. It may require that control-level adjustments be made to the income stream even when valuing a minority interest.
  • Investment Value is the value to a specific buyer or investor, based on their investment requirements and expectations, and is often based on expected synergies when the businesses are combined. This standard of value is often used in mergers and acquisitions.
  • Book Value is not really a standard of value. It is an accounting concept used to compute the difference between a company’s total assets and total liabilities. Intangible assets are usually not included in book value. Due to the nature of the accounting process, book value would equal the value of a business only by coincidence!

Before appraisers can attempt to value a business, they must fully understand the standard of value that applies. In a dispute setting, agreeing on the standard of value is absolutely critical, or the valuation result may be dismissed altogether.

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 at the time of the 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.
Why are minority interests less valuable than controlling interests?  
A controlling interest in a company is generally more valuable than a non-controlling interest because the controlling interest holder can 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. The IRS, valuation professionals and the courts recognize the appropriateness of Discounts for Lack of Control (DLOC). A DLOC is a percentage deducted from the pro rata share of value of one hundred percent (100%) of an 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 a liquid and ready market and are convertible to cash within a few days, most closely held stock has an absence of marketability. 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.
What is a certified business appraisal?  
An appraisal report is considered a “certified report” when it is signed by a qualified business appraiser who is taking technical responsibility for its content.
Does Exit Strategies appraise real estate?  
No. However we can direct you to qualified commercial real estate appraisers. Real estate appraisals are often needed when a business owns real estate or leases real estate from a related party. We can appraise real estate holding companies, and fractions interests therein.
Can my CPA appraise my business?
Probably not. First, while we have the utmost respect for the accounting profession, and while most CPAs do an excellent job in tax, audit, accounting and other consulting services, very few (under 2%) have the necessary expertise and credentials to appraise businesses. Ask your CPA if he or she is certified in business valuation. Second, for most appraisal uses, CPA’s have an inherent conflict of interest in providing valuations for their clients, so most CPAs won't appraise their own clients' businesses even if qualified to do so. We are regularly brought in by CPA’s to provide business valuations for their clients, and we rely on them to provide the quality financial information we need to do the valuation.

Do business valuation credentials matter?Remember that value is an opinion not a fact. Whether or not a valuation withstands the scrutiny of a partner, investor, regulator, lender, judge or jury, as the case may be, will depend on the credibility of the individual offering the opinion. Selecting a certified professional increases the likelihood that the valuation report will be accepted by its intended users.

The 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 Valuation Analysts (NACVA)

It’s safe to say that the two most difficult to obtain and highly regarded credentials are the CBA and ASA designations.

Established in 1978, the Institute of Business Appraisers (IBA) is the oldest professional society devoted solely to the appraisal of closely-held businesses. The IBA is considered a pioneer in professional appraisal accreditation and a leader in business appraisal education. A member of the IBA assumes an ethical obligation beyond any imposed by law and agrees to be bound by strict rules of professional conduct. The IBA currently has approximately 3,000 members and 400 CBA's. CBA’s must have a 4-year college degree, complete 90 hours of coursework or 10,000 hours of appraisal experience, pass a comprehensive written exam covering the theory and practice of business appraisal, and have 2 formal business appraisal reports pass a peer review by a qualification review committee. Maintaining the CBA designation requires continuing education. The CBA accreditation denotes a level of competence attained only by the most accomplished business appraisers, grants its recipients special recognition and prestige among fellow appraisers, the courts and throughout the business appraisal community.

Before you hire a business appraiser, understand his or her credentials and experience. Generally, those with the most demanding credentials do quality work and deliver credible opinions.

What determines the cost of a business valuation?  
The cost depends on the time and expenses required by the assignment. Factors include 1) the appraisal purpose, 2) the scope of analysis and type of report needed, 3) the nature and complexity of the business and make up of its assets, 4) the specific interest being valued, and 5) access to and the type and quality of information available. It can easily take 40 hours to analyze a company, apply appropriate valuation methods, make a final determination of value and prepare a report. When appropriate, we can provide limited appraisals or calculations for less than the cost of a full appraisal. Based on discussions with you and/or your accountant, attorney or financial advisor, we help you decide the right level of service.  Exit Strategies' fees are always competitive.
How much valuation do I need?
When you only need an estimate of value for internal use, a calculation analysis and preliminary letter form report may be adequate. For IRS purposes and shareholder disputes, a full analysis and summary or full report is best. When a third party investor will rely on the report, a summary report is usually appropriate. We can make a recommendation after our initial conversation.
How long does a valuation usually take?  
Generally 3-4 weeks from receiving the necessary information. This timeframe depends on the scope of work, the complexity of the business, the accuracy of the information we receive, your responsiveness to questions, and other factors.  We often deliver reports on accelerated time frames to meet the needs of our clients.
How do I get started?
Exit Strategies would be pleased to discuss your needs and prepare a proposal to value your closely held company. See valuation process for more information.