Frequently Asked QuestionsOn Business Valuations
Q. What is a business valuation?
A. A business valuation sounds complicated, but the concept is quite simple. A business valuation is a process of reviewing specific information in order to arrive at an estimated value of an asset. The asset could be a piece of equipment or a business. Technically, it could be the value of a liability too, but we rarely see that.
The principle concept of a valuation is to determine the risk in achieving what a “buyer” is expecting to receive. If a buyer is expecting to receive cash flow generated by a company for the time-period they will hold the asset, the buyer needs to attach a risk factor to the possibility of not receiving the expected cash flow. This risk factor will impact the company’s Cost of Capital and the selling multiples.
A business valuation reviews all pertinent operational and financial information when analyzing the financial benefits stream and the risk factors involved. The valuation should clearly express an opinion of value, usually in dollars.
Q. I see valuation and appraisal terminology. What’s the difference?
A. Both the valuator and the appraiser can provide a business valuation, but only an appraiser can provide a business appraisal. To meet the guidelines of being an appraiser, a person needs to take the necessary classes and test-out on the Uniform Standards of Professional Appraisal Practice (USPAP) course which sets the industry’s ethical and professional standards in the U.S.
Q. Do I need a business valuation?
A. The purpose of the valuation will usually answer this question. If the person who would be using the valuation if it were performed, is going to make any material decisions based on the valuation conclusion, yes – a business valuation should be performed. For a price of a few thousand dollars, you can access a limited valuation that uses the accepted valuation processes and procedures to gain a credible valuation conclusion. If the valuation purpose involves any type of commitment that is based on the company’s potential value, a business valuation is necessary. We often deliver valuations for larger companies who want to run a check on a valuation they already received. Some Employee Stock Ownership Plans (ESOP) sometimes want to see what a Fair Market Value report looks like in comparison to the report they get every year.
Other times companies want valuations to see what value they have built to date. This is particularly beneficial when the ownership team wants to plan an exit strategy upon meeting key financial goals.
Q. Who is the valuation for?
A. Valuations are for the client who will be reading the valuation. We call the client the intended user. The valuation is not automatically for the person paying for it, unless they are the intended user. It sounds a bit strange, but valuations are made up of assumptions based on the valuation purpose and the intended user and how that intended user will be using the valuation report.
Q. How do I go about getting a business valuation?
A. There are many valuation experts around, and there are many people who give valuations too. Its always best to get a valuation from a person who has good knowledge in the field. There is a fair amount of information that needs to be analyzed and applied. Don’t go to valuators who have limited experience in the valuation field as errors will be common practice. If the valuation’s opinion of value is off by 10% and the business value was $10 million, that is a $1 million miscalculation. In comparison to a few thousand dollars spent on a valuation, it is worth it to get an accurate valuation.
Most companies want a fair market value appraisal. This means the company wants to see what the value is if the company were sold on the market where the buyer and seller had access to the necessary information and were not bound by any terms to conclude and “arms-length” agreement. I have a merger and acquisitions background and see firsthand how strategic buyers can pay more for a business. So, I sometimes value a business more aggressively than an accounting firm might, unless they too, sell businesses. But all valuation experts should value a business within a range of everyone else.
Q. What does a business valuation cost?
A. Valuations run the whole range from $500 for online software applications to $25,000 for a $200 million business by a certified appraiser. For a mid-size business with sales between $5 and $20 million, valuations generally run between $4,000 and $12,000. Valuations are based on the scope of the valuation. The more detail needed, the more it will likely cost. For limited or calculated valuations, the appraiser relies more on the company management team for guidance on business operations and projections. Therefore, you will often see valuations for $3,000 to $6,000.
Q. Will someone explain the valuation to me?
A. A valuation expert should explain the valuation to the extent needed so the intended user fully understands the valuation conclusion. This generally takes about ninety minutes with another potential follow up after a person has had a chance to review the report further. The intended user is not supposed to become a valuation expert. Intended users should understand the valuation concept and the different approaches used to generate the valuation conclusion.
Q. What expertise is needed to do a valuation?
A. Expertise can come in different ways. Some experts might focus on specific industries like medical products or food manufacturers. Anyone who has a focus is most likely more informed on a specific industry. That does not mean another appraiser can’t perform the same quality of work. It just means that an appraiser might need to spend some time to get caught up on the industry trends and insight to gather the needed expertise. Generally, appraisers have an expertise in the valuation process and can perform well in many different industries.
When you look at the various standards of value, different experience might influence the value opinion. An appraisal is not all science and mathematical formulas. There is some creative and abstract thinking involve also. So, one appraiser who issues a valuation report using the Investment Appraisal standard rather than a Fair Market Value standard, could have different insight into the investment world. Talk to an expert about your business and you will see how much they understand your business and the industry.
Q. What can I expect from the valuation process?
A. A valuation engagement will begin with a conversation on what the intended user’s purpose for the valuation is and what the standard of value used in the report will be. After discussing the needed work product and pricing, upon an agreement to go forward, you should receive a letter detailing the process and what information is needed for the valuation and what time frame the engagement will begin and be completed.
Once the engagement agreement is signed by both the appraiser and the person ordering the valuation, the process can begin. For larger contracts, the appraiser usually receives 50% to 75% of the price upfront with the remaining balance to be paid upon deliver of the valuation. For smaller valuations less than $4,000, this is usually paid upfront.
The appraiser should deliver the agreed upon number of reports as well as an electronic copy of the report upon completion. The appraiser needs to keep their own work file in case further review is necessary. This is a condition placed on the appraiser by the accepted industry standards. All information is confidential which is also part of the standards practice.
Q. Should I go to my accounting firm for a business valuation or is it best to go to a broker or an appraiser?
A. Many accounting firms to a great job with valuations. We come across many accounting firms that don’t perform valuation as they tend to stick to their compliance accounting work.
Brokers tend to rely more on selling multiples and offer customized “rules of thumb” valuations. I suggest you first decide on why you want a valuation and then talk to a few experts. A clear indication of what is needed and the price for the valuation service will help you decide who can best meet your valuation needs and budget requirements.