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21 Dec Understanding Business Valuation Standards

What goes into the preparation of a formal business valuation? As more entrepreneurs begin to enlist the expertise of professionals to complete a business valuation, it’s important to understand the standards and requirements associated with this task. There are a number of reasons to solicit a formal valuation for the business and different types of situations may require differing valuations from separate groups. For instance, formal valuations can be used in court proceedings while a valuation for M&A is used to gauge how the current market may respond for a target purchase. In this case, investment bankers often focus on landing a premium valuation for the company in question. When it comes to standards for formal valuations, more narrow rules apply.

These standards must be followed by the members of the American Society of Appraisers, and are what go into the preparation of every formal business valuation.

What an appraiser must identify and define

With every valuation, appraisers are required to identify and define:

• The client, as well as all other intended users
• The purpose of the appraisal
• The business enterprise relating to the valuation
• The type of entity (meaning is it a partnership, LLC, etc.)
• The location of the principal business
• The jurisdiction of incorporation
• The business interest that is under consideration
• The premise of value
• The date in which the appraisal will be in effect
• The level of value

In addition, appraisers must identify whether the standard of value is fair value, fair market value, investment value, or some other standard.

On top of all that, the type of engagement must be defined. Generally speaking, this falls into one of three categories, as outlined below:

1 – Appraisal
An appraisal occurs when the value of a business (or security, business ownership interest, etc.) is determined.

The purpose of this appraisal is to establish an objective valuation and includes the following:

• The valuation is delivered in either a single dollar amount or a range
• The valuation takes into consideration all pertinent information made available to the appraiser (at the time the valuation is performed)
• All proper procedures are followed through
• All conceptual approaches are considered by the appraiser

2 – Limited Appraisal
A limited appraisal serves the same purpose of an appraisal, except it excludes some specific procedures that are required with a full appraisal.

For example, the appraiser – during a limited appraisal – only has to collect and analyze information that he or she deems necessary in order to supports the findings. The valuation is based on certain conceptual approaches that the appraiser believes to be most appropriate.

3 – Calculation
The purpose of a calculation is to offer an approximate indication of value, based on the performance of limited procedures as mutually agreed upon by both the client and appraiser.

These calculations include the following:

• It’s delivered in either a single dollar amount or range
• Can be based on the consideration of only limited, relevant, data
• Limited information is collected by the appraiser, who then performs a limited analysis
• The calculation is based on mutually agreed approaches

The appraiser’s duties in collecting and analyzing information

As part of his or her duties, an appraiser must gather, analyze, and adjust all relevant information pertaining to a valuation, based on the nature or type of engagement. This includes:

• The nature and history of the business, as well as all historical information, assets, and liabilities
• The characteristics of the business (such as rights, conditions, agreements that restrict sale or transfer, privileges, etc.)
• The conditions of all relevant industries and economic factors that may impact the business
• Prior transactions that involve the business or the interests/securities of the business
• Capital markets that provide pertinent and relevant information (such as public stock marketing information, relevant M&A information, etc.)
• All other information the appraiser deems relevant

While it’s vital that business owners employ the expertise of an experienced appraiser, it’s equally important for entrepreneurs to understand the professional standards as used by the American Society of Appraisers. With this understanding, you can then better assess the performance of your hired advisor as he or she provides the valuation of your business.

  • Craig Dickens

    A great first step to understanding what your company is worth. Be aware many companies have significant value in intangible value so seek an investment banker to value the intangibles!

    • Tony Montgomery

      Good advice Craig!!

  • David Lopez

    Having a general understanding of what a business is worth is good practice among owners. However, it is not unusual for owners to have no clue what their business is worth or how to approach such a task. In fact most owners believe that their business is worth significantly more than fair market value, creating unrealistic expectations when it comes to undertaking a transaction. Working with a seasoned investment banker should help temper an owners expectation of value and assist with accomplishing a transaction that ultimately provides the best overall terms and outcome for the owner.