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How many times have you, the valuation expert, been asked by a client whether they can have their business valuation in two weeks, one week, over the week- end? Or had a prospective client say to you, "Why is the price so high? It can't be that difficult to come up with a discount?" Or had other clients question you as to why the fee you have quoted isn't lower because in their mind, "There can't be much value in the entity you are valuing."

Clients in need of a business valuation are often skeptical about what they are paying for. I believe that they are skep- tical because they do not have an under- standing of what is entailed in preparing a supportable business valuation. From my experience, most clients' perceptions are that valuations are 1) easy, 2) can be completed in a couple of days, 3) that anyone's valuation is as good as anyone else's valuation (since the numbers are all subjective anyway), and 4) that your fee should certainly be less than the cost of getting a real estate appraisal. After all, don't valuators just take the real estate appraisal and maybe put an extra dis- count on the value? Or better yet, most individuals feel that a real estate appraisal is a business valuation.

Since this scenario has happened to me many times, it probably has happened to you.  I can honestly say that usually, when I had to answer questions like the ones above, I lost the engagement to someone who underbid my fee. So my approach has changed. Now, BEFORE I am asked such questions, I discuss my 12-step valuation process with a prospec- tive client so that they will know what to expect and what they are paying for.

Of course, I summarize the valuation process for the prospective client, and any questions they have regarding the process I discuss in detail using the following information:

Step 1: Identify the Critical Elements of the Valuation:

  • Is the appraiser aware of any conflicts of interest or problems about independence? (no advocacy allowed!)
  • Identify the subject and nature of the business being valued (client name, business name, type of entity, state of incorporation, principal business location)
  • Describe the equity being valued (minority, control)
  • Identify ownership size, nature, restrictions, and agreements Identify the "as-of" date of the valuation and clarify the difference between the "as-of" date vs. the "report prepared" date
  • Determine the purpose of the valuation (estate tax, estate planning, sale of a company, divorce, etc.)
  • Identify the standard of value (fair market value, fair value, investment value, etc.)
  • Identify the premise of value (going concern, liquidation, etc.)
  • Identify the type of report: an opinion of value or an estimate of value
  • Identify all key assumptions that will be used
  • Identify any limiting conditions, and scope limitations that might affect the work
  • Obtain a signed engagement letter from the client which sets forth the services and scope of the valuation assignment, including the purpose, the "as-of" date, expected time requirements until completion, responsibilities of the appraiser and the client, and the agreed upon arrangement for fees and expenses


Step 2: Information Gathering

  • Obtain background and description of the entity being appraised, including:
    • Nature of the business and history of the Company
    • Line(s) of business conducted by the Company
    • Type of business (i.e., wholesaler, manufacturer, retailer, etc.)
    • History of the Company, especially ownership changes and recent product line changes
    • History of the Company on how it got to where it is today
    • Historical financial statements
    • Projected/forecasted financial statements
    • A description of the products or services offered by the Company
    • Identify and gather information on competitors
    • Identify and gather information on the specific industry(ies) the Company sells to and competes in
    • Gather information on the location(s) of the Company's offices and other facilities
    • Identify all aspects of management's ability and depth
    • Identify ownership size, restrictions, and agreements including incorporation or partnership agreements
    • Obtain any other data the valuation expert deems appropriate


Step 3: Perform Preliminary Financial Analysis/Industry Research:

  • Obtain an understanding of the industry in which the Company operates
  • Prepare a preliminary financial analysis of the Company's past and expectations for the future
  • Develop a preliminary understanding of the Company's industry, environment, and business (Understand the Company's business!)
  • Develop questions to discuss with management


Step 4: Site Visit and Management Interview:

  • Send the Company's management a "client management questionnaire about the operations of the Company" for management to complete before the site visit
  • Review in detail the Company's background, financial position, operations, and outlook with appropriate Company management
  • Develop an understanding of the Company's industry, environment, and business from management's perspective (Understand the Company's business!)
  • Review appropriate corporate/partnership documents not normally exchanged by mail (board minutes, etc.)
  • Tour the operations
  • Inquire of, and respond to, questions from management
  • Obtain Company management's forecast for future/projected earnings


Step 5: Complete Economic and Industry Research:

  • Perform extensive relevant research on the Company's industry
  • Analyze and synthesize the information on the industry analysis back to the Company's business value
  • Perform extensive relevant research on the national, regional, and local economic environment in which the Company is operating
  • Analyze and synthesize the economic research as it relates to the Company's value


Step 6: Write Company History, Industry, and General Economic Analysis

  • Thoroughly analyze your independent research and the information obtained from interviewing management and the site tour
  • Items to discuss and include in the written report
    • Company background
    • Economic environment in which the Company competes
    • Industry in which the Company participates
    • Market in which the Company competes
    • The Company's competition


Step 7: Financial Analysis of Subject Company:

  • Adjust (recast) historical financial statements
    • Review the cost structure
    • "Normalize" expenses, as necessary (e.g., add back discretionary expenses, adjust related party transactions for items such as rent not at market rates, adjust officer compensation in excess of reasonable market rates, adjust aggressive retirement and benefit plans, adjust discretionary expenses paid by the Company
    •  Make sure all income/expense items are reported on the historical financial statements
  • Value non-operating assets and liabilities separately, if appropriate
  • Determine the "real earnings" capacity of the Company
  • Prepare key ratio analyses to include, but not limited to, current ratio, return on equity, net profit percentages, accounts receivable turnover, etc. and all key industry-specifications
  • Prepare a comparative financial analysis with industry performance (benchmarks)
  • Determine what attributes a buyer would be purchasing:
    • Ask each key member of Company management to list what they perceived to be the Company's strengths
    • Location
    • Visibility and access
    • Desirability of surrounding businesses
    • Existing site can support future growth
    • Production capabilities
    • Deferred maintenance
    • System of distribution
    • Product differentiation
    • Proprietary products or services
    • Length of time the Company has been in business
    • Length of time current owner has owned the business
    • Strength of management team
    • Profitability
    • Growth history
    • Competition
    • Entry barriers
    • Future potential for the industry
    • What is the Company's place in the industry (e.g., recent growth history, reputation, rank, etc.?)
    • Customer base
    • Customer concentrations
    • What are some major new accounts sold during the past year, and why did these new accounts take on the company's line?
    • Technology
    • Major brand name
    • The list goes on and on and is tailored to the uniqueness of the Company being value
  • Include both the historical financial statements and the "normalized" (adjusted) financial statements:
    • Discuss all adjustments to the financial statements in the report


Step 8: Valuation Analysis: Asset, Income, Market Approaches:

  • There are three generally accepted approaches to valuing a business or intangible asset: the asset, income, and market approach
    • The asset (cost) approach is based upon the value of the Company's underlying assets of all tangible assets and identifiable intangible assets
    • The income approach considers the present value of the Company's future cash flows. Cash flows are either capitalized or discounted. The discount rate utilized is a function of the risk-free rate of return and the real/perceived risk premium required to induce a buyer or investor to purchase the Company
    • The market approach compares the Company to similar
      "guideline" public companies or comparable private transactions
  • There is no single "correct" approach. Any one or combination of these approaches can form the basis for a value conclusion
  • Different valuation approaches and different assumptions utilized within a method produce different types of value-be sure to describe the type of value indicated (e.g., control, marketable minority, unmarketable minority)

Step 9: Entity Risk Analysis

  • Determine what risks are associated with the Company:
    • Based upon the determination made in assessing the attributes of the Company, the determination may be that some of those factors are risks associated with the Company rather than attributes
    • Ask each key member of Company management to list what they perceive to be the Company's weaknesses
    • Ask each key member of Company management to assess what they perceive to be the risks faced in a change of ownership
    • What are the threats to, or vulnerabilities of, the Company?
    • Are any vendors critical to success?
    • Could any materials used become in short supply?
    • Is the Company diversified or highly dependent on one service or product?
    • Were any major accounts lost during the past two years, and why are they no longer a customerIs
      the Company highly dependent on one or a few key employees
    • Is the Company highly dependent on one or a few customers?
    • Are there any other specific Company risk factors affecting value?


Step 11: Complete Draft of Valuation Report and Apply Appropriate Quality Control Procedures

  • Perform a "Sanity Check" on the value conclusion:
    • Would I pay this amount for the Company?
    • Does the conclusion of value meet the tests of common sense and reasonableness?
    • Prepare a relative value analysis to include, but not be limited to, a price/earnings ratio, price/book value, price/net assets, and total market capitalization/EBITDA to demonstrate the reasonableness of the conclusion of value
  • Check all mathematical calculations in the report
  • Perform quality control review of valuation report
  • Maintain all work papers to offer comprehensive support for the valuation analyses and corroborate your value conclusion for litigation, tax, SEC. and other regulatory situations, should any of those types of situations arise.
    • Required documentation to support value conclusion is very onerous

Step 12: Issue Final Report

  • The valuation report should state the date of the valuation and the date prepared, define the purpose of the valuation, define the standard of value employed, state the assets valued, the methods and information used in the analyses, and the conclusion of value
  • For a valuation prepared of a closely held business using
    the standard of value of fair market value under Revenue Ruling 59-60, the eight specific factors addressed in Revenue Ruling 59-60 must be considered:
    • History and Nature of the Business
    • Industry and General Economic Outlook
    • Book Value and Financial Condition
    • Earning Capacity
    • Dividend-Paying Capacity
    • Existence of Goodwill or Other Intangible Assets
    • Prior Sales and Size of Block
    • Comparisons to Similar Publicly Traded Guideline Companies
    • The valuation report should examine and discuss all commonly accepted valuation methods
  • Discuss why one valuation approach or method was chosen to value the Company over other valuation approaches and methods
  • Reconcile any differences in value indicated by different valuation methods examined
    • Define all formulas utilized in the report
    • Disclose and discuss empirical data sources for premiums and discounts
    • Disclose the sources of information contained in the valuation report
    • Prepare a certification statement signed by the principal valuator
    • Independence and Objectivity are key!
    • List the valuation analyst's qualifications
    • State the asset(s) valued and the conclusion of value
    • State that the report is in conformity with all applicable Professional Standards, including AICPA, NACVA, IBA, ASA and USPAP requirements
    • Obtain a signed representation letter from the client, if appropriate.