I. Reasons for a business valuation
There are many reasons and circumstances requiring a business valuation, some pleasant and some not so pleasant.
- Business succession planning is a common reason to obtain a business valuation. The business succession parties could be a partner, employee or other party close to the business or an outside business wishing to acquire the business.
- Business valuation requirements under not so pleasant conditions would be a divorce, multiple owner disaccord or shareholder oppression.
- Regulatory bodies sometimes require a business valuation, real property valuation and personal property valuation. Sometimes all three are needed. Examples include gifting, estate, income taxes, property taxes and financial accounting standards under generally accepted accounting principles (GAAP) or international guidelines.
II. Interest being appraised
- Enterprise Value – Enterprise value equals the total business value before deduction of long term debt.
- 100% Business Equity Value – 100% equity value equals enterprise value less business long term debt.
- Equity interest from 100% to 51% – The ownership interest is still considered a controlling interest.
- Equity interest of 50% or less – A 50% equity interest is considered neutral. A less than 50% equity interest is considered a minority interest. Neutral or minority interests usually require a discount for lack of control and lack of marketability.
- What type of equity? Examples of different equity types would be voting common stock, non-voting common stock, convertible preferred stock, preferred stock with dividend preference etc.
III. Date of appraisal
- Obviously the date of the appraisal will have an impact on the valuation.
IV. Purpose or purposes of the appraisal
Appraisals can be required for divorces, shareholder stock sales, merger/acquisitions, estate, partner buy/sell, sale to public, s-corp conversion, and minority oppression.
The purpose of the appraisal can dictate what “standard of value” (see standard of value) will be applied. An example would be a business selling to or merging with a similar company. Buyer/selling synergies need to be considered. In divorce cases, state law usually dictates what standard of value is to be used. The same is true for minority oppression.
- Applicable Standard of Value
- Examples of standards of value are fair market value and investment value.
|Market value can be called “the value of the marketplace”; investment value is the specific value of goods or services to a particular investor (or class of investors) based on individual investment requirements. Market value and investment value are different concepts; the values estimated for each may or may not be numerically equal depending on the circumstances. Moreover, market value estimates are commonly made without reference to investment value, but investment value estimates are frequently accompanied by a market value estimate to facilitate decision-making.
Market value estimates assume no specific buyer or seller. Rather, the appraiser considers a hypothetical transaction in which both the buyer and the seller have the understanding, perceptions, and motivations that are typical of the market for the property or interest being valued. Appraisers must distinguish between their own knowledge, perceptions, and attitudes and those of the market or markets for the property in question. The special requirements of a given client are irrelevant to a market value estimate. (Emphasis in original)
Appraisal of Real Estate, 10th ed. (Chicago: Appraisal Institute, 1998), p. 586.
– The Appraisal of Real Estate, 10th ed. (Chicago: Appraisal Institute, 1998), p. 586.
VI. Type of Report
- A full appraisal is usually represented by a report with appropriate disclosures.
- For special situations, the report may be abbreviated. In some cases it might be oral.
- In some situations, the task may be a consulting project instead of a valuation. An example of a consulting engagement vs. appraisal would be recasting earnings, earnings before interest and taxes (EBIT), cash flow, etc. for a potential strategic buyer.