FAQs
Why have a business appraisal?
What Types of Valuation Appraisals & Reports Exist?
Commonly Used Business Appraisal Methods
Control and Marketability Issues
Who Values Businesses?
Among the groups providing business appraisal services are the following:
* Business appraisers
* Accountants (CPAs)
* Business brokers
* College professors (Finance and Economics)
* Commercial real estate appraisers
* Investment bankers
Each group of professionals brings something different to the practice of business valuation. Each group has its advantages and disadvantages. Professional business appraisers are generally better educated in business valuation and usually have superior mathematical skills. Brokers have a superior knowledge of the market. The accountants are educated in financial concepts and terminology. This gives the accountant a distinct advantage in understanding financial statements.
NYBVG uniquely combines the advantages of all of the above with our knowledge and academic education in appraisal, accounting, and brokerage. Furthermore, the firm has direct access to the resources of mergers & acquisitions firms and business brokers, which enables us to assist our clients with superior market knowledge. NYBVG is also affiliated with commerical lending firms that provide financing. Thus, we are able to assist clients who are looking for selling or acquisition opportunities.
Simply put, a business appraisal is an opinion of the fair market value of a business (or portion of a business).
Fair market value is the price at which property would change hands between a hypothetical willing and able buyer and a hypothetical willing and able seller, acting at arms length in an open and unrestricted market, neither of whom are under any compulsion to buy or sell, with both having reasonable knowledge of relevant facts. (Source: International Glossary)
Why have a business appraisal?
Business valuation engagements are performed for a variety of reasons. Some valuations are required, such as in the cases of estate taxes or marital dissolution, while others arise from the desire to identify a value, such as a basis for a business purchase or sale.
Regardless of the motivation, it is crucial to have a business valued by an appraiser who is proficient not just in analyzing the financial statements but also who has an understanding in converting those accounting numbers into estimates of future performance, which ultimately create the basis for value in today’s dollars.
The most common reasons why a business may need to be appraised are:
* Buying or Selling a Business
* Marital Dissolution (Divorce)
* Estate Planning for Gifts or Inheritance
* Family Limited Partnerships or Limited Liability Companies
* Employee Stock Ownership Plans (ESOPs)
* Litigation Issues involving Lost Profits or Economic Damages
* Stockholder Disputes
* Insurance claims
* Mergers & Acquisitions, Reorganizations, Liquidations, and Bankruptcy
* Charitable contributions
* Allocation of purchase price
* Buy-Sell Agreement
What Types of Valuation Appraisals & Reports Exist?
The most common types of appraisals & reports typically issued are described below:
Different Types of Appraisals (Development): Complete Appraisal: An appraisal is the act or process of determining the value of a business or business ownership interest. The objective of the complete appraisal is to express an unambiguous opinion of value. In a Complete Appraisal we must use every valuation method that is relevant. We recommend this type of appraisal if a valuation has the potential to go to court and if the appraisal needs to be reviewed by others, such as the IRS for tax purposes.
Limited Appraisal: The objective of a limited appraisal is to express an estimate as to the value of a business or business ownership interest, which lacks the performance of additional procedures required in a complete appraisal. The appraiser conducts only limited procedures to collect and analyze the information, which the appraiser considers necessary to support the conclusion presented. This type of appraisal is appropriate for some occasions when a case is not going to court; for example, to assist with structuring a buy-sell agreement between two partners.
Valuation Calculations: The objective of valuation calculations is to provide an approximate indication of value based upon the performance of limited procedures agreed upon by the appraiser and the client.
Different Types of Reports (Communication): Comprehensive Report: This report is also known as the formal report or self-contained report. The comprehensive report is the highest-level report that can be provided to the client. The comprehensive appraisal describes the appraisal procedures and the reasoning that supports the analysis, opinions, and conclusions in detail. We recommend this type of report if a valuation has the potential to go to court. Also, if the report needs to be reviewed by others, such as the IRS for tax implications, this type of report best explains what was done and how the value was derived. A comprehensive report can range from 40 to 100 pages.
Summary Report: This report is also known as the informal report or letter report. A summary report contains considerably less information than a comprehensive or formal report. Most of the narrative is excluded, and many sections of the report are brief. Just as the name applies, the summary report just summarizes the appraisal procedures and the reasoning that supports the analysis, opinions, and conclusions. The summary report is acceptable in certain situation in which the user of the report is informed that much of the detail is excluded from the report. This kind of report may be used for planning purposes. A summary report can range from 5 to 25 pages.
Restrictive Use Report: A restrictive use report is even shorter than a letter report and just states the appraisal procedures and opinion of value. Reference is generally made to all of the work that has been done, including the fact that the working papers contain all of the supporting documentation for the appraiser’s opinion. A restrictive use report is restricted to the client as the only user of the report. This type of report can range from one paragraph to several pages.
Oral Report: This type of report can be anything from a quick phone call to lengthy meetings. Some attorneys prefer oral reports in litigation. However, even though oral reports are acceptable, they are not advisable.
Review of an Appraisal: An appraisal review is an opinion about the quality of a report issued by another appraiser. A letter describing the review and critique is typically issued.
The valuation section is the main part of the report and discusses the different valuation approaches and methods chosen.
A valuation approach is “a general way of determining a value indication of a business… using one or more valuation methods.” A valuation method is, “within approaches, a specific way to determine value.”
There are three valuation approaches:
* Asset Approach
* Income Approach
* Market Approach
The Asset Approach. In this approach, we seek to measure value through the calculation of assets net of liabilities. One can use book or market values of assets in this approach.
The Income Approach. In this approach, we seek to measure value by converting anticipated economic benefits into a present single amount.
The Market Approach. In this approach, we seek to measure value through comparing the subject company to other businesses or business interests that have sold. Some use information from the sale of private companies, others use the sale of public companies or the price of stock as of the date of valuation for comparable public companies in the same or similar industry.
Commonly Used Business Appraisal Methods
Adjusted Net Book Value Method
The most commonly used method within the asset approach is called the Adjusted Net Book Value Method or Asset Appraisal Method. In this method all assets and liabilities are adjusted to their fair market values, which may be a going concern value or liquidating value, depending on which is more appropriate in the context of the valuation. The fair market value of stockholder equity is then calculated by subtracting the fair market value of the liabilities from the fair market value of assets. This method generally is applicable as the primary valuation approach for two types of businesses: (a) those about to be liquidated, and (b) holding companies whose operating companies are publicly traded.
The major shortcoming of this approach is its ineffectiveness in accounting for unidentified intangible assets, including, but not limited to goodwill and assembled work force value. Therefore to the extent that these assets are missing from a “fair market value Balance Sheet,” the Adjusted Net Book Value estimate of fair market value will be too low. Additionally, it is not always economically practical to calculate the fair market value of every asset and liability, which introduced additional valuation error into this method.
Discounted Future Returns (DFR) Method
Within the income approach, the Discounted Future Returns Method is based on the concept that the value of a business is best measured by the presently estimated value of the net income, cash flow, or dividend streams it can generate in the future. These estimated streams of a business enterprise are then adjusted to reflect the time value of money as well as the associated business and economic risks of that enterprise.
The DFR Method is widely recognized as the theoretically most valid approach. The Discounted Future Net Income, Discounted Cash Flow, and Discounted Dividends Methods are subsets of the Discounted Future Returns Method. One can forecast net income, cash flows, or dividends, and then discount them to their net present value. The Discounted Dividends Method is rarely used, since most privately held firms do not pay dividends. The Discounted Net Income Method is less accurate than the Discounted Cash Flow Method and is used when cash flow information is not feasible.
Guideline Company Method
The “Guideline Company Method” is a method within the market approach, which compares the subject to similar businesses that have been sold. The “Guideline Company Method” involves developing either regression analysis and/or ratios of stock price to earnings (P/E Multiples), cash flow (P/CF Multiples), and Book Value (P/BV Multiples). The stock prices are those of public companies in the same or similar business as the Company. Consideration is therefore given to the opinion of informed investors and what they are willing to pay for the stock of comparative public companies as adjusted for the specific circumstances of the Company.
P/E multiples established in active trading are expressions of what prudent, arm’s-length investors believe are fair and reasonable rates of return for these securities, given the risk inherent in those businesses. A risk analysis is then performed to compare the Company to the publicly-traded firms in terms of size, diversity of operations and products, financial strength, profitability, growth, and other factors recognized as key indicators of risk in order to adjust the P/E multiple.
Control and Marketability Issues
Control
The percentage owned of a business has a large impact on the value. A non-controlling interest is typically worth a lot less than a control interest. A minority interest does not have the ability to sell underlying business assets, nor the ability to force the sale of the firm to achieve liquidity. Minority interests neither have the ability to change dividends or other compensation. They typically have no cash flow from their investments. The control owners are able to divert corporate funds to themselves in the form of high salaries, perks, etc. The business appraiser must determine if a discount for lack of control is applicable, and if so, the magnitude of the discount.
Marketability
Ownership interests are considered liquid, or marketable if the investors can convert their investment to cash in three days. For instance, interests in the stock market, i.e., interests in publicly-held firms, are marketable.
On the other hand, ownership interests in privately-held companies are considered non-marketable. As part of the appraisal process, the appraiser must determine the appropriate discount for lack of marketability that should be applied to a specific business ownership interest. The level of control impacts the magnitude of the discount for lack of marketability. A minority interest is less marketable than a control interest. Hence, the marketability discount should be higher for a minority interest.
