Frequently Asked Questions

As an owner, your business is one of the most important investments you’ll make in your life.  Over time, the business grows and so does your initial investment. How much is your initial investment worth today? You’d probably say it is worth more, but how much more? 

Think of the business valuation like a multifunctional tool. Although the multfunctional tool is more expensive than a metal cutting tool or a metal forming tool, for example, it can do the job of both and more. Hence, a valuation is an owner’s multifunctional planning tool, and enables an owner to answer important questions such as:

· What’s my exit strategy? Options may include sell to a third-party, transfer to a family member, or sell to a key employee.

· Do I have adequate life insurance for my business needs? Knowing the worth of a business is a prerequisite for assessing the required amount of life insurance to fund buy-sell agreements. 

· What’s the return on my investment (ROI)? Establishing a benchmark value to compare to the owner’s original investment provides a reasonable estimate of the ROI. 

· What is my company’s intangible value? For many companies, intangible value includes customer loyalty, generating new business, competitive pricing, and retaining skilled employees. 

· Will proceeds from the sale of the business fund my retirement? Knowing the value of the business enables ease of retirement planning. 

· How much is my estate worth? An accurate determination of value enables an owner to implement estate tax minimization strategies.

It doesn’t make sense that business owners regularly tracks their personal stock investments and real estate values, yet rarely give any thought to the worth of their most valuable asset — their business. This is surprising considering that a professional valuation brings to light areas of mediocre or ineffective financial performance that, when addressed, often result in greater future value. Instead, some business owners use outdated or inaccurate methods to determine value. The most common mistakes are: 

· Using an industry formula to determine value.

· Thinking the sale of a competitor’s business is a good indicator of value. 

· Failure to consider the tax implications of improper estimates.

The further one plans ahead, the more time available to enhance the value of the business. A valuation serves as a benchmark for designing an exit strategy. It determines the fair and equitable price for a partner buyout and the baseline for an estate plan that protects an owner’s family. In the event of an untimely exit, an owner who has plans in place can minimize financial burdens on the estate and decrease the family’s distress. 

Primarily, the valuation process will depend on the purpose of the valuation assignment. However, a typical engagement may proceed as follows. Once the valuation engagement is initiated, the valuation analyst will send a request for documentation (see document question following). The analyst will review the information provided by the client and schedule a management interview that may also include an onsite meeting and facilities tour. The analyst may have additional documentation requests.  After the interview, the analyst will complete the valuation model and write the valuation report. A draft report may or may not be issued to the client prior to completion of the finalized document. 

The quick answer is yes. However, the final answer will depend on what are your particular personal and business circumstances. It will also depend your particular state of marital domicile.  Basically, in order to thoroughly determine the value of the marital estate, if a business is an asset held by a divorcing spouse, it is highly recommended the business be valued. Similar to the marital home, the business may likely be one of the largest assets in the marital estate. Ultimately, consult your legal counsel for guidance. 

Two words: 1) bias, and 2) experience. Your CPA has a financial interest in keeping you as a client after your legal matter is completed. He or she does not want to disappoint or lose your long-time business relationship, for example. This is not to assume that every accounting professional will act accordingly; however, bias on the part of your CPA will be presumed by opposing counsel and could damage the integrity of your position.  

Additionally, while your CPA or accountant may be highly experienced in preparing tax returns or in compliance matters, he or she may not have the skills to conduct a thorough valuation analysis. Without proper knowledge, someone other than an experienced, credentialed valuation analyst might not apply the correct valuation method, resulting in an inaccurate assessment of worth. Keep in mind, a CPA is a Certified Public Accountant – accounting has little to do with valuing a business. Valuation is a composition of algebraic formulas, economic theory, business acumen and common sense. A valuation professional certified through the American Society of Appraisers, for example, is an “ASA” or Accredited Senior Appraiser. Likewise, you wouldn’t hire an ASA to prepare your company’s corporate return. It is highly recommended clients hire a skilled professional credentialed in the appropriate field of expertise for your particular engagement.

Essentially, there are three approaches to valuation: 1) income approach, 2) asset (cost) approach, and 3) market approach. Under each approach there are common methods for estimating the value of a business. 

The income approach is based upon the economic principle of expectation. This approach assumes the value of the business is the present value of the economic income expected to be generated. Expected returns on an investment are discounted or capitalized at an appropriate rate of return to reflect investor risks and hazards.  From a theoretical perspective, enterprise value is based either on historical earnings or future cash flows. 

Methods under this approach include: 

· Capitalization of Excess Income Method;

· Capitalized Economic Income Method; and 

· Discounted Cash Flow (“DCF”) Method.

Depending on the level of economic income, both the Capitalized Economic Income Method and the DCF Method can be used for either a minority/non-controlling or a majority/controlling equity interest, whereas the Capitalization of Excess Income Method typically assumes a controlling ownership if applied.  

The asset approach may be applied when the benefits of operating a business do not outweigh the value that could be derived through the orderly liquidation of assets. 

Methods under this approach assume a controlling premise of value and include: 

· Net Asset Value Method; 

· Adjusted Net Book Value Method; and 

· Capitalization of Excess Income Method (also an income approach method). 

By excluding an asset approach in a valuation analysis, the financial analyst assumes that an investor would evaluate the company based upon its earnings and cash-generating potential, rather than through an appraisal of the underlying tangible assets, which would not reflect the intangible value or economic obsolescence inherent in the company. Additionally, the application of a methodology under the asset approach assumes that the level of ownership being valued is that of a controlling shareholder, as only a majority equity ownership (or a 50-plus-one vote) could dictate the company’s capital structure and, thus, the orderly liquidation of assets. 

The market approach is based on the principle of substitution. The fundamental basis of this approach is predicated on the theory that the fair market value of a closely-held company can be estimated based on the prices investors are paying for the stocks of similar, publicly traded (or private) companies. This is done through the use of ratios that relate the stock prices of the public companies to their earnings, cash flows, or other measures. By analyzing the financial statements of analogous companies and then comparing their performances with those of a subject company, the appraiser can judge what price ratios are appropriate to use in estimating the market value of the closely-held entity.

Methods under the market approach include: 

· the Dividend-Paying Capacity Method; 

· the Guideline Merged & Acquired Company Method; 

· the Guideline Publicly-Traded Company Method; and 

· the Transaction Database Method. 

From these methods, value is determined through market multiples of either publicly-traded or privately-held companies. Market methodology may be applied as a sanity check to other values derived, such as those from an income approach methodology. However, a market approach also allows the valuation analyst, and/or users of a valuation opinion, to examine how the marketplace reacts to companies within the same or similar industry as the subject company, based on varying levels and types of economic incomes. For example, examination of market multiples may give a perspective on the types of buyers, demand, and rates of return for a given entity in a given industry.  

Depending on the purpose of the valuation engagement and the quality and accessibility of the client company's financial information and other documents, the timeframe may be as short as four weeks or as long as eight weeks to three months. It is highly recommended you discuss your timeframe with your valuation professional before engagement is finalized to ensure there are no unknown expectations from either client or analyst. 

A wide array of documents are needed from the company for the valuation analysis. Firstly, we need five years of company financials (both profit & loss (income) statement and balance sheet), preferably prepared on the accrual basis of accounting. 

Other needed documents may include corporate returns; revenue by customer and product/service line; working capital information; capital expenditures; debt shareholder information; dividend/distribution history; stockholder agreement; financial budgets and forecasts; list of stockholders and stock ledger; information on synthetic equity and plans; employee benefit plans; information on current, past or pending litigation; stockholder loans; officer’s compensation; board minutes; key man information; brochures and marketing information; prior appraisals; depreciation schedules; industry information; competition composition; organizational charts, etc. 

This list is not all encompassing, and will vary based on the type of entity, the industry and purpose of the valuation report. It is typical for a valuation analyst to request additional information as the valuation process unfolds and the valuation model is developing. 

Although the valuation professional may calculate the business valuation fee based on the number of hours, effort and resources needed to complete the analysis, the fee is commonly a flat fee. Any additional hours needed, for example, if the valuation purpose changes or the valuation date changes after the engagement begins, may be discussed with the client prior to final invoicing. If expert witness testimony or deposition is involved, those may not be included in the flat fee and would likely be billed at an hourly rate. 

The cost of a valuation analysis depends on the quality and availability of the company’s financials and other documents, the industry, the type of entity formation and the purpose for the valuation. Additionally, some assignments involve more than one operating entity, and therefore, the cost may likewise be impacted. In some circumstances, the client may need the valuation report to be completed on short notice or within a limited time frame from the date of the engagement, and this may also impact the cost.  

In matters of marital dissolution, depending on the state of domicile, the assessment of personal goodwill can be a factor that may be considered in the cost. Interestingly enough, the size of a company is not always an indicator of cost. Some small closely-held businesses are just as difficult to value as larger ones in the same or similar industry.  

Yes and no. A seasoned valuation expert will likely have valued various sized companies in a multitude of industries. Some industries have nuances that are similar and likewise translate from industry to industry. However, it is always recommended you hire an experienced and credentialed valuation expert no matter what your industry. 

A professional business valuation is valid for as long as its core assumptions remain valid. Absent any substantial changes in business structure, ownership or ownership intent, and depending on the nature of the business and change in profits, an update should be conducted approximately every two years. In the event there is a change or substantial and sustained increase in profits, the valuation should be updated immediately subsequent to that event. However, long-term, annual updating is necessary, such as when families sell or transfer minority business interests each year as part of their estate and succession planning.