Business valuation is the process of determining a company’s worth. Financial statements provide raw information, but the actual valuation is a separate matter. This activity is conducted when the business is being prepared to be sold. Other common reasons include a transfer of ownership, general business finance, or asset transfers as part of an estate or gift.
Any valuation procedure will incur costs, which could be thousands of dollars or higher. Some business owners try to save money by having their CPA conduct the appraisal. However, only some CPAs hold the necessary credentials to do the evaluation correctly, and mistakes can harm the business. The type of business appraisal to be performed depends on the intended purpose.
Business Appraiser Credentials
Credentials are imperative when selecting a business appraiser to conduct the valuation. This person must hold the right qualifications and have relevant experience. This professional must have appropriate education in finance and business and work experience that peers review. The Institute of Business Appraisers accredits certified business appraisers or CBAs.
The American Society of Appraisers can bestow the Accredited Senior Appraiser or ASA. These reliable credentials can help business owners make informed decisions about who to hire for the job. The selected appraiser should be conducting this work full-time and already have many years of practice.
Business Valuation Methods
The business appraiser consults with the owner to discover the reason for the appraisal. The reason for conducting it might affect the method used, so the appraiser’s skill and the owner’s ability to communicate this information are critical. In some situations, the appraiser might recommend using multiple methods because they will provide a range of useful information. The most common appraisal methods are the discounted cash flow and capitalized excess earnings methods. The discounted cash flow method evaluates the business in terms of risk and earning potential.
The capitalized excess earnings method is useful in obtaining the total business value and establishing the value of goodwill. Another method is used in preparing information for legal cases or to demonstrate business worth that exceeds the amounts represented by material assets. This is called the treasury method, and the name comes from the endorsement by the U.S. Treasury Department. The particular valuation formula carries this weighty endorsement, so this method is very useful for establishing credibility.
Why Conduct Business Valuations?
Appraising a business is necessary for various purposes. Business owners often seek investors to provide financial support to the company, for example. The ability to produce a valuation of the business is a significant statement of good faith in negotiations, and it provides credibility to investors, lenders, and buyers. The company’s evaluation also includes information about the company’s value that can be useful to the owner for making informed decisions.
Other reasons for conducting a business valuation are less formal. For example, owners may decide to appraise the business to find out how much can be given to a recipient as a gift without incurring federal gift taxes. Business appraisers have special skills that are exclusive to this line of work. Even the most qualified CPAs may or may not be trained to conduct this procedure correctly.
Additional reasons to invest in a business valuation by a qualified business appraiser include:
• Estate planning: Business owners involved in a co-ownership relationship may decide to get an appraisal done to plan for the transfer of assets and authority in the event of an owner’s death. This can be a buy-sell agreement that relies on an appraisal, but in some circumstances, the appraisal is only done at the time of death.
• Divorce: Married couples who go into business together are often faced with the issue of how to deal with the assets that were jointly created during the marriage. Business appraisals are helpful in divorce situations, which may involve rules specific to the state of operations. The status of the state is a secondary concern after the value of the business is determined. For example, many states abide by community property rules, which affect the division of assets in the event of a divorce. Other states will use a different method, but the valuation must be done first.
• Charitable giving: Charitable grants and donations are regulated just like gifts to a spouse or other family members. If the total amount of the donation is more than $5,000, the business must be appraised under the law.
• Lawsuit preparation: Litigation can be extremely draining on the company’s resources, but this is no reason to try to cut costs. The insurance companies might require specific information, and this often includes detailed financial data. These kinds of lawsuits can put owners in a challenging position. The appraisal helps in both circumstances because the information is reliable and can be used to determine a legal strategy.
• Planning: Some appraisals are helpful for general business planning, which would otherwise be an entirely subjective activity. The appraisal helps the owner or owners put their planning options into perspective.
The cost of the appraisal varies based on the business type and the operations’ scale. While many appraisals might seem expensive because the bill runs into the thousand-dollar range, appraisals for large corporations can approach six-figure digits. Appraisers charge based on the project’s scope and scale, but finding someone who charges the lowest rate is a mistake. An inaccurate appraisal can end up costing much more than the price of a good one. Think of the assessment as part of the financial investment in the company. Hire only reputable appraisers with credentials, a solid track record, and proper certifications.