Business Valuation: Do You Know What You Are Doing?
How you can derive purpose and function of engagements.
June 16, 2008
by Gary Trugman, CPA/ABV
When you are first approached about an appraisal assignment, it’s important that you have a clear understanding of the purpose and function of the engagement. Simply, what are you going to be doing for the client and how will you do it?
This also raises the question, what is going to be valued? Very often, an entire company will be valued. This is referred to frequently as the "equity" of the company. There are other times when you may be asked to place a value on the entire capital structure of the business. This is referred to as the "invested capital" of the company.
There will also be times when only a portion of the company’s equity will be valued. This may involve valuing a fractional interest in the company (less than 100 percent) or valuing only certain assets and liabilities. For example, you may be approached to value a 40 percent interest in the company. This is not as simple as taking 40 percent of the value of the entire company. A minority interest may be worth less than a pro rata share of the entire company. This will also be discussed later.
Asset vs. Stock Sales
In other situations, you might be asked to value the company for a sale in which the owner will be keeping certain assets, such as the company car or cash in the bank. Many, if not most, small businesses are sold as "asset" sales as opposed to "stock" sales. Generally this means the purchaser is is transferring the assets — and possibly liabilities — that were part of the deal to a new entity. A proper understanding of the appraisal subject is essential if you are going to do a good job.
Another important consideration is the client’s intended use of your appraisal. The intended use can affect the manner in which the job is performed. For example, if your appraisal assignment is for a divorce litigation in a jurisdiction that does not recognize goodwill, you will have to conduct your valuation in a manner that meets the requirements of that jurisdiction. However, if the same company is being appraised for a sale, the methodologies employed in the appraisal will most likely be different. Since goodwill is part of the sales price of the company, the valuation result will have to be different. After all, one has goodwill and the other does not.
The intended use is also important to know so that the valuation analyst can perform the appropriate assignment.
Amount of Time Required to Do the Job
Knowing how much time is required to do the job properly is an important part of the planning stage for your assignment. Understanding the assignment thoroughly will provide you with the ability to budget staff time and meet any deadlines that are imposed on the assignment. The client will also want to know how much the appraisal will cost. Unfortunately, an answer such as "How high is up?" is generally unacceptable. Budgeting time is probably more difficult than the appraisal itself at times, because you never know what type of research problems or document production problems you may run into.
The Scope of the Assignment
Understanding the scope of the assignment, including the possibility of giving expert testimony, will help you determine whether or not you can accept it. If a client tells you at the beginning that you will have severe scope restrictions, but are expected to testify in court, you may want to think twice about taking the assignment. You may end up on the short end of the stick if you allow the client to limit the scope.
Clients frequently look to save money and will often ask the valuation analyst to streamline the process. If expert testimony is anticipated, the judge or jury will remember only that the valuation analyst did not do a complete job. Regardless of whether you qualify your opinion because of your client's scope restrictions, the valuation analyst's reputation will be the most damaged element in the litigation. Be selective when you allow scope limitations.
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Gary R. Trugman, CPA/ABV, MCBA, ASA, MVS, is President of Trugman Valuation Associates, a firm specializing in business valuation and litigation support services. This is adapted from Understanding Business Valuation: A Practical Guide to Valuing Small- to Medium-Sized Businesses by Gary R. Trugman, CPA/ABV, MCBA, ASA, MVS; published by the AICPA and available at www.cpa2biz.com. The new third edition will be available soon.