Business Valuation Process

By avm

The scope of a valuation engagement and its fee are dependent on the complexity of the business and the timely presentation of information to the analyst.  As with most professional services, the relationship between the client and the appraiser will typically be set out in a written agreement.  This agreement defines the scope of the valuation project, the obligations of each party, the estimated time frame, the fee, and other important elements of the relationship.  It is also common practice among business appraisers to require a retainer in order for them to reserve their time and evidence the client’s commitment to moving forward with the project.

Step 1:  Scope of Work

In general, the analyst will meet with the client to determine the parameters of the business valuation.  For small businesses, the following is needed to provide an engagement agreement for a standard USPAP compliant report.

Report Purpose:

  1. Premise of Value
  2. Scope of Work
    1. Need to develop and support discounts for partial interests.
    2. Number of parties reviewing the valuation methodology and report.
  3. Most recent fiscal year P&L and Balance Sheet
  4. Performance time restrictions
  5. Site Visit Option

Other Considerations:

  1. Liability involved due to nature of engagement, such as fairness opinion, solvency opinion, or litigation (pending or in progress).
  2. Preparation for expert witness testimony.
  3. Level of report provided to support the valuation conclusion.
  4. Real Estate
  5. Intangible Assets

This list of information is not fully comprehensive since each valuation is unique. 

Step 2:  Engagement Agreement

The analyst will review the task to be completed and prepare an Engagement Agreement.  Once the agreement is in place and the retainer paid, we proceed to information gathering.

Step 3:  Information Gathering

To collect the needed information, a questionnaire and information request is sent to the client. This typically comes in the form of a list of requested data and documents, such as financial statements and company background.  A good company website can be a great source of some of this data.

Small businesses – single owner with one general line of business will need to supply:

  1. Detailed and consistent accounting records, especially the summary level for the Balance Sheet, Income Statement, and any footnotes.
  2. Five Year Proforma Business Projections
  3. Management Bios
  4. Data on owner compensation
  5. Brief descriptions of the history of the business, its products and services, its customer base and the competitive landscape

Start-up, complex or large businesses need the following additional items:

  1. Number of distinct operations or markets served which require a separate analysis
  2. Number and types of equity classes
  3. Resolutions among debt and equity holders
  4. Comprehensive Business Plan or detailed projections for the next three to five years
    1. A thorough Business Plan provides us a guide for our due diligence.
  5. Objective management assessments of their company’s strengths and weaknesses; industry competition; product life cycles; and external factors impacting growth and/or operating profitability.

Step 4:  Preliminary Analyses

After obtaining the necessary documentation, the appraiser will review and perform initial analyses to help prepare for an interview with the owner and/or key members of management. Usually, the appraiser will also conduct some independent research of the business’ industry, economic drivers, and other issues at this stage of the appraisal process. A primary aim of this step is to help the appraiser formulate relevant questions for the management interview.

Step 5:  Management Interviews and Site Visit

This is where the appraiser tries to get an understanding of business that is not apparent in the written narrative and data supplied by the client.  This can be conducted face-to-face or over the telephone.  Of course, the appraiser’s access to management is subject to the client’s approval and the level of confidentiality surrounding the engagement.

The appraiser will typically ask questions about the business itself, its industry, organizational structure, marketing activities, customers and key risk factors.  A portion of this discussion will involve the company’s historical financial performance and future prospects.

A site visit of the business is helpful, but not a requirement to complete the valuation. USPAP standards do not require a business appraiser to actually visit the business’ facility, and business appraisers will note in their report that they assume no responsibility for latent defects in the business of any nature that may affect value, and that they do not hold the expertise required to identify such conditions.  Still, a site visit does allow the appraiser to make certain qualitative judgments about the business.  Additionally, in a “high-scrutiny” situation such as an appraisal for a tax-related issue or litigation, the credibility that comes with a site visit is a positive.

Step 6:  Valuation Analyses

The appraiser will now synthesize the data, documentation, results of the interviews and independent research to determine how these factors impact the company.  It is now that the appraiser determines the one or more appropriate valuation methodologies.

If the appraiser uses multiple valuation methodologies, each will usually yield a different indication of the value of the ownership interest.  Part of the appraiser’s job is to use his/her experience and judgment to reconcile these disparate indications of value in order to arrive at a final opinion.

Step 7:  Report Writing

Although the professional standards allow for a verbal report, most appraisers do not offer them. The reason is that the appraisal process is too complex, and compliance with the professional standards too important, to allow for a verbal reporting of the appraiser’s opinion.  As a result, the appraisal will usually be documented in a written report that will typically be 50 to 100 pages.

Step 8:  Report Issuance and Follow-up discussions

The final stage of the engagement is for the appraiser to issue their report. Sometimes, the report comes in “draft” form, allowing the client and their professional advisors to review the facts outlined in the report. Other times, a signed, certified and bound report is issued with no draft. Typically, this step will also include a follow-up discussion with the client and their advisors to address any questions they may have about the appraisal report.

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