When the time comes to establish the value of a business, most owners already have a pre-determined number in their mind. They often think the value should equal a multiple of earnings or annual sales. However, this method is rarely accurate and is unlikely to maintain merit if the company is sold or involved in litigation. A good business valuation is not only about determining an accurate and reasonable value, but also about being able to defend it if needed with a clear and concise explanation supporting the conclusions. To help clients, prospects and others understand what makes a good valuation report, Smith Schafer has outlined key items below.
Key Valuation Report Elements
Below is a list of the most common elements that should be included in a written business valuation report:
- Assignment Identification – The valuation professional should identify the company's name, size of the subject interest (number of shares or percent), intended uses and effective date. It is imperative to identify the intended purpose such as gift or estate, buy/sell agreements, financing, or litigation. The purpose will dictate the standard of value, such as fair market value, fair value, strategic value or liquidation value. The standard of value should be clearly stated. Appraisals are only valid for the purposes and dates listed in the report.
- Business Description – In this section, the valuation professional should clearly articulate their understanding of the business. Specifically, this should include the nature of the company’s operations, including strengths, weaknesses, opportunities and threats. If the professional does not understand the business completely, it is more likely there will be errors or omissions. Either of those may damage the authenticity of the report.
- Industry and Economic Trends – External factors affect future cash flow and perceptions of risk, which, in turn, impacts how much a company is worth. This section tells whether an expert understands the environment in which the company currently operates.
- Financial Analysis – Past performance may provide valuable insight into future cash flow. Value is impacted by how well (or how poorly) a company has performed in the past – or relative to other companies in the same industry. Sometimes the company's financial statements require adjustment for discretionary or nonrecurring items or even for unusual accounting practices to arrive at “normalized” cash flows. Since a valuation is of future value, the report should also include a forecast of future operations or at least address company expectations for the future.
- Valuation Methods – Appraisers generally consider three approaches when valuing a business: the cost, market and income approaches. This section should include a clear explanation of which methods were applied to the subject company and why. Different methods or combinations of methods may often be used in the same situation, so this section is quite important. This area should also provide detailed descriptions of the calculations underlying the appraiser's conclusion.
- Discounts and Other Considerations – Some valuation assignments call for discounts. The most common are discounts for lack of control and marketability, but other discounts – such as voting, key person and blockage discounts – might also apply. This section of the report should discuss which discounts are appropriate and why. It should also provide empirical evidence to support the discount rates chosen. Comprehensive reports will provide nontraditional sources of valuation evidence, such as previous transactions and offers, loan applications, past appraisal reports and rules of thumb, reconciled against the values derived under the appraiser's methodology.
Business valuations are typically conducted only once or twice during a typical business’ life cycle. As a result, it is important to understand how the valuation will be conducted and what elements the report should include. If you have questions about valuation reports or need a business valuation for your company, Smith Schafer can help. For additional information please call us at 952-920-1455, or click here to contact us. We look forward to speaking with you soon.