January 16/23, 2017: Volume 31, Number 16
By Roman Basi
(First of two parts)
Each year more business appraisals are being created. While statistics are unreliable on the matter, it seems as though the word is getting out. If you are a closely held business, there’s a need to have your business appraised. This article focuses on the what, who, when and how.
Many businesspeople are not familiar with what a valuation is, why they need it and how to get a valuation done. In fact, many businesspeople are more familiar with the value of their house or automobile as opposed to the value of their business. This is surprising because their business may be worth more or carry more equity than their house. In the business world, not knowing the value of a business can translate into the loss of a lifetime of work in value and dollars.
Following are some of the basics:
What is a valuation? There are many misperceptions about valuations. Many business owners believe a successful valuation can be calculated based on simple multiples. For instance, someone is always inquiring as to whether he or she can multiply the gross income or net profit by a certain number based upon some theoretical condition of the business to reach a value conclusion. Neither the IRS nor any potential buyer will accept these multiples as a sound valuation. Two decades of experience in this profession and a whole host of IRS letter rulings, memorandums, statutes and cases demand that a simple multiple in determining value cannot be used to arrive at a valid figure. Business valuations are much more sophisticated than what a multiple can determine.
A business valuation is a report written by a qualified appraiser for purposes including business succession, estate and tax planning, litigation, buy-sell situations and other purposes. A business valuation will reflect the value of a business a willing buyer would agree to pay in an arm’s length transaction. IRS Revenue Ruling 59-60 reflects much of the methodology used in a valuation. The value of a business tends to be different than the actual selling cost of the business in 99 out of 100 cases.
By definition, the valuation must be in the form of a written report. Oral reports from a valuator simply will not suffice because buyers, sellers and the IRS will not see much credibility in an oral report. It is also impossible to remember every important detail of a thorough report. That is why a written report is highly recommended and in some cases, required.
Furthermore, the valuation must be done by a qualified appraiser. First, the appraiser must be someone who does not have a bias concerning the value of the company. Generally friends, relatives and employees are excluded automatically from the definition. Also, the company accountant should not conduct the valuation since he or she is not in a position to be objective.
Next, the appraiser must be an expert on the matter. Being a CPA or attorney is simply not enough to certify a person as a qualified appraiser. The appraiser, by definition, must have the experience and training in both the areas of valuation and in the industry in question. The IRS and the courts will disqualify individuals who try to value companies when the business appraiser does not, in actuality, know or understand the industry.
In part II I will talk about the times “when” a valuation is critical.
Roman Basi in an attorney and CPA with the firm of Basi, Basi, & Associates at The Center for Financial, Legal & Tax Planning, Inc. He writes frequently in issues facing business owners.