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Two truths and a lie: Business valuation edition

April 13, 2018

By Martha Sullivan, CPA, CVA/ABV, CM&AA, CEPA
Partner, Succession Planning Practice Leader

Martha leads HK’s succession and exit planning services division and is a regular contributor to Wisconsin’s InBusiness digital magazine.

 

“Two truths and a lie” is a game where someone tells three things about him or herself and the other players have to guess which one is a lie. It’s a fun game. It brings out a lot of creativity and dispels myths and misperceptions about a person.

Some of my recent posts talked a lot about business value, how it’s perceived, and the factors that influence it. You’ve been encouraged to know where your business stands, both now and ongoing. What you learn in the process is tremendously helpful to you and all the other stakeholders in your business.

There are assumptions about what a business valuation can or can’t do for you. Some are valid but others can lead you astray, kind of like two truths and a lie. So, let’s play!

You’re ready to get a valuation of your company. You know it’s good to have a baseline. You’re thinking about getting out in about next 10 years. You might sell it outright or possibly gift it to the kids. You’re doing some estate planning, although you and your spouse are going through a rough patch. With this scenario in mind, you start looking for the right valuation professional and service to meet your needs.

Which of these statements are true and which is the lie?

  • There are different types of advisors qualified to do my work.
  • I’ll need multiple valuations prepared depending on how things turn out.
  • My business valuation is like Kelley Blue Book. That’s “the number” I’ll get.
Truth: There are different types of advisors qualified to do my work.

There are seven or eight different credentials your advisor could hold. Three of the most common ones include:

  • American Institute of Public Accountants’ (AICPA) Accredited in Business Valuation (ABV) designation;
  • American Society of Appraisers’ Accredited Senior Analyst (ASA) designation; and
  • National Association of Certified Valuators & Analysts’ (NACVA) Certified Valuation Analyst (CVA) credential.

There are differences between these credentials; however, all require their credentialed advisors to follow the same core standards, approaches, and methodologies in the analysis and development of a valuation. These approaches have been heavily influenced by tax law and court cases, which has resulted in, for the purposes of this blog post, no discernable preference between these designations when selecting advisors.

Unlike your CPA, there is not a requirement for a valuation analyst to be licensed in a state, or for that matter even credentialed. Anyone can sell him or herself as being capable to give you a value, even if he or she is not.

However, experience and cred matter. You want to be sure your advisor is credentialed. If your valuation is involved in a tax or legal matter, your advisor’s credibility will be scrutinized. The lack of a credentialed, experienced advisor could result in your case blowing up, including having your number thrown out and the IRS prevailing with a value that’s in its favor.

If your current CPA firm doesn’t have someone who is qualified in business valuations, go find someone that does. (Your accountant won’t be offended.) Most mid-sized and larger accounting firms in Madison, as well as other specialty business valuation firms, have qualified, credentialed professionals who do this work. (Note: The AICPA’s ABV is separate from your accountant’s CPA designation. Being a CPA does not mean a person is qualified to perform and defend a business valuation.)

Truth: I’ll need multiple valuations prepared depending on how things turn out.

Remember the scenario above: You may sell or you may gift. You may divorce. You will, eventually, die.

Your advisor’s first question should be, “What is the purpose and how will the valuation be used?” Is it for:

  • Getting a baseline for a potential sale of the company;
  • Gifting of shares;
  • Estate planning and management;
  • Financing and recapitalization;
  • Divorce-forced transaction;
  • Impairment testing; or
  • Shareholder dispute resolution.

The answer determines the valuation calculation method(s) and report your credentialed advisor is required to use in your project.

Since the purpose determines the steps your advisor follows, it could generate a value that is verydifferent from a value determined for a different use. For example, let’s assume two weeks from now, one of four things occur:

  • The business is valued to guide negotiations to sell it to a third party;
  • You gift the business to your kids;
  • You file for divorce; or
  • You pass away ahead of schedule.

A valuation is appropriate, if not required, in all these scenarios. All of the above calculated values will be different, equally valid, and appropriate according to the rules and precedents.

Same company, same financial results, same market conditions and comparables, but different calculation rules apply and must be followed. Using the wrong approach and method can cost you big bucks, particularly in court.

Lie: My business valuation is like Kelley Blue Book. That’s “the number” I’ll get.

There is no Kelley Blue Book (KBB) for businesses.

KBB data for the various makes, models, conditions, and ages of vehicles comes from dealerships, lenders, and auctions. It’s a lot of data on specific vehicles that all start from the same place. For example, all 1980 Ford Pintos started the same. Use and abuse then influence the car’s book value.

True, valuation professionals and investors also consider what companies like yours sold for when preparing valuations for outright sale purposes. In that way, there are Blue Book-like resources. Unlike all those Pintos though, companies aren’t all the same, even when in the same industry. These Blue Book-like values have to be further analyzed for size, entity, and deal structure, market timing, and other factors.

Advisors are bound by an assumption of two equal parties in an arm’s length deal. Investors have inside information about synergies and structure that valuation advisors can’t know. Each has their own view of company-specific risk, and then there are market conditions. (See “The crux of multiples” part one and two and “What creates true value” for more insights.)

“The number” from your valuation is vital for you to know. Get the baseline and use it to figure out how to grow the value in your business and your wealth. Understand this data when evaluating your exit alternatives or negotiating a sale, but recognize that it’s just a reference point. You might get more or you might get less. The market and the specifics of your deal will decide your ultimate purchase price and cash in your pocket.

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