Valuation 101

Last updated on May 13th, 2019 at 02:28 pm

Business valuations can have a significant impact on your personal and corporate financial futures. Unfortunately, most business executives spend less time selecting a valuation specialist than they would selecting and negotiating the price of a new car.
That’s a huge mistake.
While we all like to have the "right" car at a good price, selecting the wrong car only has a short-term affect and only a minor economic impact. With the wrong car, you simply sell it and buy different one. Even in buying the right car, the best research and negotiating are likely to save you only $500 to $5,000.
On the other hand, a business valuation can have a lasting financial impact. A 10% difference in the amount arrived at in a valuation could amount to a multi-million dollar impact. Even when the value arrived at is only $500,000, a 10% swing equates to $50,000.
It’s worth an investment of time to find the right valuation specialist.
What do I mean by "valuation specialist?" It’s easy to find someone who will prepare a business valuation. Unfortunately, many people who offer this service lack the training, experience and credentials to provide quality results. A valuation specialist will have all of these qualifications and, in general, should provide a higher quality valuation.
You may not always need a valuation specialist. Sometimes, the "guy down the street" or a trusted advisor with a significant financial background can provide a rough idea of value.
What factors should you consider in selecting a valuation specialist?
1. Credibility – You must consider who the audience is. For example, a valuation prepared for a divorce settlement is subject to considerable review and often opposition by the other party. On the other hand, a valuation for an employee stock ownership plan is generally subject to much less contention.
The factors contributing to credibility include: professional credentials, education, work experience, valuation experience, written communication skills, verbal communication skills, poise, appearance and independence.
Are all of these always important? Not necessarily. In some circumstances, you may simply be seeking a piece of paper to meet a legal or regulatory requirement. However, in many cases, the valuation could be subject to much higher levels of scrutiny and may result in a more public role or court appearance on the part of the person preparing the valuation. In these later cases, you should carefully consider all of the factors mentioned.
It is often tempting to hire someone you know well and may already do business with to prepare your valuation. If you do so, be aware that this impairs the preparer’s appearance of independence. Don’t underestimate the importance of independence.
2. Industry knowledge – Valuation results can be highly dependent on the valuation specialist’s ability to fully understand the specifics of the business and the industry within which it operates. You need someone who can demonstrate an ability to discern the relevant information and tailor the valuation accordingly.
3. Understanding of the purpose – A valuation specialist must understand why the valuation is being prepared and the implications on the value. In some circumstances, it is appropriate to value a business as a going concern, without considering the premium that might be paid in an acquisition. In other cases the acquisition value or liquidation value may be more appropriate. These three figures may be significantly different.
4. Value is forward-looking – A valuation generally should not be based on historic information such as book value or prior earnings. The true value of a business is most often based on expected future performance. To arrive at an appropriate value, past accounting figures often need adjustment to reflect economic reality, rather than accounting reality. Frequently, closely held businesses are operated in a way that minimizes reported earnings, thereby reducing annual tax payments. To accurately value such a business, it is often necessary to review and adjust reported earnings to approximate earnings that might have been reported under different circumstances. Be careful to hire someone who is aware of and capable of making these adjustments.
5. Creativity – While valuations may seem like straight-forward applications of standardized methodologies, this is far from the truth. To be most useful, a valuation specialist must be creative. This will allow them to see and express the less-than-obvious components of a company’s value.
6. Who – If you are hiring a firm to prepare a valuation, it is important to understand exactly who will be involved in the work on your valuation and who will sign the report. A valuation by an exceptional firm that assigns inexperienced, under-supervised personnel to your valuation isn’t going to produce the results you need.
7. Price – You may very well find a wide range of prices among valuation specialists. In the world of valuations, price does not always correlate to quality. Be sure you understand what you are getting for your money.
How do you apply these factors? I suggest that you develop a series of questions to ask each potential candidate. Your accountant or attorney may be quite helpful in this regard. Interview each candidate to determine how well they fit your needs. You will find that a good valuation can bring even more satisfaction than a new car.
William McGinnis, CFA, is a Chartered Financial Analyst and president of W. McGinnis Advisors, LLC, a Milwaukee-based business valuation, litigation support and securities expert witness firm. He can be reached by telephone at (414) 228-1888 or through the company’s Web site at www.wmcginnisadvisors.com.

May 28, 2004 Small Business Times, Milwaukee, WI

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