Many business owners who have had their businesses valued remember providing a large amount of information and documents that went into a long and expensive report containing only a few pages of relevant information.
Smart Business spoke with Bob Evans, a senior manager at Clarus Partners, about business valuations and a lesser known, but still useful, service called a calculation of value.
What’s the difference between a business valuation and a calculation of value?
A full business valuation is a formal document that arrives at a thoroughly documented conclusion of value. It contains extensive background information about the company and its management, its economic environment, and historical and sometimes projected financial statements. It’s designed to provide enough information to enable a person having no prior knowledge about the company to read the report, understand the company, and also understand the rationale and methodology used to value the company. In theory, the report should be so well documented that the reader would come to the same conclusion as the author.
In a calculation of value, the appraiser and company agree on a limited amount of background support and/or procedures to be used to calculate and document the value of the company. The conclusion is then expressed as a calculated value.
A calculation of value report can be significantly less expensive than a full valuation report, and under the right circumstances just as useful. This is because even though the background support is less, the analysis done within the agreed upon methodology is the same whether the report is a conclusion of value or a calculated value. However, a calculation of value report is required to include a disclaimer stating that had a valuation engagement been performed, the results may have been different. This makes a calculation of value report inappropriate in certain situations.
In a calculation of value, a detailed history of the company, management biographies, analysis of competition and a discussion of the economy can be reduced or eliminated. Support for the rationale used in the report may also be reduced.
A full valuation must consider value using each of the income-based method, market-based method and asset-based method. In a calculation of value, it may be agreed that only one or two of the methods are considered.
When is a calculation of value report useful?
Calculations of value are useful when the users of the report are familiar with the company — for example, if an owner is thinking of retiring and wants to estimate the proceeds from the eventual sale of the business. It’s useful when business owners receive an unsolicited offer to buy the company and want to know if the offer is a good one, or for new owner buy-ins and when retiring owners are bought out. Calculations of value may be useful when drafting or periodically reviewing buy-sell agreements and the adequacy of the life insurance that funds them. A divorcing husband or wife trying to settle on a property division in an inexpensive and amicable way may agree to use a single calculation of value to value the business.
When is a full valuation report required?
Generally, a full valuation report is required any time the report will be used in a court case or submitted to a third party for an official purpose. A full valuation report is required any time the report will be submitted to a court or to the IRS. The required disclaimer makes calculation of value reports inappropriate for official uses. If there is any question whether a calculated value is acceptable for the users of the report, it’s important for the accountant to know before work begins.
What is the takeaway for someone considering having their business valued?
The primary takeaway is that calculation of value reports cannot be used in submissions to third parties in an official setting, such as an income or estate tax filing, or to a court trying a case. In these third-party situations, the report will not be accepted. However, if the report is for internal use only, a calculation of value is a cost-effective level of service that can still deliver useful information.
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