Most owners already have a predetermined number in their mind when the time comes to establish the value of a company. 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.
6 Key Valuation Report Elements
Below is a list of the most common elements included in a well-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 purpose
· Effective date
It is important to identify the intended purpose of the report 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. Note: 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 company completely, it is possible 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 supports the expert’s understanding of 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:
· Cost
· Market
· Income
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 important. This area should 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
· Marketability
Other discounts, such as voting, key person, and blockage discounts, may also apply. This section of the valuation report should discuss which discounts are appropriate and why. It should 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.
