What Type of Business Valuation Do You Need?
“Fair market value” is a powerful term in the business and finance world but what does it actually mean? There are variations of definitions of fair market value depending on the standards but us, valuators, mostly use the term “fair market value” as defined by the Internal Revenue Service (IRS) in its Revenue Ruling 59-60 – “the price at which the property would change hands between a willing buyer and a willing seller when the former is not under any compulsion to buy and the latter is not under any compulsion to sell, both parties having reasonable knowledge of relevant facts”.
There is a great amount of literature about valuation methods such as asset approach, income approach and market approach and even though applying these methods can get extremely complicated, the end result is that we will use the most reliable method to determine the value of an enterprise.
I don’t find, however, a lot of discussion about the types of valuations and there are two – calculation of value and conclusion of value. What’s the difference? Think of it as compiled financial statements that are prepared by management and the CPA gives no assurance versus audited financial statements where CPA (independent public accounting firm) gives an opinion (certifies) that the financial statements are fairly presented according to particular standards such as generally accepted accounting principles (“GAAP”). There is a big difference in price from a compilation to an audit and the same goes from calculation of value to conclusion of value. How do you know what kind of valuation you need? It is always based on the purpose of the valuation. Here is the list of most common reasons/purposes and the type of valuation it will require.
|Purpose||Type of Valuation|
|Your own interest of your business value||Calculation of Value|
|You are selling your business||Calculation of Value|
|You need your business value for estate planning purposes||Conclusion of Value|
|You need your business value for gifting purpose||Conclusion of Value|
|Your business needs to be valued for litigation purpose||Conclusion of Value|
|You are looking for a partner that will buy in||Calculation of Value|
|You need to value your business for buy/sell agreement||Usually Conclusion of Value but Calculation may work in certain cases as well|
“Business appraisal” is a commonly used misnomer. While financial professionals use these terms interchangeably, there are differences. Appraisals only pertain to tangible assets while business valuation includes both tangible and intangible value. Ongoing businesses contain intangible value including such intangible assets as: accounts receivable, branding, contracts receivable, customer deposits, customer lists, key employees, patents, recipes, special knowledge, trademarks, unique company name and reputation, and goodwill in general as well as other intangible assets in addition to the tangible value of their physical assets. Generally, these intangible assets far outweigh the value of the business tangible assets unless the business is insolvent. For whatever purpose you are engaging professionals to perform services for you make sure that the terms of engagement are clearly stated and you know what type of service you are engaging in – an appraisal, a calculation of value or a conclusion of value as there are huge cost differences amongst these services. For more information on your businesses’ valuation, call us at 407.650.9088 or Info@MyCPASolutions.com.