Are valuations really necessary?
A valuation of a business entity or ownership interest, though recommended in many circumstances, may not always be necessary. If it is necessary, a valuation analyst may not have to perform the valuation. If a taxpayer, however, performs the valuation in a tax-favored transaction and either understates or overstates the value of the business entity or ownership interest to his advantage, the IRS will impose fines and penalties. Examples of reasons why valuations should be performed by a valuation analyst include:
- Calculating the amount of estate, gift or income taxes
- Determining how much insurance to carry (i.e., key person life insurance)
- Determining the economic damage claim amount (i.e., breach of contract) for settlement or litigation purposes
- Setting the charitable donation amount
- Setting the selling price or establishing the purchase price (i.e., buy-sell agreements)
- Estimating the replacement cost, auction price or collateral value
- Apportioning (or assigning) the separate and community property values in a marital dissolution
Why can’t I just use valuation software? It looks easy enough.
Using software sometimes gives us the false sense of security. Software users feel that if they are able to maneuver through it and plug a whole bunch of numbers, the eventual product will be adequate. Have you heard of the expressions “garbage in, garbage out” and “you get what you pay for”? Software, by and large, is the most economical tool for products not requiring technical ability and seasoned judgment such as a simple tax return or tenant agreement. So before using software instead of a qualified and competent professional for a business valuation and anything else requiring ability and judgment, balance the savings enjoyed now against the possible headache in the future.
My CPA tells me he is qualified to perform valuations. Is he really?
CPAs, much like doctors and lawyers, specialize in different areas. Only a small percentage of CPAs in fact have one of the four industry-accepted credentials demonstrating, at the very least, their technical understanding of business valuations (See below). Furthermore, the IRS has defined a qualified appraiser (valuation analyst) as an individual who (1) holds himself out to the public as an appraiser, (2) regularly performs appraisals or (3) is qualified to appraise the property because of his qualifications. As a CPA, I limit my practice to business valuations and forensic accounting. Unlike a traditional CPA, I do not perform audits and income tax returns. Just be sure that your tax CPA, for instance, is qualified to perform business valuations.
FACT: A statistic taken from a website indicates that about 128,000 members of the American Institute of Certified Public Accountants are in public practice, which represents about 38.4% of its total membership. The rest are in private industry, education, government or are retired. Of its members in public practice, fewer than 3% have earned a designation for undergoing a valuation training program. A CPA without a designation may be entirely capable of doing an excellent valuation, but this statistic suggests that valuations are not something most CPAs do as part of their core tax or audit practice.
Why do valuations cost what they do?
Many people incorrectly assume that business valuation analysts use a predetermined set of rules (such as rules of thumb) and procedures, which makes them wonder why valuations cost so much and take so much time. Business valuation is a consulting specialty that requires creativity, subjectivity and flexibility. Unlike real estate and publicly traded companies, sales of private companies are not “made public”. This means the valuation analyst must first dig to find comparable data and then perform complex analyses.
How long should valuations take?
The time it takes depends on the nature and complexity of the assignment. The following are reasonable guidelines for what to expect after considering the valuation date, standard of value and interest being valued:
- Valuations in “contemplation of a sale” take about one week since full valuations are not necessary. Instead the company’s asking price and floor value are calculated and a short report is written.
- Valuations for Family Limited Partnerships (FLPs) or Limited Liability Companies (LLC) take about two weeks when the underlying asset values, entity balance sheet and operating agreement are provided.
- Estate and gift tax valuations take about four weeks from when the requested business and financial information is received since full valuations are necessary.
- Valuations for litigation matters, such as divorces and shareholder disputes, can take at least four weeks since full valuations may be required. Additional time is always helpful because in many cases getting the required information takes time.
Are valuation analysts from bigger firms better? Their marketing is very convincing.
Just because a valuation analyst is associated with a large firm, it does not necessarily make him or her more careful, more competent or even more ethical. In fact, valuation analysts from small and large firms, much like in other professions, are equally likely to be negligent, incompetent and unethical. So do not be fooled by common fallacy, myth or “good” marketing when choosing a valuation analyst. Instead, get a several recommendations from people you trust. If your network of trusted people cannot recommend anybody, then vet (or critically examine) several business business valuation analysts.
A partner at a valuation firm tells me that he is personally involved. Is he really?
Unfortunately partners (and principals) at other valuation firms are not always personally involved. You must understand that some partners, especially in larger firms, have major managing and marketing responsibilities that they spend less time than they should reviewing the valuation and speaking to the client. These firms are referred to by the profession as “mills”, “factories” or “assembly lines”. These partners instead use less experienced valuation analysts or, if they are CPA firms, audit and tax staff to do most of the work like research.
Your bottom Line: No matter how big or small the valuation, it is important to you. So you need a business valuation analyst that is completely committed to providing you a quality, personal and detailed service. You need to know that your analyst is personally involved in the entire valuation process and that he promptly responds to and resolves any valuation issue.
The preceding article is intended as general information and should not be considered legal, tax, accounting or other expert advice. As the author, I represent that neither the information nor its impact is comprehensive. If legal, tax, accounting or other expert advice is required, please use a qualified and competent professional.