More about business-valuation professionals and techniques

An article titled "Business Valuation Processes," authored by Jerry Golanty, was published in the Jan. 30 edition of the Northern Nevada Business Weekly. In my opinion, portions of the article presented some very narrow and even some uncommon applications of financial information used in the valuation process. Also, Mr. Golanty has made misrepresentations about there being any significant differences among business valuation professionals based on which organizations awarded their credentials.

Mr. Golanty considers an appraiser with his credential or with a credential from one other particular organization to be superior to the credentials awarded by other organizations. This is a complete fallacy. All valuation professionals, irrespective of the organization awarding the valuation credential, must undergo training, pass an exam in valuation methodology and application, and meet ongoing continuing education requirements. Any differences among the organizations' credentialing criteria are not nearly as important as how a valuation professional performs and applies his/her training and knowledge.

Two valuation credentials are only awarded to CPAs who meet the aforementioned requirements. Mr. Golanty stated that few CPAs hold valuation credentials. I do not know what he means by "a few," but CPAs credentialed by the American Institute of CPAs as Accredited in Business Valuation number over 3,000, and this does not include CPAs accredited by other organizations. In any event, although Mr. Golanty is not a CPA, the business appraisal credential he holds is a very respectable one, as are others.

Also, Mr. Golanty made the statement that "qualified appraisers are taught and trained to appraise all types of businesses." I interpret this as his saying that any business appraiser is capable of appraising any type of business. Businesses in certain industries have peculiarities that require special knowledge. In these situations, an appraiser who is not familiar with such peculiarities needs to take the time to acquire a familiarity of the specialized industry in which the business operates. Often, the client in need of having such a business valued is better off finding an appraiser who has experience in valuing businesses in the particular industry requiring specialized knowledge.

As for other portions of Mr. Golanty's article, I have the following comments:

* Regarding the three approaches to business valuation that he describes, below is my attempt to clarify portions of those descriptions that may be misleading or otherwise misconstrued.

* The cost approach: He states that the cost approach "looks at the solvency of a business ... and determines the net worth of a business". To clarify, there are different methods under the cost approach, the most commonly used of which is the adjusted book value method, although another method that is not uncommon is the capitalized excess earnings method. The purpose of the cost approach is not to look at the solvency of the business. When using the adjusted book value method for example, the purpose is to value a business based on the underlying values of each of the assets and liabilities.

* The income approach: Under this approach, either a capitalization rate based on the risk of investing in the business (i.e. the rate of return that an investor expects on the investment) is applied to an average or weighting of past earnings, with appropriate valuation adjustments; or, if future earnings are forecasted, then these earnings are discounted to present value. Under either method, the risk attributed to the particular business is factored into the calculation in arriving at a value. Mr. Golanty used the terms "capitalization of net income (EBITDA) and discounted future benefits (cash flow or earnings)." Actually, "earnings" can be cash flow, pre-tax or after-tax; EBITDA; or accrual basis income, before tax or after tax. Which earnings figure is used will be a factor in arriving at a capitalization rate or discount rate.

* The market approach: When using this approach, in general, data from private company mergers and acquisitions, and sometimes from public companies, are used to arrive at multiples that are applied to the subject business' earnings and/or revenues. The data obtained should be that of companies in the same industry or at least having similar characteristics of the business being valued.

* Mr. Golanty states that "an interest of 50 percent or less is considered to be a minority interest subject to discounts for lack of control and marketability," and later, under the definition of fair market value, says, parenthetically, that "minority interests could be subject to discounts for lack of control, lack of marketability." Actually, an interest in a business that is less than 100 percent may very well be subject to a discount for lack of control, even though it may not be a minority interest. As for a discount for lack of marketability, except under certain circumstances, this discount is appropriate when a business interest of 50 percent or less is being valued, and often is applicable for an interest of more than 50 percent.

* Mr. Golanty says that in testing the value arrived at, the revenue should cover expenses, debt service and a reasonable compensation for a working owner and, if not, "the appraiser must go back to the drawing board." Well, hopefully there will be no big surprises if the valuation process was performed with sufficient care. If the cash flow after income taxes and debt service needed to finance some portion of the value arrived at (e.g. 75 percent) does not produce a return of the investment (usually the down payment) within a reasonable amount of time (e.g., up to three, five or seven years, respectively, for investments that are relatively risky, moderately risky, or of relatively low risk), then the appraiser will have to review and analyze the work, and undoubtedly will be able to determine what components used in arriving at the value need to be modified.

The above discussion is very general in nature, only touching on some of the ways a business value might be determined, and primarily applies to small, closely held businesses. If you find yourself in need of having a business valued, you should find a professional who is qualified in valuing businesses.

Richard M. Teichner is a certified public accountant and the manager and sole member of Teichner Accounting Forensics & Valuations, PLLC in Reno. Contact him at 828-7474 or at accountingforensics@gmail.com.