How to make sure you have a good appraisal of your business

What's your business worth?

Any number will do unless there's something serious at stake, like a lawsuit, a tax issue, or a business decision. Being frugal could save you a few bucks at first but, could cost you a lot more in the end. The courts are full of lawsuits with buyers who paid too much, sellers who sold too cheap, partners who were bought out at too high a price, partners who were not paid out enough and divorces where a spouse was cheated out of a reasonable share of a business or practice. The answer? Retain the best business appraiser you can afford. So, how do you select that appraiser?

You need to know something about business appraisers because they come in all shapes and forms part-timers, full-timers, educated, uneducated, experienced, unexperienced, certified and non-certified. Some are brokers, accountants, economists, academics and quacks. Many appraise businesses when they have nothing better to do or when they need money. Many do not maintain offices or business locations and are nowhere to be found when called upon to defend their opinions, especially in litigation settings. Some have just purchased valuation software for their computers and have become "instant appraisers." How would you like to go to a brain surgeon whose sole experience and knowledge is from a computer program?

Business appraisers are either certified (accredited) or non-certified (non-accredited). Certified and accredited appraisers have gone the extra mile through education, training, testing, experience, and, in the case of two of the five North American organizations that accredit business appraisers, they have gone through peer review, proving that they are capable of performing valuations at an acceptable and professional level. Not all accrediting organizations are the same.

A common misconception is that accountants, MBAs and business brokers are automatically qualified to value a business. It does not take long for a skilled attorney to disqualify a non-qualified "valuation expert," especially if the attorney has been well-prepared by a well-qualified expert. It is estimated that, of the hundreds of thousands of CPAs in the USA, less than 1 percent have been certified as business appraisers by their own CPA organization.

There are also many misconceptions regarding goodwill and its value. Revenue Ruling 59-60 (valuation guidelines) says that goodwill is based on earning capacity (profit). In order for goodwill to have value, it must be transferable. Consider the solo-practitioner brain surgeon whose revenue depends upon referrals from other doctors. Is his goodwill easily transferable? Possibly not! Does that mean his practice has no value? Absolutely not! There are many litigious situations where the practice might have considerable value.

While almost every piece of real estate has some value, even if it's minimal, there are some businesses that you cannot give away. Consider a retail business that depends on pedestrian and vehicular traffic where the neighborhood has changed (a new freeway, zoning, etc.). It loses money, has no assets, and is locked into a disastrous lease that no one in their right mind would be willing to assume. It could be a business that you could not give away.

Most certified and accredited business appraisers are required to comply with strict standards of performance. They deal with the ethical practice of valuation and the level of competence required of the appraiser. Standards include requirements for research and fact-gathering (financial, economic, industry, market); studies (officer's/owner's compensation, rent, competition, etc.), discount and capitalization rate development; valuation methods considered and applied; financial document recasting; arriving at conclusions; testing the conclusions and developing a report. Users of valuation services should ask to see a copy of those standards.

At this time the major appraisal organizations are attempting to standardize valuation standards that include those of the Institute of Business Appraisers, the American Society of Appraisers, the National Association of Valuation Analysts, the Uniform Standards of Professional Appraisal Practice as promulgated by Congress and the IRS Business Valuation Standards and Guidelines.

Take a look, for instance, at the factors to be considered with Revenue Ruling 59-60, which provides valuation guidelines:

1. The nature of the business and its history.

2. The economic outlook in general and of the specific industry.

3. The book value and financial condition of the business and its balance sheets.

4. The earning capacity of the business with detailed profit-and-loss statements for representative periods.

5. The dividend-paying capacity of the business.

6. The prices at which similar business have sold.

7. Whether or not the enterprise has goodwill.

The Institute of Business Appraisers Standards also deals with the following issues:

* Non-advocacy as opposed to advocacy. "The appraiser's obligation to serve the public interest assures that the integrity of valuations will be preserved. Hence, the appraiser may only advocate for his unbiased process and conclusions." This means that the appraiser cannot be an advocate for his/her client. It makes no difference who retains the appraiser; the opinion should be the same)

* Disinterestedness: "It is unethical for a business appraiser to accept any assignment when the appraiser has a present or contemplated interest in the property being appraised, or a bias for or against any person associated therewith, either directly or indirectly." This means, if you are the accountant or brokerage agent for the client, your opinion may be considered to be tainted or slanted.

* Replicability: "The appraiser's procedures and conclusion in the formal report must be in sufficient detail to permit the reader to replicate the appraisal process." The object, of course, is to produce the most credible, understandable and defensible opinion possible. Appraisals must be based on informed judgment, common sense and reasonableness.

Jerry F. Golanty, president of BizVal in Reno, is Nevada's only Master Certified Business Appraiser and Business Valuator Accredited in Litigation. Contact him at 332-4881 or jerrygolanty@bizval.net.