FAQs by Attorneys
- Q. WHAT ARE APPROACHES TO VALUE?
- A. They are broad umbrellas of valuation and consist of the Cost, Income and Market Approaches. The Cost Approach is usually a balance sheet exercise. The Income Approach views a business as a money-making machine. The Market Approach is a transaction-based approach.
- Q. WHAT ARE METHODS?
- A. They are valuation techniques under the various approaches. There is no body of knowledge that requires a certain method to be part of a specific approach, and it really doesn’t matter, as long as the methods are used correctly.
- Q. AN APPRAISER ONLY USED ONE METHOD TO VALUE A BUSINESS. WAS THIS CORRECT?
- A. A rifle cannot be zeroed in by shooting only one shot. Professional appraisers generally agree that a single method may not produce a credible result and will therefore attempt to use as many methods as are applicable. After exploring various methods however, the appraiser may only find one applicable method. In such a case the appraiser should justify the use of all methods in the report.
- Q. WHAT IS MEANT BY SINGLE PERIOD METHOD AND MULTI-PERIOD METHOD?
- A. A single period method of valuation (ie. Capitalization of Income) is used when a business’ revenue and profit has become fairly stable. A multi-period method of valuation (ie. Discounted Future Earnings) is used when the business is in a growth mode. Obviously, single period and multi-period methods cannot be used in the same appraisal as a business cannot be stabilized and growing at the same time.
- Q. SHOULD APPRAISERS AVERAGE THE VALUES DEVELOPED BY DIFFERENT METHODS?
- A. If a person sticks his head in the oven and his feet in the freezer can we say that, “on the average he feels pretty good”? Neither should appraisers “average” values. The appraiser should however, weight the values according to their relevance to the overall conclusion.
- Q. SHOULD PUBLIC COMPANIES BE USED AS GUIDELINES IN VALUING CLOSELY HELD BUSINESSES?
- A. Raymond C. Miles, CBA, ASA, founder of the Institute of Business Appraisers, and nationally renowned business valuation educator says they should not be used. He bases his opinion on the Principle of Substitution, a cornerstone of business valuation. The principle states that “The economic value of a thing tends to be determined by the cost of acquiring an equally desirable substitute”. For a public company to be “an equally desirable substitute” it must satisfy two requirements:
- “be similar to the company being appraised” (the same kind of business, similar financial structure, size of investment, liquidity, investor’s time horizon, risk tolerance, expected return on investment, involvement in management).
- “the transaction from which the value of the Guideline Company is determined must reflect investor viewpoints and expectations to those potential buyers of the business being appraised. There must be relevancy between the Guideline Company and the subject business”.
In other words, it is not sufficient for the guideline business to be similar to the business being appraised. It is also necessary that the investment in the Guideline Company be relevant to investment in the subject business.
- Q. WHAT IS THE ALTERNATIVE?
- A. The use of smaller, closely held company guidelines such as are contained in the Institute of Business Appraiser’s Transaction Database and in BIZCOMPS.
Jerry F. Golanty, MCBA, BVAL
Master Certified Business Appraiser
Business Valuator Accredited in Litigation
BizVal - Reno
1575 Delucchi Lane
Reno, NV 89502
Phone (775) 332-4881
Fax (775) 827-0137