How a business appraiser determines the value of an enterprise may seem like a technical issue. But for business owners and their counsel, having a basic understanding of the approach suggested by a business appraiser —a calculation of value or a conclusion of value—is key to obtaining valuation services that meet the unique needs of your situation.
More often than not, attorneys advise their business owner clients to hire a valuation expert in situations such as a divorce, disputes with co-owners, or when a business is put up for sale. An appraiser may use one of two distinct approaches to estimating the value of a business: a “calculation of business value” or a “conclusion of business value.”
The type of analysis the appraiser performs depends upon the specific needs of the business owner and the particular facts of a case. For instance, the business owner may need a quick estimate early on in a dispute to help facilitate a settlement. A calculation of business value may be appropriate in this scenario. In more complex litigation or transactions, the owner may require a deeper examination—a conclusion of business value—that will help the valuation stand up to more rigorous scrutiny from dealmakers, opposing counsel, or finders of fact.
THE PHASED APPROACH: A STRATEGIC OPTION
What if the business owner and counsel are unsure about the approach they should choose? In this circumstance, a phased approach may offer the best alternative.
The phased approach starts with the business appraiser conducting a calculation of business value. This initial phase is particularly advantageous in the early stages of legal disputes or negotiations, where a preliminary valuation can significantly influence decisions or facilitate settlements.
Should the need arise—often when a case moves beyond preliminary settlement discussions and towards trial or when a more detailed valuation is required for finalizing a sale—the phased approach readily transitions to a more comprehensive analysis, the conclusion of business value. This second phase involves an in-depth evaluation of the business, considering a wide range of factors including financial performance, market conditions, industry trends, and other qualitative aspects that influence value.
By adopting a phased approach, business owners and counsel have the flexibility to start with a less intensive and more cost-effective analysis , with the option to escalate to a more detailed analysis if necessary. This flexibility is particularly advantageous for managing costs and for adapting to the evolving dynamics of a dispute or transaction.
UNDERSTANDING A CALCULATION OF BUSINESS VALUE
Let’s explore, in greater depth, the two approaches that may be used by business appraisers.
The first, a calculation of business value, is largely a quantitative approach that applies limited valuation methods to a specific set of financial metrics. The result is an estimate or potential range of a business’s value. These estimates are particularly useful for internal planning, settlement discussions in divorces or partnership disputes, and preliminary negotiations in a sale. Key characteristics of a calculation of value include:
• Limited Scope: Calculations of value often rely only on financial statements, income tax returns, and industry metrics. Limited valuation methods are applied to the company’s historical or hypothetically adjusted financial information to arrive at an estimate of value.
• Reduced Due Diligence: Calculation engagements involve less extensive due diligence compared to full valuation projects. The focus is primarily on utilizing readily available financial data and industry benchmarks to arrive at a quick estimate.
• Formulaic Approach: A calculation engagement often reflects ranges of valuation formulas and multiples applied to ranges of historical or potential future company performance. The estimate of the business’s value is based on limited financial metrics such as revenue, earnings, or industry-specific benchmarks.
• No Expert Testimony Needed: Most, if not all, business appraisers will not provide expert testimony on a calculation of value.
UNDERSTANDING A CONCLUSION OF BUSINESS VALUE
The conclusion of business value is a more comprehensive and qualitative assessment that involves a thorough examination of financial performance, market conditions, industry trends, and qualitative aspects unique to the business. The approach provides a more holistic understanding of value, often in the form of a detailed report. Key characteristics of a conclusion of value include:
• Holistic Analysis: A conclusion of business value encompasses a broader and deeper analysis of the business, considering not only financial metrics but also qualitative aspects such as management expertise, competitive positioning, and future growth prospects.
• In-Depth Due Diligence: Professionals conducting a conclusion of value engage in more extensive due diligence. This typically involves interviews with key stakeholders, a deep dive into financial records, and developing a comprehensive understanding of business operations and market dynamics.
• Customized Approach: A conclusion of value allows for a more customized and tailored assessment than a calculation of value. Appraisers incorporate all relevant valuation methodologies based on the specific characteristics and complexities of the business.
• Expert Testimony Available: Armed with a deep understanding of the business and in-depth due diligence, most business appraisers will provide expert testimony based upon a conclusion of value.
CHOOSING THE RIGHT APPROACH
What factors should a business owner consider when making a decision about whether to pursue a calculation of business value, a conclusion of business value, or a phased approach? Consider the following:
1. Transactional Scenarios. When a quick estimate of value is needed for internal transactional purposes, a calculation approach may suffice. For example, it could be suitable for buy-sell agreements or pre-sale internal planning.
2. Complex Valuation Needs. When a more detailed and comprehensive understanding of a business’s value is required, especially in the context of mergers, acquisitions, or legal proceedings, a conclusion of value provides a more robust and thorough assessment. A rapidly changing industry or substantial changes to business operations can also necessitate an in-depth review.
3. Budgetary Considerations. Budget constraints may also influence a business owner’s choices. Businesses might opt for a calculation approach because it provides a quicker and less costly estimate. It is important to note, however, that budgetary considerations should not be the primary factor in the decision-making process. The particular facts and circumstances of a deal or dispute should drive decision making. Business appraisers may influence this decision as well, as their professional standards govern how and when a calculation of value can be used.
THE BOTTOM LINE
In the end, choosing a valuation approach comes down to the particular circumstances facing an enterprise. Business owners may need a quick calculation of business value for internal purposes or settlement negotiations, or they may require a more comprehensive conclusion of business value to drive critical decisions or litigation. They may also deploy a phased approach, which can offer a cost-effective pathway through the valuation process and ensure that business owners are equipped with the insights needed to make informed decisions at every stage of a dispute or decision.
Our team can help business owners and counsel navigate the decision-making process around business valuations. Visit our litigated business valuation practice page to learn more about our services or contact us for a consultation.