The top ten things every attorney and corporate officer should know about business valuation Content provided by Mercer Capital.  www.mercercapital.com

1. Define the Project. In order for the appraiser to schedule your work, set the fee and understand your client’s specific needs, the attorney needs to provide some basic benchmark information, such as: a description of the specific ownership interest to be appraised (number of shares, units, bonds); a clearly stated understanding of the “level of value” for the interest being appraised; a specific valuation date, which may just be current, or may be a specific historical date and a description of the purpose of the appraisal (inform the appraiser why your client needs an appraisal and how the report will be used).

2. Understand the Standard of Value. There are different standards of value for appraisals under certain circumstances and in different jurisdictions. Typical tax compliance appraisals are based on “fair market value,” certain jurisdictions require “fair value” in dissenters’ rights cases; and “liquidation value” may be appropriate in certain cases.

3. Involve the Appraiser Early On. Even in straightforward buy-sell agreements, family limited partnerships, or corporate reorganizations, it is usually helpful to seek the advice of the appraiser before the deal is set, to see if there are key elements of the contract document that could be modified to provide a more meaningful appraisal to your client.

4. Distinguish Between a Business Appraisal and a Real Estate Appraisal. Many of the corporate entities appraised either own or rent the real estate where the business is operated. For a successful operating business, the most meaningful valuation is typically based on some measure of capitalized earnings rather than the value of the underlying real estate. However, one should recognize that some businesses, due to the nature of their operations, are characterized more by their underlying assets and less so by their earnings power. This is true for asset-holding entities, and for some older family businesses with marginal earnings but with appreciated real estate on the books. Many business appraisers are not asset appraisers and, therefore, may need to consider a qualified real estate appraisal in the business valuation process.

5. Establish a Reasonable Time Frame. Your client’s business appraisal is a custom piece of work and he or she may not have immediately available all the information requested at the outset of a valuation assignment. Typically, a valuation project takes several weeks to complete once the authorization to proceed has been received. That can be accelerated to meet special needs, but it is usually a good idea to avoid rushing the production of a complex appraisal project.

6. Insist on an Appraisal Firm with Experience and Credentials. Each business appraisal is unique and experience counts. Most business valuation firms are generalists rather than industry specialists. However, the experience gained in discussing operating results and industry constraints with a broad client base helps an appraisal firm understand your client’s special situation. And while credentials are no guarantee of performance, they do indicate a level of professionalism for having achieved and maintained them. More and more valuation designations are appearing in the market, but many do not mandate stringent requirements. Look for the Accredited Senior Appraiser (ASA) designation from the American Society of Appraisers—without a doubt the best credential for a valuation expert.

7. Know the Primary Business Valuation Methods. Business valuation is an art as well as a science and appraisers will use and give different weights to various valuation methods as they suit the particular needs of an assignment. Key methods typically used include: transactions method (focuses on actual transactions in the security being appraised); underlying net asset value method (considers estimates of fair market value of the entity’s net assets, on a tax-adjusted basis); capitalization of earnings method (based on estimates of underlying earnings power times a derived capitalization rate); guideline company method (similar to the capitalized earnings method, but uses comparable, or guideline companies to derive the appropriate capitalization rate); or discounted cash flow (derives the present value of future cash flows, based on a combination of projected future cash flow and a derived discount rate appropriate to the situation). Other valuation methods may be appropriate to certain companies in specific industries where particular comparable transaction data may be available.

8. Consider the Appraisal as a First Line of Defense. A well-reasoned and documented appraisal report serves as an indication of the seriousness and professionalism with which you address your client’s needs. Having an independent appraisal in a transaction situation provides a level playing field for negotiations in good faith on both sides. For tax-compliance cases, the appraisal serves notice to the other side that they need to be equally prepared to support their opinion of value.

9. Litigation Support Issues. The business appraiser cannot serve as advocate for your client, but it is always helpful to have an experienced business appraiser available for expert opinion testimony. In addition to providing a well-reasoned and documented report, the appraiser must be able to articulate the reasonableness of valuation and investment conclusions to the court and be able to deal with intensive cross-examination.

10. Expect the Best. In most cases, the fee for appraisal services is nominal compared to the dollars at risk and the marginal cost of getting the best is negligible. You can help your appraiser do the best job possible by ensuring full disclosure and expecting an independent opinion of value. The best appraisers have the experience and credentials described above, but recognize the delicate balance between art and science that enables them to interpret the qualitative responses to due diligence interviews and put them in a stylized format that quantifies the results.

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