Business appraisals are needed in many situations. Regardless of the situation, if your goal is an objective and reasonable result, a competent and credible expert is your logical starting point. A professional who is abreast of current best practices and able to exercise proper due diligence will save you time, money, and grief.
Consider the case of three owners each owning one-third of the business. Two brothers wanted to buyout the uncle. The uncle didn’t like their offer. The business relationship grew tense and eventually the parties went to court to decide a proper valuation.
Case for the Expert: Family Business Dispute
The brothers relied on a CPA who also performed business valuations, though he lacked a business valuation credential. He issued a three-page valuation report, using the company’s tax returns, and discussions with the firm’s accountant and its principals. The CPA used only the income approach and a capitalized income method. After normalizing adjustments, the income stream was $206K. He derived a 20% capitalization rate based on customer concentration and lack of management depth, and applied a 20% discount for lack of marketability to arrive at a valuation of $230K for the uncle’s one-third ownership. He didn’t use a market approach because he said he couldn’t find comparable market or industry transaction data and that the company was not public.
The uncle hired a CPA who was a credentialed appraiser. His more comprehensive review included bank statements, tax returns, and sales reports. He found sales had doubled, while gross margin declined. Sales reports found unrecorded sales of almost $1 million; 20% of sales were cash payments not recorded on the books. Using industry data, he adjusted gross margins to 35% from the 25% that the company reported. His income approach produced an income stream of $486K. After applying a 12% capitalization rate and a 5% discount for lack of marketability his value was $4.1M. Further, he used the market approach with Pratt’s Stats transaction data to check the reasonableness of his income approach. The range of market values was between $3.9M and $4.2M. He weighted the income approach at 70%; and weighted market approach at 30%. He concluded the uncle’s one-third interest was worth $1.3M.
The court affirmed the conclusion of the uncle’s expert citing his “credibility and reliability of valuation methods.” Specifically, noting the use of more than one approach, his qualifications, and, importantly, a more objective and rigorous analysis. In addition, he also demonstrated legal acumen regarding state law on how to apply minority discounts.
This case illustrates the wide range of value that can occur in the real world of business valuation. Conflicts of interest arise often when there is a difference in appraisers’ skill and experience. Regardless of the intended purpose for your valuation, engaging knowledgeable and accredited valuation professionals will likely provide you with the most credible indication of value.
In this case, a buy-sell agreement properly executed could have selected the appraiser BEFORE the conflict became a reality. All shareholders would have agreed to the process so when the buyout time became reality, all owners would have known what to expect. The outcome would have been objective and unnecessary legal expenses, stress, and family acrimony could have been avoided.
Jerry Matecun helps business owners to discover key planning and investment considerations vital to build and protect the value of your business and personal assets. For a no cost, confidential conversation regarding your business valuation and exit plans call or email Jerry at 949-273-4200, 616-499-2000 or firstname.lastname@example.org.