Too often valuers concentrate their efforts on the 'number crunching'. However, valuation is more than mathematics. If a proper valuation process is not followed, then a valuer may arrive at misleading conclusions. Weakness in the process can result in confusion and disagreement about the final results.
AES-2 issued by the ICANZ sets out minimum professional standards for the performance of independent valuation engagements and should be consulted at the start of a valuation project. Clause 18 states; "A member must plan the independent business valuation work so that the engagement will be performed in an effective manner". The following format offers one approach to planning a valuation.
Before proceeding the appraiser needs to establish some basics:
The legal interest (business) to be assessed
Date of valuation (the same business may have different values at different dates).
Purpose of Appraisal
Applicable standard of value (fair value or fair market Value)
Going concern or liquidation value?
Total entity or part ownership?
Is it to be an indicative valuation or a full valuation?
Any special requirements, limitations or instructions?
1. Full information.
Full information (history, operational, and financial) underpins a credible valuation. The appraiser needs to ask many questions.
Information may include:
management and organisation structure
lease details
products and service
intangible assets (e.g. brands, agencies, domain names, etc.)
suppliers and customer spread
up-to-date financial records
2. Internal Analysis and Risk Assessment.
reliance on key personnel
agency loss
security of tenure
personal goodwill
legislative changes
the economy
technological developments
competition
4. normalisation of financial and assessment of future maintainable earnings.
identify discretionary expenses
consider revenue and profit trends
establish reasonable management remuneration
assess any budgets or forecasts
5. Consider and supply appropriate valuation approaches and methods
There are three economic models used in business valuation:
Earnings Based
Asset based
Market Based
For details on these approaches and the valuation methods associated with each, refer to our Bizstats September 2008 newsletter.
An appraisal should use more than one method of valuation. The method chosen should reflect the size and nature of the business being assessed. Investments in large businesses are fundamentally influenced by economic and financial factors. However, the acquisition of smaller businesses (SMEs - i.e. those with less than 20 employees) may be influenced by other factors such as independence, employment, security, family welfare or life style.
Direct market data can provide a reality check on the valuation of smaller businesses (SMEs). However, it is important to remember that historical data is only that historical! Applying past ratios without consideration to current modifying factors that are identified in the valuation process can lead to misleading results. Historical data is a useful guide, but the valuer must decide how relevant it is to the case in hand.
6. Valuation Conclusion.
The results from the methods used should be reconciled so the appraiser can provide an opinion. Often a range is the more accurate answer.
NZICA's AES 2 provides a framework for the appraiser to supply his or her opinion in a professional fashion.
Bibliography:
(1) Pratt, Reilly & Schweihs Valuing A Business 1996 McGraw Hill
(2) Sloan & MacLeod Buying, Selling and Valuing SMEs. 2004 ICANZ
Guy Crozier MBA BCOM
The Bizstats Data Base has comprehensive statistics on sales of many thousands of New Zealand SME's and is used by brokers and valuers to support defensible valuations. If you would like to learn more about the availability of Direct Market Data, contact us:
