EXECUTIVE
SUMMARY | EACH VALUATION
ASSIGNMENT IS UNIQUE, and often
there’s more than one way to answer a
question, interpret a fact or approach a
problem. How the valuator prepares the
client for the BV engagement sets its
direction and becomes the foundation of
the engagement letter and, ultimately, a
responsible and accurate final product.
THE ENGAGEMENT
LETTER ENSURES both client
and practitioner understand the
assignment and can help a CPA/valuator
clarify the ownership interest to value,
the appropriate professional standards
to follow and the fees and payment
terms.
THE VALUE OF A
COMPANY for gift-tax purposes
likely will differ from its value for a
sale to a specific purchaser, and an
entity’s value for sale on a
going-concern basis will differ from its
liquidation value—which similarly
differs if the valuation is for an
orderly liquidation as opposed to a
forced one.
THE VALUATOR'S
DECISIONS about BV
methodology, discounts and premiums and
other formulas depend on knowing whether
what’s being valued is an entire entity
vs. a 49% interest in a limited
liability company, for example.
FINDINGS ARE
REPORTED IN DIFFERENT WAYS:
formal (traditional) written
reports, informal (summary) reports, no
written report at all or a hybrid of the
three. The amount of time to produce
each of these varies substantially, so
know what the client wants and budget
time accordingly.
BV FINDINGS ARE NOT
TRANSFERABLE to serve
multiple purposes. An engagement letter
should specify that a valuation opinion
is valid as of a particular date for a
particular purpose—and no other.
| TIMOTHY W.
YORK, CPA/ABV, is a principal of Dixon
Odom PLLC in Birmingham, Alabama; he
serves in the valuation services group of
the firm. He speaks and writes on
valuation issues and serves on AICPA
business valuation committees. He also is
a member of several valuation
organizations. His e-mail address is
tyork@dixonodom.com .
|
ime is money and the marketplace can
be unforgiving of mistakes in today’s professional
services environment, so listen well when someone
asks you to perform a business valuation (BV).
Clients’ reasons for needing valuations vary
greatly and may include an emotional component (as
in death, divorce, litigation or retirement, for
example) that makes them especially anxious about
the process. In contrast to compliance-based CPA
services, which lend themselves to schedules,
checklists and clear-cut decisions, many aspects
of BV rely on interpretative rather than
definitive answers. Valuators must take care to
begin each assignment with a crystal-clear
understanding of its context and purpose. This
article offers instruction on how to frame a
business valuation to minimize the possibility of
missteps.
GET ON THE GOOD FOOT
CPAs have
been developing BV as a practice area for
about a decade, and certification,
competence and due care are important
aspects of their technical proficiency.
The fifth article of the “Principles of
Professional Conduct” in AICPA
Professional Standards (ET section 56),
says, “A member should observe the
profession’s technical and ethical
standards, strive continually to improve
competence and the quality of services,
and discharge professional responsibility
to the best of the member’s ability.” In
the case of business valuation services,
the Statement on Standards for Consulting
Services and ET section 102, “Integrity
and Objectivity,” not only requires member
integrity and objectivity but warns
against conflicts of interest and
subordination of judgment to others. Not
meeting those standards can be construed
as negligence. However, CPA valuators
who obtain solid credentials in this
practice area (an ABV, for example) know
that methodologies, procedures and even
valuation standards are not absolute.
Each situation has unique aspects, and
often there’s more than one way to
answer a question, interpret a fact or
approach a problem—it is up to an
informed valuation professional to make
the call. How the valuator prepares for
the engagement sets its direction and
becomes the foundation of a responsible
and accurate final product. The sequence
involves gathering information for the
project, preparing the engagement
letter, performing the valuation and
reporting the results. |
Your BV Report
Will Be Stronger If You…
-
Clarify
the definition of value
for the assignment.
-
Choose the most
appropriate appraisal
method.
-
Locate the relevant
market data (it’s there).
-
Select good guideline
companies.
-
Make sure the
financial analysis is
complete, with clearly
explained adjustments.
-
Support your discount
and capitalization rates
and premium calculations.
-
Avoid typographical
errors.
-
Are logical and
consistent.
Source: Understanding
Business Valuation ,
Gary Trugman, AICPA.
| |
DEFINE THE ENGAGEMENT
Prior to accepting a BV assignment, you must
understand your subject and your purpose. As soon
as the person hiring you (who may be the owner of
the business to be valued, an acquiring business,
an attorney or a bank representative, for example)
broaches the subject, you should begin the process
of gathering data for preparing an engagement
letter. Finding out the relevant facts of
the assignment is something valuators refer to as
“defining the engagement.” It’s more complex than
it sounds, and the crux of doing it well is to
assume nothing and spell out as much as possible.
Robin E. Taylor, CPA/ABV, a Dixon Odom LLC
principal and president of the Financial
Consulting Group national BV alliance, says its
members often use its Web site to refine ideas
about “defining the assignment before the actual
work begins.” Obtain as many relevant
facts as you can about the entity and the
circumstances the valuation is intended to satisfy
(whether it’s for a liquidation, M&A, divorce
or tax purposes, for instance) and note them. To
ensure you and the client agree about what
services you will perform, send the client an
engagement planning form and ask him or her to
complete and return it (see
exhibit ). This form covers basic contact
information: who actually is engaging you (such as
the client or the user of the report), the purpose
for the valuation, timing, fees, the subject to be
valued and other relevant items. The valuator will
incorporate these data into the engagement letter
and review and note the assumptions and conditions
likely to apply. You will include all of this in
your letter and, later, in the valuation report.
To avoid problems such as conflict of
interest, “it is extremely important to identify
your client,” says Linda B. Trugman, CPA/ABV of
RCH Trugman Valuation Associates. “For example, in
a divorce situation, if the valuator is hired by
the wife or the wife’s attorney, the wife is the
client even if the husband is the business owner.
It will be necessary to discuss the business
operations with the husband, but it is
unacceptable to discuss the case with him or his
attorney.” The CPA valuator always should remember
who the client is in all interactions.
BUILD A BETTER LETTER
A written engagement letter clarifies the
assignment for both client and valuator. It can
help you to
Value the correct entity or ownership
interest.
Apply the best approaches and
methods.
Follow appropriate professional
standards.
Apply the correct standard of value
for that job.
Ensure the appropriate effective
valuation date.
Use productive time efficiently.
Get paid timely—and in full.
Avoid risk to the firm and a
challenge to the findings.
Maintain client confidence.
Consult the AICPA, state CPA societies and
colleagues for a suitable model if you’re in doubt
about the language. Gary Trugman’s
Understanding Business Valuation (an
AICPA publication) covers this topic well. Another
good resource is the CPA’s Guide to Effective
Engagement Letters,
Aspen Publishers,
www.aspenpublishers.com . To express a clear
understanding on all critical issues, make sure
your letter does the following:
Identifies the subject and the purpose
of the valuation . Be specific
about what you are being asked to value. It could
be an entire entity, asset or something less, such
as a 49% interest in a limited liability company.
Crucial decisions about the appropriate valuation
methodology, discounts and premiums and other
formulas ultimately used depend on an exact
understanding. For example, instead of saying, “We
will estimate the value of XYZ Inc.,” say, “We
will estimate the fair market value of a 1%
limited partner interest in XYZ Inc. as of
December 31, 2003.”
Identifies the standard and
premise of value. There
are many reasons for valuing an entity,
and those circumstances can lead to
different outcomes. To clarify, “premise”
deals with whether the business is a going
concern (most are) or one slated for
liquidation, while “standard” relates to
why the business is being valued. For
instance, a business’s value for sale on a
going-concern basis will differ from its
value for liquidation purposes. It
similarly makes a difference if the
valuation is for an orderly liquidation as
opposed to a forced one. For example, the
value of a company for estate-tax purposes
(fair market value) likely will differ
from its value for a sale to a specific
purchaser (investment or strategic value).
In some instances involving litigation,
the courts or the law may dictate which
standard of value to use. Many
valuators say the parties who hire them
don’t always understand the nuances of
standards of value and the consequences
of the choice to an assignment. You can
significantly benefit clients by
teaching them about standards of value
and helping them choose the most
appropriate standard for the engagement.
Nancy Fannon, CPA/ABV and
principal in valuation consulting at
Portland, Maine-based Baker Newman &
Noyes LLC, says: “Many clients say to
the appraiser, ‘I want to know the value
of my business,’ without realizing that
it can mean many different things
depending on the context. Often,
appraisers hear this and launch into a
fair-market-value analysis. However, if
a client is selling a business, what she
really may want to know is what the
highest multiples being paid in the
marketplace are at that time. Another
client who is a buyer may want to know
what amount she can afford to pay based
on whether the entity’s cash flow will
support her ability to fund a portion of
the purchase price. A fair-market-value
approach may not be very helpful to
either of these clients.” |
Business Valuation
Resources
Web sites
For a variety
of BV resources, check out
www.bvresources.com and
www.gofcg.org
.
Organizations
AICPA 1211 Avenue
of the Americas New
York, New York 10036-8775
Jfeldman@aicpa.org ; www.aicpa.org
American Society of
Appraisers (ASA) 555
Herndon Parkway, Suite 125
Herndon, Virginia 20170
www.appraisers.org
Appraisal Foundation
1029 Vermont Avenue, NW,
Suite 900 Washington,
D.C. 20005
www.appraisalfoundation.org
Institute of Business
Appraisers (IBA) P.O.
Box 17410 Plantation,
Florida 33318
www.instbusapp.org
National Association of
Certified Valuation Analysts
(NACVA) 1111 E.
Brickyard Road, Suite 200
Salt Lake City, Utah
84105
www.nacva.com
| |
Informs the client which professional
standards apply. Adhere to the
professional ethics and conduct guidelines that
apply to all CPA engagements and include
appropriate information about performance
standards in your engagement letter. Many
appraisers belong to multiple valuation-related
organizations, each having different development
and reporting standards. Reconciling them can be
complicated and time-consuming. Where a question
or conflict arises, check the societies’
literature or help desks (if applicable). Make
sure the work follows the model that most
stringently protects and serves the client and the
public good. Include a specimen “statement of
assumptions and limiting conditions” as an
attachment to your engagement letter. Here are
three examples of such statements:
We have no present or contemplated
financial interest in the company referred to in
this report. Our fees for this valuation are based
on our normal hourly billing rates and are in no
way contingent upon the results of our findings.
We have no responsibility or obligation to update
this report for events or circumstances occurring
subsequent to the date of this report.
Our report is based on historical and
prospective financial information provided to us
by management and other third parties. Had we
audited or reviewed the underlying individual
company data, matters might have come to our
attention which would have resulted in our using
amounts that differ from those provided.
Accordingly, we take no responsibility for the
underlying data presented or relied upon in this
report. All of the representations and information
supplied by management and agents are assumed to
be true, accurate and complete.
The indication of value included in
this report assumes the company will maintain its
character and integrity through any reorganization
or reduction of existing owners’/managers’
participation in the existing activities of the
company.
Identifies what the client expects in
reporting. Valuators report
their findings in different ways: formal
(traditional) written reports, informal (summary)
reports, no written report at all or a hybrid of
the three. The amount of time to produce each
varies substantially, so determine the client’s
reporting expectations at the beginning of the
engagement. Report writing can consume 50% of the
total time budgeted for the assignment.
Occasionally the purpose of the valuation dictates
what type of report is required.
Covers fee issues and billing
arrangements. Valuators and
clients should have a clear, mutual understanding
of fee amounts and payment timing. “Valuation
services are premium services that require
professionals to have the best qualifications,
experience and education. As such, BV commands
premium fees. Billings should be addressed at the
beginning of the assignment, and the valuator
should obtain a commitment from the client,” says
Mel H. Abraham, CPA/ABV, of Wood Ranch,
California.
Ask for and get a retainer of
at least 40% of the expected total fee,
applicable to the final invoice. It shows
the commitment level of the hiring party
and gives an indication of the party’s
ability to pay. This helps to avert
situations (such as in a divorce or other
legal proceedings) where a client
subsequently may not be motivated to pay.
Link subsequent payments to stages of
completion—for example, on completion of
the report and at agreed-on interim
stages, depending on the complexity of the
engagement. Here’s an example of how
and how not to express a fee
understanding:
Don’t say: We will issue
billings on a monthly basis and may
increase our estimate of the $10,000 fee
if unusual circumstances arise.
Say something like: We will
issue billings as often as weekly and
will notify you immediately of issues
that will cause our fee to change. We
reserve the right to change the original
fee estimate as the project progresses
and we are able to predict more
accurately the total time the project
will incur. We request a retainer of 50%
of the original estimate ($5,000 based
on the original estimate of $10,000),
which is due upon the execution and
return of this engagement letter. We
will apply this retainer to the final
invoice, and all invoices must be paid
within five working days, or we reserve
the right to cease our work on the
matter.
PUT PROTECTIONS IN YOUR REPORT
The valuation report, regardless
of the type, should |
|
PRACTICAL
TIPS TO REMEMBER
|
Keep the following in mind:
Prior to
accepting an engagement, know
what the valuation will be
used for and review the likely
assumptions and conditions
that apply to it.
To ensure you and
the client agree about what
services you will perform,
send the client an engagement
planning form and get him or
her to complete and return it.
Obtain as many
relevant facts as you can
about the entity and the
circumstances the valuation is
intended to satisfy (whether
it’s for a liquidation,
M&A, divorce or tax
purposes, for instance).
Specify the
client’s reporting
expectations at the beginning
of the engagement.
Teach clients
about standards of value and
help them choose the most
appropriate one. Values for
similar entities or assets may
differ significantly for
entirely appropriate reasons.
A valuation
report should include a
“statement of assumptions and
limiting conditions” to inform
the client and the user of the
report of what was done as
well as what was not done in
the engagement.
| |
Include the “statement of assumptions
and limiting conditions.” The
length of such statements varies, but most
professional reports have them. Prior to taking
the assignment, you will have reviewed the likely
assumptions and conditions that apply with the
client and attached a specimen statement to the
engagement letter. Reiterate them in the report to
inform the client and the user of the report of
what was done and not done in the engagement.
Identify your client. When
you gathered data for the assignment, you learned
from the hiring party (an attorney, a subject
company or a fiduciary, for example) who would be
using the BV report (for instance, the IRS, a
possible purchaser or seller, a court of law or a
lending institution). Reiterate here the identity
of the client and the subject company being
valued. Furthermore, describe the final users of
the report. In many instances, attorneys prefer to
be the conduit for their clients to keep privilege
protections in force. (This is not always
applicable, but the matter should be addressed in
preliminary discussions.)
Limit distribution of the report.
The report or findings typically are
useful for only limited purposes. Circumstances
vary, and values for similar entities or assets
may differ significantly for entirely appropriate
reasons. Make it absolutely clear the reports or
findings are not transferable to serve multiple
purposes. The engagement letter will have
specified that your valuation opinion is valid as
of a particular date for a particular purpose—and
no other. Restate this in your report. The
CPA/valuator can avoid costly mistakes by adhering
to a few relatively simple procedures. Sound
planning and preparation can make a valuation
engagement proceed smoothly and enhance your
success in the BV field. Resources
For information about AICPA courses,
practice aids and publications, go to
www.cpa2biz.com . For
information about the ABV credential, go
to the following AICPA Web page:
http://www.aicpa.org/members/div/mcs/abv.htm
. |
National Conferences on
Fraud and Advanced Litigation Services
October 2–3, 2003
Fontainebleau Hilton Resort
Miami Beach, Florida |
National Business Valuation
Conference November
16–18, 2003 Marriott Desert Ridge
Resort & Spa Phoenix |
Succession Planning
Conference
December 8–9, 2003 The Royal
Pacific Resort Orlando, Florida | |