Sometimes situations arise where parties desire to have a business appraised but do not have sufficient financial records for the business valuator to perform a valuation. There are two levels of business valuations that have different professional standards and information requirements, a “Conclusion of Value” and a “Calculation of Value.”
A “Conclusion of Value” is an estimate of the value of a business ownership interest arrived at by applying the valuation procedures appropriate for a “Conclusion of Value” engagement and using professional judgment as to the value based on those procedures.”A “Conclusion of Value” requires much due diligence by the business valuator including the following:
- Site Visits.
- Interviews with key personnel.
- Appraisals of assets by outside appraisers or use of outside specialists.
- A comprehensive evaluation of national, regional, local, and industry economic conditions.
- A comprehensive evaluation of the Company’s industry, products, markets, customers, suppliers, and competitors.
- Due diligence including verification of assets and liabilities such as accounts receivable, inventory, fixed assets, etc.
A “Calculation of Value” is “an engagement to estimate value wherein the valuation analyst and the client agree on the specific valuation approaches and valuation methods that the valuation analyst will use and the extent of valuation procedures the valuation analyst will perform to estimate the value of the business interest. A “Calculation of Value” engagement generally does not include all of the valuation procedures required for a “Conclusion of Value” engagement. A “Calculation of Value” will not include the same degree of due diligence or analysis by the professional valuator as a “Conclusion of Value.”
Cases arise where a party may request a “Conclusion of Value” of a business, but because of significant changes to the nature of the business, a “Calculation of Value” may be the only type of appraisal the valuator may perform. Consider the following case.
A party engages a business valuator to perform a “Conclusion of Value” of his closely held specialty manufacturing business for litigation purposes. The date of the disputed issue and the required date of valuation is six years before the date the business valuator is engaged. The business owner provides the valuator with all tax returns and financial statements for five years before the date of valuation, or eleven years before the date of engagement. However, during the past six years, the owner liquidated the business’s specialty manufacturing equipment, terminated a majority of the manufacturing employees, terminated the management team, contracted with a company in Vietnam to manufacture its product line, converted the manufacturing building into a distribution warehouse, and purchased a fleet of delivery trucks. Thus, the business does not exist in the same form at the date of engagement as it did at the date of valuation.
Here, the business valuator is unable to follow business valuation professional standards and perform a “Conclusion of Value.” The valuator is unable to inspect or appraise the special manufacturing equipment, fixed assets and inventories allegedly owned by the business six years prior. The valuator is unable to obtain equipment appraisals of the liquidated equipment. The valuator is unable to interview terminated key personnel. However, the business valuator may perform a “Calculation of Value” of the business from the tax returns and financial statements.
The appraisal starting point for most closely held businesses is the tax returns. In many cases, the tax returns and bank statements are the only financial records of the business. However, sometimes these business records are unavailable where the records are lost due to fire, computer failure, theft, or other causes. In some cases, tax returns are not filed to avoid paying taxes or because the activities of the business are illegal.
Now let’s consider a case where a “Calculation of Value” may not be performed. A party engages a business valuator to perform a “Calculation of Value” of his closely held food truck business for litigation purposes. The date of the disputed issue and the required date of valuation is ten years before the date the business valuator is engaged. The business owner provides one tax return for a tax year two years after the date of valuation and does not have any other tax returns or financial records. The business owner states that the tax returns are lost while the opposing party claims that tax returns for the years before the date of valuation were not filed. Bank stsatements are unavailable and may be deemed unreliable because the owner alledgely did not deposit significant amounts of cash sales. Copies of the tax returns may not be obtained from the IRS because the IRS only retains tax returns for six years.
Here, the business valuator is unable to follow business valuation professional standards and perform a “Calculation of Value.” The valuator does not have any records with which to calculate the value of the business ten years ago. Thus, the business valuator is unable to perform a professional valuation of the business.
The lesson herein, is an appraisal of a business interest is contingent upon the information available to the professional business valuator. A business valuator may not be able to ascertain the value of a business if there is insufficient or non-existing information.
Please let us know if you have any questions or would like to schedule a valuation.