By Shawn Hyde, International Society of Business Appraisers (ISBA)
If you have ever seen a business appraisal report, you by no means have seen them all. There are almost as many different styles and types of reports as there are business appraisers. Fortunately, each report should have a few things in common that a reader can lock onto and use to decipher what the rest of the report means. I want to share a few of these and some tips I have come up with over the years for reading valuation reports.
Things to look for –
1. Not all business appraisers follow, or are required to follow, the Uniform Standards of Professional Appraisal Practice (USPAP), but most of them will still put a page somewhere in the report where they state their concluded value. Usually, they will also state what exactly it was that was appraised. Do not assume that the appraiser appraised what you thought was appraised. Many times, I have been asked to appraise a business, and when I asked for more information on what exactly the client was looking for, I had to educate the client on the possibilities.
I can appraise an ownership interest in the entity that owns the business assets, or I can appraise only the assets that would normally transfer in a sale.
In the first option, I can appraise a 100% ownership interest in the equity or in the invested capital. Equity means just what it means elsewhere — assets minus liabilities equals equity. Invested capital means I am providing the value regardless of how the operations were financed. Each option will come up with a different number and both will be correct.
I can also appraise a partial ownership interest in a company, and depending on how that ownership interest is structured, there may or may not be applicable discounts that need to be investigated. Voting rights, or the lack of same, can be a big issue in a valuation.
In the second option, generally the cash and accounts receivable are not included in the value conclusion, and it is assumed that whatever debt and liabilities exist as of the effective date will be paid off, but there are variations on this as well.
2. Check the effective date of the report. There are usually two dates that are very important when one is reading a business appraisal report, and what those two dates are can tell quite a bit about both the appraiser and the report. There is an effective date, sometimes called the “valuation date,” that acts like a balance sheet or a photograph, and it tells you as of what date the value was determined.
The value of a business is dynamic, in that it changes over time as the expectations of future results evolve. That means that a valuation is date-specific. Imagine a valuation report of a manufacturing plant for tax purposes as of a specific date, but the plant burned down two months later. The value of the business as of the effective date prior to the plant burning down would be different than the value after the plant had been destroyed. The effective date is very important.
The other date is the ‘report date,’ or the date the report is actually written. If the report date is prior to the effective date, then we can tell that the report is based on events that have yet to occur and the projected assumptions will be an area that a reader will need to pay extra attention to. If the report date is after the effective date, as most are, then we know that the appraiser relied on historical data in the analysis.
If the gap between the report date and the effective date is a year or more, then we know that this is a retrospective appraisal and the appraiser needed to be careful to not let knowledge of events that occurred after the effective date to color the analysis. One example is a valuation report of a travel agency with an effective date prior to September 11, 2001. The industry changed drastically after that date, but prior to it, appraisers were not able to predict that such an event might occur.
3. Check for a comparative financial ratio analysis. The value of a business is based on the risk of it continuing to generate income for the owner on into the future. In order to identify if a subject business is riskier or less risky than similar businesses, an appraiser should compare its operating results with the industry averages.
Unfortunately, I have seen several reports where such a section did not exist. Without such an analysis, it is difficult to say if a business is really doing well or is simply getting by. My favorite example is of a business where the appraiser stated that because the business was generating a profit it was a less risky operation and used a capitalization rate that led to a higher value conclusion.
If that appraiser had compared the operations with the industry averages, that appraiser would have seen that the average business operating in this same industry was much more profitable than the subject, and that the subject business had a much higher cost of goods sold than similar businesses. This information might have had an impact on the final value conclusion, if the appraiser had investigated it.
Tips for reading a report –
1. If possible, I like to read the introduction part of a report, so I understand what is being appraised and why. Then I skip immediately to the end and look at the schedules where all the numbers are. Then I read through the numbers and try to follow the appraiser’s thought process and adjustments through to the conclusion. Then I read the rest of the narrative report. I do it this way so I can track and make sure that what the narrative says was done was actually done. I have read several reports where the narrative said one thing, but the actual analysis showed something different.
Some appraisers simply don’t separate their reports into these sections and prefer to embed schedules within the document as they write the report. In those types of reports, I just have to follow along, reading the report like a book, but I am careful to check the narrative against the schedules to make sure that they match.
2. If one doesn’t have time to read through the whole report, or just wants to get to the fun stuff fast, I suggest finding the page where the appraiser has reconciled all the various analyses and methods into a single number, and then focusing on the sections that have to do with the final conclusion. For example, if the reconciliation shows the appraiser relied heavily on the market approach, then go through the sections of the report that discuss the selection of the market data and how the multiples were derived and used.
3. My last tip for this blog post is about reading appraisal reports that consist of one or two pages and no inclusion of how the appraiser ran the analysis. Usually in these types of reports there is no illustration of how the appraiser actually ended up with the value conclusion. In these types of reports, the best way to read them is usually to have a phone call with the appraiser and ask them to explain their process to you. Personally, I do not find these types of reports to be very helpful or useful.
If you have any questions, or would like to learn more about how to write your own valuation report of a privately held business, or even pursue your own Business Certified Appraiser (BCA) certification, please contact me at shyde@intlBCA.com. The International Society of Business Appraisers (ISBA) can teach you what you need to know to get started.
About the Author: Shawn Hyde, CBA, CVA, CMEA, BCA has over 20 years of valuation and appraisal experience in numerous industries. He currently serves as the Executive Director of the International Society of Business Appraisers (ISBA), www.intlBCA.com. He is a Certified Business Appraiser, Certified Valuation Analyst, Certified Machinery & Equipment Appraiser, and a Business Certified Appraiser. He has written and taught courses for the Institute of Business Appraisers (IBA), the National Association of Certified Valuators and Analysts (NACVA), and the International Society of Business Appraisers (ISBA). He has served on the IBA’s Education Board, and the IBA’s Board of Governors, and is a past Editor in Chief of the IBA’s professional journal, “Business Appraisal Practice.”