The National Association of Certified Valuators and Analysts estimates that in the United States there are five million businesses generating over $100,000 each in annual revenue and over 15 million businesses generating under $100,000 each annually. At some point in time, a value will need to be placed on almost all of these businesses. If the owner is selling the business or trying to get financing from a bank or an outside investor, an independent business valuation will be required. Under different circumstances, bankruptcy or probate proceedings will also require business valuations. Appraisers or other financial professionals can become certified business valuation specialists, and many accountants have also added this service to their practices.
While any financial professional can earn business valuation credentials through study and experience, CPAs are uniquely well-positioned to complete business valuations for their clients. The current waive of retiring baby boomers presents a unique opportunity for CPAs to expand client services, and boost personal income. There is a growing need for sound valuations that clients can rely on. Small business owners will turn to the financial professionals they trust most as they sell their businesses to fund retirement. Sometimes the business owner dies before retiring, an all too common situation. In these cases, their heirs will need a business valuation to settle the estate. Determining the value of a business would use many of the same numbers the CPA already uses when preparing tax returns. This helps the accountant serve the client during a business valuation, as they have a more complete understanding of the client’s financial picture
In simplest terms, a business valuation is like an appraisal on a home and is an estimate of what the business should be able to sell for. Companies with listed stocks have the benefit of being continuously valued by traders. Small businesses are usually closely-held as sole proprietorships within a single family, or among several partners. As such, there is no established market for the stock of these small companies, and a lack of liquidity means they don’t have the benefit of independent valuation as would be provided by the market for publically traded companies. Closely held companies aren’t necessarily small. In fact, Forbes reports that the largest private company in America is Cargill, with estimated sales in 2010 of more than $110 billion.
Business valuations take many forms. They can look like a home appraisal and be reduced to a single page. However, the valuation should be more like a thorough Wall Street research report. At minimum, it should be inclusive of the following information:
A complete valuation will be rather lengthy and take a great deal of effort. Much of the time will be spent collecting the data. Often valuators who also acted as the company’s CPA will already have access to the company’s financials. Developing the data for the industry and local economic outlooks will likely require access to additional resources. Most industries have associations that offer detailed reports that this information can be drawn from and several companies like IBISWorld offer detailed research on industries that can be accessed and used by business valuators. The local Chamber of Commerce is also a good starting point or getting economic history and projections for a given business.
Both large and small business owners may need a professional valuation for a variety of reasons. Retirement could mean that the owner actually stops working and cashes out the value of the business built up through their labor over time. The greatest asset of many businesses is the time and effort the owner has devoted to it over the years. To unlock this value, they may decide to sell the business and both parties to this type of transaction, both buyer and seller, will want an independent valuation performed. The current owner will be seeking to maximize gains, while the buyer will want to avoid overpaying for what may be a business built solely around the current owner’s skills or reputation. Valuing the business requires an independent determination of what the assets are worth and how much earning power the business will have as a going concern. Often the owner adds significant value with expertise and contacts, and the business valuation analyst will be responsible for determining how much the business is worth without the owner.
Personal reasons may also drive the requirement for a valuation. Divorce, as in the now infamous case of the Los Angeles Dodgers baseball team, can lead to the forced sale of a business. Both parties would want an estimate of the business’s fair value prior to the sale to ensure they receive the greatest potential gain. In other cases, a business asset cannot be easily divided or a freely traded market for it may not exist, as is the case sometimes with intellectual property. Business valuations are then used to assist the parties as they fairly divide all of the assets.
Estate and gift taxes may need to be paid based upon the fair market value of a business, and the government requires these valuations to follow guidelines detailed in Revenue Ruling 59-60. Upon the death of a business owner, the estate is liable for taxes on the amount of the business if it exceeds the standard exemption, which varies based on Congressional action. Business owners who give shares of their companies as gifts may also be creating tax obligations, if the value of the gift exceeds $13,000 in any year. The IRS rules on business valuation are also followed by banks in deciding on the value and creditworthiness of a business. The Federal Deposit Insurance Corporation specifically requires the use of revenue Ruling 59-60. These rules are no more detailed or challenging than any of the other rules CPAs deals with on a daily basis.
Business valuations may determine the price the owner receives for their life’s work. The valuation may set the market price for a private sale or an initial public offering of stock in the business. The valuation may also be required to obtain access to capital from a bank or investor for expansion. Like a home appraisal, the business valuation ultimately determines whether or a not a deal closes.
The tasks required to complete a business valuation are similar to those undertaken by a security analyst evaluating the stock of a publicly traded company. Financial statements, often prepared by a CPA, serve as the starting point of a valuation. The CPA who prepares these statements is probably the best person to assess whether the business meets the going concern assumption, based not just on the financial statements but also on their personal knowledge of the owner’s role in the business. The going concern assumption is a decision the valuation specialist must make as to whether or not the business can continue to function in the future, Sometimes a business will fail this test because it just runs out of cash. However, many businesses will fail when the founder leaves. The full financial impact of the owner can be hidden in seemingly steady earnings and cash flow. Intimate knowledge of the operations, gained in conversations over tax preparation, will allow the CPA to present an honest business valuation, including the likelihood that the business will fare better or worse without the current owner stewardship. Other professionals will have to develop this knowledge through extensive interviews with the owner, in addition to conversations with customers and suppliers of the business.
Most business valuations combine several approaches to develop their estimate of the business’s worth. The basic valuation models are similar to those used in appraising commercial real estate and include the cost approach, using comparable companies to derive a value, and the income model to discount the future cash streams.
Determining how much money would be required to start the business from scratch is the basis of the cost approach. Replacement of all assets at present market value is assumed to be a sufficient estimate of the valuation under this model. A variant of this approach, using the actual market value of existing assets, might be the best approach for a company about to cease operations and liquidate all its assets. However, the cost approach fails to recognize that a business is usually worth more than the sum of its parts since intangibles like goodwill and human capital are often a business’s greatest asset.
The comparable approach will look at the business relative to recent sales of similar business or use the multiples of similar publicly-traded companies to derive the valuation estimate. This model involves comparing the company based on its revenue and income to companies in the same industry. There will rarely be enough data on recent private sales to create a reliable valuation. Data on publicly traded companies is readily available, but these companies will not generally have a business model that is very close to the subject of the business valuation. Using comparables require the analysts to make a number of assumptions based on how recent the data is, whether value should be increased or decreased based on where and how the companies operate, what discount or premium is appropriate if the company is closely held, and a number of other factors. These assumptions decrease the reliability of the business valuation.
Discounting the future earnings or cash flow of a company is the basis of the income approach. While some assumptions are still required as inputs to the model, they can be made with a sound supporting rationale. Two very important values for the model, a growth rate for the future and a discount rate to determine the current net present value, will need to be estimated. The growth rate of the sales, earnings, and cash flows may be based on the past history and the CPA will have knowledge as to whether or not it is likely to accelerate or decelerate. Multiple stage models can be used to account for changes in growth due to the economic cycle or the maturity of the business. Discount rates are easily estimated based on a long-term interest rate adjusted for risk. A commonly used starting point to establish the discount rate is the yield on long-term corporate bonds, adjusted for additional risk in the business. With twenty-year bonds paying about 5.0%, for example, a discount rate of 7.0% could be used. The higher rate reflects the fact that investors in a closely held business will demand a higher return than those buying into an industry giant like IBM. Preparation of a business valuation based on the income approach is a fairly straightforward process for the CPA who will use the income statement or the statement of cash flows as a starting point. This approach uses current data, indirectly recognizes the intangible assets of the business, minimizes assumptions, and doesn’t rely on comparables which may not precisely fit the business being studied. Its advantages make it the preferred approach in most cases.
Several organizations offer training, testing, and certification of business valuation specialists. A bachelor’s degree is required, although some organizations will accept experience equivalent to a degree. Among the leaders is the American Institute of Certified Public Accountants (AICPA) which offers members a chance to earn the Accredited in Business Valuation (ABV) designation.
More CPAs have chosen to pursue the Certified Valuation Analyst (CVA) program offered by the National Association of Certified Valuation Analysts (NACVA). This association also offers the Accredited Valuation Analyst certification for those who don’t have a CPA.
Non-CPAs can also turn to the Institute of Business Appraisers or the American Society of Appraisers for certification programs. Chartered Financial Analysts (CFAs) are also qualified to complete business valuation.
The certification programs can generally be completed through self-study programs and total fees are under $1,000. The CFA is a multi-year process that is more expensive, but the others can be completed within a year. Testing, and ongoing continuing education, is required in all cases. Specifics of some certifications are summarized in the table below.
When asked what a business valuation will cost to prepare, the answer should almost always be “it depends.” Boilerplate valuations are advertised on the internet for as little as $695, but these are based solely on owner-provided earnings and the owner’s assumption of what assets are worth. Without judgment or analysis, these valuations are worth little when seeking financing or attempting to sell to a disinterested party.
Detailed reports are generally prepared for fees totaling $3,500 to $10,000. Those requiring a great deal of effort and outside research assistance may cost $25-50,000. Some of the data collection and formatting can be done by junior associates, while the final valuation will need to be done by the professional since it requires judgment and experience to properly value a business.
Business valuation specialists can work independently if they choose to. Large national accounting firms, like the Big Four, regional or local accounting firms, and business management consultants also employ these specialists.
Data from the Bureau of Labor Statistics shows that accounting will be one of the fastest growing career fields, with an annual increase of 22% in total employment. Demand will exist in all areas of the industry, and there will be growing demand for business valuation specialists. NACVA reports that more than 80% of their members expect to see growth in their business valuation practice, The BLS also reports the average salary of accountants is more than $61,000 a year, while financial analysts average over $73,150.
More important than the income potential for the CPA is the closer partnership this service brings to the client. Instead of needing yet another firm to offer financial services, clients can turn to the trusted advisor who prepares their taxes and is involved in every major financial decision they make. The CPA is the one who knows a client’s total financial picture better than anyone, and providing an accurate business valuation helps both client and CPA to make the best decisions about the client’s financial future.