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Business Valuations: Communicate the Purpose of the Valuation with Your Valuator

The initial phone call goes like this:

Potential Client: Hi, I’m calling because I own a business, and I’m interested in having an appraisal done.  I would like to know what my business is worth and the fee for you to do a valuation.

Business ValuatorOkay, great! Can you tell me a little bit about your business?

Potential Client: Sure, (and they proceed to talk about their entity and operations).

Business ValuatorInteresting. What is the purpose of the appraisal? We should discuss your intended purpose for having this business valuation prepared.

Potential Client: ….pause, Um, okay, but why do you need to know? I mean the value is the value, no matter the purpose, isn’t it?

We’ve had this conversation many times, and the answer is, “not necessarily.” Why DO valuators care about the purpose of the valuation?  Why are they asking so many nosy questions?

The short answer is this: Because it allows the valuator to deliver a valuation to the client that is actually useful to the client under their circumstances. It is so that the client is not wasting money on something that doesn’t fit their needs. A couple of (true story) examples illustrating this point follow:

Example 1: 

A client (let’s call him “Al”) called, and wanted a business valuation done.  Al owned 25% of a business for which he worked, and it was modestly successful.  Al was very reserved, and did not seem to be very talkative or forthcoming when I asked him questions.  Fine. Some people are not chatty. He paused when I asked what the purpose was. 

Al eventually said he was doing some retirement planning. He was thinking about retiring in a year or two, and wanted an idea of what his 25% ownership interest was worth. No problem. We had a couple of discussions and emails, and we agree on how to proceed. 

I requested the needed information, one item being the Operating Agreement of the company. I remember that it seemed difficult to get the information that we requested, and in many cases, other managers of the company were providing information to us.  After a few touches with them, we learned that Al had stopped working there about two months prior, and that he was going to be bought out by the other owners. It felt a little bit awkward because I was under the impression that Al still worked there. I wasn’t sure whether I should say anything to Al or not, so I did not. 

I read the Operating Agreement, and this Operating Agreement happened to be fairly specific about how the business was to be valued upon the exit of Al. This is NOT how we were valuing the business, and I did not know whether Al had read the Operating Agreement, and if he knew what it said about valuing his share. At that point, I decided to address it with Al, because I was concerned that we were doing work that was not going to be very useful to him. I called Al, and told him what the Operating Agreement said, and asked him whether he wanted us to proceed as we had been doing, or if he wanted us to value the business in the manner in which the Operating Agreement prescribed. He said to use the methodology as set forth in the Operating Agreement. We changed gears, and were able to provide Al with something useful, but Al almost paid us a lot of money to do work that would have been fairly useless to him under his circumstances.

Example 2

A dentist (“Dr. Tooth”) wanted a business valuation done. She was the sole owner of her practice, and had an employee/dentist that would most likely be purchasing 100% of the practice. The value is the value, right? Well, as it turned out, Dr. Tooth needed something fairly specific as well. In this case, Dr. Tooth (seller) was not going to retire right away, and she had certain salary and benefits requirements, which were robust. We were able to build those expenses into the expected cash flows of the practice in order to help the seller determine a reasonable asking price, given her future salary expectations. Thankfully, these dentists were very forthcoming in answering our questions, and that enabled us to provide them with something that was very useful to them given their specific situation.

These examples illustrate the necessity to talk to the valuator, because it will enable the business owner to get what they actually need. 

There are many reasons for the purpose of a valuation. Sometimes clients do not need a very detailed analysis. Take, for example, the business owner who is doing some estate planning for himself/herself. Perhaps a calculated range of value is good enough, and the owner does not necessarily need the more expensive service of getting the detailed report and an opinion of value. The valuator/CPA can advise the owner as to options of services that can be performed, potentially saving the client in fees while fulfilling the business owner’s need. Any CPA who does business valuation work is subject to a set of valuation standards that must be adhered to. The CPA can help to advise the client on what level of services are available, what the IRS deems acceptable, and what might fit their needs.

Another reason the purpose should be known is because the valuator needs to know what standard of value to use – our AICPA standards require this.  The standard of value is the “definition” of value that the valuator adheres to as they work through the valuation assignment. For example, for estate and gift tax purposes, the standard of value is typically “fair market value,” and there is a widely accepted definition for that.   For divorce purposes in Virginia, the standard of value is “intrinsic value,” and the definition for intrinsic value can be more of a gray area. The valuator is required to address the standard of value in each valuation assignment. If courts receive a “fair market value” valuation for divorce purposes, when it should have been “intrinsic value,” then credibility is lost. Different states have different definitions of value, depending on the circumstances.

Business valuators need to gather a lot of information up front in order to make sure that the work that they will perform is what the client actually needs and wants. Having open and honest communication with the valuator will allow the valuation expert to do his/her best work for the client, and to provide a practical valuation that is actually useful because it serves its intended purpose.

Meet the Author

Sally Silver graduated from Shepherd College in 1990 with a Bachelor of Science in Accounting and later Virginia Polytechnic and State University in 1991 with a Master of Accountancy, Tax Specialization. Before joining YHB in 1998, Sally worked for KPMG as well as private industry as a Tax Manager.

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