“Can I use a valuation for more than one purpose?” If you have ever asked yourself this question, I guarantee you are not alone. My standard answer to you would be, “It depends, but generally not.” Why? Because in many cases, the values will be different. Although this is not the only answer, it is quickly understood. What follows is a more complete answer. [Note: I have used the terms “valuation” and “appraisal” interchangeably.]
As a quick refresher, here are just some of the reasons why you, as a business owner, may need a valuation:
• Gift/Estate Tax
• Employee Compensation
• Shareholder Dispute
• Employee Stock Ownership Plan (ESOPS)
• Key-Person Insurance
• Sale or Purchase of a Business
• Succession Planning
• Charitable Contributions
• Destruction of Business
• Financial Reporting
• Bank Financing
• Attracting Equity Capital
The value of a company will often be different from purpose to purpose due to differences in one or more key factors. Here are a few:
1. Level of precision required. Sometimes, you might only need a general idea of value. Reasons may include: preliminary succession planning, preliminary negotiations regarding the sale of a business, litigation settlement discussions, or for the purchase of key person insurance. Valuations for such purposes are often based on a very limited analysis and produce only a “ballpark” value. If I have prepared for you a valuation for key person insurance purposes and, two months later, you decide you will be gifting some part of your business to certain family members, my analysis, process, and report will be more in-depth than the one I prepared for insurance purposes, and consequently the second one will likely have a different value. I would therefore tell you that, although I might be able to “re-use” some part(s) of the first analysis, an upgrade will probably be necessary to conform to the IRS’s standards for gifts of business interests.
2. Litigation versus non-litigation setting. Valuations prepared in connection with litigation (e.g., divorce or shareholder disputes) often require extra and/or different procedures in some areas. These invariably lead to different values—sometimes with large differences—than non-litigation valuations.
3. Existence of shareholders agreements. I was recently engaged to determine the value of an owner’s shares in a business because she wanted to retire. The shareholder agreement she signed years before required the use of a specific valuation “formula,” which was to be calculated and applied by a valuation professional. It was my professional opinion that the formula to which they agreed would not produce a “market” value. If I had been asked to prepare another valuation of the company for many other purposes (e.g., recapitalization, insurance, employee compensation, etc.), the methods I would have used—and the result—would have been different.
4. Real-world considerations. It is not unusual for family members who have inherited a parent’s business to disagree about whether or not to continue that business. In such a case, one outcome may be the decision to sell. The personal representative of the decedent’s estate may need a valuation for both estate administration purposes and for the eventual sale of the business to an outside party. For the first purpose, the appraiser will often value the business under the assumption that a “hypothetical” (unknown) buyer of the business would run that business in the same manner as that of the decedent, and earn similar profits. However, for the second purpose, if the heirs decide to sell to an outside buyer who wants to purchase only selected assets of the family’s business (e.g., customer list and contracts, but not the staff), the appraiser’s valuation will look very different than the first one, and will produce a different value.
As indicated, a valuation for one purpose can sometimes be adapted by the appraiser for another purpose. Of course, each case is different.
If you need a valuation for more than one reason, consult with your valuation professional to understand timing issues and to help you minimize extra costs you might incur for the second valuation.