Engaging a professional to complete a business valuation is an important corporate governance activity that more entrepreneur are undertaking on a regular basis. As a public service announcement, we thought it would be benefit to provide some insight into the professional standards as per the American Society of Appraisers that go into the preparation of a formal business valuation.

The following is a summary of the general requirements for developing a business valuation which must be followed by all members of the American Society of Appraisers. A document of the entire standards can be found here.

Appropriate Definition of the Engagement

A. Business valuation is the act or process of determining the value of a business enterprise or ownership interest therein.

B. In developing a valuation of a business, business ownership interest, security, or intangible asset, an appraiser must identify and define, as appropriate:
  1. The client and other intended users
  2. The purpose or intended use of the appraisal
  3. The type of engagement as defined below
  4. The business enterprise to which the valuation relates
  5. The type of entity (e.g., corporation, limited liability company, partnership or other)
  6. The state or jurisdiction of incorporation, if applicable
  7. The principal business loca tion (or headquarters)
  8. The business interest under consideration
  9. The standard of value applicable to the valuation (e.g., fair market value, fair value, investment value, or other)
  10. The premise of value (e.g., going concern, liquidation, or other)
  11. The level of value (e.g., strategic control, financial control, marketable minority, or nonmarketable minority) in the context of the standard of value, the premise of value, and the relevant characteristics of the interest
  12. The effective (or as of) date of the appraisal
  13. Any extraordinary assumptions used in the assignment
  14. Any hypothetical conditions used in the assignment

C. The nature and type of the engagement must be defined.

An acceptable type of engagement will generally be one of the three types detailed below. Other types of engagements should be explained and described.

Appraisal

a. An appraisal is the act or process of determining the value of a business, business ownership interest, security, or intangible asset.

b. The objective of an appraisal is to express an unambiguous opinion as to the value of a business, business ownership interest, security or intangible asset which opinion is supported by all procedures that the appraiser deems to be relevant to the valuation.

c. An appraisal has the following qualities: (1) Its conclusion of value is expressed as either a single dollar amount or a range (2) It considers all relevant information as of the appraisal date available to the appraiser at the time of performance of the valuation (3) The appraiser conducts appropriate proce dures to collect and analyze all information expected to be relevant to the valuation (4) The valuation considers all conceptual approaches deemed to be relevant by the appraiser.

Limited Appraisal

a. The objective of a limited appraisal is to express an estimate as to the value of a business, business ownership interest, security or intangible asset . The development of this estimate excludes some additional procedures that are required in an appraisal.

b. A limited appraisal has the following qualities: (1) Its conclusion of value is expressed as either a single dollar amount or a range (2) It is based upon consideration of limited relevant information (3) The appraiser conducts only limited procedures to collect and analyze the information that such appraiser considers necessary to support the conclusion presented (4) The valuation is based upon the conceptual approach(es) deemed by the appraiser to be most appropriate.

Calculation

a. The objective of a calculation is to provide an approximate indication of value of a business, business ownership interest, security or intangible asset based on the performance of limited procedures agreed upon by the appraiser and the client.

b. A calculation has the following qualities: (1) It’s result may be expressed as either a single dollar amount or a range (2) It may be based upon consideration of only limited relevant information (3) The appraiser collects limited information and performs limited analysis (4) The calculation may be based upon conceptual approaches agreed upon with the client.

Information Collection and Analysis

The appraiser shall gather, analyze and adjust the relevant information necessary to perform a valuation appropriate to the nature or type of the engagement. Such information shall include:

  1. Characteristics of the business, business ownership interest, security or intangible asset to be valued, including rights, privileges, conditions, quantity, factors affecting control and agreements restricting sale or transfer
  2. The nature, history and outlook of the business
  3. Historical financial information f or the business
  4. Assets and liabilities of the business
  5. The nature and conditions of relevant industries that have an impact on the business
  6. Economic factors affecting the business
  7. Capital markets providing relevant information; e.g., available rates of return on alternative investments, relevant public stock market information and relevant merger and acquisition information
  8. Prior transactions involving the subject business, or involving interests in, the securities of, or intangible assets in the subject business
  9. Other information deemed by the appraiser to be relevant

In Summary

It is prudent for business owners to vet the expertise and experience of the professional engaged to perform a business valuation. It is our hope that this brief summary of the professional standards used the American Society of Appraisers will help a business owner assess the rigor employed by any advisor engage to provide advice on the value of a business.