Business Valuation Engagements
We provide business valuations under the guidelines of Statement on Standards for Valuation Services No. 1 (SSVS 1). This statement became effective on January 1, 2008, and provides standards that must be followed by all CPAs involved in business valuation engagements.
SSVS No. 1. defines identification standards, methods, and characteristics of business valuations; business valuation models and approaches; the types of engagements and conditions that must comply with this standard; how to determine the data and analysis needed for a business valuation; valuation approaches, adjustments, and subsequent events; reviews valuation or calculation engagement documentation requirements; identifies required items to include in a valuation or calculation report, discloses assumptions and limiting conditions; reviews Interpretation No. 1-01 and the scope of this standard; reviews and analyzes the importance of IRS and Court rulings.
Some of the Valuation methods we may use include:
The Adjusted Net Assets Method – This method is an asset-based approach to business valuation whereby the company’s assets and liabilities are adjusted to their current fair market value. An asset-based approach is an excellent example of what is known as the “economic substitution principle.”, which states that no one would be willing to pay more for an asset than the price to obtain a substitute asset. Thus the asset approach presents a net value of all the company’s tangible and intangible assets and its liabilities. We determine the definitions of value and the factors to consider under IRS Revenue Rulings when establishing the value of a business. The value of certain assets such as property, plant and equipment are seldom the equivalent of book value and therefore generally require separate experts to provide appraisals for these items. When determining the value for land for example, the land should be valued separately from its improvements and should be valued at its highest and best use. We demonstrate when the adjusted net assets method should be used to value a business and how to value certain assets under this method, and identify when other asset-based approaches that may be more appropriate. Generally the asset approach is relied on when the business is an investment or holding company. It may also be used in the valuation of a small businesses or professional practices where there is little or no goodwill. Some of the issues under the asset approach valuation are unrecorded assets and liabilities such as goodwill or intellectual property. We believe it is important to review the steps necessary with you when using this method, explain the necessary adjustments and discuss the pros and cons of this method over other methods. We also discuss with you how the courts view this valuation method.
The Income Approach – This is another method used to value businesses and is probably the most widely used approach in business valuation. This approach is based on the theory that an investor will require an investment to yield a return sufficient to recover the initial cost of the investment, as well as provide a return sufficient to compensate for the perceived risk of that investment. In other words, the higher the perceived risk, the higher the expected return required to attract potential investors. This return comes in the form of future earnings. It is reasonable to assume that the actual or expected earnings and/or cash flows of a business are critical components when determining a value for such an organization. We review the foundation of this method as discussed in Revenue Ruling 59-60 and other subsequent Revenue Rulings. We review with you the capitalization of earnings, capitalized cash flow, excess cash flow and the discounted earnings methods. Each of these methods requires the determination of a future benefit stream and a rate of return or risk that the projected future economic benefits will actually be received. We review the pros and cons of the income approach itself. We discuss the theory behind the income approach valuation methods of business valuation such as the conversion of anticipated economic benefits into a present single amount and identify the importance of certain Revenue Rulings for this business valuation method. In the process of developing this information, we collect and review historical financial data and make normalizing adjustments. We discuss the strengths and weaknesses of this approach with you and identify an appropriate benefit stream and discuss how we develop normalized earnings and calculate projected future earnings. We carefully explain and review the steps in this method in order to ensure you fully understand how this may impact your business valuation.
The Excess Earnings (Treasury) Method – This is another method used to value businesses. We look at the foundation of this method as discussed in Revenue Rulings and court cases. We review with you how to apply this method and how it combines an asset-based method with an income-based method of valuation. We identify and carefully explain and review the steps in this method to ensure you fully understand how this may impact your business valuation.
The Normalization of Earnings – This is an important step in the business valuation process. Many companies subject to business valuations are smaller, closely held companies. It is not unusual for such organizations to treat various financial items differently than the publicly held companies chosen as comparables. Thus, earnings often need to be normalized in order to make an effective comparison. Even when market or income business-valuation approaches are used, normalization adjustments are frequently needed for the financial statements of closely held companies. Required adjustments are addressed in detail with the client.
The Market Approach – This is another method used to value businesses. A market approach determines a value of a business interest using methods that compare your business to similar businesses that have been sold. The theory is the value of a business can be determined by comparing it to the sale of another similar business. This valuation method is preferred by the IRS and courts, so a search for comparables should be performed, though it can be difficult, and often impossible, to find useful comparables. This method is used real estate appraisers. However, real estate appraisers, have a much easier time finding comparables from which to choose from as homes have similar qualities such as size and location. It is much more difficult for a business valuation professional to find comparables for business being valued. Generally market transactions in businesses, business ownership interests or securities can provide objective data for developing value measures to apply in business valuations. Such measures are frequently derived from “guideline companies.” Guideline companies are companies that provide a reasonable basis for comparison to the relative investment characteristics of the company being valued. A comparable company has been defined as one which has reasonable and justifiable similarity to the business that is being valued. The issue of reasonable similarity has been addressed in many court cases. Two of which come to mind are Tallichet v. Commissioner, 33 TCM 1133 (1974), which stated that there are “guideposts in determining comparability.”, and Estate of Victor B. Clarke where it was stated “it is imperative that the characteristics of the subject company and the purported comparable company relevant to the question of value be isolated and examined so that significant comparison can be made.”
Let Tax Client Services help you with any business valuation needs!