Will Two Valuations Have the Same Conclusion?

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In an ideal world, different appraisers arrive at the same conclusion when valuing a company. If there were a magic calculator that produces the valuation, then this dream would come true.

Reality differs.

A valuation is called an opinion of value for a reason. Appraisers, in most instances, must by professional and regulatory standards be independent of the subject company, its owners and the person or entity that engages them. Being independent does not mean they will see a set of facts and circumstances like another appraiser.

You and a friend see the latest Quentin Tarantino movie. You love its idiosyncrasies; they find it confusing and uninteresting. Who is right? You both are. You interpret differently the same film.

In a valuation, there are several areas where such variations can occur. The simplest is in the discounting.

Put simply, a lack of control discount (or minority discount) attempts to measure the fact that a holder of a minority interest cannot influence the daily or strategic operations of a company. There are several databases which measure this discount which the appraiser can reference.

But the databases just provide the starting point.

The company and its owners may have operating agreements, buy sell agreements or other such documents (“Agreements”) that may mitigate or even increase this discount. Some of examples where an Agreement may influence the discount include approvals of a majority, supermajority or even unanimous agreement to take certain actions.  A minority owner may be on the Board.  The Agreement may restrict transfers of interests.

Appraisers will hold different views of what the ultimate lack of control discount reflecting these will be.

The lack of marketability discount attempts to measure the loss in value associated with the difficulty of selling a small business, regardless of the size of the interest. Time on market, professional fees to support the sale, and broker fees contribute to this discount. The data backing these factors is often dated and subject to appraiser interpretation.

These discounts can be substantial; a minor variance in discounting between two appraisers will have a major effect on the opinion of value.

In determining value, the appraiser looks at three approaches: the market approach, the income approach, and the asset approach.

Briefly, the market approach looks at transactions in similar companies in both the public and private sectors. The income approach examines the income and cash flow the company can yield. The asset approach looks at the adjusted balance sheet where the assets and liabilities are restated to fair market value.

All three approaches require appraiser judgment. With the market approach, not only can the selection of comparable companies differ, but the normalizing adjustments the appraiser makes to their reported results may not be the same.

With the income approach, the appraiser may rely on a projection or on historical results to determine income or cash flow. The market approach and the income approach both require normalizing adjustments to items including compensation to key players and rent paid to related parties. The magnitude of these adjustments can differ depending on the data sources the appraiser relies on.

Under the asset approach, value reflects the fair market value of the underlying assets and liabilities. With assets such as cash, determining market value is straightforward. With receivables and inventory, determining market value is simpler when there are audited financial statements. Most small businesses though do not have audited statements.

When valuing assets such as machinery and equipment, and land and buildings, the appraiser depends on outside professionals to determine asset value.  Two such professionals may have different opinions of value on the same asset.

Valuing liabilities can be a challenge and is subject to appraiser interpretation.

With all this, it’s not surprising valuations have different results that doesn’t mean either one is wrong!