By Grover Rutter CPA/ABV, CVA, BVAL
Current economic conditions have a significant impact on the fair market value of business enterprises and also on the valuation process. This article is not intended to be a complete treatise on business valuation. However it does provide a few tips and reminders for accounting practitioners to keep in mind when they consider taking on business valuation assignments. In the context of this article, the term "value" refers to "fair market value" (defined below) which can be different from fair value, intrinsic value, investment value, synergistic value, etc.
Accounting practitioners traditionally have been immersed in "formula" and "calculation" routines in their accounting, auditing, and tax practices. This is especially true in tax practices. Formulas and calculation protocols have been handed down from legislators to regulators and from the regulators to the accounting community. Accounting and tax practitioners follow those protocols in tax planning and tax preparation assignments.
Unfortunately, many accounting and tax practitioners approach business valuation in a manner similar to the approaches taken for tax and accounting assignments: they crunch some numbers and apply some formulas to arrive at an answer (what they call the value). Often very crucial "value considerations" are ignored when making valuation "calculations." And, ignoring crucial valuation considerations can prove misleading - in both, good and bad economic environments.
Tip # 1
My first tip is for the practitioner to consider what, exactly, is Fair Market Value? Fair Market Value is defined in Regulation 25.2512-1 as:
"The value of the property is the price at which such property would change hands between a willing buyer and a willing seller, neither being under any compulsion to buy or to sell, and both having reasonable knowledge of relevant facts." (Court decisions frequently state in addition that the hypothetical buyer and seller are assumed to be able, as well as willing, to trade and to be well informed about the property and concerning the market for such property.)
Regulation 25.2512-1 provides an immediate follow up to the foregoing definition:
"The value of a particular item of property is not the price that a forced sale of the property would produce. Nor is the fair market value of an item of property the sale price in a market other than that in which such item is most commonly sold to the public, taking into account the location of the item wherever appropriate."
Persons performing "fair market valuations" must take into account the considerations that would be made by both the knowledgeable buyer and the knowledgeable seller within a particular demographic and under current industry and economic conditions.
My second tip is for the practitioner to learn and understand how to make appropriate value considerations concerning a fair market value engagement. For this tip, I am going to turn back the clock by half a century: fifty years! Revenue Ruling 59-60 is an "oldie but a goodie" that has continuing significance even in these troubled economic times. The ruling states, in part:
"A determination of fair market value, being a question of fact, will depend upon the circumstances in each case. No formula can be devised that will be generally applicable to the multitude of different valuation issues arising... Often, an appraiser will find wide differences of opinion as to the fair market value of a particular stock. In resolving such differences, he should maintain a reasonable attitude in recognition of the fact that valuation is not an exact science. A sound valuation will be based upon all the relevant facts, but the elements of common sense, informed judgment and reasonableness must enter into the process of weighing those facts and determining their aggregate significance."
The ruling specifically discusses valuation considerations for changing economic times:
"The fair market value of specific shares of stock will vary as general economic conditions change from 'normal' to 'boom' or 'depression,' that is, according to the degree of optimism or pessimism with which the investing public regards the future at the required date of appraisal. Uncertainty as to the stability or continuity of the future income from a property decreases its value by increasing the risk of loss of earnings and value in the future. The value of shares of stock of a company with very uncertain future prospects is highly speculative. The appraiser must exercise his judgment as to the degree of risk attaching to the business of the corporation which issued the stock, but that judgment must be to all of the other factors affecting value."
Revenue ruling 59-60 provides some specific (although not all inclusive) considerations that must be made in performing a business valuation:
a) The nature of the business and the history of the enterprise from its inception.
b) The economic outlook in general and the condition and outlook of the specific industry in particular.
c) The book value of the stock and the financial condition of the business.
d) The earning capacity of the company.
e) The dividend paying capacity.
f) Whether or not the enterprise has goodwill or other intangible value.
g) Sales of the stock and the size of the block of stock to be valued.
h) The market price of stocks of corporations engaged in the same or similar line of business having their stocks actively traded in a free and open market, either on an exchange or over-the-counter.
Anyone contemplating the value of a business interest would do well to consider each of the eight factors set forth in 59-60.
Tip # 3
If you are going to become involved with business valuations, obtain the proper and necessary training. Just as prudent accountants do not engage in certified audits or tax preparation without the proper training, accountants should not attempt business valuation work without training and the recognized professional credentials. Taxing authorities and courts are increasingly citing the importance of having valuations performed by "qualified" valuators who possess the required training and experience and who hold themselves out as valuation professionals. In today's bad economy and litigious environment, accountants shouldn't risk exposure to malpractice suits.
How does an accountant obtain business valuation training? There are various professional valuation organizations that provide training and certification programs. In my opinion, the best program to begin with is offered by the National Association of Certified Valuation Analysts (NACVA). Compared to other valuation organizations, NACVA has the largest number of certified valuation professionals and offers the greatest number of courses and continuing education courses. Certified Public Accountants can study and test for the certification of CVA (Certified Valuation Analyst). Non CPAs can study and test for the certification of AVA (Accredited Valuation Analyst). Most of NACVA's membership has come from the ranks of accounting and tax practitioners. If you are interested in learning more, you can simply type "NACVA" in your web browser and you'll find ample information on the organization.
About the author
Grover "Grove" Rutter is a practicing business intermediary (broker) and valuator in Findlay, Ohio. He is licensed as a Certified Public Accountant in Ohio, and also holds the following business valuation designations/credentials:
- Certified Valuation Analyst (National Association of Certified Valuation Analysts)
- Accredited Business Valuator (American Institute of CPAs)
- Business Valuator Accredited in Litigation Support (Institute of Business Appraisers)
As a business intermediary he has valued and sold dozens of businesses for clients throughout the United States. He has also valued hundreds of businesses for purposes of divorce, gift tax, estate tax, buy/sell arrangements, and ownership disputes. Rutter's business valuation articles have been published in numerous professional journals including American Journal of Family Law, Ohio Lawyer, Ohio Lawyer Weekly, Value Examiner, IBA Quarterly Review, IBBA Quarterly Update, and the AICPA FOCUS Newsletter of the Forensic and Valuation Services Section. Rutter's e-mail address is firstname.lastname@example.org. Also he can be found on the Web.