Business divorce and business valuation are inseparable. By that I mean, in almost every business divorce matter where the co-owners are beyond reconciliation, determining the value of the business is essential to any resolution, whether by settlement or court verdict, whereby one owner usually buys out the other or they divide the business assets.
Valuing a closely held business for which no active market exists is no simple thing. Sure, for certain industries there are rules of thumb that can give a very rough indication of value, e.g., EBITDA multiples, but the specific and often unique attributes of every business, including customer relationships, dependency on key personnel, accounting practices, and owner discretionary spending, make reliance on such simplistic formulas an unsatisfactory proposition in the super-charged, high stakes atmosphere of a contested separation of business partners.
So what valuation options does the business owner have? Sometimes the only feasible option is to engage an accredited business appraiser to prepare a comprehensive, detailed report setting forth the appraiser’s conclusion of value in a form admissible at trial, such as in dissolution proceedings when one side elects to buy out the other and the case is headed to a judicial hearing to determine the fair value of the seller’s shares. Such appraisals can take a significant amount of time to complete, depending in large part on the ease or difficulty of the appraiser’s access to company information, and can cost tens of thousands of dollars (or even six figures) depending on the size and complexity of the business (and the sophistication and billing rates of the appraisal firm, which can vary widely).
In most instances, when the parties to an incipient business divorce “lawyer up,” the need for a full-blown appraisal can be too remote to justify the effort and expense. The dispute may settle without litigation or in the early stages of a litigation. Or sometimes the parties litigate the grounds for dissolution over a period of months or even years before a buyout remedy is ordered.
It’s in the initial stages of a business divorce that a “quick-and-dirty” appraisal can be most useful and cost effective.
Conclusion of Value vs. Calculated Value
There are two types of valuation engagements recognized by the Statements on Standards for Valuation Services (“SSVS”) No. 1 promulgated by the American Institute of Certified Public Accountants (“AICPA”). One is the valuation engagement — what I referred to above as the full-blown appraisal — and the other is the calculation engagement a/k/a quick-and-dirty appraisal.
The rigorous standards governing a valuation engagement require the appraiser to consider all three basic valuation methods (asset-based, income-based, and market-based) and to comply with detailed development and reporting requirements set forth in SSVS No. 1.23 -.45. The ultimate purpose of a valuation engagement is to provide a conclusion of value that can stand up to the scrutiny of an adversarial proceeding in court or before the Internal Revenue Service.
A calculation engagement requires the analyst to follow fewer procedures, entails relaxed development and reporting requirements, and yields a calculation of value based only on the valuation methods that are discussed and agreed upon beforehand with the client. Most importantly, the calculation engagement enables the client and legal counsel, in consultation with the appraiser, to customize the scope of the engagement to suit its intended purpose, the extent of available company information — in some instances, in advance of pretrial discovery a frozen out minority shareholder may only be able to provide the appraiser with tax returns and/or financial statements — and the client’s budget. These less exacting requirements compared to the valuation engagement make the calculation engagement far less expensive but also mean that the resulting calculation likely is less accurate and not usable in court.
5 Reasons to Get a Quick-and-Dirty Appraisal
#1: A Reality Check on Value. Most business owners think they know what their business is worth. The problem is, (a) most of the time their idea of value is based on a rule of thumb formula, and (b) the statutory fair value standard prevalent in the business divorce context at its core is a judicial construct that can confound the owner’s common-sense notions of business value. In addition, human nature being what it is, the owner likely will have an overly optimistic or overly pessimistic view of the subject company’s business outlook and value depending whether he or she is likely to be a buyer or seller when it comes to the buyout. A quick-and-dirty appraisal therefore can serve as a highly useful reality check on the owner’s expectations of business value.
#2: An Aid in Setting Strategic Goals. Buy out the adverse business partner. Be bought out by the adverse business partner. Split up the company assets. Sell the company to an outside buyer. These are just some of the strategic alternatives to consider in a business divorce case, each of which can have important ramifications for financing, career, lifestyle, retirement, taxes, estate planning, etc. It is essential that the business owner have a reasonably good idea of the company’s value in choosing the right strategy. Getting a quick-and-dirty appraisal at the earliest stage of a business divorce enables the business owner to make a better-informed, more confident strategic decision.
#3: A Negotiating Tool. Buy-out negotiations are an inevitable feature of most business divorce cases. Whether they occur before or amidst litigation, experienced lawyers know that, to conduct such negotiations effectively, you need to do more than just put a bare number on the table. You need to justify and explain the valuation method and date, income figures and major adjustments, capitalization rates, discounts, and other material assumptions underlying the number. A quick-and-dirty appraisal report can present the data and valuation methodology in a format that can be shared with opposing counsel for settlement purposes at a mediation or in private negotiations.
#4: A Cost Effective Tool: In my experience, most business owners are highly reluctant to shell out $15,000, $25,000, $50,000 or more for a full-blown appraisal unless they have no choice, i.e., the litigation has advanced to the point where experts must be disclosed and business appraisals exchanged. I’ve had quick-and-dirty appraisals done for $5,000, some for less, some for more. The price will vary depending on the amount of time devoted by the appraiser, which is turn will vary depending on the volume and quality of the available data, the agreed scope of the valuation, and the report content and format. In any event, it’s a relatively small and worthwhile price to pay for an early-stage business valuation that can help ground owner expectations, guide the owner’s strategic decisions, and bolster the owner’s negotiating posture.
#5: A Down Payment Toward Full-Blown Appraisal: The money clients spend on a quick-and-dirty appraisal is not wasted, even if the case doesn’t settle and a full-blown appraisal subsequently is needed. This is especially so if the client engages the same appraiser for both assignments, which underscores the necessity of choosing a highly qualified, experienced business appraiser for the initial, quick-and-dirty assignment. Either way, the initial work done by the calculation analyst can give the valuation analyst a significant head start.