When valuing small businesses, the appraiser must first understand the circumstances for which the report is being prepared. Unlike machinery and equipment appraisals, where the definition of value is the key variable driving the conclusion, business appraisals will lean more on the purpose and scope of work to determine the best way forward.
For example, if the reason is for an outright sale of the company, the appraiser will need to exclude cash, receivables, and liabilities from the balance sheet since the seller will take these current assets and obligations with them as part of the closing transaction.
If the purpose is a minority share buy-out or buy-in, the business appraiser will need to consider and apply lack-of-control and marketability discounts to the percentage shares being purchased or sold. These discounts will factor heavily into the share value unless the owner or potential buyer has a 50% or greater interest in the company.
Another example is in a divorce scenario, where the company being valued is part of a contested or negotiated asset division. There may be factors pertaining to the ongoing litigation or settlement that will need to be considered before finalizing the value.
How the appraiser calculates and weights the different approaches is also a driving factor that plays into methodology. A business can be valued in different ways, using a discounted cash flow and/or multiples of gross revenue, EBITDA, net income, and discretionary earnings. How these differing conclusions are ultimately weighed will influence the overall estimate of value.
There is always a degree of subjectivity in the ultimate reasoning behind any appraisal. Opinions will differ depending on the data relied upon, the methodologies used, and the appraiser's experience. They need to make sound, common-sense decisions based on supportable data to reach conclusions about value.
As a professional appraiser, all of these critical factors must be carefully considered throughout the valuation process. If you are an accredited valuation professional, always strive to fully understand the big-picture perspective of the underlying transaction your work product will apply to. The purpose and scope of work are important components of developing your appraisal framework. The more you know about your role within the confines of the larger deal, the better your decision-making will be.