Most often, the only interaction between a lender and a business appraiser is to place an order and hope it doesn’t blow up the deal in progress. As a former lender myself – I get it. However, to a business appraiser, the report is an expression of skill and expertise, while paying homage to the decades of precedent that have shaped the field into what it is today. Here are three takeaways that lenders should know about business valuation:
#1 An art and a science.
There are many widely recognized methods of valuation, but valuation largely remains an art form. Two skilled business appraisers may arrive at similar values using very different techniques. Business risk and discounts can be applied in different ways. In the case of divorce or litigation, attorneys on both sides may hire business appraisers and defend their valuation in front of a judge. Valuation practice has evolved over decades following guidance that comes down from IRS revenue rulings and legal precedent.
Automation has made value calculations accessible to many buyers and sellers (which is great!). However, expert judgment is required to ask the right questions, properly identify risk, and determine which method or methods of valuation best represents the interest being valued. When bank credit policy and the SBA are requiring business appraisals as part of the underwriting requirements, it is the expert judgment that protects the bank’s interest in the deal.
#2 The “write a check” test.
Ultimately, when an appraiser signs off on a report, he or she is signifying that they would be willing to write a check to acquire the interest being valued. An ethical appraiser is not swayed by third parties and has no ulterior motives.
Sellers may suggest there are a number of “add-backs” that should be considered. Attorneys may suggest certain discounts be applied. At the end of the day, the appraiser will reach his or her own conclusion using research and experience.
#3 Known or knowable.
Every report is written as of a specific moment in time. This moment may be several months in the past. In that case, the appraiser may not consider events that have occurred unless they were “known or knowable” as of the date of the report.
To further this point, especially as it relates to small businesses, the dates may be several months in the past depending on the sophistication of financial reporting. Also, small businesses may not be able to provide all the data that the appraiser would like. The appraiser is often tasked with completing their work with limited information. This is explicitly documented in the report, and the appraiser should cite the information used in the analysis.
Lack of information leads to uncertainty on the part of the appraiser, and this will negatively impact the value. To the extent possible, bankers or brokers should work with sellers to improve their reporting capabilities leading up to a sale as it will benefit all parties involved.
