Before taking a leap into a new business-development effort, such as joining Yellow-Tie or starting your city’s chapter, you should understand the potential downside to success and plan for it. That way, you won’t be caught off guard and find yourself facing unforeseen problems that occurred as a result of your actually accomplishing your goals.

For example, suppose you start a Yellow-Tie chapter and build it into a well-oiled operation. And further suppose that the increased credibility allows you to increase fees, acquire premier clients and grow your company from three people to 25, from 100 people to 5,000, and so forth. Achieving this type of success means you’ll face new business issues, and one of the issues that bites the unprepared is the need to put dollar values on their businesses. Why would you ever need to know the true book value of your company? Lots of reasons, actually:

• Time to go public?
• Is a business partner coming on board or leaving the company?
• Did a current business partner die unexpectedly? Do you need to buy her interests in the company from her husband or estate?
• Are you getting married? How about divorced?
• Facing a tax crisis from growing too fast?
• Would you like to know what your company is really worth, so you can reduce that tax burden?
• Are you retiring soon? Are your children taking over the company?

There is a host of reasons for valuing your business once you’ve generated success, and many pitfalls to avoid when this need occurs. But the most important pitfall to avoid today – before you embark on an effort to build your business – is not to understand the nature of business valuations now, so you can plan ahead.

Following is a list of the seven common pitfalls to avoid when you must put a dollar value on your business. By learning these pitfalls now, you can take small steps today, so that valuing your business later will be a snap.

Pitfall 1: Don’t Use Someone to Value Your Business Who Lacks Business-Valuation Credentials.

The first person to whom people turn for business valuation is their accountant. That makes perfect sense, doesn’t it? After all, doesn’t your CPA have a grip on all important financial matters related to your company?

No – and I’m not anti-CPA. In fact, I’m a CPA with 25 years of accounting experience, and when I took the CPA exam, I earned one of the five highest scores out of more than 1,000 people who took it in my state. The CPA exam is tough. But how many questions did that three-day exam have on valuing businesses? Precisely zero. A CPA license doesn’t qualify one to value businesses. Why not?

Business valuation and accounting are entirely different professions. The key for me is this: I have three professional business-valuation credentials; these are in addition to my CPA license. My firm doesn’t do taxes, accounting or auditing. We value businesses. You wouldn’t hire a business appraiser to do your taxes, so why would you hire a CPA to value your business?

What about using a financial planner, investment manager, business broker or real estate appraiser? Don’t they also understand the financial aspects of business? Yes, but understanding how the finances in a business work does not qualify one for setting the value of that business. (Note: Like CPAs, some may be qualified appraisers if they’ve also obtained quality business-valuation skills.)

Okay, so what about the last “expert” on our list – the software program that supposedly allows anyone to plug in the numbers and get a true picture of a company’s worth? Well, I can’t even get a valuation software to produce an accurate picture, and I’ve worked closely for several years with the creators of one of the most popular programs. Why doesn’t this work? Because there are too many intangibles that can dramatically increase or decrease the value of your business – and software just isn’t good at intangibles.

So if a guy like me can’t get the software to accurately calculate the value of a company, what are the odds that you can?

The solution: When you need to know what a business is truly worth, turn to an accredited expert in the business-valuation field.

Pitfall 2: Don’t Hire a “Certified” Valuation Person Who Lacks True Knowledge.

What matters most when you hire a business-valuation practitioner? Don’t you want to make sure that person is an expert in valuation? So why can’t you just hire anyone with a business-valuation certification?

Three separate national organizations award four different business-valuation certifications in the United States, and those credentials differ dramatically.

Two of these organizations require that applicants meet rigorous requirements for their senior valuation designations. The Institute of Business Appraisers awards the Certified Business Appraiser (CBA) designation. The American Society of Appraisers awards the Accredited Senior Appraiser (ASA) credential in business valuation. Besides passing an exam, applicants for each certification must submit reports that meet the appraisal and report standards of each organization.

In contrast, the National Association of Certified Valuation Analysts (NACVA) has extremely low standards for its Certified Valuation Analyst (CVA) and Accredited Valuation Analyst (AVA) certifications. It is widely believed that the pass rates are virtually 100 percent. In fact, I don’t know of a single person who paid the fee and turned in all the paperwork, and then flunked.

I highly recommend that you look first at business appraisers with CBA or ASA credentials. But what do you look for next?

How well has that professional kept up with the dramatic changes the business-valuation profession has experienced? Barely 25 years old, business valuation is one of the newest professions. When I taught business-valuation classes earlier this year for the Institute of Business Appraisers, I was amazed at how little even well-credentialed people knew about current developments in our profession. Many people were top appraisers 10 years ago and are still doing the same quality of work. That work is poor; I’ve seen it.

Just like attorneys, accountants and other well-established professionals, business appraisers must keep up with change through continuing education (CE). For example, top experts typically earn more than 100 hours of valuation-related CE credits each year. Would you rather have someone who does the minimum to keep a certification, or a professional who teaches and takes far more education than is required?

Unfortunately, there is no official reporting body that lists the CE credits of each person. But here’s a little trick you can use to better judge the expertise level of the business-valuation expert you’re considering. The first time you’re at his or her office, ask the candidate, “May I see your valuation library?” A business appraiser must understand valuation theory, have a broad knowledge of business and have many CE credits. And that requires books – lots of books. We, for example, have more than 600 valuation, finance and business books in our library – and we’ve read them all.

Pitfall 3: Don’t Buy a Business Appraisal That Is More, or Less Than What You Need.

OK, if you avoided Pitfalls 1 and 2, you’ll finally be speaking with a truly qualified valuation professional. And if you’re like most buyers, your first question will be, “What do you charge?”

That’s not an easy question for true experts to answer, because, just like everything else, business valuations have different purposes that require different methods, so the appraiser should always tailor the type of valuation to meet your specific needs.

For instance, formal (full) appraisals with comprehensive written reports take the most time and are the most expensive. Do you need that? It depends. If you’re getting the valuation for tax or litigation purposes, you’ll need a formal appraisal. In litigation, ask your attorney how detailed of a report he or she needs.

For many other purposes, a formal appraisal and comprehensive report are usually overkill. The majority of the appraisals we do are less detailed than that, because we spend time with our clients up front to understand exactly what they need. Then we recommend the valuation work that will meet those specific needs most effectively and cost-effectively. So, meet with your appraiser to get your specific needs know. By doing that, you can save up to two-thirds of the appraisal fee.

Pitfall 4. Don’t Hire a Business Appraiser Only Because He or She Charges Less Than Everyone Else.

Why do the appraisal prices you see vary so drastically? How can some be far less expensive than others? Based on my valuation experience, I estimate that 95 percent of all business-valuation practitioners are incompetent – they suffer the classic syndrome of having no idea what they don’t know. As a result, they believe they can appraise a business in a matter of hours, and can therefore charge a minimal fee. And the unsuspecting buyer doesn’t know the difference, so he pays the fee and pats himself on the back for saving some money.

But did he really save money? Let’s do the math.

We recently completed a valuation for a wealthy family that owned a business. Our thorough, objective appraisal saved the family about $10.4 million in taxes, compared to the five-hour, inexpensive appraisal an uninformed appraiser would have done. Yes, they might have saved a few thousand dollars on the cheaper appraisal, but that’s a drop in the bucket compared to the millions in additional tax dollars paid as a result of shoddy work.

In a different recent appraisal for a family that owns a modest construction company, our valuation legitimately reduced the tax bill by about $270,000 more than what a typical appraisal could have achieved. And had the family gone that route, they would likely never have known that they had just “donated” more than a quarter-million dollars to Uncle Sam.

Do these examples make you think expert valuations result in lower values? That’s not the case. The difference is this: Expert valuations can save you money by properly applying valuation theory to the specific facts and circumstances. Let’s look at one more example.

We recently met with a woman who was going through a divorce. Her husband had offered her a modest amount for her share of the couple’s insurance company, and she was concerned that it wasn’t valued properly. After meeting with us, this woman told her husband’s CPA that she’d be having the business appraised by an expert in the field.

Guess what? Before we got the chance to value the business, her husband responded to this new information by offering to pay her an extra $250,000 without the valuation.

True expertise has immense value, and when it comes to business valuations, you definitely get what you pay for.

Pitfall 5: Don’t Hire Someone Who Mainly Analyzes Financial Statements.

Did you know that a company’s accurate financial statements can mislead you greatly about the company’s value?

Financial statements and valuation look in opposite directions. Financial results are historical. Value depends on future expectations. If you’ve ever invested in publicly traded stocks or mutual funds, you already have experience with this.

But how can we know what’s going to happen in the future? We can’t know with certainty, but that’s exactly what you consider when making any financial investment. Roughly how many dollars do you expect to receive in the future, how long will that likely take, and how high or low is the risk to you?

Certificates of deposit have very little risk. And they earn low returns. Stocks of public companies have considerable risk. Small privately owned companies usually have even more risk. How do we estimate those future benefits in our valuations? How do we assess risk? What are the factors that contribute to the bottom-line value of your business?

An expert appraiser analyzes expectations for relevant external and internal factors, which include future expectations for the following:

• Economic, technological, demographic, political/regulatory and other factors that the industry itself cannot control.
• The general industry and the part of the industry in which the company operates.
• The company’s competitors.
• The company’s ability to manage growth, create profits and reduce risk.

Financial statements can help, but they tell us about the past, not the future. If you’re buying a company, which of these two matters to you more?

Pitfall 6: Don’t Buy a Business Appraisal and Report That Fail to Meet Appropriate Business-Valuation Standards.

What makes a valuation credible? Top appraisers aren’t magicians; we’re very similar to skilled attorneys who put together persuasive legal cases. We understand the nuances of legal theory and rules, and apply them carefully to the relevant facts. This care leads to a defensible, credible legal argument about the value of your business.

Skilled business appraisers use their knowledge of valuation theory and apply it to your facts and circumstances. But the report itself should also lead you by the hand and take you through the valuation process. While there is no substitute for analysis and work, this is only as valuable as your ability to understand what was learned.

Valuation associations have “standards.” These are requirements that appraisers must meet to appropriately value a business for you. Many times you’ll see reports in which appraisers basically say, “I think that this is the value.” They don’t tell you clearly how they got to that number, and they don’t explain the valuation process. For tax, litigation, and some other purposes, this is not adequate. Only objective measurements have value.

What standards should an appraiser follow when doing a valuation for you? Typically, he or she should follow the Uniform Standards of Professional Appraisal Practice (USPAP). The Institute of Business Appraisers and the American Society of Appraisers also have respected standards. The national CPA association doesn’t yet have any standards specific to valuation.

Carefully read the engagement agreement that you sign with the business appraiser. That agreement should specify which standards will be met.

Pitfall 7: Don’t Hire a Business Appraiser Only Because He or She Has Testified Many Times in Court.

Many appraisers will brag to you that they’ve testified scores of times about valuation in court. What does this mean to you? Should you be impressed?

Quite the opposite, in fact, because, the appraisers who testify the most are typically the ones who failed to provide a valuation analysis and report that the other side found persuasive. The other side decided they had a good chance to attack the valuation in court, so the appraiser was called by the opposition to testify.

So, in all court cases, you want an appraiser whose work is challenged the fewest times, not the appraiser who brags about court appearances. And before you flinch about the additional cost of hiring the best appraisers, think about the substantial costs of having your attorney fight the challenges made by the opposing lawyer.

Of course, virtually all appraisers end up in court every now and then – some parties go to court for emotional reasons, sometimes to fight about non-valuation issues. But most top appraisers find this is the exception, not the rule.

Another exception to this rule is the high-quality appraiser who testifies regularly in court, but does so for only high-profile cases. This may happen when the appraiser’s staff does most of the valuation work, and, in high-profile cases, everything is challenged.

But most appraisers you meet who have testified hundreds of times are not this kind of expert – they’re simply appraisers who make a ton of money by producing valuations that fail to persuade the other side to settle, rather than fight.

Conclusion

Choosing the right business appraiser is a key to avoiding valuation pitfalls, and understanding what you may face once you create success is the first step to avoiding those pitfalls early. So as you participate in Yellow-Tie programs – shaking hands and building business relationships – keep your eyes open for the business-valuation expert you can trust. This will allow you to choose your expert quickly, when the unexpected eventually happens.
 

About the Author

Philip M. Hamilton is president of Hamilton Valuation Group, Inc., in Austin, Texas. His firm’s team specializes in business valuations and fraud prevention. Phil himself holds the Certified Business Appraiser (CBA), Certified Public Accountant (CPA), Accredited in Business Valuation (ABV), Business Valuator Accredited for Litigation (BVAL), Certified Fraud Examiner (CFE), Certified Forensic Interviewer (CFI) and TMCA Credentialed Mediator certificates.