Understanding the business valuation process

The process involved in valuing Facebook for its recent initial public offering was a complex one, requiring professional judgment and the application of a variety of economic, market and asset-based business valuation techniques.Many business valuation techniques are available to use in determining a business’s fair market value, including asset, income or market-based valuation approaches. The tools available to the valuation analyst include databases that record and categorize types of business sales by region, industry, price, debt load, year and length of time on the market prior to a sale.During the course of a valuation, the analyst will require a multitude of financial documents that can yield the economic data typically required to complete the valuation engagement: • Audited or unaudited financial statements or business tax returns • Internal accounting documents • Fixed asset ledgers • Intangible asset documentationThere are two types of business valuation engagements – a valuation engagement, which yields a conclusion of value, and a calculation engagement, which is considered smaller in scope and typically yields a range of calculated values.IRS Revenue Ruling 59-60 defines fair market value as the amount at which the property would change hands between a willing buyer and a willing seller when the former is not under compulsion to buy and the latter is not under any compulsion to sell, and both parties having reasonable knowledge of the relevant facts.Professionals providing business valuation services perform their due diligence with the goal of deriving a fair market value.Many professional organizations promote and license the business valuation or appraisal field. They include the American Institute of Certified Public Accountants, which has formed an entire section, the Forensic and Valuation Services to promote and provide technical and ethical guidelines for business valuation. They include the current official designations of Accredited Business Valuation (ABV) analyst and the former Certificate of Educational Achievement for Business Valuation (CEA-BV).The valuation analyst is required to assess a wide variety of topics when conducting a business valuation, including: • The equity interest being valued, which may be an entire interest or a fractional one • How the business entity derives its revenues • Whether the primary assets of the business are tangible assets (machinery, inventory) or intangible assets (goodwill, patent, intellectual property) • Calculation of the business value, given the fluctuations in the economic conditions in the industry or in its operating regionOne area that causes much discussion and can produce wide variations in a valuation report is the area of discounts or premiums for control interests — or the lack thereof.Control interests can affect the final determination of a business’ fair market value under the theory that an equity interest of the entire business entity is worth more, in terms of cash flow control and decision-making, than an equity interest of less than 100 percent.Valuation reports have many users. These include the IRS and the U.S. Tax Court, estate planners, the U.S. Small Business Administration and other business lenders, mergers and acquisition groups, employee stock ownership plan trustees and current and potential shareholders, among others.Whether your business appears to be valued at $134 billion or $134,000, undertaking this valuable business valuation procedure can often make the difference between a resulting fair and balanced business sale or acquisition or an improperly valued business that could jeopardize the future operational ability of the business or its assets.Jeffrey A. Graham, owner of the CPA firm of Graham & Graham, Concord and Laconia, is an adjunct professor in financial forensics at Southern New Hampshire University.