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During the lifetime of a business, there are many instances where it’s imperative for a small business owner to know and understand the true value of their business. The “value” or “worth” of a company isn’t a single number on a ledger or something easily generated in QuickBooks—there’s not even a single, simple way to decide what the value of a business is.
That’s where business valuations come in—and the gold standard of a business valuation is the certified business appraisal.
It’s important to note that “valuation” and “appraisal” are often used synonymously. You may see some companies or professionals refer to “certified appraisals” as a specific type of “business valuation.”
Lately within the industry, there’s been a shift in referring to business appraisals as business valuations. This is because “appraisals” can imply the appraisal of tangible assets such as real estate, while “business valuations” are the professional valuing of all the moving pieces that make up a business.
In this article, we’re using “certified appraisal” and “business valuation” to denote the differences in a certified valuation (certified appraisal) and non-certified valuation (business valuation). The key to remembering which is which is that very important word: certified.
A certified business appraisal analyzes important elements such as economic and industry conditions, business financials, and the tangible and intangible assets of the business. Using this analysis and the appropriate valuation method, a Certified Valuation Analyst (CVA) will compile their findings into a detailed report that includes the final value of the business.
Many details and considerations go into a certified business appraisal. Besides the analysis of the company’s details such as financials and assets, the CVA decides on a “valuation approach” to apply to the business being appraised.
A valuation approach is a general way of determining value using one or more specific valuation methods. Valuation methods fall within three broad approaches: asset, income, and market.
These valuation methods are part of the reason why certified appraisals are held in such high regard—non-certified business valuations often only use one valuation method in their approach. As these approaches all vary in detail, it’s up for debate as to which approach is the most “correct,” leading to challenges in deciding the appropriate value of a business.
The asset approach may also be referred to as the cost or replacement cost approach. In this approach, each asset component of the business is adjusted, valued separately, and totaled; then liabilities are subtracted from the total. To review the assets, the CVA examines the amounts on the balance sheet and then adjusts them to fair market value if necessary.
There are two main valuation methods in the asset approach. These are the book value and the adjusted net asset methods.
The asset approach normally applies to holding companies but can also be used to value a company that has poor financial performance.
The book value method is an accounting-based value that is calculated by subtracting the book value of total liabilities from the book value of total assets. This method assumes that the underlying assets are the driving factor in the valuation of the company and that the book value approximates fair market value.
The adjusted net asset method uses one of the following three premises: replacement cost premise, liquidation premise, and going concern premise. In this method, assets and liabilities are adjusted to reflect their fair market value. The fair market value of the subject company’s equity is the fair market value of the assets, minus the fair market value of their liabilities.
Depending on the purpose of the valuation, this method sometimes uses the replacement or liquidation value of the company’s assets, minus liabilities. Tangible and identifiable intangible assets are both valued in determining the total adjusted net assets.
Other approaches commonly used include the market approach and income approach.
Certified appraisals are required for certain events throughout the life of a business. However, they aren’t always required, and there are times when a simpler form of business valuation will do—allowing you to save time and money.
Estimated business valuations have a briefer analysis than certified business appraisals. However, this allows for a less invasive, faster process. An estimated valuation is calculated based on the financial information you provide, while a certified appraisal requires an appraiser to collect, analyze, and report on your financials. This means it’s extremely important that you provide accurate financial and bookkeeping data for the best-estimated business valuation.
Because of the expertise and standards that come with this certification, there are important events where a certified appraisal is required, rather than an estimated business valuation. Legal situations are one of the biggest examples where an appraisal is required—for example, divorce settlements or bankruptcy.
Notable business events such as business recapitalizations, stock buybacks, and taxable events or tax issues also require a certified appraisal. It’s common to need a certified appraisal when applying for certain types of growth capital financing, like SBA loans.
An accredited, certified appraiser conducts a certified appraisal—this appraiser is often a CVA. This professional designation is granted by the National Association of Certified Valuators and Analysts (NACVA) after meeting several requirements. These include meeting qualifications and experience requirements, providing several professional references, submitting a case study or sample valuation report for peer review, completing a training program, and passing an exam, explains Blake Foster, senior CVA at Guidant Financial. Once all of these requirements are met, candidates can then apply for the CVA certification.
CVA is just one credential that is offered in the business valuation community. Other certifications for appraisers and certifying organizations include:
The International Society of Business Appraisers (ISBA) is an organization for appraisers that offers training, education for consumers, and a database of appraisers. By making a valuation request through the ISBA, they can help match you with an appropriate appraiser.
Some CPAs are also accredited and can perform certified appraisals. If you already have a CPA within your organization, be sure to ask them for recommendations of appraisers, if they can’t perform the appraisal themselves.
There are also companies that offer certified appraisals, such as Guidant Financial. When working with a company for a certified appraisal, make sure to verify their appraisers’ credentials and thoroughly discuss cost. You should receive a letter of engagement that includes the final cost before the appraisal begins.
Certified appraisals usually vary in cost, mostly depending on the scope of the project. A small business without many assets doesn’t cost as much to appraise as a multi-million dollar corporation. That being said, even a small business should expect to pay over $1,000 for a certified appraisal—while other types of non-certified valuations tend to start closer to $500.
Understanding the value of your business is an important part of business ownership, but it’s also important to understand what goes into the valuation and how it’s decided. And while the expense and depth of analysis in a certified business appraisal isn’t always necessary, when you do need one, you need one done right.