Time To Update The Guiding Principles To A Valuation Report

May 2017 bvresources.com 9tiMe to uPDate the GuiDinG PrinciPleS to a Valuation rePort
Time to Update the Guiding Principles
to a Valuation Report
By Robert E. Kleeman Jr., OnPointe Financial
Valuation Group LLC, (Englewood, Colo., USA)
In my 40 years in the business valuation profes-
sion, I have seen the typical valuation report go
from three or four pages to 50 pages or more. The
increasing complexity that has become inherent in
the business valuation community has mandated
a good part of this change.
The purpose of this article is to attempt to provide
the preparers and users of these reports the knowl-
edge to understand what is really being said in
those pages. Many years ago, I provided CPE semi-
nars on many business valuation subjects, includ-
ing report writing. At that time, I indicated that the
elements of a great valuation report could be sum-
marized using the acronym TACO, which stood for:
Teach
Analyze
Communicate
Opine
Today, I find that the TACO concept must be taken
to the next step, and I have developed the five
“principles” (5 P’s) of the report. I believe that,
if the valuation expert keeps these principles in
mind, it can be valuable in helping to ensure the
overall quality and reliability of the report. For the
individual reviewing and critiquing a report, these
principles can help in the evaluation. With that in
mind, let’s review what I consider the five guiding
principles to a successful valuation report.
1. Precision. (Definition: 1. The state or quality of
being precise; exactness. 2. The ability of a mea-
surement to be consistently reproduced.)
One of the first things I do when reviewing a busi-
ness valuation report is to look at the opinion or
conclusion of value. The more precise the conclu-
sion is, the more concern I have as to the valid-
ity of the appraisal. I recently reviewed a report
covering a 100% equity interest in a closely held
company, and the appraiser determined the value
of the company was $5,288,372.46. No appraiser
today can operate with that degree of precision. In
fact, if we look to the old standby, Revenue Ruling
59-60, we see that Sec. 3.01 states:
A determination of fair market value, being a ques-
tion of fact, will depend upon the circumstance in
each case. No formula can be devised that will
be generally applicable to the multitude of differ-
ent valuation issues arising in estate and gift tax
cases. Often, an appraiser will find wide difference
of opinion as to the fair market value of a particular
stock. In resolving such differences, he should
maintain a reasonable attitude in recognition of
the fact that valuation is not an exact science.
A sound valuation will be based upon all the rel-
evant facts, but the elements of common sense,
informed judgment and reasonableness must
enter into the process of weighing those facts and
determining their aggregate significance.1
As appraisers, we must make subjective decisions
regarding a myriad of items that go into the valua-
tion conclusion. What is the specific company risk
profile? What accounting adjustments must be
made to the benefit stream to reflect “normalized”
operations? What are the appropriate discounts
for marketability and minority interests?
I would suggest that if competent business val-
uation professionals prepared two reports and
the final opinions of value are within 10% of each
other, they might well both be correct.
When we look at the real world, the public stock
markets, we see various analysts following a specific
stock, and we see a wide array of projected earnings
and even pricing targets for the stock. Why does one
analyst rate the stock as a buy, while another thinks
that it is hold, and still another rates the security as
a sell? The only precise value on a block of closely
held stock is the actual cash that is ultimately paid
1 Revenue Ruling 59-60, 1959-1 CB 237.

10 Business Valuation Update May 2017tiMe to uPDate the GuiDinG PrinciPleS to a Valuation rePort
that is now showing projections with great improve-
ment in future earnings? Or do we have just the
opposite, an entity that has been very profitable but
now is showing mediocre or no earnings? In real
life, these situations can exist, the company, the
industry, and/or the economy impacts any current
value. Company fortunes can improve, or they can
decline. A plausible report explains the impact of
those outside variables to demonstrate the reasons
for the apparent changes in economic results.
What sources did the appraiser use to get eco-
nomic data? What about industry data? The data
are readily available but can be expensive. But,
without the data, how does the appraiser present
a plausible discussion regarding the company’s
future considering the expectations of the industry
and the economy? If the economy is expected to
grow by 3% over the next five years, and the data
indicate that the industry will grow at 3% over the
same period, what data are presented to support
an indication that the subject company will grow
by 5% a year over the next five years? It might be
true, but, without sufficient support, is it plausible?
What about the state/local economy? Unless the
subject company operates in a national or global
marketplace, the local economy will impact the
company more than the national economy. As
I write this, the Colorado economy is booming,
while the Illinois economy is still in the doldrums.
The local economy will impact the market the
company operates in.
4. Proficiency (Definition: “Having or marked by
an advanced degree of competence, as in an art,
vocation, profession or branch of learning”; “a
person who exhibits competence, an expert.”)
Does the report adequately demonstrate the pro-
ficiency of the appraiser? I’m not suggesting that
a first-time appraiser cannot produce a credible
report, but what I am suggesting is that there
should be adequate information in the report to
allow the reader to determine the background and
qualifications of the appraiser. Also, did more than
one individual work on the report, and what are the
qualifications of those individuals? It is not unusual
in an arm’s-length transaction, and we as appraisers
cannot determine the ultimate payment.
2. Practicality (Definition: “The quality of being
of practical use.” “Of, relating to, governed by, or
acquired through practice or action, rather than
theory or speculation.”)
What are the practical aspects of the report? Is it
written in a manner to educate the reader, or is it
filled with undefined technical terms and industry
jargon? A well-written report helps the reader un-
derstand what the expert is trying to convey and
why the appraiser should be believed.
Is the benefit stream based on historic informa-
tion or is it based on future income projections? In
short, is the most important part of the valuation,
the measurement of future economic benefits, prac-
tical considering the facts surrounding the entity,
the industry, and the economy? As Dr. Pratt would
remind us: “The economic interest measure capi-
talized should represent expected future economic
income.”2 If the report uses projected benefits, are
they reasonable based on the historic information?
How was the capitalization rate achieved? What
methodologies did the appraiser use? Are the
conclusions of value well explained and docu-
mented in the report or were just conclusions
without support provided? It always benefits the
reader if the appraiser clearly defines the work
done and, where practical, provides the calcula-
tions and exhibits to support the conclusions.
3. Plausibility (Definition: “Seemingly or apparently
valid, likely or acceptable; credible; merit belief or
acceptance.”)
Every appraisal report must include assumptions
the appraiser made. This is a natural part of the
appraisal process. The question is: Are these as-
sumptions plausible? Do we have an entity that has
demonstrated mediocre earnings in the past years
2 Shannon P. Pratt, Valuing a Business, The Analysis
and Appraisal of Closely Held Companies, 5th ed.,
McGraw-Hill, 2008, page 247.