Proper Valuation Depends on Who, What, When and Why

When companies change hands or are involved in bankruptcy and litigation, or when an owner is cashing out or preparing an estate plan, establishing the value of the business is critical. According to Tom Pratt, director of Gleason & Associates, it can also be challenging.

Just as beauty is in the eyes of a beholder, a company’s value is relative.

“Everyone involved should understand what is being valued, at what time, under what premise, for what purpose and to whom. The value of a business will differ based on the answers,” says Pratt, a certified public accountant, certified valuation analyst and an accredited business valuation professional. “Reaching consensus on these issues is often more difficult than determining the value itself.”

Timing Is Everything

Even a few months can make a world of difference when determining a company’s worth. When Gleason was originally engaged to valuate a software firm, the company had no plans for future growth. Although the firm had been in business for several years, the owners hadn’t considered whether to continue growing at a modest rate or expand aggressively. In that state, the value of the business was limited. Nine months later, the company began implementing a plan to acquire competitors and capture significant market share.

“Once the plan was in place and there were prospects for substantial growth, the value increased dramatically,” notes Pratt.

Often, the question of timing isn’t clear cut. When a minority shareholder in a privately held aviation company who had left the business several years earlier wanted to exercise his sell-back option, the owners were at odds over the price of the shares. At issue was the value of the company when the shareholder resigned, which was pre-9/11, an event that negatively impacted the entire aviation industry.

“To fairly interpret the value of the shareholder’s shares, it was critical to determine the value of the company at the time of his departure,” explains Pratt. “Our analysis showed that the business was already experiencing a down cycle before 9/11 and wasn’t worth what the shareholder believed it was worth at the time.”

One Person’s Treasure...

Certain assumptions also factor into a company’s value. When Gleason was engaged to assist the reorganization of a professional sports franchise, ongoing questions of the team’s worth under multiple scenarios were critical to the interested parties—for example, moving the franchise versus maintaining it in its current location. The value of the team to its owners was also different than the value of the team as a community asset.

“The economic results are different, given different circumstances,” says Pratt.

In addition, a company may be more valuable to some people than to others —an issue that often arises in acquisition negotiations. According to Pratt, “If a strategic buyer can gain market share or benefit from economies of scale as a result of an acquisition, whose value is that—the acquiring company’s or the current owner’s? Defining the interest to be valued up-front lessens confusion.”

Before assigning value to a business, ask these questions:

• What interest is being valued—for example, 100 percent, 25 percent, stock ownership, a limited partnership, invested capital?
• As of what date is the business being valued?
• Why is the business being valued—for a sale or purchase, estate purposes, as part of a dispute, etc.?
• Under what premise is the business being valued—for example, liquidation or will it continue to operate as a going concern?

Excerpted from Briefly Speaking, a complimentary newsletter published by Gleason & Associates. Subscribe