How to choose the right type of valuation

Valuations come in all shapes and sizes. When sorting through valuation services, consider both a valuation report’s intended use and its costs.

Menu selections

The following menu highlights the three common types of valuation analysis:

1. Valuation analysis - Most valuation engagements fall into this first category. A valuation analysis is “the act or process of preparing a conclusion of value” in conformity with a valuator’s professional standards.

Although valuation analyses are more costly than the other two options, they are also more extensive in scope and generate more reliable conclusions. Therefore, when submitting a valuation for tax purposes or when hiring a valuator as an expert witness, a thorough valuation analysis is generally the best bet.

2. Limited valuation analysis - Unfortunately, there are times when a traditional valuation analysis is not possible because a valuator’s procedures are in some way limited. For example, in adversarial situations (such as a divorce or shareholder dispute), a controlling shareholder may prohibit the opposing side’s expert from touring the company’s facility or may limit the expert’s access to financial documents.

Occasionally, a company intentionally opts for a limited valuation analysis to save time or money. Or it may limit the valuator’s access to internal data and documents for fear of sharing proprietary information with an outsider.

When preparing a limited valuation report, the valuator clearly outlines the specific limitations in scope, procedures and analyses. In litigation situations, this may be a problem. By drawing attention to ways a valuator deviated from procedural norms, opposing counsel can persuade a judge or jury to believe that the limitations compromised the report’s quality.

3. Calculation analysis - In contrast to valuations and limited valuations, which generate value conclusions, a calculation analysis provides an indication of value based on assumptions and procedures to which the company has agreed.

The difference between a value conclusion and a value indication is more than mere semantics. A value indication is one step on a valuator’s journey to arriving at a value conclusion.

For instance, a discounted cash flow analysis and the guideline public company method may produce two different value indications for the same business. To arrive at his or her value conclusion, a valuator generally reconciles numerous value indications, which differ substantially in some cases.

The least expensive and comprehensive type of service, a calculation analysis may be appropriate for someone toying with the idea of selling a business, updating a buy-sell agreement or seeking a valuation for other informal purposes. (See the sidebar “A valuation is no time for thriftiness.”)

Many potential pitfalls - Don’t jump head first into a valuation engagement. To avoid the many pitfalls involved, discuss the alternatives with your valuation expert to ensure he or she chooses the most appropriate valuation analysis for the situation.

Sidebar: A valuation is no time for thriftiness

Some business owners mistakenly request a calculation analysis to save money, even though a valuation analysis would be more appropriate. Such thrift often backfires and costs them more in the long run.

To illustrate, Mr. X, who was concerned with costs, initially hoped for an out-of-court settlement and hired a valuator to perform a calculation analysis. When the opposition refused to back down and a trial appeared inevitable, Mr. X upgraded his calculation to a valuation analysis.

When the expert expanded her scope to a full-blown valuation, her analyses revealed several different value indicators. Accordingly, her final value conclusion differed from the amount Mr. X used during settlement talks. The difference — although technically valid and explainable — discredited the expert in court. The difference may have also cost Mr. X additional fees through needless negotiations, because the two sides may have been much closer in their conclusions than originally thought.