Business owners and executives who do
not allot the time and budget for valuations could suffer unexpected consequences, including tax penalties and lack of
compliance with financial reporting rules.
“Post Sarbanes-Oxley, auditors are taking
fair value measurements and related requirements seriously,” says Donna Beck Smith,
who leads the financial advisory services
(FAS) practice at Brown Smith Wallace LLC.
But, before enlisting a professional for a valuation, check for certification and, for highly
specialized or regulated industries like health
care, banking or insurance, be sure the individual is experienced in those fields.
“Valuations require extra training and experience, and it’s risky if you consult with someone who does not have that expertise,” says
Brad Pursel, a principal in the FAS practice at
Brown Smith Wallace LLC.
Smart Business spoke with Smith and
Pursel about how to prepare for a valuation
and how to select a reputable appraiser.
When should business owners or executives
call on a professional for valuation services?
Closely held businesses cannot easily convert their interests into cash equivalents for
gifting to individuals or charitable organizations. A proper valuation establishes the
worth of interests so owners can pursue
estate tax planning. To comply with tax and
financial reporting rules, there are requirements related to the granting of stock-based
compensation. Those grants must be at fair
value or the recipient and grantor may suffer
negative tax consequences. Valuation frequency will depend on how often the company grants equity-based compensation but
the valuation must not be more than 12
months prior to the grant date. Additionally,
whenever a company makes an acquisition,
financial reporting rules require a fair value
analysis of assets and liabilities acquired as
part of any transaction. Valuations are also
necessary when a company owner wants to
buy out a partner or invite another individual
to take ownership in the company.
How should you prepare for a valuation?
First, a valuation professional will ask for
audited financial statements, and if those are not available — which is often the case with
smaller, privately held companies — the
owner will be asked to supply past tax
returns. Owners should prepare to discuss
their projections for the future and goals.
Where do they see the business going? What
are the company’s cash flow drivers? Who is
its customer base and supplier base, and who
are key industry competitors? Common mistakes business owners make is waiting until
the last minute to find a valuation professional and choosing a service provider based on
price. In most instances, owners should really plan on a minimum of four weeks for a
proper valuation. Six weeks or more is even
better. Rather than shopping price, find a professional who is best qualified to work up a
valuation that will withstand scrutiny. Getting
an inferior product that might be lower-cost
can have serious implications down the road
if the IRS reviews the valuation and assesses
penalties. For valuations necessary for financial reporting purposes, an inferior work
product may lead to increased accounting
and valuation fees if the company’s auditor
finds problems with the methodologies
and/or assumptions used by the appraiser.
What due diligence is necessary before performing a fair value measurement?
Start by checking credentials. Valuation
experts should have a long history of relevant experience. They must keep abreast of
changes in the appraisal and valuation industry, which is ever-changing. Valuation should
not be an area of occasional practice. With
evolving financial reporting rules, there is a
pretty good chance that an accountant
moonlighting as an appraiser will overlook
details. That said, find out if the person you
want to hire for the valuation is a member of
the American Institute of Certified Public
Accountants, the American Society of
Appraisers or the National Association of
Certified Valuation Analysts. These organizations require a course of education with written exams, field experience and continuing
education to maintain accreditation.
What do business owners need to watch for
in the financial reporting world?
There are new standards that will be effective at the end of this year that could have significant implications for companies that
make acquisitions and the financial reporting
consequences associated with those acquisitions. In the past, companies have not had to
value certain contingent considerations that
were included in the transaction. If the seller
was eligible to receive an earn-out based on
post-acquisition performance, in most
instances, there was no recognition of the
earn-out as of the acquisition date. Going forward, companies must value such contingent
considerations of the acquisition date and
any changes in value will flow through the
income statement. In this situation alone, the
scope of valuations will increase.
Also, as baby boomers that are running privately held or family businesses begin to pursue succession planning, there will be greater
ownership turnover and, as a result, demand
for valuations to ensure fair measurement of
company interests. You know the saying
about being ‘penny wise and pound foolish’?
That applies to valuation. You may be enticed
by a low-priced valuation service, but on the
back end, after you go through an IRS review,
you may rue the day you made the decision
to go with a less qualified purveyor.
DONNA BECK SMITH leads the financial advisory services practice at Brown Smith Wallace LLC. BRAD PURSEL is a principal in
the FAS practice at Brown Smith Wallace LLC. Reach Smith at [email protected] or (314) 983-1259. Reach Pursel at
[email protected] or (314) 983-1344.
