Being Effective and Efficient
A Quick Initial Assessment of an Appraisal Assignment Can Help Determine Which Approach and Which Tools to Use. Hereâ€™s Why That Matters.
Appraisers have a large toolkit. When we pursue certifications, the tests we have to pass and our demonstration reports show that we know how to use tools properly, and certifications demonstrate our competency. In the real world, we are also in this profession to make a profit. Profits reward us for both competency and efficiency. Rand Curtiss explains how to be both effective and efficient.
Over the years, I have discussed dozens of business appraisal procedures that we might use in a given assignment. To use a carpentry analogy, we have a large toolkit. When we pursue certifications, the tests we have to pass and the demonstration reports we have to submit examine our knowledge of and ability to use each tool properly.
Certifications demonstrate our competency.
In the real world, we are also in this profession to make a profit. Profits reward us for both competency and efficiency.
As such, our goals are twofold:
- Use the proper procedures to be effective (coming up with and supporting reasonable values)
- Use only the proper ones to be efficient (make money)
Consider this example. We are to appraise the fair market value of a non-marketable minority interest in a cash- flow positive, growing, going concern, a very small privately owned service business that has few tangible assets, few liabilities, and no funded debt.
Right off the bat we rule out the Asset Approach.
A liquidation premise of value contradicts going concern status, liquidation value is far below going concern value, the control owner has no reason to liquidate, and the minority owner cannot force it. Use of the Asset Accumulation Method is possible (and required if the assignment is for financial reporting purposes, but this is a tax-related valuation), but extremely inefficient in that it requires the Income Approach (which we will use) to support it. It is ruled out on efficiency grounds.
There is no buy-sell agreement and no prior transaction history in the companyâ€™s stock (assume the business was founded 20 years ago with minimal capital contributions from the owners). The business is too small to be compared to public companies, and there are no private sale transactions reported for its industry in any of the standard databases, even if we â€śstretchâ€ť the definition of comparability to include related industries (something I am reluctant to do). Lack of data rules out the Market Approach.
We will use the Income Approach, Multi-Period Discounting Method (If growth is sustainable and constant, we could use the Single Period Capitalization Method.). We will use four tools: a financial forecast of cash flow to the minority shareholder (obviating the need for a lack of control discount), a discount rate build-up, a justification of purchase test (for enterprise equity value), and a lack of marketability discount. These tools are my hammer, screwdriver, saw, and wrench, in the carpentry analogy.
In our appraisal report, we can quickly rule out the Asset and Market Approaches in our introduction/summary. We state our reasons and are done discussing them (We reiterate them when we list the eight Revenue Ruling 59-60 factors and their relevance.). This is very effective and efficient!
Additional efficiency arises if we become aware of all of the above facts early in the process. Say we are referred by an attorney who provides them to us. The first few rule out the Asset Approach. Quick checks of the transaction databases rule out the Market Approach. We know the scope of work and can quote a competitive and profitable fee (This is a huge advantage when competitors price jobs assuming more elaborate scopes of work.).
Being Effective and Efficient
As carpenters say, there are proper tools for every job, and no job requires all of them (except for certification exams and demonstration reports). Good carpenters carry the portable tools they usually need on their belts and put the non-portable ones they usually need near the doors of their trucks. Business appraisers are in the same situation. The best (most effective and efficient) ones use the proper tools, and only those tools, to do their jobs.
Rand M. Curtiss, FIBA ,MCBA, is President of Loveman-Curtiss, Inc. in Cleveland, Ohio. Reach him via e-mail at email@example.com or by phone at (216) 831-7038.
This article first appeared in the Second Quarter 2012 issue of Business Appraisal Practice (BAP). For more information visit www.Go-IBA.org