Mar 19 2018

Avoid This One Key Mistake Regarding Business Appraisals

When considering a business appraisal, business owners will often turn to their trusted advisers for guidance.  Owners and advisers who are unfamiliar with business appraisals tend to focus on the experience and credentials of the appraiser first and foremost.  This is key mistake.  If you are a business owner, this mistake can cost you a lot of money.  In many cases, more than just the fee for the appraisal.  If you are a adviser, the damage to you is measured by the loss of your client’s trust.

This mistake is entirely avoidable by asking one key question:  What is the purpose of the business appraisal? 

The answer to this question is the key to avoiding the most common pitfall….ordering the wrong type of business appraisal.

There are two general types of business appraisals: Compliance appraisals & Market appraisals

Knowing which one you need will save time, money, and potentially serious problems later on.

COMPLIANCE APPRAISALS:

Compliance appraisals are used for complying with some external authority, such as the IRS or a court of law.  If you bequeath your business to your son or daughter, you’ll need a business appraisal, because the IRS says so.  If you and your spouse divorce, you will need a business appraisal, because the court says so.  There are many examples of compliance appraisals, but they share two common traits.  First, they are required by an external authority to comply with the law.  Second, they have little to nothing to do with market value, despite misleading terms such as “fair market value”.

MARKET APPRAISALS:

Market appraisals are used to estimate the market value of a business at a particular time, under a set of assumptions,  including assumptions about the market of potential buyers.  Is this business appraisal assuming a strategic buyer or a financial buyer?  A general buyer, or a specific buyer?  Market appraisals attempt to estimate the value of a company based on market forces under these assumptions.  Furthermore, high quality market appraisals use real market data from actual business sales of similar businesses.  Compliance appraisals rarely use comparable sales data…and only as a secondary method.

 

Why This Is Important

Since the result of a market appraisal is based on market forces, and the result of a compliance appraisal is based on non-market forces (e.g. legal precedent of the established authority), the results are NEVER the same, and only similar, on occasion, by accident.  Just as one should choose the right tool for the job…one should choose the right business appraisal for the purpose of the appraisal.