Cheaper is always better, right?
Almost every agency owner I know has expressed frustration that customers only care about price. And many agents and carriers are extremely willing to take advantage of customers.
My favorite story of all time is about a consumer who told an agent that another agent was saving them a ton of money on the same coverage. My client was only recommending $100,000 liability for the auto policy. The insured advised, “The other agent gave me the same amount: $25,000/$50,000/$25,000. And it costs less!”
Lower prices are easy to achieve: just reduce coverage.
Many agency owners are no different when it comes to buying a valuation of their insurance agency. And there are well-known appraisers just as willing to take advantage of ignorant agency owners who believe all appraisals are the same, just as there are agents willing to take advantage of insureds thinking all insurance policies are the same.
Moreover, many agency owners think all agency owners have the same appraisal needs, just like so many insureds think that everyone has the same insurance needs and therefore, shouldn’t one policy, the cheapest, be fine for everyone!
Don’t read any further if you’d like to believe the cheapest is the best for everyone.
There are many kinds of business appraisals because businesses have many different reasons for being appraised, just as insureds have many reasons for buying insurance. The most basic is the back-of-the-envelope kind. These are common in this industry, and I see agency owners paying $3,000, $4,000, $5,000, and more for them. They may look nice, but they are basically worthless for any official purposes.
Worthlessness is not my opinion. In the business appraisal world, accreditation and reporting standards matter a lot. The business appraisal accrediting boards have ruled that such reports are worthless for any official purpose. I’ll define “official purpose” shortly, as definitions matter just as in an insurance policy.
Back-of-the-envelope calculations are what one accrediting board calls "A Calculation of Value”. You might think all valuations are calculations, which is correct, so how can this be a problem? All business income insurance policies read the same, right?
As one source states, “Due to the reduced scope of a calculation engagement, the valuation analyst generally spends less time and effort in determining a calculated amount, resulting in lower fees for the client. However, many clients may desire a calculation engagement due to the reduced price without understanding the difference between a calculation engagement and a valuation engagement.”
Calculation engagements should only be used for informal strategic planning and preliminary work. Calculation engagements DO NOT MEET valuation standards for anything official.
What is an “official purpose”? Anything that might involve tax, litigation, divorce, and estate, to name a few primary situations. This is one area where business brokers, in particular, take advantage of agencies. They use the same Calculation Report regardless of whether they’re selling an agency or completing a report for official purposes. And you, the agency owner, don’t know the difference.
I often get the question, which is really a statement, “My estate is too small, so I don’t need a 'real' appraisal, do I?” And CPAs and valuation consultants will agree with them or suggest they do a cheap valuation report. These people are all wrong. Tax law does not work like criminal law. In criminal law, you are innocent until proven guilty. In tax law, you’re guilty until you prove yourself innocent.
This means the IRS has the right to assign any value they want to your estate, and if you disagree, you must prove yourself correct. A famous recent case involved a portion of Michael Jackson’s estate (Estate of Michael J. Jackson et al. v. Commissioner). The estate completed a very, very good full valuation report. Their appraiser calculated a value of $7 million. The IRS appraised it at $1.25 billion! The Tax Court found for the estate and even lowered the number to a little more than $4 million. But the estate had to prove themselves innocent. And $7 million is far less than the taxable estate amount! If they had hired one of these charlatans to complete the valuation, the estate would likely have paid taxes on $1.25 billion.
Moreover, when someone says their estate is too small, they’re appraising their own estate. This is like the “O” in Errors & Omissions. It’s not that something was done wrong. It’s that something was omitted. The IRS and courts are clear: just as in an insurance policy appraisal requirement, you are not allowed to do your own appraisal.
100% of all transfers of ownership between family members must be valued under the Valuation Engagement standards, unless you want to take unnecessary risk. All estate scenarios require a Valuation Engagement. If your attorney is smart, they will require a full Valuation Engagement for divorces.
And for anything involving a buy/sell between partners, especially a disagreement, you would be very, very wise to get a full Valuation Engagement. So far at least, all my clients have won their litigation against others who went the cheaper “aren’t all valuations the same” approach.
Valuation reports are discoverable. Therefore, a good valuation report is always written for two readers. The first reader is the party that bought the report. Unless they have an excellent CPA or attorney, they don’t know that they need a report written for the second reader. The second reader is whoever is mad at you. It could be the IRS. It could be a disgruntled partner or even a partner’s soon-to-be ex-spouse. It could be someone suing you.
I often also get a comment like, “Well, what difference does it make if a cheap report has the same value as the expensive report?” The cheap report is not defensible. I see a lot of owners whose agencies are worth far more than $7 million paying for cheap reports. If Michael Jackson’s estate had followed the advice of the same agency owners’ accountants, attorneys, and appraisers, they would be paying tax on $1.25 billion.
And that gets to an essential difference. The back-of-the-envelope report may, often accidentally, arrive at a value similar to that of a quality valuation report. But because it is cheaper, the documentation, the use of multiple approaches, the research, and the report's quality make it indefensible in court. Furthermore, courts may not even recognize those reports, but they are discoverable, which means you’ll pay more legal bills trying to explain what those reports show. Even if the number is correct in a Calculation Engagement, it will not likely hold up.
Last but not least, to pay $5,000 for a Calculation Engagement is a waste of money. Get it for $2,000. If they are worth anything, $2,000 might be the right price.
If you want to know more, or if you need to, there is a lot of information on this subject online. Look for USPAP standards (which are also used in some insurance appraisal claims), NACVA standards, and if a CPA is involved, look for their AICA and ASA standards. Then make sure your appraiser is individually accredited because the courts and IRS generally require the appraiser to be accredited.
NOTE: The information provided herein is intended for educational and informational purposes only and it represents only the views of the authors. It is not a recommendation that a particular course of action be followed. Burand & Associates, LLC and Chris Burand assume, and will have, no responsibility for liability or damage which may result from the use of any of this information.
None of the materials in this article should be construed as offering legal advice, and the specific advice of legal counsel is recommended before acting on any matter discussed in this article. Regulated individuals/entities should also ensure that they comply with all applicable laws, rules, and regulations.