When you need a valuation done right, call the person who will do it right

Business valuations are complex, at least when done correctly. One reason for this complexity is that a business’s value varies based on factors such as the parties involved, the purpose of the valuation, and what is being valued.

​For example, if an agency is being sold between family members, the parties MUST ABIDE by the IRS valuation guidelines. This is not optional. This rule has been in place since 1959! I do not know why some accountants, and more importantly, some business appraisers, do not advise their clients of this mandate. That is blatantly a professional error.

Not only must the ultimate value meet IRS guidelines, but the report format and how it is written must also meet specific guidelines. Furthermore, the person conducting the appraisal must be an independent, third-party, certified appraiser.

Some CPAs advise clients they don’t need a third-party valuation because the sale or estate is too small. Again, this is a serious professional error. To say this means the CPA or family determines the value, which violates the independent third-party certified appraiser rule. A great example of this was a portion of Michael Jackson’s estate. That portion was appraised at around $1 million, if I remember correctly. The IRS valued it at some enormous number. I’ll use $1 billion. The estate then had to prove the IRS wrong. This is because, under this aspect of tax law, the taxpayer is presumed guilty until proven innocent. In criminal law, the defendant is innocent until the state proves him guilty. The opposite is true in this part of the tax law, which means the taxpayer bears the financial burden of proving they are correct.

Therefore, if you follow your CPA’s advice and don’t get a valuation, and the IRS knocks on your door, you’re guilty. They can place any value they want on your agency, just like they did in the Michael Jackson case. In the Michael Jackson case, the court ultimately ruled mostly in favor of the estate, but do you have hundreds of thousands of dollars available to prove your innocence?

I recently reviewed an agency’s valuation report. The report did not meet the IRS’s requirements on multiple levels, so the agency could not submit it to the IRS. But the agency owner still paid full price for a useless report. Most business owners do not know all these requirements exist, so they are prone to being taken advantage of.

Another factor is that, in these scenarios, the IRS requires a Fair Market Value (FMV) valuation. The values most often seen in the marketplace are Fair Values (multiplied by a lot, which I’ll get to in a moment). Fair Value and Fair Market Value generally do not have the same legal definition. If you have a Fair Value valuation completed when a Fair Market Value valuation is required, and if discovered, you’ll likely have a problem.

Publicly traded brokers report what they pay and the valuation standard they use (at least some do) in their 10-K filings. By and large, they report they pay in “excess of” Fair Value. Not only do they not use or pay Fair Market Value, but they also do not pay Fair Value either. The “excess” varies, but, for example, if Fair Value is 8 times EBITDA and they pay 12 times EBITDA, the “excess” equals four times EBITDA. Those numbers are in the ballpark of what they are paying by category.

Also, it is important to understand what is being valued. In a family situation, equity is usually valued. Equity does not have the same value as assets, and assets are what third parties purchase almost 100% of the time.

An appraiser should explain all of this to agency owners up front, and the appraiser should understand the legal nuances. Also, don’t hire business brokers doing free valuations unless you want them to market your agency. The conflicts of interest are huge.

Sometimes, potential clients seeking an appraisal do not hire me because they choose someone who promises an easier process. That’s great, but in my experience, valuations should always be written with the expectation of litigation. (The only exception is if the valuation is for informal purposes or is only an Indication of Value, and you can never use an Indication of Value for any formal purpose!) Maybe a tax authority reviews the valuation, maybe a partner down the road gets upset, or maybe someone gets divorced and that valuation becomes a factor in determining how assets are split. When someone promises you an easy, less work, and maybe less expensive valuation, ask yourself if those corner-cutting, easy-button solutions will leave you with a defensible situation if litigated.

Business appraisals are like anything. Spend a little more and do it right because litigating an agency's value is an extremely expensive process. Is spending $2,000 more and taking the time to provide the required data worth mitigating the potential for six-figure factors down the road? What is the value of risk mitigation?

And for all those optimistic people who think no one will ever come looking, I wish you the best. But it’s foolish to think life will not take unexpected turns, resulting in the need for a quality valuation, a quality buy/sell agreement, and simply good advice to mitigate those unexpected life events.

I have long found that those professional advisors who tell people how much easier they can do things are often not being disingenuous, though some are. Instead, I find they simply do not know enough about what they’re doing to understand the complexity. Either way, how are you best protected? By an advisor who is ignorant but honest or someone who is knowledgeable but disingenuous. I’d select the third option: hire someone who isn’t ignorant, has no conflicts of interest, and is honest enough to tell you about all the complexities you are facing.

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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.