In my previous article, I discussed the critical need for business owners to have their business valued by a professional appraiser. In this article I will discuss the two types of business appraisals that you might want to consider.
- Calculation engagement
- Valuation engagement
First a few definitions:
The American Institute of Certified Public Accountants defines a calculation engagement as follows:
An engagement to estimate value wherein the valuation analyst and the client agree on the specific valuation approaches and valuation methods that the valuation analyst will use and the extent of valuation procedures the valuation analyst will perform to estimate the value of a subject interest. A calculation engagement generally does not include all of the valuation procedures required for a valuation engagement. If a valuation engagement had been performed, the results might have been different. The valuation analyst expresses the results of the calculation engagement as a calculated value, which may be either a single amount or a range.
Obviously, the key thing for a business owner or attorney to understand is that it is an agreed upon scope. Be sure to ask adequate questions on exactly what the valuation expert will do in this type of engagement. The purpose for the engagement is also critical (I will discuss this further below).
The American Institute of Certified Public Accountants defines a valuation engagement as follows:
An engagement to estimate value in which a valuation analyst determines an estimate of the value of a subject interest by performing appropriate valuation procedures, as outlined in the AICPA Statement on Standards for Valuation Services, and is free to apply the valuation approaches and methods he or she deems appropriate in the circumstances. The valuation analyst expresses the results of the valuation engagement as a conclusion of value, which may be either a single amount or a range.
As you can see from the above definition the business valuation professional in performing a “valuation engagement” will be following rigorous standards as promulgated in the AICPA Statement on Standards for Valuation Services.
What type of business valuation do I need?
Answer: It depends
As a general rule if the valuation is going to be distributed to a third party it is advised to have a valuation engagement performed as opposed to a calculation engagement. A calculation of value is generally not appropriate in a litigation setting. Obviously, your attorney will need to examine the relevant case law in your jurisdiction.
Here is a general rule of thumb on when each might be appropriate:
Calculation Engagement: Conclusion of Value not necessary, Internal management planning, pre-litigation planning.
Valuation Engagement: When a valuators’ conclusion of value is required. Valuations for IRS purposes, litigation context, financial reporting.
1. Be clear about what exactly you are purchasing, engagement letter should contain adequate language to understand nature of engagement.
2. Understand the difference in scope and price, perhaps the difference in price simply just doesn’t warrant the additional work based on business owner’s objectives.
3. Calculation engagements are generally used when a client wants a preliminary value.
A calculation engagement may fit your objectives as a less costly alternative to a conclusion of value report.
Consult a professional business valuator to discuss your alternatives. Contact us to discuss further.