ICYMI – Article originally appeared in 2015…. updated and revised for 2018! While getting my daily dose of Quora this morning, someone posed the question “What are the Top 5 Questions a VC should […]
How long is a
This is a question we get a lot as folks begin to think about engaging on a valuation. With the business environment constantly changing, is engaging now the right time? Read on.
How Long is a Valuation Good For?
It’s a logical question from business owners: how long is a valuation good for? The short answer: probably for about a year. The longer answer: it depends.
Context is critical
Business valuations are always completed for 1) a particular purpose and 2) at a specific point in time. While a valuation will take into account a wide range of data – future projections, management’s past ability to hit projections, prior performance, structural trends in an industry – it remains that the valuation is as of a certain date.
For instance, here is what the American Society of Appraiser (ASA) has to say on valuations:
The determination of value for a business is always done as of a specific date; however, the final opinion of value most always considers historical information as well as the future projections about the subject company and its industry. Each day there could be slight modifications of value due to changes in the capital structure of the company; however, in general practice, if there are been no significant changes in the operations of the business or its capital structure, annual updates may satisfy most uses of the appraisal report.
The ASA definition gives us a starting point. There can be small fluctuations on a daily basis in value but on a macro level, a valuation is usually good for about a year. However, there are situations when a valuation is not good for a year, which is why understanding context is critical.
What might change your value within a year?
When we say “about a year,” this generally assumes that nothing has materially changed that would impact our analysis. For example:
- Has something happened to materially impact revenues? Or earnings?
- Has there been a change of control?
- Is there a new management team?
- Loss of a key salesperson?
- Legislation that has a material impact on your industry?
- Has the purpose of the valuation changed? 0l>
Any of the above might impact the validity of a valuation inside the one-year period.
How Can a Change in Purpose Affect Value?
One aspect of value many business owners don’t consider is the impact that “purpose” has on the validity of a valuation. For instance, we are likely to arrive at vastly different conclusions if a valuation is done for a minority buyout vs. a strategic purchaser. Understanding the context of the valuation is critical – and by default, a change in context (or purpose) is likely to impact value.
Valuation and Divorce: A Case Study in Purpose
A great example of valuation purpose affecting value is when a valuation is performed in the context of a divorce. Valuations are often required when a privately held business is part of a marital estate. In order to perform a division of property the parties must know the value of the asset, and in the absence of a public market price a third party valuation is required.
If we assume for a moment that we are valuing a minority interest (50% or less, lacking elements of control and liquidity), as a valuation analyst we would ordinarily consider applying a Discount for Lack of Control and/or a Discount for Lack of Marketability. This may result in a discount from the pro rata share of the business of anywhere from 20-50%.
In many jurisdictions, the courts have stepped in and limited the ability to apply so called discounts. In order to not “punish” an exiting spouse, the valuation is precluded from applying these discounts, instead developing a value that is higher than what we would conclude if we were performing the value for a different purpose.
Staying with the divorce scenario, in many situations as a valuation analyst we might look at the impact of “personal goodwill’ on the overall value of a business. That is to say, how much value is attributable to an individual owner vs. the enterprise itself? This is very common in medical and professional practices, or scenarios where the “owner is the business.”
Similar to limiting discounts, states take wildly differing views on the treatment of personal goodwill in divorce matters. In many states personal goodwill is considered a marital asset, this divisible in the separation of assets. In others, personal goodwill attaches to the individual and is separated from our valuation.
Given the above scenarios, a valuation performed in the context of a divorce could have a materially different finding than a valuation performed for, say, exit planning purposes. In our examples above, not only does purpose affect the validity of a valuation, but so does jurisdiction!
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