Can you recycle a business valuation report?

If you’ve previously obtained a formal business valuation, you might be tempted to reuse it for another purpose. This might seem like a good way to save time and money. But doing so without first determining whether the report and its conclusions are appropriate for the new use can create significant risks.

Timing issues

Think of value as a moving target. An expert must consider market conditions on the valuation’s effective date when estimating how much a business or business interest is worth. Internal and external factors — such as employee turnover, equipment condition, market share, government regulations, and merger and acquisition (M&A) activity — may influence value. As those factors evolve, the subject company’s value may change over time.

To illustrate: Suppose Alice bought 5% of a closely held corporation’s stock for $10 per share in 2016, based on a formal business valuation. Today, Peter wants a piece of the action, and the controlling owner offers to sell him 5% of the company stock for the same price, using the 2016 valuation. Would it be prudent for the parties to rely on a 10-year-old report in this situation? The answer depends, in part, on how internal and external factors have affected the company’s value over time.

Often a business’s value increases over time, but that’s not always true. For example, if this hypothetical company has lost 25% of its market share due to increased competition and several key employees have left to work for competitors, the 2016 valuation may overstate its value.

Even though the intended uses are the same — both Alice and Peter are buying the same amount of stock — 10 years is a long time to expect a valuation to remain applicable.

Standards and levels of value

Another reason repurposing a previous valuation can lead to inaccurate conclusions is that “value” depends on how you define it. Different standards of value — such as investment value, fair value or fair market value — may apply. Each of these standards has a different definition, which may impact a valuator’s analyses.

There are also different levels of value, such as:

• Controlling interests,
• Noncontrolling, marketable interests, and
• Noncontrolling, nonmarketable interests.

The applicable level of value can affect the valuation analysis, including whether adjustments or discounts are appropriate. Discounts for lack of control and lack of marketability can be significant, but they don’t always apply and may differ based on the characteristics of the business interest. Similarly, adjustments to the business’s income stream depend on the facts and circumstances.

Continuing with the previous example, suppose Peter wants to buy 75% of the company’s stock from the controlling shareholder. But Alice bought a 5% interest that’s unable to control the company’s day-to-day operations. Valuing a large block of stock in a closely held business requires different adjustments and analyses than valuing a noncontrolling interest with limited marketability. So, even if Alice’s purchase had happened in the current year, a valuation report prepared for purposes of buying her noncontrolling interest may still need to be adjusted to reflect the characteristics of a controlling interest.

Valuation purpose

A valuation is prepared for the purpose (or purposes) listed in the report and the parties’ engagement letter, so its conclusion shouldn’t automatically be relied on for unintended uses. Valuators face different considerations depending on why a business is being appraised. Shareholder disputes, M&A and tax purposes are just a few common reasons for obtaining a formal business valuation.

It’s important to disclose all intended uses of a valuation report. A valuation’s purpose can affect the scope of the work, the applicable standard and definition of value, assumptions, and other aspects of the valuation. In some cases, recycling may work out. But often the expert will need to update — or even redo — the valuation, depending on how much the two assignments differ.

Continuing with our previous example, let’s say that the company obtained a formal valuation when Peter was considering buying 75% of its stock. Peter backed out of the deal, but the controlling shareholder files for divorce six months later. Should she (or her spouse) rely exclusively on the recent valuation when divvying up the marital estate?

In this situation, the recent valuation may provide insight into the company’s value, but a new (or updated) valuation would be prudent. Why? First, the sale to Peter never actually happened. More importantly, the standard of value used in a divorce (typically fair value) may differ from the standard applied in M&A transactions (usually fair market value or investment value). In addition, the treatment of goodwill in divorce varies by jurisdiction. In some jurisdictions, all or part of the company’s goodwill may be excluded from the marital estate, requiring the valuator to perform additional analyses.

No shortcuts

A business valuation provides a snapshot of value on a specific date and for a specific purpose. A previous valuation can be a useful starting point for understanding value drivers and risk factors. But never assume the conclusion remains applicable today — particularly in high-stakes litigation or M&As. Before relying on a valuation beyond its intended use, contact us to assess the situation. We can help you evaluate whether recycling is appropriate or whether a new or updated valuation is needed based on the facts and circumstances.

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