Why valuations without interview can be misleading
Valuations without an interview can be misleading. For this very reason, they are typically not accepted in the courts. However, each court ruling is unique and it is not possible to predict any rulings. Exceptions can be made for companies that more or less only own property, which doesn’t necessarily have to be real estate, but also other property. However, if the business has some form of activity, then an interview is required, because otherwise the business appraiser is unlikely to understand your business. Down below are two fictive scenarios of how valuations without interview can be manipulated towards a higher value, or a lower value.
Jane Doe Design Inc is a business that designs logotypes. They primarily work with large companies. One day, a major beverage manufacturer who is a client of Jane Doe Design Inc decides to sue them, as they claim that a logotype made by Jane Doe Design Inc is the subject of a copyright infringement. Jane Doe Design Inc don’t think that they violated any copyrights, and believe that their chances of winning in court are quite high. While potentially true, the lawsuit itself consumed too much time, money and other resources for them, and they are now on the way to making a big loss at the end of the fiscal year. They may even have to cut other important expenses, due to lack of financing, which previously wasn’t a problem. What is even worse than losing an important client and having a financially poor fiscal year, is that if this becomes public knowledge within the industry, then they risk losing more of their high profile clients.
When the company is later appraised by a business appraiser who doesn’t meet their client and hold an interview, Jane Doe Design Inc gets a high valuation. The appraiser was unaware of the situation, because he didn’t spend the effort required to appraise the business. The business could potentially be worth a lot less than the appraised value.
Jane Doe Cleaning LLC is a cleaning company with 15 employees, which is located in a small town where a single employer is creating most of the employment opportunities. This employer makes the decision to outsource the cleaning instead of using internal employees to do so. As Jane Doe Cleaning LLC is the only cleaning company in the town, the contract naturally goes to them. The owner of Jane Doe Cleaning LLC has every reason to be happy with herself and her business. All the cleaners that were fired from the town’s major employer, were immediately given jobs at his company instead. These were the very same employees, and they were already familiar with the routines at their previous employer, where they were to remain, only with a different company name on their shirts. This caught the attention of the local newspapers and Jane Doe Cleaning LLC were given free positive publicity. This gave them several more leads to work with. They were now on their way to making their best fiscal year ever.
When the company is later appraised by a business appraiser who doesn’t meet their client and hold an interview, the appraiser gives Jane Doe Cleaning LLC a low valuation. The appraiser was unaware of the situation, because he didn’t make the effort to meet his client. The business is on its way to double the revenue from one fiscal year to another, but in this case, it doesn’t affect the valuation.
Business valuation is the process of determining the most likely value of the business, in a transaction, where both parties are equally motivated to transact. A qualified valuation of a business should be according to the concept of intrinsic value and include an unbiased normalization of the financial statements. The final calculation of a business appraisal is fairly simple and quick, which is typically what you only get, when ordering an online valuation, without an on-site visit. The process of normalizing the financial statements along with weighing in the different valuation methods against each other, is what requires the most amount of time and competence, by the business valuator. The normalization of the financial statements is typically what affects the valuation the most. A company valuation should only be considered as reliable when it is properly independent and unbiased.
The most common methods for valuing a company are; the market approach, the income approach and the asset approach. They all have their strengths and weaknesses, and their own subcategories. No valuation method is complete enough, to solely be used to value a company.
The market approach doesn’t properly weigh in the profitability or assets of the company, which arguably are the most central aspects when valuing a business. Therefore, most valuations according to the market approach, are not of intrinsic value.
The income approach doesn’t take the assets that the company owns, into account. Therefore, companies with lots of assets get deceptive valuations.
The asset approach doesn’t take the profitability into account. Therefore, profitable businesses get deceptive valuations.
Want to go with a cheaper option or even do the valuation yourself? Nothing is stopping you, but...
You may lose the lawsuit, due to the valuation failing to be waterproof.
You may never settle the conflict, hurting the relationship with your counterpart.
You may get deceived while entering or exiting your partnership.
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