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Why valuations without on-site inspection can be manipulated

Valuations without on-site inspection are somewhat easy to manipulate. 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 to companies that no longer exists, such as litigation for businesses where the building has been burnt down, or for businesses without a location, such as e-commerce businesses that employ drop shipping. If your business is not one of the previously mentioned or similar, the courts may potentially not accept the valuation due to its easiness to manipulate. This creates a scenario where your counterpart may ignore the valuation too, due to its lack of potential enforceability. Down below are two fictive scenarios of how valuations without on-site inspection can be manipulated towardss a higher value, or a lower value.

Scenario 1:

Big Rig Dealership Inc is the largest dealership of heavy commercial vehicles in the United States. The company is primarily focused on vehicles that are employed to move heavy equipment for mining and oil production. The company’s bread and butter is the sales of brand new tractors, and brand new lowboy trailers. Since they are well connected in the industry, the news reaches them, that plant in North Dakota is to be moved to Texas. None of the trucking companies have enough vehicles to accommodate such a large job, in the time that is required, and they were unwilling to cooperate with their competitors due to an infected conflict. Big Rig Dealership Inc however, has a large inventory of brand new trucks and trailers. In fact, they are the only one, which puts them in a situation with price leverage. The parties manage to agree on pricing,so the jobs starts, and then eventually also finishes. Big Rig Dealership Inc delivers a very healthy profit and loss sheet at the end of the fiscal year, and the balance sheet only has minor changes to the prior year.

When the company later is appraised by an appraiser that doesn’t do an on site inspection, the company gets a high valuation. What the appraiser didn’t know, is that what was previously brand new trucks and trailers of a kind that cost a lot more than an average highway vehicle, are no longer brand new. The difference in value between a brand new special purpose vehicle and a slightly used one, multiplied by the large inventory, makes the valuation off by millions of dollars, despite the low mileage on the vehicles.

Scenario 2:

Aviation Welding Specialists LLC is a sub supplier to the aircraft manufacturing industry. It is an asset intensive company, with a lot of their special purpose welding equipment reaching high numbers in purchasing price. Most of their equipment is older than five years. They have a dedicated service department, with the sole purpose of maintaining the equipment and hopefully also expanding the service life of it. Their competitor Aircraft Fuselage Welding LLC shows an interest in purchasing Aviation Welding Specialists LLC. As both CEOs are shrewd negotiators, they fail to reach an agreement on price, so they bring in an independent business appraiser.

When the company is appraised by a business appraiser who doesn’t do on site inspections, the appraiser values the welding equipment at the book value, which makes the valuation very low. In fact, what at the time of the appraisal has been written off, has a market value that exceeds the annual revenue, but the business appraiser doesn’t know this, because he didn’t spend the effort to visit the company and inspect their equipment.

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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