Avoiding Trips and Traps in Valuation
By Chris Thorne
There are many reasons why a business owner needs a valuation ranging from wanting to sell whole or a part, negotiating a merger, creating new shares through to calculating capital tax liabilities. For a typical small business, the events that trigger the need for a valuation will not occur on a regular basis. This means that when one is required, business owners often do not know where to look to find advice they can trust.
The various methods involved in valuing a business are not complicated to explain. A quick search of the internet will bring up many summaries of the principal methods used. This is not what this article is about. However, while a basic understanding of the methods and some of the jargon used in valuation is helpful to a business owner, such articles no more make the reader an expert than reading about open heart surgery would qualify them to carry out the procedure. If the valuation is going to be relied upon to justify an investment or payment, then an expert with experience is needed. In this article I look at where the owner of a small business in the UK may look for such expertise and, when they have found a potentially suitable valuer, some of the questions that they should ask before instructing them.
Business Valuation Experts
One of the curiosities of the business world is that outside of the USA and Canada few countries have a distinct and respected profession around share and business valuation. While many countries, although not the UK, have laws or regulations on who may value property for certain purposes, very few have similar conditions on business valuation, which does leave the market open to chancers and charlatans. Even in the USA, where there are at least five professional bodies accrediting and regulating business valuers, the Securities and Exchange Commission has complained that they do not always know whether valuations submitted by firms in their filings have been prepared by people with the necessary skill and experience.
There are well established experts in certain types of asset such as property, plant and equipment, minerals, livestock and even intangibles to name but a few, and many of these are members of a professional body that regulates their conduct. However, the value of the business is very rarely the sum of the value of the assets it owns, so even going to the trouble and expense of having a reputable expert value each asset is not going to help a great deal. Finding an expert in valuing an entire business is somewhat harder.
Professional Business Appraisals In The UK
In the UK, most businesses naturally turn to their accountant for advice on all things financial. However, just like the law, accountancy is a very broad profession encompassing many specialist areas, and just because someone has an accountancy qualification it does not mean that they are an expert business valuer. In the big international firms there will be specialist valuation teams, but these firms are not really set up to serve small business clients, and this will be reflected in their fee rates!
To put things into perspective, the Institute of Chartered Accountants in England and Wales (ICAEW) has over 140,000 members, but in its Valuation Special Interest Group there are fewer than 1,000. While some of the other accounting bodies offer courses and training modules on business valuation topics to their members, none of the UK bodies provides a supplementary designation that enables prospective clients know that a particular chartered accountant has a recognised specialisation in this area. The chances of your friendly local accountant having significant skill and experience in business valuation are therefore fairly limited.
In recent years the Royal Institution of Chartered Surveyors (RICS) has started to expand into the world of business valuation. It is obviously best known for property valuation although for many years it has had specialist groups dealing with the valuations of other types of asset, so recognising that complementary skills are required when valuing an entity that owns those assets is a natural progression. It now offers a qualification pathway for those wishing to specialise in the valuation of businesses and intangible assets and additionally a post qualification Certificate in Business Valuation Techniques for existing members. However, just like accountants, the number of “surveyors” that have been specifically trained and have meaningful experience in this field remains a very small proportion of the total membership, although if they call themselves a “Chartered Valuation Surveyor” you will at least know that they have trained in valuation and not in building construction or auctioning livestock!
The Advantage of Professional Ethics
Although finding someone with a CA, ACA, ACCA, or even MRICS designation is not difficult, finding one with specific training and experience in business valuation is a challenge. However, these designations do mean that the holder is a professional bound by a code of ethical conduct, and as such they should not take on work outside their competence and experience. This at least gives a negative assurance that nothing is lost by at least asking the question, and if they cannot accept the work they will hopefully be able to refer you to a reputable firm or firms that can provide this service.
Some Tips On Finding The Right Valuer
Given that the business valuation profession in the UK has few shop windows on the high street but many back street wheeler dealers, I have put together some tips for anyone seeking a reliable valuation.
Here are some things you should avoid:
- Getting a “valuation” from a broker. While you might be willing to rely on an estate agent’s free price estimate before you put your house on the market as a guide to what you might expect, to do the same for a business is asking for trouble. The differences between businesses in the same sector are far more significant than those between houses in the same locality. And like the estate agent, a broker’s estimate is very unlikely to comply with any recognised professional or technical standard and would have little to support it if challenged..
- Using free on line valuation tools. These suffer from the same drawbacks as broker quotes and many are just designed to draw in business for the firms behind them, many of whom give little or no information about their professional credentials.
- Being blinded by jargon or false science. If the potential valuer cannot explain to you in plain language what needs to be done and how they will go about it, avoid them. Those who try to impress by making what they do appear complicated or claim to have a formula or valuation solution that produces a more favourable figure than others should be avoided. A good valuer and bad valuer will have the same tools, but the difference is that former knows how to use them properly.
Here are things you should do or look for:
- Do not be afraid to question whether the valuer has experience in valuing businesses like yours. A reputable valuer should have no difficulty in providing you with details of their experience – just don’t expect names and numbers as a professional would have to keep this confidential unless their client had consented to disclosure. A conversation will soon reveal how much the valuer knows about your type of business and the sector in which you operate.
- If your business has intellectual property, such as patents or a brand, make sure that the valuer understands the significance of these and has experience in valuing these items.
- Check whether the valuer is a member of or regulated by a recognised professional body. This will be shown by a professional designation after the valuer’s name. I have mentioned the most common of these earlier. Membership of a professional body gives you the assurance that the individual is subject to a code of ethical principles and would be subject to disciplinary action if their professional conduct falls short of what is expected.
- Check if the valuer has professional indemnity insurance. For members of most professional bodies this is compulsory. However, remember that this is just covering the valuer in case they make an error that causes you loss – it is not a guarantee that the valuation itself may not change over time or under different circumstances.
- Ask what valuation standards they will use. Using standards should be a guarantee that best practice will be followed and that valuations are prepared on a recognised basis. There are International Valuation Standards. Of the professional bodies mentioned above, only RICS requires its members to follow these by embedding the IVSs in its own professional standards. However, the IVSs are available for anyone to use and there is no reason why members of other professional bodies, such as the accounting bodies mentioned, cannot use them, and any accountant specialising in valuation should be familiar with them. Certainly members of the accounting profession from around the world have been closely involved in their development.
Caveat Emptor, This Is An Unregulated Area
Given the amount of regulation around financial services generally, the lack of any recognised credentials or regulation of business valuers is as surprising as it is unfortunate. Not only does it make it difficult for business owners to know who to trust when they need a valuation, but also it means that the whole SME sector is missing a vital component that handicaps its growth prospects. Unless prospective investors have confidence in the valuation of businesses it makes it harder for those businesses to raise capital, and is perhaps one reason for SMEs in the UK having greater reliance on bank funding, often secured against physical assets, than is the case in places such as North America. An effective and trustworthy valuation environment would also help improve the liquidity of shares in SMEs, again making the sector more attractive to investors.
While there are signs that a growing number of UK practitioners see the need for the business valuation profession to become better organised and raise its profile, regrettably it will probably need active encouragement from the financial regulators for the various disparate groups to start working towards common solutions. There are precedents for this elsewhere; as a result of the publicly expressed concerns of the SEC I referred to earlier, three of the leading professional organisations in the USA have joined together to develop a common credential for experts in valuations for financial reporting, and in Asia a number of governments have been actively encouraging the establishment of self-regulating professional bodies in the sector.
Some Useful Resources
In the meantime, business owners and prospective investors needing a valuation of a business interest in the UK have to be diligent and patient in their search for a suitably qualified expert, as making the wrong choice could have severe financial consequences. I list below some links that might be useful in getting started.
About the Author
Chris Thorne is a former professional valuer. After more than 30 years in practice he was Technical Director of the International Valuation Standards Council between 2010 and 2015. He is now a director of Valuology, which offers consultancy services on valuation issues to professional bodies and risk management advice to valuation firms. www.valuology.org