Human error leads to mistakes and mistakes in a business valuation report can prove costly. The complexities involved in valuing a business are tremendous and this process should be undertaken with due care by a licensed professional.
Grossly overvaluing or undervaluing a business because of careless mistakes could prevent a transaction from occurring, leading to disputes and potential litigation down the road or bring the CRA to your doorstep either looking for further support and clarification or with a tax reassessment.
To avoid these errors, you should always involve a licensed valuator that has experience in your industry and is familiar with your business’s unique characteristics.
A reasonable and supportable valuation report is important for successful exit/succession planning, helping to avoid or resolve a dispute (shareholder or matrimonial) and arming you with the tools you need to effectively negotiate a sale transaction. A quick and dirty valuation using rules of thumb is never advisable.
8 Common Valuation Errors
Below, we have summarized the more common errors made by inexperienced valuators.
Wrongly Applying Price/Earnings Ratios
One of the more common missteps is to pit P/E multiples against time periods or earning streams that are not appropriate. For instance, it is not acceptable to apply a P/E multiple (or any other multiple for that matter) intended for the earnings stream of a publicly traded Fortune 500 company to that of a privately held million dollar service company.
Conflating Incompatible Data
This refers to the valuator combining pre-tax and post-tax data, such as if the valuation report reflects a post-tax P/E multiple applied to pre-tax income streams.
Generalizing the Company vis-à-vis its Competitors
This refers to the inaccuracies that arise when the valuator blindly relies on industry averages and does not take that specific company’s financial situation or risk factors into consideration.
Drawing Too Heavily From Historical Financial Data
Unseasoned valuators are known to refer only to historical financial statements when conducting a valuation analysis and preparing the valuation report. They neglect to consider current and/or projected data by seeking the management’s counsel on the business’s growth prospects or performing a site analysis.
Misusing Data Relating to Capitalization Rates
This occurs when the valuator blindly takes into consideration those capitalization rates that stem from inappropriate time periods, applies rates only to safe investments, doesn’t commensurate the capitalization rate with the earnings base or confuses required rates of return with historical information. In effect, the valuator has selected a capitalization rate or valuation multiple that does not appropriately reflect the market conditions as at the valuation date or the company-specific risk factors facing the business being valued.
Misapplying Discounts
Oftentimes an inexperienced valuator may ignore the rules and the jurisdiction that dictate the report’s purpose. They could mistakenly apply a premium or discount to a value that is not applicable. Likewise, they could apply a discount without any knowledge of the information and processes that went into compiling those discount studies.
Not Understanding the Subject of the Valuation
Many valuation reports are much too brief to be useful and reveal that the valuator’s thought process was lacking. The valuator may not fully grasp the subject of the valuation and may ignore the subject’s share ownership.
Casting Unreasonable Assumptions Based on Standalone Trends
There are several instances when an inexperienced valuator may create a report founded on unreasonable and unsupportable assumptions. For example, they may draw inferences based on the assumptions that past successes will follow the company into the future, or one weakness will derail the business’s future prospects.
A Licensed Valuator Sees Things That Usually Fly Under the Radar
Given the various missteps that can occur, it is crucial to approach a professional and credentialed business valuator. These professionals have spent a significant amount of time to earn their license, putting them in a better position to understand the nature of your business and the reason for the valuation.
They also take special care to adhere to professional standards as laid down by the Chartered Business Valuator Institute in Canada. This knowledge of all the factors that influence the valuation outcome reduces the likelihood of errors and, subsequently, the inherent liability.
Some of the finer points in a business valuation report that should not be ignored include:
- Selecting and justifying the appropriate valuation approach
- Demonstrating a sufficient understanding of the business and the risk factors facing the business
- Conducting appropriate industry research and selecting comparable industry transactions with insights into how they are applicable
- Selecting and justifying an appropriate capitalization rate and/or valuation multiplier
- Adequately supporting the reasonableness of major assumptions underlying the valuation conclusions
- Effective storytelling that convinces the reader in an unbiased manner that the valuation conclusion is reasonable
Skip the Mistakes. Get Your Report From Trusted and Licensed Valuators.
We specialize in independent business valuation reports that will aid you at every stage of your company’s lifecycle, right from start-up to maturity and exit. Don’t take a gamble on your business. Get your valuation report done right the first time! Contact us for more information.