Simple Truths About ESOP Appraisals

After years of experience listening to and working with clients and their financial advisors, as well as preparing hundreds of appraisal reports, we have learned a few general and often overlooked simple truths about ESOP appraisals. We share the following six observations in hopes that they will broaden your perspective of business valuation and possibly provide you with some “tips” to assess future appraisals you may review.

1. An engagement letter should be prepared for client acceptance. Every ESOP appraisal should officially begin with a proposal or engagement letter specifying what is being valued, the “as of” date, the purpose of the appraisal and the fee arrangement. If the business appraisal firm you have retained does not provide this, request it. While not a requirement, it is generally considered good practice and tends to avoid confusion later in the process.
2. There is no such thing as a “simple” ESOP valuation. We are often asked how a particular business might be valued, but unfortunately there is no simple answer to that question. The methodology used to value a company is dependent on a number of factors which will differ, just as companies differ. Be wary of appraisers who provide a short and simple answer to that question.
3. There is no such thing as “the value” of anything. Valuation is a range concept tied to another concept, that of “reasonableness.” The appraisal of any business may fall within a certain range of values, but the final determination of value must be considered in light of the purpose of the valuation and its overall reasonableness. A valuation purpose which generally illustrates both ends of the continuum is a divorce situation in which the business owner desires the lowest valuation (within reason) and the spouse generally desires a higher value for the business. The concept of reasonableness is tied to number 4 below.
4. If the valuation starts with reasonable facts and makes reasonable assumptions along the way, chances are the conclusions will be perceived as reasonable. Bankruptcies are being filed daily for companies whose business plans were based on assumptions and projections that were not possible or reasonable. Make sure you and your business appraiser communicate regarding the sensibility of all assumptions.
5. The public marketplace provides many objective “markets” as reference points for appraisal of closely held companies. A thorough valuation conclusion will sit reasonably in relationship to one, or preferably, several of these markers. Peruse the valuation report for this. If it is not there, the appraiser should, at a minimum, explain why an analysis of this nature was not performed.
6. In a litigation or potential litigation situation, every word written in a report is fodder for cross examination. Remember this if you feel your appraiser appears to be particular about the manner in which something is worded. If you have a concern, ask for an explanation as to why the appraiser believes the passage should be worded like it is.

Remembering these common sense yet important points should give you a feel for the general perspective and tone the business appraiser is trying to create. If our perceptions have prompted questions, contact one of our professionals. We will be happy to discuss any valuation issues with you in confidence.

Reprinted from Mercer Capital’s ESOPval.com – Spring/Summer 1997.