We’ve turned the page on 2022, another year defined by challenges, record profitability and elevated valuations for auto dealers.  As we enter 2023, there will likely be unique challenges and opportunities for auto dealers regarding business valuations.  We will dedicate future blogs to the discussion of these opportunities from the perspective of succession planning in an environment with sunsetting tax exemptions and depressed asset values, especially if interest rates continue to rise and profitability subsides in 2023.

We previously discussed six events that could trigger the need for a business valuation. In this post, we discuss six things that attorneys or auto dealers should consider when selecting or working with a business appraiser.

When you are hiring someone for a plumbing or electrical project, you select a licensed plumber or electrician.  Likewise, when you hire someone to analyze and value your business, you want to select an appraiser that meets certain professional standards.  There are several credentials or professional designations that are applicable to business valuation and related subjects.  Some of these credentials are outlined below:

Accredited Senior Appraiser (ASA).  This designation is granted by the American Society of Appraisers (“ASA”).  The American Society of Appraisers is a multi-disciplinary organization (including members in real estate, business valuation, fine arts, machinery and equipment, and gemology), and the Accredited Senior Appraiser designation initially requires passing an ethics exam and a course and examination of the Uniform Standards of Professional Appraisal Practice. Once these two requirements are met, the applicant must pass or demonstrate acceptable equivalency for a series of principles of valuation courses.  Upon successful completion of the courses, an individual must have a minimum of five years of full-time equivalent appraisal experience. Additionally, candidates must submit a representative appraisal report for review by the organization.

Accredited in Business Valuation (ABV). This designation is granted by the American Institute of Certified Public Accountants (“AICPA”).  The ABV requires that members hold a valid CPA certificate and pass a comprehensive business valuation examination.  Also, substantial involvement in a minimum of 1,500 hours of valuation engagements within the five-year period preceding the date of the credential application is required. Paths to obtain this designation are also available to non-CPAs.

Certified Valuation Analyst (CVA). This designation is granted by the National Association of Certified Valuators and Analysts (“NACVA”).  The CVA designation requires the successful completion of a 5-day Business Valuation and Certification course, a proctored exam, a case study, two years of full-time equivalent experience in business valuation, as well as the completion of at least 10 business valuations.

Chartered Financial Analyst (CFA). While not specifically a business valuation credential, many business appraisers hold the designation. Granted by the CFA Institute, to become a CFA Charterholder, one must pass all three levels of the CFA curriculum, each level with its own exam. In addition, candidates must complete work experience requirements before, during, or after participation in CFA Program. Experience “must be directly involved with the investment decision-making process or producing a work product that informs or adds value to that process.” Professional references from two or three people regarding work experience and professional character must also accompany the membership application.

Additionally, all four certifications require ongoing continuing education so that the appraiser stays current on relevant business valuation topics and methodologies.

While this list of credentials is not exhaustive, appraisers with one or more of these credentials typically work in the business valuation space full-time as opposed to those that may only perform a few valuations each year.

The initial process to a business appraisal involves more than just the attorney or the auto dealer determining that they need to have their dealership appraised.  The appraiser must work with the clients to properly define the assignment.  What are the companies that need to be valued?  What is the purpose of the valuation?  What is the specific ownership interest that needs to be appraised?  What is the standard of value?  What is the date of valuation?  What is the level of value?  While we won’t dive into each of these in this post, we have previously written about levels of value in prior posts: here and here.

Why is defining the assignment so important?  I often refer to the assignment definition as the roadmap for the valuation project.  Just like a roadmap, the assignment definition lets the appraiser and client know where they will end up at the conclusion of the project.  There may be several paths along the way to eventually arrive there, but the roadmap is the guiding force.  Without a correct roadmap, the appraiser and client will not end up at the correct place.  It’s critical to establish the assignment definition at the beginning of each project to maintain efficiency and costs, which will be discussed later in this blog.

In addition to professional qualifications, should your appraiser have specific industry experience?  In other words, should your appraiser be a valuation or industry expert?  Why not both?

It is critical to engage a business appraiser who is both a valuation expert and an industry expert for an industry like auto dealers.  Auto dealers have unique financial statements and specialized terminology.  An appraiser familiar with auto dealerships will understand the importance of dealer/factory statements vs. audited financial statements or tax returns.  Further, an experienced appraiser will know how to utilize industry-specific valuation methodologies such as ongoing earnings and blue sky multiples vs. general valuation methodologies often reserved for other industries (for example, discounted cash flow or multiples of earnings before interest, taxes and depreciation (EBITDA)).

The costs of a business appraisal can vary. One might think that the cost of an appraiser is a linear relationship to the size of the business.  This is not necessarily true, as many small businesses have less formal/sophisticated financial statements and records making them more challenging to value.  As discussed above, properly defining the assignment at the initial consultation will also aid in selecting the proper deliverable according to the needs of the project.  Is a formal valuation report needed, or would a summary report or calculation worksheets suffice?

For most non-litigation appraisals, a qualified business appraiser should be able to state or estimate the total fees for the project.  While fees for appraisals are not insignificant, often the fees for these appraisal services are nominal compared to the dollars at risk.  The marginal cost of selecting the best appraisal can be negligible in the overall picture.  Attorneys and auto dealers can assist the appraiser by ensuring full disclosure, efficient access to requested information and the expectation of arriving at an independent conclusion of value.  The best appraisers have the industry experience and credentials described above, but recognize the delicate balance between art and science that enables them to interpret qualitative responses from management interviews and place them in a stylized format that quantifies the results.

When selecting a business appraiser, communication may not be the first thing that attorneys or auto dealers consider.  Why is communication so important?  First, consider the deliverable for the business valuation assignment.  While the concluded number/value of the auto dealership grabs all of the headlines, the entire valuation report communicates the entire results of the project. Appraisers must demonstrate that they have an understanding of the assignment, the auto dealership or business, the industry, competition and economic factors.  Additionally, the report must communicate complex financial matters and valuation methodologies that allows the reader to understand how the conclusion was derived.

Communication is also critical throughout the valuation process.  The entire valuation process can last six weeks, or in some cases longer.  Business appraisers should maintain communication with the attorneys and auto dealers throughout the various stages of the project to keep the project moving in an efficient timeline.  The process involves numerous steps and cooperation by the auto dealer and other keepers of the financial records, any of which can prolong the process without proper communication.

Finally, communication skills by the appraiser can become important if the valuation is ever challenged.  Some engagements begin with a litigation purpose, such as divorce, commercial lawsuit etc.  Others can turn into litigation down the road.  In addition to the written report, will your business appraiser be able to discuss and defend the valuation conclusion and complex valuation methodologies and theories to a judge, jury or an IRS agent?

If you’re contemplating a sale, going through a personal or business divorce, or developing a succession plan, do you want everyone to know?  You will need to select a business appraiser that will respect your confidentiality.  Confidentiality is not only important to the facts of the case, but also pertains to the financial records of your business.  In the course of a business valuation project, appraisers request and review financial statements, tax returns, governance documents, and sensitive data about customers and competition.

If it’s important or a concern to you, ask your appraiser to execute a Non-Disclosure Agreement and find out what steps they will take to receive and protect the information.  Discuss confidentiality with your business appraiser and select tools such as Sharefile/DropBox or password-protected files to transfer sensitive information for use in the business valuation.

Conclusion

Mercer Capital provides business valuation and financial advisory services, and our auto dealership industry team assists dealers, their partners, and family members in understanding the value of their auto dealerships and related entities.  Contact a member of the Mercer Capital auto dealer team today for any questions about this post or to learn more about the value of your dealership.