What is the appropriate role of a financial valuator? Objectivity, above all else. As a member of the most prestigious governing body, the American Society of Appraisers (ASA), the credible valuator follows a very defined code of ethics. At the same time, valuation/appraisal is part quantitative and part qualitative.
The more factual market and client data that can be applied to the particular engagement, the more supportable the end analysis and conclusion(s). So how can one valuator differ so much form another? Typically, when two valuation firms are appraising the same business as of the same date, the answers should be within about 10% of each other. A competent valuator must stand in the shoes of a prudent but potential outside investor in the subject company.
Recently, we were asked to perform a detailed review of two appraisals that were over 300% apart in value. How does that happen? Following are the reasons we isolated:
- The client cash flow projections were significantly revised downward by one valuator, and not the other.
- One firm used market data based on guideline public company metrics (e.g. earnings per share, etc.). The subject was small versus the publics, so very subjective adjustments were necessary. The second firm did not use a guideline approach. Rather, it relied on extracting data from actual sales transactions. In other words, based on interpreting deal terms of similar firms' sales, a multiple range was estimated. This range was applied to an adjusted EBITDA of the subject. These two approaches should dovetail with each other, but were far apart in concluding a market approach.
- Risk assessed, in terms of the future cash flows, varied widely. Thus, the discount rates used to create present value of the cash flows and residual value were apart by more than 4%. Since this was a large revenue and profit firm, a 1% variance reflects a large delta in overall value.
The above factors were significant in the value difference. In addition, we identified several other variances in assumptions, leading us to conclude that the expertise (quality) of one firm was severely lacking.