Are Valuations Really Beneficial or Necessary at the Time of Equity Exchange?

Are Valuations Really Beneficial or Necessary at the Time of Equity Exchange?
If I had a dollar for every time I was asked what an accounting, financial planning or legal firm was worth, I would be a very wealthy woman. Of course, my reply is generally, “how long’s a piece of string” or “that depends on a number of factors such as ……….”.

One of the hardest aspects to consider is how each specific attribute or characteristic of a firm compares to the marketplace and impacts upon its particular overall value. This is probably my greatest criticism of online or template driven valuation software/programs. How does the user really know which of the five choices (for example) under a particular question is actually most applicable to them or their client? We can all have the ‘rose coloured glasses’ on when it comes to our own view of our business but it’s very hard to be independent and objective.

An excellent example of the disparity that can be found in practice values is when I consider all the valuations that we have completed over the past 40 years. The lowest result was 19 cents in the dollar of fees for an accounting practice and the highest was $1.36 in the dollar of fees for a multidisciplinary firm. However, generally a good proportion of them equated to a value of somewhere between 50 and 80 cents in the dollar. As a side bar, for us, cents in the dollar is simply a unit of measurement with which the profession is familiar.

So, let’s think what this actually means for the parties involved in such a transaction, the vendor and purchaser. If we take an accounting practice with $1 Mill in fees, the potential range for goodwill value in this instances could be somewhere between $190,000 and $900,000. This is a huge variance. But even if we say between $500,000 and $800,000, this is still somewhat of a significant range. Naturally, the specific purpose or proposal in terms of the transaction will also be fundamental to the process and its derived value.

Moving forward, how is a decision reached in circumstances such as above? No doubt the person selling will want $800K or more and the person buying will want to pay a fair value at the most. This can result is some really tense negotiations, which from experience, can end without an outcome. Naturally, the negotiation could always end up splitting the difference, but in the example above that still could mean a difference of $150K.

Importantly, as valuers, we are the first to agree that small differences in value between the involved parties should hopefully be able to be resolved without a valuation. If all parties are in agreeance regarding value, then a valuation is neither necessary, nor beneficial. However, when the cost of a valuation is only $6K – $8K in most instances, or less for short form valuations, going through the valuation process can certainly add value to an equity exchange. It provides an independent party’s view about the value of that particular practice, from which all parties can then negotiate and be satisfied with the outcome and value that is subsequently paid. Such a result is far better than potentially receiving too little, paying too much, or having one of the parties in the negotiation walk away without an outcome.

Valuations can be conducted for a range of reasons such as the entry or exit of equity holders, the sale or purchase of a practice, the sell down of equity to another party, stamp duty or CGT purposes, general strategic planning, inclusion within proprietorship agreements, succession planning, to underpin risk insurance or marital breakdown situations, just to name a few. The valuation process can be conducted throughout the calendar or financial year, however for those firms expecting to experience a change in ownership or equity around December 31st – January 1st, we recommend you start thinking about initiating the process soon to enable sufficient negotiation time in the lead up to these dates.