Calculation of Value: A Limited Scope, Less Costly Valuation Option

By Jason W. LeRoy, ASA, CVA, CFE Shareholder, Valuation and Litigation Support Group

Business owners, attorneys, brokers and advisors frequently have the need for a business valuation. Often times their needs require something less than a lengthy, comprehensive business valuation report, which can be relatively costly. A calculation of value may be the perfect option for someone needing a preliminary or “back of the napkin” business valuation.

Calculation of Value

A calculation of value is an estimate of the value of a business arrived at by applying valuation procedures agreed upon with the client and using professional judgment as to the value or range of values based on those procedures.

A calculation of value can be performed as part of a calculation engagement, which is defined by the American Institute of Certified Public Accountants (AICPA) as:

“A valuation analyst performs a calculation engagement when (1) the valuation analyst and the client agree on the valuation approaches and methods the valuation analyst will use and the extent of procedures the valuation analyst will perform in the process of calculating the value of a subject interest and (2) the valuation analyst calculates the value in compliance with the agreement.  The valuation analyst expresses the results of these procedures as a calculated value either as a single amount or a range.  A calculation engagement does not include all of the procedures required for a valuation engagement and if a valuation engagement had been performed, the results might have been different.”

A noteworthy item from the above definition is that a calculation engagement does not include all of the procedures and requirements of a full, comprehensive valuation, which is technically referred to as a valuation engagement by the AICPA. In the event a full, comprehensive valuation was performed, that value may be different from the value reached in a calculation of value.

Scope Limitations

The scope of a calculation engagement is less than what is required in preparing a full, comprehensive business valuation. Examples of scope limitations for a calculation of value include, but are not limited to, the following:

• The approaches or methods used to value the company are agreed to in advance, often time limiting the valuation to one or two methods.
• A site-visit or interview with management is restricted or prohibited.
• The value is presented as a range rather than a single number.
• Limited information is available which may eliminate the use of one or more valuation methods and also limit the qualitative analysis typically performed.
• Restrictions are placed on the intended users of the report.

Uses for a Calculation of Value

The AICPA standards do not prohibit or endorse the use of calculations of value under any specific purpose of valuation. However, other regulatory bodies such as the Internal Revenue Service (IRS), Tax Courts, Family Law Courts, the Department of Labor, etc., have requirements or standards which may prohibit the use of calculations of value. Common purposes for using a calculation of value rather than a full, comprehensive valuation are as follows:

• Litigation – Calculations of value may be useful for settlement purposes in matters relating to marital dissolutions, bankruptcy, contractual disputes, owner disputes, shareholder oppression matters, or employment and intellectual property disputes. In the event the matter proceeds to a hearing, arbitration or trial, the calculation of value will need to be enhanced into a full, comprehensive report.
• Transactions (or potential transactions) – Business owners, corporations or their advisors may need a preliminary value in matters relating to mergers and acquisitions, leveraged buyouts, partner and shareholder buy-ins, or stock redemptions. A calculation of value may be a good option at the beginning stages of negotiation in a transaction. In the event a more credible or substantiated report is required to complete the transaction, the calculation of value can be updated to meet the requirements of a full, comprehensive business valuation.
• Tax Compliance – Business valuations are frequently needed in tax compliance matters relating to corporate reorganizations, S-corporation conversions, estate and gift tax compliance, or charitable contributions. A calculation of value may be useful in these situations if a preliminary value is needed for planning purposes; however, in the event the valuation will be used for tax purposes and reviewed by the IRS, a full, comprehensive report would be needed to comply with IRS requirement.
• Personal Financial Planning – Business owners and their advisors often want to know the value of a business interest for purposes of personal financial planning. A calculation of value can be a great tool to provide the business owner or their advisors with a value of the business at a reasonable cost.  In the event the business will be listed for sale, gifted to family members, sold to an ESOP, etc., a full, comprehensive valuation would be needed.

If you’re in need to of determining a preliminary or “back of the napkin” business valuation, contact Doeren Mayhew’s advisors to learn more about our business valuation services.

About the Author

Jason LeRoy specializes in preparing business valuations for litigation and non-litigation purposes, and providing expert witness testimony and marital dissolution consulting services, as well as fraud and forensic accounting services. He can be contacted directly at leroy@doeren.com or 248.244.3177.