Valuation of businesses is an art, not a science. This belief is contrary to the trust held by many in numbers alone, eg a valuation multiple or an EBIT figure.

It is commonplace for people to believe things are worth a specific sum, call it $X. One number. $X is what is charged for each grocery item, new car and even residential premises.

But inflation makes those $X rise and unemployment and interest rates makes them fall. The boom and bust cycle make the rise and fall dramatic. Purely historical accounting numbers applied to the future can very quickly become purely optimistic.

In valuation of businesses, as contrasted to houses for example, there are vastly more variables to factor in. For example what is an IT system worth if it has only been used in-house? What is untraded business IP worth? I would respond, it depends… on many considerations that can be dealt with in an evaluation report combined with a valuation report.

I believe in business evaluation combined with valuation. As a business lawyer I’ve been involved for decades in business evaluation, indeed I’ve written, edited and assessed numerous reports on the subject.

To illustrate the breadth of issues in business evaluation, below is a checklist designed to assist in the purchase of a professional practice. It may be a practice run by accountants, engineers, architects, consultants, lawyers or other professionals.

Professional practice evaluation checklist

  1. Settle your methodology for reviewing target practices and making proposals.
  2. Obtain tax planning advice for your proposed acquisition.
  3. Define the services provided by the target firm and the framework and market potential of those services.
  4. Examine the client base and client industry projections, the client database and any CRM system, and review any client satisfaction surveys collected over the past three years
  5. Consider how transitions for any incoming principals and professional staff is to be handled including earn out options, instalment payments, and non-competition obligations both while associated or after leaving the new combined firm.
  6. Review work in progress, billing history, revenue and profit records, financial statements, and tax returns.
  7. Obtain the “claims history” of each principal’s former firm from the relevant professional indemnity insurance provider (which will be supplied in confidence only to the professional or firm that is the subject of the claims history, or any successor firm that is to inherit the claims history).
  8. Review at least 20 current files of your choosing of each principal.
  9. Speak personally to at least 10 clients of each principal of your choosing concerning their perceptions of that each professional’s performance in matters.
  10. Speak personally to professionals nominated by each principal concerning their perceptions of that principal.
  11. Review each principal’s continuing professional education attendance records over the past three years.
  12. Check each principal’s creditworthiness and criminal antecedents.
  13. Obtain a “Certificate of Fitness” concerning each principal from the relevant professional society (which will be supplied only to the professional who is the subject of the Certificate).
  14. Obtain each principal’s “complaints history” from the relevant department of the governing professional body. For example for lawyers in NSW it is the Manager, Professional Standards at the Law Society (which will be supplied only to the solicitor who is the subject of the complaints history).
  15. Arrange to meet the life principal or immediate family of each principal on some social occasions. Be prepared to reciprocate if any principal seeks at the same time to review your standing and performance.
  16. Come to an understanding of the numbers taking into consideration the above information, valuation multiples, and EBIT (if relevant).
  17. Formulate view on transaction structuring and documentation terms and conditions.

Since the 1990s my view has been that business variables and risks increase in this era of rapid, constant, and dramatic change in the way we live, work and play. This is strengthened by my reading of Taleb. I’ve shared his mistrust of common opinion, see Private equity or private debt? Beware the Ides of March. I accept there are some continuities in this era, see Australia’s first 11 in performance and valuation.

I have little trust in business valuation numbers when that’s all that’s available. We move numbers around. We’re regularly involved in helping clients increase market perception of their value. See for example 51 hints to achieve your premium business sale price and Four tasks to increase values or prices in business transactions.

I believe in valuation numbers supported by business evaluation understanding. Call for a discussion of your circumstances and for a quote.

Contact us with any questions or requests.

Noric Dilanchian