During my recent break from this blog, I’ve been thinking about the future of ChrisMercer.net. Over the years on this and my previous blogs, I have written about many valuation-related topics and some personal topics, like walking, pickleball and other things.
I’ve written series of posts on broad themes, including themes of statutory fair value, the largest valuation discount (guess which one), buy-sell agreements, corporate finance for private businesses and their owners, the integrated theory of business valuation, and a number of others. These series of posts spawned, among other things:
- Buy-Sell Agreements for Closely-Held and Family Business Owners, its out-of-print predecessor, Buy-Sell Agreements: Ticking Time Bombs or Reasonable Resolutions), and its Kindle sister publication, Buy-Sell Agreements for Baby Boomer Business Owners.
- Unlocking Private Company Wealth: Proven Strategies and Tools for Managing Wealth in Your Private Business.
- Enhancements to our main valuation theory book, Business Valuation: An Integrated Theory Third Edition (with Travis W. Harms)
- Significant (to me) articles in capitalizing EBITDA, on the uselessness of restricted stock studies to determine marketability discounts, subsequent events, fair market value, and many more.
- Many speeches on topics related to the above and more in the nature of one-offs.
In short, ChrisMercer.net has been the place I’ve tried out most of my new thinking prior to its later exposure in books, articles, and speeches.
My next major theme will be the broad theme of appraisal review. The review of appraisals is essential. We should think about appraisal review in three broad contexts. The first context consists of the situations where appraisal review is important. The second relates to the background that an appraiser must bring to the appraisal review process to be effective. And the third relates to the methods, or the manner in which effective appraisal reviews are rendered.
When Is Appraisal Review Important?
Appraisal review is important for the development of credible assignment results in a number of circumstances, which begin at the initial level of personal review of our own reports and move to reviews in litigated matters where differences in valuation assumptions and assumed facts or circumstances can lead to wide variations in conclusions.
- Our own reports. Every business appraiser must be in a position to review his or her own reports. This is the first and most basic concept of appraisal review, and it is often overlooked. I tell all valuation analysts at Mercer Capital and elsewhere that review begins with self-review. A draft valuation or related report is not complete until the drafter sets time aside to review his or her own draft report. I’m old-school, but I suggest waiting a day or two after completing a draft, then printing the draft, then reading the draft from beginning to end, including all so-called “template” or “standard” material, from the viewpoint of non-appraiser readers of the report. This personal review, however, is generally inadequate to finalize a high-quality appraisal report. But this first and personal review is a critical first step in developing reasonable valuation reports.
- Reports of others in your firm. If you are the senior on a project in a firm with other analysts working with you on valuation projects, your personal review of all draft reports is a critical element in the production of quality appraisal reports. In addition, you may be asked to review the work of other appraisers prior to their release externally to get your input on their effectiveness and credibility.
- Reports of other appraisers not in your firm. We are sometimes asked to review reports prepared by other firms as an independent check on quality control by the other firms. An attorney or an ESOP trustee will ask often us to review a report prepared by another firm to determine if there are problems or issues based on our review. These reviews may be preliminary to a more formal retention or may be stand-alone in nature. There may or may not be any formal “reporting” of the review in these circumstances.
- Reports in litigated situations. In significant litigations involving disputes over the value of businesses, each side typically retains an appraiser. The “dueling appraisers” prepare their reports and they are exchanged. In smaller litigations, each expert may be asked to “review” the report of the other expert, and these “reviews” become a part of the process. In larger litigations, one side or the other may retain an independent expert to review the report of the opposing side, or even to review both reports, providing an independent opinion for the court regarding the relative merits of the two reports. These reviews tend to be more formal in nature than for the other types of reviews noted above. They might be formal reviews under the review standards of USPAP, i.e., Standards 3 and 4.
The need for appraisal review, then, ranges from informal personal reviews conducted by individual appraisers of their own work to formal reviews conducted in litigation. This concept of a range of reviews is broader than the typical thought of appraisal review, which is of the formal type. All types of review are, however, important.
Important Background for Appraisal Review
By review, I mean much more than a series of tasks that an appraiser should consider or follow in reviewing the work other appraisers or even her own work. Review, in the broadest sense, relates to the body of knowledge that a reviewer must bring to the table to be effective.
The question then becomes whether the reviewer can bring this body of knowledge to the review task at hand. The following areas of knowledge and understanding are among those needed for effective appraisal review, whether informal or formal in nature.
- Business appraisal theory and methods. It is difficult to assess the reasonableness of an appraisal or related report without a good understanding of basic valuation theory and methods employed to exercise that theory. That understanding is developed over years of reading, training and practice.
- Generally accepted appraisal practice. Particularly in a litigation context, a review appraiser may be asked if the report under review follows generally accepted appraisal practice. This is a broad and somewhat loose term; however, the review appraiser must be familiar with this concept and be able to discuss it knowledgeably.
- Business appraisal standards. Credentialed business appraisers are required to comply with the business appraisal standards of their respective credentialing organizations and, for many, with the Uniform Standards of Professional Appraisal Practice (USPAP). The review appraiser must have knowledge and understanding of appraisal standards. In the context of a formal appraisal review, a review appraiser may be asked her opinion of whether the report under review is compliant with relevant business appraisal standards.
- Standards of value. Every business appraisal report is rendered under a specified standard of value. Fair market value is the most common standard of value. While the definitions of fair market value are well-known, the understanding of the implications of the standard and the impact they have on appraisal practice are less well-known. Statutory fair value is defined, either by statute or judicial interpretation or both in the various states. The review appraiser must have or develop an understanding of fair value in any jurisdiction in which a fair value report is being reviewed.
- Levels of value. The concept of “levels of value” falls under the heading of valuation theory. However, differing interpretations of the appropriate level of value in contested valuation situations are often the major source of differences in conclusions. The differences may arise from unclear language in a buy-sell agreement, from uncertainty regarding interpretations of the meaning of statutory fair value in a jurisdiction, to plain misunderstanding of the nature of the required valuation. The review appraiser must be able to make reasonable interpretations regarding the appropriate level of value in each review situation.
- Valuation literature. The review appraiser must have reasonable exposure to the valuation literature available at the time of review. No one can read everything, but reasonable knowledge regarding current valuation literature is important.
I have been a review appraiser often over the last 40 years or so, and have seen widely disparate valuation opinions based on differences in each of the categories of the body of knowledge outlined above. The background required of an effective review appraiser is more extensive than many would imagine. That background includes the entire body of knowledge about business appraisal.
Effective Appraisal Review
The third broad context within which to discuss appraisal review relates to the methods used and the manner in which reviews are conducted. his section will be short because we will address the conduct of appraisal review in future posts. At this point, however, let me suggest that following a careful reading and analysis of the text of a report, replication lies at the heart of good appraisal review.
By replication, I mean that the review appraiser should replicate all the math of the report under review. his process enables the reviewer to, among other things:
- Identify mistakes in math or logic.
- Understand the nature of the valuation and the key assumptions that drive it.
- Verify the sources for key inputs or assumptions.
- Understand the reasonableness or not of the valuation methods employed.
- Test the sensitivity of the report under review to changes in key assumptions.
- Facilitate understanding whether the report is compliant with prevailing valuation standards.
- Compare the valuation on a side-by-side basis if multiple reports are under review.
We will discuss appraisal review methods in detail in future posts on this blog.
Until the next post with a focus on appraisal review, be well.