A brief description of how to appraise a business, a home, or anything else.
By Mark D. Harris
Determining the value of something is a daily task for everyone and has been since the dawn of time. We value groceries, dishwashers, and even our time in dollars, so a bag of groceries that costs $50 is worth one hour of our time, while the dishwasher is worth ten hours. Value includes a host of factors. Acquiring a business, for example, should result in direct financial gains. Acquiring one of your suppliers, however will result in direct financial gains and synergies with your existing business. Reacquiring a shop once owned by your grandfather should result in direct financial gains and meet your emotional needs. Value is unique to each individual but will usually fall within a widely accepted range. Legally, value is what a reasonable buyer with full information and under no undue influence would pay for an entity in a free market (Hitchner, 2017). Valuation has become entertainment, with expert valuators at the Antique Road Show identifying “rags” (clothes, furniture, letters, items of unknown value) that are actually “riches” (valuable artifacts, antiques, and collectibles) for the owners and viewers.
USPAP History
In the Savings and Loan scandal of the mid-1980s, undercapitalized businesses with real estate received sky high appraisals. These businesses were given loans of far greater value than the underlying property and many firms defaulted (Hitchner, 2017). Congress stepped in, and the resultant entity, the Appraisal Foundation, created and adopted the Uniform Standards of Professional Appraisal Practice (USPAP). The three types of appraisers delineated are real estate appraiser, personal property appraiser, and business appraiser (Hitchner, 2017).
USPAP
USPAP standards are prefaced with requirements common to all valuations. An appraiser must not perform any appraisal with bias (conduct). Appraisers must disclose to their clients any conflicts of interest (Hitchner, 2017). Appraisers may not conduct an appraisal contingent on the reporting of a predetermined value. Appraisers must act in good faith regarding client confidentiality (Hitchner, 2017). Appraisers must keep complete records including names of client and users, report copies (written and oral), and supporting documentation for at least five years after preparation (Hitchner, 2017).
The competency rule stipulates that appraisers must have the knowledge and experience to appraise correctly. The scope of work rule notes appraisers “must identify the problem to be solved, determine and perform the scope of work necessary to develop credible assignment results, and disclose the scope of work in the report” (Hitchner, 2017). Finally, since appraisal regulation is primarily done by the states, not the federal government, USPAP standards conflicting with state law may become void. All USPAP standards not in conflict remain in effect. The USPAP standards are as follows: (Appraisal Institute, 2023)
- Standard 1 – Real Property Appraisal, Development
- Standard 2 – Real Property Appraisal, Reporting
- Standard 3 – Appraisal Review, Development
- Standard 4 – Appraisal Review, Reporting
- Standard 5 – Mass Appraisal, Development
- Standard 6 – Mass Appraisal, Reporting
- Standard 7 – Personal Property Appraisal, Development
- Standard 8 – Personal Property Appraisal, Reporting
- Standard 9 – Business Appraisal, Development
- Standard 10 – Business Appraisal, Reporting
The standards are considered the minimum standards required for valuations, but are not all-inclusive (Hitchner, 2017). Based on the situation, far more investigation may be required of the appraiser,
USPAP Standard 10 – Discussion
The report, whether written or oral, can be considered the “bottom line” of any inspection, investigation, or study. Rule 10-1 requires reports to be clear, accurate, and sufficiently detailed to communicate all the pertinent information. Notably, it also requires appraisers to reveal their assumptions, hypothetical, and limiting conditions. An assumption common in all valuation is that historical information predicts future results, at least in some manner. The possibility of six sigma (black swan, very uncommon) events cannot be ignored.
Rule 10-2 contains the meat of the report, beginning with fundamental information like the identity of the client, the purpose and date of the appraisal, and the business or entity appraised. Ownership control must be noted, as participants with minority interest have far less ability to protect themselves (Hitchner, 2017). Parts of a business that lack marketability or liquidity must be noted. Appraisers must mention the information analyzed, the procedures followed, and the reasoning behind those procedures (Hitchner, 2017). The Restricted Appraisal Report requires similar information. Rule 10-3 specifies elements of a signed certification from the appraiser.
Example of a valuation – The Christian bookstore
A friend died of brain cancer in the summer of 2021, leaving behind a widow, adult children, grandchildren, and a sole proprietor Christian bookstore in town. The bookstore occupied one storefront in a strip mall which also included Tudor’s Biscuit World, a popular local chain. The mall was well established with several anchor stores including Wal-Mart, Lowes, and Kohl’s. The Christian bookstore was profitable even during the height of the COVID pandemic and became much more so in the aftermath.
The Christian bookstore could be valued by the income approach (discounted cash flow), the market approach, the asset approach, a combination thereof, or all three, providing a range of values. The store is an ongoing concern despite the demise of its owner, disfavoring the asset approach. Also, no other Christian bookstore exists in our town (pop 18,000) so finding comparable stores in the market approach may be difficult. As a private business, standard financial statements are not available, complicating the income approach.
In USPAP Standard 10, Reporting, the appraiser would include and explain all this information and reasoning should a valuation have been needed, such as if the business needed to be sold. As a sole proprietorship, all control would accrue to the new owner. The appraisal would be based on the highest and best use (Lim, 2022). No part of the Christian bookstore lacked marketability and liquidity was high. The appraiser would record and analyze all balance sheet items as follows:
- Assets such as cash and cash equivalents would be recorded at current market value.
- Inventory would most likely be assessed at replacement value.
- The Christian bookstore leased its storefront and so owned no property or plant. Equipment included only a depreciated cash register and some computer equipment.
- Liabilities were few.
The appraiser would also record and explain historical income statement information and projections for revenue in the future. The scope of work for a small entity like the Christian bookstore would be limited. Finally, any appraisal would require a Standard 10-3 certification (Hitchner, 2017).
Conclusion
USPAP standards mandate a minimum standard of practice for appraisers in real estate, personal property, and business valuations. Standard 10 focuses on business reporting. It includes background information (10-1), report methodology and findings (10-2), and certification (10-3). The right knowledge and experience, and the courage to report truth despite pressure towards errors, cannot be forgotten. Had my friend’s business been sold, its value would have been all his widow had to sustain her later years. An accurate valuation would be essential to her well-being. When the Bible tells God’s people to defend widows and orphans, this is part of what it is talking about (Isaiah 1:17).
References
Appraisal Institute. (2023). Standards of Professional Practice. http://Www.appraisalinstitute.org. https://www.appraisalinstitute.org/professional-practice/ethics-and-standards/standard-of-professional-practice/
Hitchner, J. R. (2017). Financial valuation: applications and models. Wiley.
Lim, H. (2022, November). How to Read Commercial Real Estate Appraisals – ProQuest. http://Www.proquest.com. https://www.proquest.com/docview/2731213411?pq-origsite=summon
