The Value in Valuation

Like many small businesses, we are spending some time this winter looking back and thinking forward.

We are grateful and excited to have the opportunity to take the experiences and real-world education we gained in 2020 and apply them to our practice in 2021 and beyond.

In that spirit, we are thinking about the foundations of our own industry and practice. What do we actually offer our clients?

What is the value in valuation?

What is an Appraisal?

An appraisal is:

an independent opinion of value.

That’s it. Simple enough!

But those three key words each hold a great deal of meaning to appraisers and their clients.

INDEPENDENT: Every party involved in a business or transaction has bias. The Endowment Effect - what I like to call the Beautiful Baby syndrome - doesn’t just apply to the business owner.

It applies to every buyer, seller, broker, accountant, attorney, banker, employee, family member, vendor, and customer of the business.

Everybody who could gain any potential benefit from a business or a transaction wears their own pair of glasses with their own unique tint.

This does not just apply to financial benefits: psychological and professional benefits often tint one’s glasses as much as, and often more than, financial benefits.

The appraiser is also a fallible person with his or her own experiences and influences; but the appraiser has no interest in the business or the assets being appraised. The appraiser is trained to view a business and its assets with clear lenses.

If you don’t have independence, you’re no more reliable than the parent judging their own baby in a beauty contest. You will see what you want to see.

OPINION: Appraisers are not fortune tellers, and although many try to hide behind charts and tables, we are not able to mathematically predict the selling price of any asset.

As was demonstrated (often painfully!) in 2020, we can’t say with any certainty whether a selling price achieved last month will be duplicated for a similar asset sold next month.

Many of our colleagues have been appraising through several long-term market-resetting events, such as the dot-com crash and the 9/11 attacks. We came of age (professionally speaking) in the extended aftereffects of the 2008 financial crisis, built our practice over the recent domestic manufacturing boom years, and now are making it through the COVID roller coaster and the coming post-COVID churn.

We are learning for ourselves that our appraisals may be based on the best available market data, but they are definitely not predictions! They are opinions with support, yes - but they are still opinions.

The only way to know with absolute certainty what an asset is worth is to sell it and see how the market responds. Even then, you may wonder if it would have brought more or less if you have followed a different plan for marketing, hired a different broker, waited for a better offer, and so forth.

Clients rely on appraisers to help them understand asset values and mitigate risks by presenting likely potential market outcomes. Promoting the appraiser’s opinions as facts could encourage clients to take inappropriate risks with assets. Acknowledging uncertainty is the duty of the responsible appraiser.

VALUE: Value is not a fixed concept. Or, as I have heard many appraisers say, “Value is a moving target.”

Value isn’t necessarily equal to selling price, or new cost, or the amount of profit you can make by using an asset. As discussed above, even if you have sold an asset, you must accept the reality that the outcome could have been different under different circumstances.

Value is simply what an asset is worth to a specific party at a specific time and under specific selling circumstances.

The number on the front page of your appraisal report may look like a fixed selling price – but the appraisal report gives you important context for that value opinion. When you read the report, you will find that the appraiser considered a very specific buyer or type of buyer; a very specific date or marketing timeframe; and a very specific set of selling circumstances.

Changing any of those considerations could have resulted in a very different number on the front page!

A Moving Target

For example, think about the value of a piece of machinery which is necessary to produce a specific product. (Perhaps like the giant donut proofer shown at the top of this article...mmmmm that was a delicious appraisal!...but I digress...)

First, consider the buyer to be a competitor who is unable to produce this product currently, but wants to do so immediately; consider the marketing timeframe to be as long as it takes to identify the best buyer and close financing for the purchase; and consider the selling circumstances to be that the machine is offered with full warranty and is to remain installed and operating as it currently does.

Now, consider the buyer to be a competitor who already has this production capacity and doesn’t need another machine; consider the marketing timeframe to be one week because you have to vacate the premises; and consider the selling circumstances to be for immediate removal, as-is, where-is, for cash, with all risk and costs belonging to the buyer.

Obviously, the value of the machine in the first scenario is likely to be much higher than the value of the same machine in the second scenario.

The appraiser can give you their opinions of likely selling price outcomes in either scenario. Both of them will be A value of the machine – but neither will be THE value of the machine.

Such a thing does not exist!

Tim Roy, ASA, Senior M&E Appraiser

Capitale Analytics

[email protected]