No, that is not a typo in the title. Being a good valuation analyst requires a considerable amount of artistic ability. When most people think of their accountant, they probably do not picture someone terribly creative or artistic. However, valuation analysis is one of the few areas of accounting that is subjective and doesn’t involve one single “correct” answer.
To be clear, valuation work is largely based on scientific evidence and procedures that have been tested and proven over time.
After all, valuation experts are not simply making up numbers. The valuation profession is regulated by organizations such as AICPA and NACVA, which have published guidelines on how to apply the appropriate valuation approaches and methodologies. These guidelines are the standards of the valuation industry because they are based on proven financial theory. However, they are only guidelines and not specific instructions because each business has unique characteristics that must be considered in a business valuation.
The art of valuation can be found in various components of a valuation analysis, including making adjustments to normalize income, selecting guideline companies or determining a discount for lack of marketability. When valuing a minority interest in a company, it may be appropriate to value the equity of the total enterprise on a controlling basis and later apply a discount for lack of control. Another option is to value the minority interest directly by using only the cash flows available to a minority owner. Deciding which approach to take is up to the valuation analyst to determine.
Selecting appropriate guideline companies is not always easy when valuing a small business. Many small businesses have developed a niche or unique characteristics that set them apart from other companies. There may not be any other existing companies that operate within that niche. This may force the valuation analyst to “think outside the box” in finding guideline companies that exhibit similar business or financial characteristics such as identifiable brand names or market share.
In The Eye of the Beholder
Determining a discount for lack of marketability is often one of the most subjective components of a business valuation. Over the past several decades, numerous restricted stock studies and pre-IPO studies have been conducted with widely varying results. Depending on the type of ownership interest being valued, a valuation analyst must not only consider these “scientific” studies, but also consider several company specific factors when determining the level of discount appropriate for the subject company. This is just another example of how art must be applied to the science of valuation.
Business valuation is an interesting and exciting field because each project allows for this creativity and variety. However, a valuation analyst should be extremely careful and thorough when determining the more subjective (or “artistic”) inputs of his or her analysis. Each of the subjective inputs discussed in the previous paragraphs can significantly affect the value of a company, and therefore will be closely scrutinized by auditors and opposing parties. A valuation analyst has the freedom to be somewhat artistic in the development of his analysis, but his assumptions must also be logical, based on supportable evidence and well-documented.