Nearly all appraisers use private transaction databases, the most common and extensive being Pratt’s Stats. Nancy Fannon and others have warned about errors that result when appraisers average comparables, for the obvious reason that not all sellers and buyers structure deal terms similarly. The best analysis of how to use Pratt’s Stats and other transaction databases is available in Fannon and Heidi Walker’s just-updated Comprehensive Guide to the Use and Application of the Transaction Databases.
The ASA’s Statements on Business Valuation Standards confirms the necessity to perform adjustments (only Pratt’s Stats includes sufficient documentation to allow this kind of analysis). SBVS-2 Guideline Transactions Method states that “adjustments to the financial data of the subject company and the companies in the guideline transactions should be considered to minimize the differences in accounting treatments when such differences are significant.” The AICPA’s SSVS-1 also suggests that adjustments to guideline company data, as needed, constitutes good business appraisal practice.
Jim Hitchner (Financial Valuation Advisors), who does not have a subscription to Pratt’s Stats but who has been active in the 15 years of daily peer review received by the transaction database, highlighted some of the red flags any appraiser should look for in individual transactions prior to simply averaging a set of comps. As always, and unlike any of the other transaction databases, Jim pointed out that Pratt’s Stats includes footnotes on every transaction so that appraisers can easily adjust or normalize a set of comparables as needed. Jim examined nine copyrighted transactions he copied into his presentation documents from Pratt’s Stats to illustrate typical adjustments at the AICPA National BV Conference in San Francisco.
Some of Jim’s warning signs to look for in the Pratt's Stats footnotes, which Fannon and Walker discuss extensively in their Guide, include:
1. Is working capital (excluding inventory) included? This could influence MVIC multiples when averaged with transactions that treated this asset differently. 2. Are other assets or liabilities included in the purchase price? Often, purchase price allocation information available in Pratt’s Stats can help highlight non-standard transactions (those that include more than cash paid, notes, or interest bearing liabilities). Not every lawyer and accountant prepares what most appraisers would consider “complete” documentation in the underlying deal documents, so it can sometimes be difficult to know exactly which assets and liabilities were included in certain transactions. 3. Were contingent earn-outs included? Contingent payments are normally excluded from MVIC, so transactions where contingent elements were included should generally be adjusted. 4. Is the income statement concurrent with closing? Since many of the proprietary deal documents collected by Pratt’s Stats financial analysts include statements generated as part of the offering memo or last period available, material changes may be incorrectly reflected in resulting multiples. 5. Does the purchase price allocation derived from the deal documents exclusively reviewed by Pratt’s Stats apply value to the non-compete, if any? Pratt’s Stats is the only database that reports the amount allocated to a non-compete, when it’s available or reported. Since CPAs are often lax in this accounting practice for small business transactions, business appraisers may have to derive this value based on their own judgment to compare comparables.