Calculations, appraisals–and how to satisfy clients

By Richard A. Warner, ASA, AVA; Sr. Contributing Editor, BVWire

Recently there was a discussion on LinkedIn regarding whether Accredited Senior Appraisers (ASAs) were permitted to perform “calculation engagements”. The discussion proceeded along the lines of what constituted a calculation engagement, how this differed from an appraisal, and in part provided a dissection of the various professional standards in place applicable to the work that we do as appraisers.

Some background and definitions might be useful at this point. By the way, these are my own thoughts, and they don’t necessarily comport with the nuanced language of the various professional standards. The other qualifier here is most of the work that I do is performed under a standard of value of “fair market value”.

Let’s start off with what constitutes an appraisal. When I as an appraiser am retained to complete an appraisal of a business, or a business interest, my scope of work includes putting myself in the shoes of an investor and looking at all available relevant information that will allow me to reach an independent “opinion” of the value of whatever it is that I’m appraising. I should consider all approaches and methods of valuation that help me to reach my opinion. Basically, when doing an appraisal, the scope of work for my analysis is limited to what I think will be useful to me.  The scope of work for my report is well defined by the Uniform Standards of Professional Appraisal Practice (USPAP) and other applicable standards (as published by the National Association of Certified Valuators and Analysts, or the American Institute of Certified Public Accountants, and others).

What constitutes a “calculation engagement”? The American Society of Appraisers’ Business Valuation standards provides a definition, as do the AICPA and NACVA standards, but basically these boil down to a calculation engagement providing an “approximate indication of value”. The scope of work for the supporting analysis is less than that for an appraisal, and the reporting requirements for calculations offer considerable flexibility to the appraiser with regard to what ultimately ends up being reported, or even how it is reported (written vs. orally). And why does such a work product as a calculation even exist? I can only think of one reason–cost. Clients don’t want to pay any more than they have to for whatever work product meets their needs.

At some point, someone must have thought about the types of engagements where an appraisal is required and others when a more limited scope work product would suffice. It used to be that reports submitted in support of certain tax related issues needed to be in the form of an appraisal, but I’ve even seen this thinking challenged recently. Others have suggested that if a valuation issue is going to be litigated, then you want the most comprehensive analysis possible, in the form of an appraisal. In other situations where a client is simply in the planning phase (say for the possible sale of a business), or in a pre-litigation settlement discussion phase (perhaps in a divorce), maybe a more limited, less costly work product will do.

But just to keep things interesting is the requirement for ASA accredited members and candidates to be in compliance with USPAP.  USPAP however does not provide for a work product called a “calculation”. Some have interpreted these writings to suggest that ASAs cannot engage in a “calculation engagement” nor can they provide a more limited “calculation report.”

So keep this in mind as we turn to the issue of what do clients think about and what do they need to know about the differences between calculations and appraisals?

Let’s walk through a pending divorce and role play a bit to see where this goes.  Let’s also assume that my client is an experienced attorney, who is comfortable with valuation issues.

The attorney (my client) contacts me, explains that she and her client have a need for a valuation, because they are in the early stages of a divorce and need some information for possible settlement discussions.  The business in question is an operating entity with say $2 to $3 million dollars in revenue. The business got beat up during the recession, but now appears to be digging out. The end client doesn’t have a lot of money to spend on a valuation, and only needs a number to be used in preliminary discussions with opposing counsel.

For me as an appraiser to start a discussion that says, “well, a comprehensive appraisal that will be used in court will cost between $8,000 and $12,000” is generally a non-starter. A “calculation engagement” is a deliverable that might make sense here.

But do both the client and his/her attorney really understand what is being offered here? What are the limitations to a calculation engagement? What’s included?  What’s not included in a calculation that is included in an appraisal? If I limit my valuation methodology to a capitalization of earnings, will that provide a number that is anywhere near reality for the client? Are there limits to how this deliverable can be used? How approximate will the number be that you provide in the calculation engagement?

These and others are all questions that as appraisers I’m not sure we take enough time to talk about with the client, or client’s counsel. I think it’s always challenging to set expectations properly for one of these types of engagements. Think about it.  I’m going to give my client a “calculated value”. But maybe I didn’t do a full economic analysis; maybe I didn’t do an industry analysis; maybe I relied on a single cost of capital estimate; perhaps my financial analysis was otherwise limited.  The question becomes at what point do the limitations inherent in a calculation engagement limit its ultimate usefulness? If my analysis is so limited as to call into question the range of value to be assigned to whatever it is that I’m appraising, then why would a client ever pay for that?

Well, as my father often told me, “it’s not a perfect world.” So given the realistic, pragmatic needs of clients, and our ability as appraisers to deliver something called a calculation to clients, what should we do to make this type of engagement as satisfying as possible for all concerned. Here are my suggestions;

  • Engage in plain-spoken, blunt conversations with the attorney and the client about what type of analysis will be included as part of the engagement; discuss the impact of not doing certain types of analysis; for example, if you’re not going to do a full industry analysis, talk about how this might impact any indication of value provided;
  • Talk about how the deliverable can be used, and how it cannot be used; if the deliverable cannot be used in open court, or the subject of any deposition proceedings, make sure everyone understands this and what this means;
  • Be prepared for both the attorney and the client to refer to your work as “an opinion”, or “your appraisal”, when in fact your calculation is neither; in fact, try to make sure these words never show up in your calculation report;
  • Take a look at the last year or two of company financials before even completing an engagement letter; I can’t tell you how many times I’ve gotten roped into engagements thinking that the business was a simple operating business and then found out that the capital structure of the company was much more complex than imagined, that excess non-operating assets were in play, that significant adjustments would be required to the income statement to get to anything resembling an approximate value for the company, that the entity was a pass-through entity, that significant net operating losses were present, etc., etc. Shame on me.
  • Be prepared to walk away from such engagements; this is really easy to say, but hard to do in practice especially if the attorney involved has been a source of referrals in the past; remember, if there really is a need here, somebody’s going to do the work; only you can decide if the risk-return for taking the engagement makes sense for you and your practice.

The plain fact is that calculations are part of what we as appraisers can be expected to deliver at sometime during our career. They may in fact make up a majority of the work that we do. Maybe the best that we can do is go into these engagements with our eyes wide open, and help our clients understand what exactly it is that they are contracting with us to deliver.

On a related note, it would be helpful for the various standards bodies to remove any ambiguities with regards to ASA accredited members and candidates being able to engage in these types of calculation engagements. Pragmatically, no one should assume that ASAs are going to walk away from this significant share of the market for valuation services. But that’s a topic for another day.