Proposed method to deal with confusion over discounts

There has been a call for action for the profession to speak with one voice and eliminate the confusion over the use of discounts (see prior coverage in BVWire). One valuation expert offers up some nomenclature and—more importantly—a framework that he hopes will help in developing a common language that could be used in valuation reports.

Map it: One way to make sense of discount adjustments is to provide a road map describing the adjustment process/method used, according to Mike Smith, a senior manager in the valuation department of Baden, Gage & Schroeder LLC (Fort Wayne, Ind.). “This mapping of the adjustment process would clearly show others where the valuation practitioner made the adjustments and the extent of each adjustment. Any factor the analyst feels requires an appropriate adjustment should be listed as one of the forces impacting value.”

Many valuation reports fail to include a discussion of adjustments. Valuation standards require that the base value to which a discount or premium is applied must be specified and defined. “Unfortunately, not all business valuation practitioners take heed,” says Smith. Also, one of the complaints of using discounts is that many factors presumably represented in the discount are already accounted for in the risk, cash flow, or growth assumptions. “Adjusting the three income approach model variables is likely the purest form of adjustment and should be the first place to turn when addressing an adjustment,” he says. “But we still need a way to understand how all adjustments are knotted together.”

Smith observes that discounts have a “warm place” in the hearts of many practitioners, “but I would submit that the valuation community is doing a disservice allowing such a wide diversity of practice regarding documentation of discounts and adjustments in general,” he says. “Business valuation is a complex endeavor indeed, but a little transparency regarding all adjustments would go a long way toward educating each other, our clients, and the courts.”

Smith demonstrates his approach in an article “Adjustment Mapping and the Public-vs.-Private Company Discount Debate,” which appears in the August issue of Business Valuation Update. It's also available as a standalone article. What do you think about this issue? We’d love your feedback.