In the course of teaching, mentoring, consulting, and litigation support, I have reviewed reports prepared by many other appraisers. I usually reach an overall opinion of the quality of a report after reading it for the first time:
1. It is way off the mark (due to many fundamental errors and omissions).
2. I am not sure (so I need to read it again).
3. It is probably pretty good.
Here are ten things I look for in my first readings of reports, with explanatory examples of each, assuming the assignment is to determine non-marketable minority fair market value:
1. Did they identify the relevance of each Revenue Ruling 59-60 factor?
Earning capacity: Equity cash flow was the selected metric. It is the annual change in cash before dividends. It adjusts profits for non-cash items, capital outlays, asset sales, and changes in working capital, debt, and liabilities.
2. Did the economic analysis focus on company value and risk drivers?
The valuation of a local car dealership should consider things like the outlook for domestic automobile sales, the local economy, and consumer credit. Trends in other macroeconomic factors like business investment, balance of payments, etc. are irrelevant.
3. Did the industry analysis focus on company value and risk drivers?
For a car dealer, there’s a big difference between General Motors and Honda today!
4. Did the company analysis focus on value and risk drivers?
Key person risk is always at the top of my list.
5. Were financial statement adjustments identified and justified authoritatively?
Appraisers who ignore good sources like ERI (Economic Research Institute) and rely on Risk Management Association data are not sufficiently diligent,
6. Was their financial forecast complete (full statements) and were the assumptions clearly identified and justified?
Debt is repaid as scheduled per the Company’s financial statement footnotes.
7. Did the Market Approach development justify the price multiple chosen?
If you compare the subject company to industry norms (e.g. Risk Management Association ratios) you can build a strong case for its relative attractiveness.
8. Did the Income Approach development justify the company-specific equity risk premium?
Did they mention revenue and expense uncertainty, amount of debt, adequacy of equity capital, etc.?
9. Was enterprise value subjected to a justification of purchase test?
If someone bought the business for the indicated value, could they pay themselves or a manager a fair market salary, adequately service debt, and earn a satisfactory return on equity investment?
10. Was the discount for lack of marketability justified with multiple methods and based on company-specific facts?
Benchmarking and the QMDM can be used in tandem for this purpose.
I am sure there are more aspects of good reports that I have not mentioned here…as always, your input is appreciated! What I have found is that reports that hit all of the above points well are usually pretty good. If I have disagreements with them, they will be either judgment calls (should the growth rate be 5% or 6%) upon which there can be legitimate differences of opinion, or the errors are local in nature (e.g. a math error or inconsistent levels of value concluded with various methods) and easily corrected.