Revenue Ruling 59-60 and business valuation standards require that we consider economic trends in our appraisals. I rarely see a report that does not do this in some fashion: we get it. But our reports do not have to contain multi-page, detailed, quantitative recitations of economic statistics and forecasts for every sector of the economy at the international, national, regional, state and local levels. Rather, the really good ones identify up front the most important economic drivers (such as business investment in construction, wage levels, and labor market conditions) for a commercial contractor) and the economic level (perhaps regional for a smaller contractor) relevant to the business. When I read this type of incisive diagnosis, my confidence in the appraiser rises.
For many business valuations, however, a focus on pure economic trends might be incomplete. The pace of technological change is much more important for biotechnology and Internet businesses. Demographic trends – the aging of the population – are consequential for health and elder care businesses. The list of potential non-economic factors is potentially endless and unique to each assignment.
As an aside, if you have ever been part of a strategic planning exercise for a non-profit or community organization, you may have run into this challenge. These exercises often begin with a “SWOT” (Strengths, Weaknesses, Opportunities, Threats) analysis that considers the organization (S and W) and the environment (O and T). Badly facilitated sessions can easily get way off track discussing trends of questionable relevance, and people can easily get lost in that thicket. It can be hard to keep such sessions focused on trends of real consequence.
Bearing this in mind, no appraisal can address every possible trend that might affect a business. It’s impossible, and certainly not acceptable in terms of what it would cost a client to commission such a treatise. We need way to home in on the most important trends – the drivers. I have found that key questions to ask are: “What makes this business tick?” and “What could really hurt this business?” First, I think about them by myself, based on my general knowledge (or lack thereof, in some cases). Then I consult our standard industry information sources like First Research, which (particularly in the management questions section of its reports) often mention critical trends. Finally, I ask these questions during my management interviews. (By the way, try this in your next community service strategic plan exercise. You’ll be a superstar! You will also, however, be asked to chair the committee and write the report. You have been warned
One last hint: call your “Economic” section of your report your “Environment” section instead. This encompasses all relevant trends, and helps you broaden your thinking while at the same time sharpening your focus on what really drives or endangers a business and its value.