In my favorite novel, Ayn Rand’s Atlas Shrugged, a philosophy professor constantly urges his students and others to “Check Your Premises” – to be aware of their fundamental assumptions.
In business valuation, our fundamental assumptions are the parameters of our engagement: identifying the client, the purpose and use of the appraisal, the size and type of interest to be valued, the date, standard, level, and premise of value, extraordinary assumptions (such as reliance on a fixed asset appraisal), and the scope, type, and restrictions on use of the report.
Engagement parameters form the foundation of our work: they govern our research, analysis, methodology, and conclusion. If we mess up any of them, we risk being way off base.
Most engagement parameters are established without confusion. If we are doing a gift tax valuation, the standard is fair market value; the valuation is as of the gift date; and so forth. We don’t have to think a great deal about them, and our clients and their advisors are on the same page with us.
But there’s a big trap there! Some engagement parameters may be undefined. We have all seen buy-sell agreements that fail to stipulate the standard or level of value. In divorce, the valuation date is often an issue. Even worse, clients and advisors may not understand that business interests can have legitimately (and dramatically) different values depending on the chosen parameters. (How many times has an estate valuation client wanted to know “what their business is REALLY worth” – i.e., what they could sell it for to a strategic buyer? You and I can think of dozens of examples of clients / advisors trying to infer values using different engagement parameters.
The lessons are obvious:
Always check your premises. Clearly understand each engagement parameter before you start work. Explain them in your engagement letter and report.
- Do NOT let yourself get boxed into assuming an undefined engagement parameter because nobody else can establish it. If the valuation date is at issue, reserve the right to update your report (at additional cost and with adequate time to do so) if it changes, or issue a report with conclusions for multiple dates.