FAQ Advanced Valuation Topics

Interested in Valuing your Business? Contact a Certified Appraiser in Australia

Business Valuation FAQs

Find answers to common questions about company valuations, methodologies, and financial analysis

Search through our valuation knowledge base

What is goodwill impairment?

Goodwill impairment is a non-cash accounting charge that occurs when the carrying value of goodwill on a company's balance sheet exceeds its fair value, requiring a write-down that reduces reported assets and earnings, typically resulting from acquisitions that paid premiums subsequently not justified by actual business performance or market conditions. Goodwill arises when companies acquire other businesses for prices exceeding the fair value of identifiable net assets, with the excess recorded as goodwill representing intangible value like brand reputation, customer relationships, market position, or expected synergies. Under accounting standards ASC 350, companies must test goodwill for impairment at least annually or more frequently when triggering events suggest potential impairment including significant adverse changes in business climate, increased competition, loss of key personnel, regulatory changes, or decline in stock price for public companies. Impairment testing compares the fair value of reporting units containing goodwill to their carrying amounts including goodwill; if fair value falls below carrying amount, goodwill is impaired and must be written down. Goodwill impairment charges can be massive, sometimes billions of dollars for large acquisitions that failed to deliver expected returns. These charges reduce shareholders' equity and reported earnings but do not affect cash flows or taxes since goodwill is not tax deductible. Impairment signals that management overpaid for acquisitions or that business conditions deteriorated since acquisition. Companies in declining industries, those that overpaid during market peaks, or those experiencing operational challenges face higher impairment risk.

How do you test for goodwill impairment?

You test for goodwill impairment by first identifying reporting units which are operating segments or components one level below operating segments where goodwill resides, determining the fair value of each reporting unit using income or market approaches, comparing fair value to carrying amount including allocated goodwill, and recording impairment charges if carrying amount exceeds fair value. The testing process under ASC 350 begins with identifying reporting units, which are the lowest level at which discrete financial information is available and reviewed by management. Companies may perform optional qualitative assessments considering factors like macroeconomic conditions, industry trends, competitive environment, and company-specific events to determine whether it is more likely than not that fair value exceeds carrying value, potentially skipping detailed quantitative testing if qualitative factors suggest no impairment. Quantitative testing requires valuing reporting units using appropriate methodologies including discounted cash flow analysis projecting future cash flows and discounting to present value, or market approach applying multiples from comparable companies to the reporting unit's financial metrics. The fair value determination considers market participant assumptions about growth, margins, capital requirements, and risk reflected in discount rates. If reporting unit fair value exceeds carrying amount including goodwill, no impairment exists. If carrying amount exceeds fair value, impairment equals the excess, limited to total goodwill allocated to that reporting unit. The impairment charge is recorded immediately, reducing goodwill and earnings. Companies must document their testing methodology, assumptions, and conclusions. External valuation specialists often assist with complex impairment testing to ensure compliance and defensibility.

What is the difference between personal and enterprise goodwill?

The difference between personal and enterprise goodwill is that personal goodwill represents value attributable to the individual owner's personal reputation, relationships, and skills that cannot be transferred to buyers and therefore has no value in business sales, while enterprise goodwill represents value attributable to the business entity itself including systems, brand, workforce, and customer relationships that transfer with the business and justify premium prices. Personal goodwill arises from the owner's individual characteristics including professional reputation and recognition, personal client relationships based on trust and rapport, unique expertise or specialized skills, industry connections and networks, and personal work ethic or service quality. This goodwill is inseparable from the individual and disappears when the owner leaves, providing no value to buyers who cannot replicate these personal attributes. Enterprise goodwill arises from business attributes including established brand recognition, documented systems and processes, trained workforce and organizational capabilities, customer relationships tied to the company rather than individuals, proprietary technology or intellectual property, and market position or competitive advantages. Enterprise goodwill transfers with the business, justifying acquisition premiums because buyers acquire these valuable attributes. The distinction matters enormously for tax purposes; enterprise goodwill qualifies for capital gains treatment and creates tax basis for buyers, while personal goodwill may receive different tax treatment. In C corporation sales, allocating value to personal goodwill can reduce double taxation by avoiding corporate-level tax. Professional practices like medical, legal, or consulting often have significant personal goodwill tied to individual practitioners, reducing enterprise value and transferability.

How do you value customer lists?

You value customer lists using the multi-period excess earnings method that isolates cash flows attributable to existing customer relationships after charging for all other contributory assets, or the cost approach estimating what it would cost to recreate equivalent customer relationships through marketing and sales efforts. The multi-period excess earnings method is most common, projecting revenues from existing customers over their expected relationship lives considering historical retention rates and attrition patterns, applying appropriate profit margins to customer revenues, subtracting returns on contributory assets including working capital, fixed assets, assembled workforce, and technology that support customer revenue generation, and discounting the remaining excess earnings attributable to customer relationships to present value using discount rates of 12 to 20 percent reflecting customer retention risk. Customer attrition rates significantly impact value; businesses with 5 percent annual attrition have much more valuable customer lists than those with 30 percent attrition. The analysis considers customer concentration, contract terms, switching costs, competitive alternatives, and whether relationships are tied to specific salespeople or to the company. Customer lifetime value calculations estimate how long customers remain active and how much profit they generate. The cost approach estimates customer acquisition costs including marketing expenses, sales commissions, and time to close, multiplied by the number of customers, adjusted for the fact that not all acquisition attempts succeed. Customer list values typically represent 10 to 30 percent of total business value for companies where customer relationships drive value. These valuations support purchase price allocation, tax planning, and financial reporting under ASC 805.

What is the income tax impact on business valuations?

The income tax impact on business valuations affects value through the entity's tax structure (C corporation versus pass-through), the transaction structure (stock versus asset sale), the buyer's ability to use tax attributes, and the after-tax cash flows available to equity holders that drive value in income approach calculations. C corporations face double taxation with corporate-level tax on earnings plus shareholder-level tax on dividends, reducing after-tax cash flows and typically justifying 10 to 20 percent lower valuations than equivalent S corporations or LLCs with pass-through taxation. The valuation must consider whether to use pre-tax or after-tax cash flows; most appraisers use after-tax cash flows reflecting actual returns to equity holders. Tax rates vary by jurisdiction with federal corporate rates at 21 percent plus state taxes ranging from 0 to 12 percent, significantly affecting cash flows. Asset sales create tax liabilities for sellers through ordinary income on inventory and recaptured depreciation plus capital gains on goodwill and appreciated assets, but provide buyers with stepped-up basis generating future tax deductions worth 15 to 25 percent of purchase price. Stock sales preserve tax deferral for sellers but deny buyers basis step-up, typically reducing prices by 10 to 20 percent unless sellers compensate through lower prices. Tax attributes including net operating loss carryforwards, tax credits, or favorable depreciation schedules add value to buyers who can use them. Estate and gift tax valuations must consider built-in capital gains taxes that reduce net proceeds to heirs. Deferred tax liabilities on balance sheets represent future tax obligations reducing equity value.

How do you value non-compete agreements?

You value non-compete agreements using the with-and-without method that compares business value with the non-compete protection to value without it, measuring the incremental value the covenant provides by preventing competition from former owners or key employees, or using the income approach that projects lost profits if competition were allowed and discounts the protected earnings to present value. Non-compete agreements prevent specified individuals from competing with the business for defined periods (typically 2 to 5 years) within geographic areas, protecting buyer investments by ensuring sellers or key employees cannot immediately start competing businesses or join competitors taking customers and knowledge. The with-and-without method values the business assuming the non-compete exists, then revalues assuming the individual could compete freely, with the difference representing non-compete value. This requires estimating how much revenue and profit the business would lose if competition occurred, considering the individual's customer relationships, industry knowledge, competitive capabilities, and likelihood of actually competing. The income approach projects annual profit protected by the non-compete over its term, applies probability factors reflecting enforcement risk and likelihood of competition, and discounts to present value using rates of 15 to 25 percent reflecting uncertainty. Non-compete values typically represent 1 to 10 percent of total purchase price depending on the individual's importance and competition threat. Strong non-competes with key individuals in industries where personal relationships drive business have higher values. Enforceability varies by state; some jurisdictions limit or prohibit non-competes, reducing their value. These valuations support purchase price allocation for tax purposes, with non-compete payments typically deductible by buyers over the covenant term.

What is the valuation of employment agreements?

The valuation of employment agreements in acquisition contexts determines the portion of total consideration that represents compensation for future services rather than purchase price for the business, with employment agreement values based on the difference between compensation specified in agreements and market rates for equivalent positions, discounted to present value over the employment term. When sellers remain employed post-acquisition under employment agreements, the IRS and buyers scrutinize whether specified compensation represents market rates for services or disguised purchase price, because the classification affects tax treatment; employment compensation is deductible by buyers as ordinary business expense but taxed as ordinary income to sellers, while purchase price creates capital gains for sellers but no immediate deduction for buyers. The valuation compares employment agreement compensation including salary, bonuses, and benefits to market rates for executives with similar responsibilities in comparable companies, using compensation surveys and industry data. If employment agreement compensation is $300,000 annually but market rate is $150,000, the $150,000 annual excess represents disguised purchase price rather than compensation for services. This excess is present valued over the employment term using discount rates of 8 to 12 percent. Factors suggesting employment versus purchase price include whether compensation is contingent on continued employment or guaranteed regardless, whether amounts are reasonable compared to market rates, whether the individual has unique skills justifying premium compensation, and whether compensation aligns with historical pay or represents significant increases. Properly structured employment agreements specify market-rate compensation with excess consideration allocated to purchase price, non-competes, or consulting agreements with appropriate tax treatment.

How do you value a business for transfer pricing?

You value a business for transfer pricing purposes by determining arm's length prices for intercompany transactions between related entities in different tax jurisdictions, ensuring that prices reflect what unrelated parties would charge in comparable circumstances, using methods including comparable uncontrolled price, resale price, cost plus, profit split, or transactional net margin methods prescribed by IRS regulations and OECD guidelines. Transfer pricing prevents profit shifting where multinational companies manipulate intercompany prices to move profits to low-tax jurisdictions, requiring that all transactions between related parties occur at arm's length prices that independent parties would negotiate. The comparable uncontrolled price method compares prices charged in controlled transactions to prices in comparable uncontrolled transactions between unrelated parties. The resale price method determines arm's length prices based on resale prices to unrelated parties minus appropriate gross margins. The cost plus method adds appropriate markups to costs incurred by suppliers in controlled transactions. The profit split method allocates combined profits between related parties based on their relative contributions. The transactional net margin method compares net profit margins from controlled transactions to margins earned by comparable independent companies. Transfer pricing valuations require extensive documentation including functional analysis describing activities, assets, and risks of each entity, economic analysis supporting pricing methodology selection, and comparability analysis identifying truly comparable uncontrolled transactions. These valuations are critical for multinational companies to defend against IRS challenges and foreign tax authority audits. Penalties for transfer pricing violations can be severe, making proper valuation essential. The analysis must consider intangible property transfers, service agreements, financing arrangements, and cost-sharing agreements between related entities.

What are the IRS standards for business valuations?

The IRS standards for business valuations require that appraisals supporting tax positions including estate tax, gift tax, and charitable contribution deductions be performed by qualified appraisers with recognized credentials, use appropriate methodologies considering all relevant factors, comply with Revenue Ruling 59-60 providing guidance on valuation factors, and meet qualified appraisal requirements under Treasury Regulations including independence, timing, and documentation standards. Revenue Ruling 59-60 identifies factors to consider including nature and history of the business, economic outlook and industry conditions, book value and financial condition, earning capacity, dividend-paying capacity, presence of goodwill or other intangible value, prior sales of stock and size of block to be valued, and market price of comparable publicly traded companies. Qualified appraisers must hold recognized credentials from professional organizations, have relevant education and experience, and regularly perform appraisals. Qualified appraisals must be conducted no earlier than 60 days before transfer and no later than tax return due date including extensions, performed by independent appraisers with no prohibited relationships to parties, contain detailed descriptions of property valued and valuation methodology, and include appraiser declarations and qualifications. The IRS scrutinizes valuations claiming significant discounts for minority interests or lack of marketability, requiring substantial support from market data and empirical studies. Penalties for substantial valuation misstatements reach 20 to 40 percent of tax underpayments when reported values differ significantly from determined values. The IRS may challenge valuations through audits, requiring taxpayers to defend appraisals or negotiate settlements. Engaging credentialed appraisers, providing complete information, using appropriate methodologies, and documenting all assumptions creates defensible valuations more likely to withstand IRS scrutiny.

How do you value a business with multiple classes of stock?

You value a business with multiple classes of stock by first determining total equity value using appropriate income, market, or asset-based approaches, then allocating value among stock classes based on their respective rights, preferences, liquidation priorities, dividend entitlements, voting power, and conversion features, often using option pricing models or waterfall analysis to capture complex interactions between classes. Common scenarios include preferred stock with liquidation preferences, dividend rights, or conversion features alongside common stock, or multiple common stock classes with different voting rights or economic interests. The valuation process values the enterprise as a whole, then models how proceeds would be distributed to each class under various scenarios including liquidation, sale, or going concern value. Preferred stock with liquidation preferences receives priority in distributions up to specified amounts (typically 1x to 2x invested capital) before common stockholders receive anything, making preferred stock more valuable in downside scenarios but limiting upside participation unless participating preferred. Convertible preferred stock contains embedded options to convert into common stock, requiring option pricing models like Black-Scholes or binomial models to value the conversion feature considering stock volatility, time to liquidity event, and strike price. The analysis examines multiple scenarios including immediate liquidation, sale at various prices, and IPO, calculating distributions to each class under each scenario and probability-weighting results. Voting rights affect value; shares with superior voting rights command premiums of 2 to 10 percent over economically identical non-voting shares. Dividend preferences where certain classes receive preferential dividends affect value allocation. These valuations are critical for 409A compliance, financial reporting, and tax purposes when companies have complex capital structures.

What is the impact of debt structure on valuation?

The impact of debt structure on valuation affects enterprise value calculations, equity value determination, risk assessment through leverage ratios, cash flow availability for distributions, and buyer attractiveness depending on whether debt levels are optimal, excessive, or insufficient for the business's characteristics and industry norms. Enterprise value represents total business value independent of capital structure, calculated as equity value plus debt minus cash, ensuring that businesses with identical operations but different financing have the same enterprise value. However, debt structure significantly affects equity value; high debt levels reduce equity value dollar-for-dollar and increase financial risk requiring higher equity discount rates. Optimal debt levels vary by industry; stable businesses with predictable cash flows like utilities or real estate can sustain higher leverage (60 to 70 percent debt to total capital) while volatile businesses like technology or retail require conservative leverage (20 to 40 percent debt to capital). Excessive debt creates financial distress risk, potentially reducing enterprise value if leverage impairs operations or limits strategic flexibility. Debt covenants may restrict dividends, capital expenditures, or acquisitions, reducing operational flexibility and value. Interest coverage ratios measuring EBITDA to interest expense should exceed 3x to 5x for healthy businesses; lower coverage suggests financial stress. Debt maturity matters; near-term maturities requiring refinancing create risk while long-term debt provides stability. Interest rates affect value; below-market rates on existing debt create value while above-market rates destroy it. For acquisitions, buyers may prefer low-debt targets allowing them to optimize capital structure post-acquisition, or may accept higher debt if rates are favorable and cash flows support service.

How do you value contingent liabilities?

You value contingent liabilities including pending litigation, warranty claims, environmental remediation, tax disputes, or regulatory penalties by estimating the probability-weighted expected cash outflows, considering the range of potential outcomes, timing of resolution, and uncertainty surrounding amounts, then discounting expected payments to present value and subtracting from business value. Contingent liabilities represent potential obligations that may or may not materialize depending on future events, creating valuation challenges because amounts and timing are uncertain. The valuation process identifies all contingent liabilities through legal review, management interviews, and examination of disclosures in financial statements and SEC filings. For each contingency, the appraiser estimates potential outcomes ranging from best case (no payment) to worst case (maximum exposure), assigns probabilities to each outcome based on legal advice, historical experience, or expert judgment, and calculates expected value. For example, if litigation has 30 percent probability of $5 million settlement, 50 percent probability of $2 million settlement, and 20 percent probability of zero, expected value is $2.5 million. This expected payment is discounted to present value using rates of 8 to 15 percent reflecting timing uncertainty. Some contingencies like warranty obligations can be estimated using historical claim rates applied to outstanding warranties. Environmental liabilities require engineering studies estimating remediation costs. Tax contingencies consider IRS challenge likelihood and potential assessments. The valuation also considers whether contingencies are covered by insurance, indemnifications, or reserves. Disclosure in valuation reports is critical; buyers need transparency about contingent liabilities affecting value. Large uncertain contingencies may make businesses difficult to value or sell, sometimes requiring resolution before transactions can proceed.

What is the role of management depth in valuations?

The role of management depth in valuations is critical because businesses with strong management teams that can operate independently of owners are more valuable, less risky, and more transferable than businesses dependent on single individuals, justifying 20 to 40 percent higher valuations through reduced key person risk, lower discount rates, and broader buyer appeal. Management depth encompasses having multiple qualified executives capable of running the business, documented succession plans identifying and developing future leaders, delegated decision-making authority rather than centralized control, cross-training ensuring critical knowledge resides in multiple people, and demonstrated ability to operate successfully during owner absences. Businesses with deep management teams reduce key person risk; if any individual leaves, others can maintain operations without disruption. This reduces business risk, justifying lower discount rates that increase present values. Buyers pay premiums for businesses with strong teams because they acquire operating capabilities rather than just buying themselves jobs. Management depth affects transferability; businesses requiring new owners to step into operational roles attract only individual buyers seeking employment, while businesses with teams attract financial and strategic buyers seeking investments. The valuation assesses management depth through organizational charts showing reporting relationships and talent bench strength, management tenure and experience, compensation competitiveness retaining talent, succession planning documentation, and evidence of delegated authority through decision-making processes. Businesses where owners make all decisions, possess critical relationships, or hold unique expertise suffer key person discounts of 20 to 40 percent. Building management depth requires investing in talent, documenting knowledge, delegating authority, and creating systems-dependent rather than people-dependent operations.

How do you value a business with pending litigation?

You value a business with pending litigation by analyzing the nature, potential outcomes, and timing of legal proceedings, estimating probability-weighted expected costs including settlements, judgments, and legal fees, assessing impacts on operations and reputation, and subtracting expected litigation costs from business value while potentially applying additional risk discounts if litigation threatens business viability. Pending litigation creates valuation challenges through direct financial exposure from potential judgments or settlements, legal fees and costs that drain cash, management distraction reducing operational focus, reputation damage affecting customer and employee confidence, and uncertainty that increases risk and discount rates. The valuation process reviews litigation details including claims asserted, potential damages sought, stage of proceedings, legal counsel's assessment of merits and likely outcomes, and whether insurance covers claims. For each case, the appraiser estimates potential outcomes ranging from dismissal to maximum exposure, assigns probabilities based on legal advice, and calculates expected value. Material litigation may require independent legal analysis or expert opinions. The expected litigation cost is subtracted from business value, either as lump sum or present value of future payments depending on timing. Beyond direct costs, litigation may impair operations; intellectual property disputes may prevent product sales, employment disputes may trigger workforce issues, and customer lawsuits may damage reputation. These operational impacts may justify additional valuation discounts beyond direct litigation costs. Existential litigation threatening business survival may make valuation impossible until resolution. Buyers typically demand indemnifications for pre-closing litigation, affecting deal structure. Some litigation creates opportunities; businesses may have claims against others creating contingent assets, though conservative valuations exclude these until realized.

What is the impact of regulatory environment on business value?

The impact of regulatory environment on business value varies dramatically by industry, with heavily regulated sectors like healthcare, financial services, energy, and telecommunications facing compliance costs, operational restrictions, and barriers to entry that can either enhance value through limited competition or reduce value through regulatory burden, while lightly regulated industries face fewer constraints but less protection from new entrants. Favorable regulatory environments create value through barriers to entry that limit competition, such as licensing requirements, permits, or regulatory approvals that new competitors cannot easily obtain, protecting market position and pricing power. Certificate of need requirements in healthcare, liquor licenses in hospitality, or regulatory approvals in pharmaceuticals create valuable barriers. Regulatory protection can justify premium valuations of 20 to 40 percent compared to unregulated alternatives. Conversely, burdensome regulations reduce value through compliance costs including personnel, systems, reporting, and audits that reduce profitability, operational restrictions limiting business strategies or growth opportunities, regulatory uncertainty creating risk that increases discount rates, and potential penalties or enforcement actions creating contingent liabilities. Changes in regulatory environment significantly impact value; deregulation may reduce barriers allowing new competition and reducing values, while new regulations may impose costs or create opportunities depending on competitive position. The valuation assesses regulatory compliance status, identifying violations or deficiencies requiring remediation, pending regulatory changes that may affect operations, and whether the business has competitive advantages navigating regulatory complexity. Industries facing regulatory tightening like environmental rules or data privacy requirements may see compressed valuations, while businesses positioned to benefit from regulatory changes may command premiums. Regulatory expertise and relationships can be valuable intangible assets justifying premium valuations.

No questions found matching your search. Try different keywords.