United States

An Update on Pending Best Practice Business Valuation Guidance

The past decade witnessed the greatest number of business valuation pronouncements from domestic and international standard- and guideline-setting organizations that have ever been experienced.

INSIGHT ARTICLE  | 

Valuation guidance was published by an alphabet soup of organizations from the American Institute of Certified Public Accountants (AICPA) to the International Valuation Standards Committee, a non-government organization member of the United Nations.

Based upon current valuation working groups we can only expect this decade to continue to experience a plethora of new guidance. The four pending documents discussed below will directly impact how private equity firms will need to value portfolio investments. We can expect to see releases shortly on topics related to intellectual capital, intangible assets, complex capital structures and financial instruments.

Pending guidance from the Appraisal Foundation

The Appraisal Foundation (AF) is a not-for-profit organization established by the appraisal profession in the United States in 1987. Among other important objectives the AF is responsible for the Uniform Standards of Professional Appraisal Practice (USPAP). The USPAP provides authoritative information on standards relevant to real property, personal property, intangible assets and business valuation appraisal analysis and reports in the United States.

In late 2006, the AF created several financial reporting work groups to develop valuation best practices. At present, there are two working groups addressing the following topics: contributory asset charges and how they impact the valuation of customer-related assets (i.e., customer relationships) and control premiums.

Pending guidance from the AICPA

The AICPA recognized practice divergence and changes in valuation methodologies since the beginning of the decade on the valuation of in-process research and development (IPR&D) as well as complex capital structures. The organization has therefore also created two working groups addressing both of these issues.

In 2001, the AICPA issued a practice aid addressing the process for valuing IPR&D. Originally this practice aid was written targeting just a small number of industries, specifically the software, electronic devices and pharmaceutical industries. However, it quickly became accepted as a best practice for valuing assets acquired in research and development activities. The AICPA has assembled a task force updating this practice aid, given the substantial methodological changes related to valuing intellectual property that has occurred since 2001.

In 2004, the AICPA issued a practice aid prolixly entitled Valuation of Privately-Held-Company Equity Securities Issued as Compensation (also known as the cheap stock practice aid). While designed to provide guidance relating to valuing stock-based compensation, the practice aid also provided a framework for allocating value for firms with complex capital structures (i.e., multiple classes of preferred and common equity). In early 2009, a task force was formed to update this practice aid for significant new valuation methodologies that have occurred since 2004 with its release expected in the first or second quarter of 2011.

As our economy and regulatory environment have evolved enormously in the last 10 years, the business valuation profession is racing to keep pace. Across the globe, new standards and guidelines will continue to be published addressing the multi-faceted issues impacting the fair value of intellectual property and financial instruments.

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