Formal valuation or opinion of value: which one your situation actually calls for

Which one you need, in brief

If you are deciding whether and when to sell, an opinion of value is usually enough: it is a market-based range from an advisor who sells companies like yours, built from your recent financials. If the number has to stand up to someone outside the deal, such as the IRS, a court, a partner on the other side of a buyout, an ESOP or an estate, you generally need a formal third-party valuation, a documented appraisal of the company's value on a specific date. Many owners use the first for planning and order the second only when a legal or tax purpose requires it.

We at MDR & Associates offer both. The opinion of value is free and follows a complimentary discovery meeting. Formal third-party valuations are a separate service. Owners often ask which they need, and the honest answer depends on who will rely on the number and for what. This guide explains the difference, the situations that call for each and how to prepare.

What an opinion of value is, and what it is not

An opinion of value is an experienced advisor's estimate of what the market would pay for your company today. In our case, one of our partners reviews the last three years of financials with you during a one-hour discovery meeting, adjusts earnings for owner perks and one-time expenses, considers your growth, size, industry and risk, and gives you a range from low to high. It reflects what buyers are paying for comparable companies and what we see in active negotiations.

It is a planning tool, not a legal document. It tells you whether an offer is in the right neighborhood, whether now is a sensible time to sell and what would move the number. It is not written to satisfy a tax authority or a judge, and you should not present it as an appraisal in a dispute or a filing.

• Free, and based on three years of financials
• A low-to-high range rather than a single figure
• Grounded in what buyers are actually paying
• Best for planning a sale, testing an offer or timing an exit

What a formal third-party valuation adds

A formal valuation is an appraisal of the company's value on a specific date, written to be relied on by people outside the transaction. It sets out the methods used, the assumptions behind them and the reasoning that connects the numbers to the conclusion. That narrative matters: a value is only useful in a negotiation or a review if a reader can follow how it was reached and see that it holds together.

The U.S. Small Business Administration describes three common approaches to valuing a business: an income approach based on projected earnings adjusted for risk, a market approach based on comparable recent sales, and an asset approach based on total assets minus total liabilities. A formal appraisal typically weighs these against the facts of the company and explains the choice. Our formal valuations are performed by third-party appraisers and usually take about 10 to 14 business days once all required documents are received.

Situations that call for a formal valuation

The common thread is that someone other than you and a willing buyer will rely on the number, or the number has legal or tax consequences. The uses below are the ones we list for our formal valuations. In most of them, your attorney or CPA will tell you a documented appraisal is needed, and often what standard it must meet.

Two of these come up often with owners I meet. Partner buyouts are one; if you own a company with a partner and have never written down how a departing owner's share is valued, read what happens when partners have no buyout agreement. Divorce is the other, where the business may have to be valued for a property division; how a Texas divorce values and divides a business covers that side. In both cases, talk to a licensed attorney about what kind of valuation the situation requires.

• Buyouts between owners or of a departing partner
• Estate and gift tax planning and filings
• Purchase price allocation after an acquisition
• Litigation, dissenter's rights and fiduciary matters
• Equitable distribution of property
• Employee stock ownership plans and charitable contributions
• Bankruptcy and reorganization

Situations where an opinion of value is enough

Most owners who are thinking about a sale do not need a formal appraisal to start. If the goal is to learn what the company is worth to buyers, decide whether to sell now or in a few years, or judge whether an offer that arrived is fair, an opinion of value from someone who closes deals in your size range answers the question faster and at no cost.

In a market sale, the price is ultimately set by competing buyers, not by an appraisal. A formal valuation can still be useful there, especially to support the asking price with a clear narrative, and we include third-party valuations in many sale engagements for that reason. But you rarely need to pay for one before you even know whether you want to sell.

• Deciding whether to sell this year or in a few years
• Testing an unsolicited offer
• Setting priorities for pre-sale preparation
• Comparing the value of selling with the value of keeping the business

Why the two numbers sometimes differ

Owners are sometimes surprised that a formal appraisal and a market opinion are not identical. They answer slightly different questions. An appraisal estimates value under a defined standard and set of assumptions on a specific date. A market opinion estimates what real buyers would pay today in a competitive process, which can reflect strategic interest, financing conditions or demand in a particular industry.

The purpose of the valuation also shapes it. A value prepared for an estate filing and a value prepared to support a sale may use different standards. Neither is wrong; each is built for its job. That is why you should tell whoever prepares a valuation exactly how it will be used. For more on the gap between what owners expect and what buyers pay, see what owners get wrong about what their company is worth.

Documents to gather for either one

The good news is that both start from the same records, so gathering them is never wasted. For a formal valuation, these are the documents we ask for. An opinion of value needs a subset, mainly three years of financials and a list of add-backs.

Pay particular attention to owner perks and one-time expenses. Every personal or non-recurring cost you can document is added back to earnings, and earnings drive value. Perks you cannot prove do not get added back, and unreported cash does not count at all.

• Interim profit and loss statement and interim balance sheet
• Federal income tax returns for the last three years
• Fair market value of furniture, fixtures and equipment
• Current inventory value
• A list of owner perks and one-time, non-recurring expenses
• A completed business questionnaire

Mistakes owners make with valuations

The first mistake is using the wrong tool for the job: presenting an informal estimate in a dispute, or paying for a full appraisal to answer a planning question. The second is relying on an online calculator or a rule of thumb from a friend's sale. Those numbers ignore the things that move value most in a specific company, such as customer concentration, dependence on the owner and the quality of the records.

The third is treating any valuation as permanent. Value changes with the company's results and with the market, so a number from three years ago is history. If you are planning an exit, refresh your view as you prepare; the signs that a business is ready to sell shows what to work on between now and then.

Putting the number to work once you have it

A valuation is most useful when it changes a decision. If the range is below what you need, look at what drives it down and decide whether a year or two of preparation could close the gap. Cleaning up records, documenting add-backs, reducing dependence on one customer and handing relationships to managers are the usual levers, and each one shows up in the next valuation.

If the range meets your goals, the question becomes timing and process. A company with two to three years of consistent growth is in its strongest position, and waiting for one more great year carries real risk if the trend turns. If an offer is already on the table, compare it with the range on structure as well as price: cash at closing, any earnout, any note you would carry and how long you would be expected to stay.

Keep the valuation confidential either way. Sharing a number with employees, a banker or a customer before you have a plan can start the very rumors a careful sale is designed to prevent.

Getting the right number for your purpose

If you are not sure which one you need, start with the free conversation. Our discovery meeting takes about an hour, at our Frisco office or by phone. We review three years of financials with you, give you a low-to-high opinion of value and tell you whether your situation calls for a formal third-party valuation as well. If it does, we can arrange one.

We work with owners of manufacturing, distribution, service and construction companies across Dallas–Fort Worth, Austin, Houston and San Antonio, generally with roughly $3 million to $100 million in revenue. Everything you share is kept confidential.

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