2.16 Materiality in valuators’ reports

When a business valuator values a business using the capitalized cashflows method, he or she will exercise judgment in respect to many issues, notably the capitalization rate, pro forma cashflows, redundant assets, transferability of goodwill, and discounts. The valuator’s judgment will be impacted by the materiality of the data.

Given the amount of judgment involved, it is impossible to find an absolute, “correct” number for fair market value (although the more work that is done, the greater the valuator’s confidence in the result).

Business valuators exercise significant judgment in preparing business valuation reports. In this context, some factors will be immaterial.

For example, assume that the valuator has determined that the pro forma free cashflow lies in the range $1,250,000 to $1,350,000 and that a suitable WACC (weighted average cost of capital) has been determined as 15.5% to 17.0%. This would put the enterprise value in the range of $7,941,176 ($1,350,000 / 0.17) to $8,064,516 ($1,250,000 / 0.155).

The range is therefore $123,340 and either end of the range is $61,670 or 0.77% from the mean of $8,002,846. If it then appears that adjusting capital assets from net book value to fair market value will lead to a swing of less than $50,000, it may be reasonable to conclude that net book value is an acceptable proxy for fair market value of these assets and there would be no need to go to the expense of figuring out their fair market value more precisely.

Materiality is very much influenced by the purpose of the report. A valuation for a client negotiating to sell a business is primarily an advisory guide for negotiations and requires less accuracy than an expert report involving a litigated shareholder dispute, which could determine the damages awarded by the court.

Contact MVI to discuss the different influences on the value of your business and the extent to which each could have a material impact.