Business Valuation Versus Business Appraisal

What is the difference between a valuation and an appraisal?

Both produce a figure for a business, and that is where the resemblance ends. An appraisal estimates the price a business might achieve if it were offered for sale in current market conditions. It is usually brief, often provided at no charge, and prepared by a broker or agent who would be paid a commission if the business sells. A valuation is an opinion of value at a defined valuation date, prepared for a defined purpose, by someone with no interest in the outcome, and documented so another person can follow the reasoning and test it.

Property valuation settled this question long ago. The Valuers Registration Board of Queensland, which registers valuers in that state under the Valuers Registration Act 1992, describes an appraisal as a broad estimate of the potential sale price or rent of a property that cannot be relied upon as a basis for a financial decision, legal or statutory requirement. A valuation it describes as an unbiased and independent assessment of value that can be relied on for those purposes.

Business valuation is not registered the same way. The Australian Taxation Office guide Market valuation for tax purposes records that there is no formal admissions board in Australia for business valuers, pointing instead to the professional institutes that set standards for and certify them. The substance of the work carries the weight, not a registration number.

What a broker appraisal is, and what it is for

An appraisal is not a failed valuation. It answers a different question: what would a purchaser probably pay if we took this business to market now?

A broker active in healthcare business sales holds useful information: which practices attract enquiry, what finance is available, how long comparable businesses sit on the market and what vendors accept rather than advertise. That is market evidence, and a valuer considers the same kind of evidence.

The limits follow from the purpose. An appraisal is typically prepared quickly from summary financial information, without a stated valuation date, without normalising earnings, without separating the business from the entity that owns it and without a written method, and often while the broker is still seeking the listing.

What an independent valuation is

A valuation is an opinion of the value of a defined subject, at a defined date, on a defined basis, supported by evidence and reasoning that is written down.

The subject

The subject may be the business as a going concern or the shares or units in the entity that owns it, and those are different numbers. Enterprise value is the value of the operations, usually expressed debt-free and cash-free and assuming a normal level of working capital, being the stock, work in progress, debtors and creditors the practice needs to trade without interruption. Equity value is what an owner receives for their shares or units: enterprise value adjusted for cash, borrowings, surplus assets and any shortfall or excess in working capital.

The size of the interest matters too. A parcel carrying control is not a proportionate slice of the whole, because a controlling holder can set remuneration, distributions, strategy and the timing of a sale where a minority interest holder generally cannot. Partner exits and shareholder disputes turn on that, and on what the owners agreement says. See share and equity valuations and shareholder dispute valuations.

The valuation date and the basis of value

The valuation date fixes the information that may be used: a valuation reflects what was known or reasonably foreseeable then, not what happened afterwards. The ATO lists reliance on post valuation date information, and on events that were not reasonably foreseeable at that date, among the issues it commonly sees when it reviews valuations, and says an estimate prepared for a future date is not acceptable where the legislation specifies the valuation date.

The basis of value is usually market value. For tax purposes the ATO adopts the International Valuation Standards Council definition, which it treats as consistent with the judicial definition: the estimated amount for which an asset should exchange on the valuation date between a willing buyer and a willing seller in an arm's length transaction, after proper marketing, with each acting knowledgeably, prudently and without compulsion, and reflecting the asset's highest and best use. Two consequences follow. The sale is notional and assumes voluntary bargaining rather than a forced sale, and market value disregards advantages available only to a specific owner or purchaser, because the assumption is a willing buyer, not a particular one. Fair value under AASB 13 is defined in a similar way but is not always the same concept, so a report should say which basis it adopted.

The method and the earnings

The method is chosen for the business, the purpose and the available information rather than applied by habit. For most healthcare practices that means capitalisation of future maintainable earnings, applying a multiple to a sustainable level of profit, the multiple reflecting that practice's risk and growth prospects. Discounted cash flow, which discounts forecast cash flows to a present value, suits a changing earnings profile. A net assets approach, valuing assets less liabilities, is the reference point where a business is asset heavy or unprofitable. Market evidence, being observed transactions and the terms on which they settled, informs and cross-checks all of them, and the ATO recommends applying a cross-check methodology where possible. See healthcare business valuation methods.

The earnings are maintainable earnings, not reported profit. Normalisation puts owner and practitioner remuneration onto arm's length terms, brings related-party rent to a market rate and removes one-off items, so what is capitalised is profit the business can repeat. See what is maintainable earnings and the glossary.

Independence: who pays, and on what terms

The ATO says a valuation must be objective and supported with appropriate evidence, and that valuations undertaken by professional valuers are more credible than those from someone who is not. It then sets out what you must demonstrate about your instructions: that scope and purpose were stated, the valuer's independence acknowledged, access to premises and records granted, and any fee stated not to depend on the report's outcome.

That last point is the structural difference. An agency appointment is contingent by design: the agent is engaged to sell and is paid when a sale settles. That is not a criticism, but it does mean whoever assesses the number later, a tax officer, a judge, a financier or a co-owner's lawyer, will ask whether the preparer's fee turned on the answer. The same principle appears in court rules: under the Federal Circuit and Family Court of Australia (Family Law) Rules 2021, an expert witness's duty to the court prevails over the obligation to the person instructing or paying them.

It is worth being plain about the money, because the word free does most of the misdirection here. An appraisal offered at no charge is not unpaid work: it is paid for out of the commission earned when the business sells, which is a fee calculated on the sale price. Two things follow, and neither is hidden. The person who states the number is paid more when the number is higher, and is paid nothing at all if there is no sale. That is an ordinary commercial arrangement for a selling agent. It is not an arrangement that survives the question a tax officer, a judge or a co-owner's lawyer asks about the fee.

Charging by the hour breaks the link between the fee and the conclusion, but it introduces a different unknown, because the cost is then settled once the work is finished rather than before it starts.

The third arrangement is the one HPNA uses. The fee schedule is published on this website: a fixed amount set by the annual revenue of the business being valued, so it is known before an enquiry is made rather than quoted case by case. It is agreed in writing before any work begins, it does not change with the conclusion reached, and no commission or referral payment is received from any party to a transaction. Each of those features answers a question that gets asked of a valuation later, and together they are what allows the same report to be given to the other side of a transaction, to a court or to the Australian Taxation Office without the terms on which it was prepared becoming the argument.

Why an appraisal may not be accepted

Tax and the ATO

The ATO sets out what a market valuation report must contain at a minimum, from the purpose and scope through to the records that explain the basis of the market value, and its detailed guide adds the valuer's identity and qualifications, a declaration of independence and conflicts, the methodologies chosen and why, and any cross-check.

Acceptability for tax purposes, the guide says, usually depends on the valuation process undertaken rather than on who conducted it, with limited exceptions such as the GST margin scheme. Process is the test: a one page estimate fails not because of the letterhead but because there is nothing in it to examine. The onus of producing a replicable and defensible valuation stays with the taxpayer even when a professional is engaged.

Two published examples show this. In one, a company valued its own properties before lodging, compared them with properties that had few characteristics in common, could not satisfactorily explain its assumptions, and was found not to satisfy the maximum net asset value test, an entry test for the small business capital gains tax concessions that caps the net value of the CGT assets of the taxpayer, its connected entities and its affiliates at $6 million. A penalty for recklessness applied. In another, an owner relied on an appraisal from a real estate agency owned by her husband when she sold a property to a company he controlled, and a penalty for intentional disregard applied. The ATO also states the other side: generally, if you engage and properly instruct a professional valuer, you will not be liable for penalties if the professional valuation is later found to be deficient. See valuing a healthcare business for tax purposes and our tax and restructure valuations service, and confirm your own position with your accountant.

Courts and family law

Where a healthcare business forms part of a property pool, the expert evidence rules control what the court will read. An expert's report must give the reasons for the conclusions, state the methodology used, and set out the expert's qualifications, the facts, matters and assumptions relied on, any range of opinion and any limits on the expert's expertise. It is verified by an affidavit stating that the opinions expressed are independent and impartial.

The rules draw the same line this article does: the division governing instructions to expert witnesses and disclosure of their reports does not apply to a market appraisal or an opinion as to value obtained for a procedural hearing or conference. An appraisal has a place, and it is procedural rather than evidentiary.

The rules also aim, where practicable, for evidence on an issue to be given by a single expert witness. The court's guidance lists property valuers and financial consultants among the experts who give evidence in family law matters, and says expert evidence is challenged through the court process, for example by cross-examination. See valuing a healthcare business for family law.

Duty and state revenue offices

State revenue offices set their own evidentiary requirements. Revenue NSW, in Revenue Ruling DUT 012 version 4, says brief market appraisals, estimates of value or other statements that do not indicate a full inspection has been undertaken will not be acceptable as evidence of value for land, and that other dutiable property must be valued by a person whose business it is to make valuations of that class of property. Requirements differ between states and territories, and your lawyer or accountant can confirm what the relevant office expects.

Financiers, auditors, insurers and co-owners

Financiers, auditors and insurers apply their own policies about whose valuations they rely on and what a report must contain. So do the parties to a shareholders or partnership agreement, where the buy-out clause often specifies who values the interest, on what basis and at what date. Where someone other than the person commissioning the report will rely on it, their requirements are typically worth confirming first.

Why the gap is wider for healthcare businesses

In healthcare the gap between an estimate of sale price and an opinion of value is wider, because much of what determines value never appears in the profit and loss statement.

Goodwill is the clearest example: the part of value not represented by identifiable net assets, being the earnings a practice generates beyond a return on its plant, fit-out, stock and receivables. Part attaches to the practice: location, systems and patient records, brand, referral relationships that survive a change of owner and the recurring patient or participant base. That is transferable, or commercial, goodwill. Part attaches to a particular practitioner and leaves with them, and that is personal goodwill. Only the first is being sold, and how much of it actually transfers can turn on the handover and on any restraint the departing practitioner accepts. Does a medical practice have transferable goodwill works through the distinction and how practitioner dependence affects business value covers the key-person risk.

The revenue base needs the same treatment. Healthcare earnings mix Medicare billing under the Medicare Benefits Schedule, patient out of pocket fees, private health insurance, the Department of Veterans' Affairs, workers compensation and motor accident schemes, NDIS participant funding, and in pharmacy the Pharmaceutical Benefits Scheme, community pharmacy programs and retail sales. Each behaves differently when ownership changes and each carries its own compliance exposure. See government funding exposure and healthcare business value.

The entitlements that let a practice trade need the same attention. Practitioner registration sits with Ahpra and the national boards, not with the business. Medicare provider numbers attach to a practitioner and a location. A community pharmacy depends on approval to supply pharmaceutical benefits under section 90 of the National Health Act 1953, and a pharmacist must apply to the Department of Health, Disability and Ageing for approval both to establish a new pharmacy and to change the ownership of an approved one. State and territory legislation also limits who may own a pharmacy. An NDIS provider's registration and its audits against the practice standards sit with the NDIS Quality and Safeguards Commission. None transfers automatically with a contract of sale, and an appraisal rarely asks whether it does.

Then there is how the people are engaged: many practices run a service entity model with practitioners engaged as contractors, an arrangement that has attracted sustained state payroll tax attention and that affects both the earnings figure and the risk attaching to it. Add concentration of revenue among a few practitioners, referrers or funders, the lease on premises fitted out for clinical use, and equipment from chairs and imaging to dispensing automation, and the two documents produce different outcomes. See medical practices, pharmacies, dental practices, NDIS providers and payroll tax and medical practice value.

How the two can be used together

They are not alternatives. A common sequence is to obtain a valuation first, then take the business to market. The valuation tells you what the business is worth and, more usefully, what is limiting that value. It gives you a reference point when appraisals arrive and flags what a purchaser's adviser will raise in due diligence while there is still time to fix it, which preparing a healthcare business for sale covers. The broker then reaches purchasers and negotiates terms.

Value and price also differ. A valuation is an opinion of what a hypothetical willing buyer and willing seller would agree. The price a particular purchaser pays may be higher or lower for reasons specific to them: the practitioners they bring, the sites they operate, the overhead they can remove, the terms they accept. Because market value disregards advantages available only to one purchaser, a negotiated price above the valuation is not evidence the valuation was wrong.

Questions worth asking about any figure you receive

Before you rely on a number, whoever gave it to you, ask:

• What is the valuation date, and what information was available at that date?
• What purpose was it prepared for, and can it be used for another?
• Is it the business, or the shares or units in the entity that owns it?
• Is the figure debt-free and cash-free, what level of working capital does it assume, and does it include stock, plant and the clinical fit-out?
• Is it a controlling interest or a minority one, and does an owners agreement set the basis?
• What earnings figure was used, and what was adjusted to get there?
• How was goodwill split between what transfers with the practice and what stays with a practitioner?
• What method was applied, and was a second method used as a cross-check?
• Who prepared it, what are their qualifications, and did their fee depend on the outcome?

An appraisal is not expected to answer all of these. A valuation should answer every one in the report itself, and what information is needed for a business valuation sets out what a valuer will ask for.

Where HPNA fits

HPNA prepares independent business valuations for healthcare businesses, for a stated purpose and at a stated valuation date, setting out the method, the evidence, the assumptions and the limitations. We are engaged to value a business, not to sell one, and we take no commission from any party to a transaction. Scope, information requirements and timeframe are confirmed before the work begins, and the fee is already published: see the fee schedule, which sets a fixed amount by the annual revenue of the business being valued.

If you are weighing an appraisal you have received, or need a valuation a third party will scrutinise, see how the process works, the reasons a valuation is required, or request a valuation.