What is a Hypothetical Appraisal and why would you Need One?

Whenever we take on a new Exiting client, we get a 3rd party business appraisal done by a reputable company (one that the banks will take, hold up in court, etc.). We also utilize a business appraisal in our targeted search program for Entering Clients. Our website is chock full of good reasons to get one. Occasionally in addition to a regular or enterprise appraisal, we use a Hypothetical Appraisal. From the American Society of Appraisers (ASA) website, here is the definition:

A hypothetical appraisal is an appraisal based on assumed conditions which are contrary to fact or which are improbable of realization or consummation. The Society takes the position that there are legitimate uses for some hypothetical appraisals, but that it is improper and unethical to issue a hypothetical appraisal report unless (1) the value is clearly labeled as hypothetical (2) the legitimate purpose for which the appraisal was made is stated, and (3) the conditions which were assumed contrary to fact are set forth. A hypothetical appraisal showing the value of a company which it is proposed to form by merging two existing companies would he deemed to serve a legitimate purpose. On the other hand, a hypothetical appraisal of a projected apartment house, based on an assumed rent schedule which is so much above the market that it is practically impossible for it to be realized, would not serve any legitimate purpose and its issuance might well lead to the defrauding of some unwary investor.

So from this you can see why we sometimes utilize a hypothetical appraisal. If your business will be purchased by an individual or financial buyer who hopes to run it, grow it and earn a nice living after debt coverage; a hypothetical appraisal is probably not right for you. If your business is large enough or unique enough that it will add immediate synergies to a strategic buyer like a PEG or larger company, then it make sense.

Warning! There are unscrupulous companies who try to get $40,000 or more from business owners selling them on the merits of purchasing a hypothetical appraisal. They will dangle their roster of strategic and international buyers as a lure. Please use some common sense. If the size of your business or its lack of uniqueness would not entice these larger buyers, don’t be fooled. These companies are in the business to sell appraisals for $40k, not to sell your business. A reasonable appraisal will be a fraction of that price. See this INC article for details.

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