Held Businesses Purpose of a Valuation Estate Planning FLP, Gift, - - PowerPoint PPT Presentation

Valuations of Closely Held Businesses

Purpose of a Valuation

• Estate Planning

 FLP, Gift, Trust

• Corporations

 ESOP, M&A, Options, FAS, Buy-Sell

• Litigation

 Damages, Minority Interests, Disputes

• Family Law

 Divorce, Alimony

Valuation Roles

• Valuation Expert
• Consultant
• Rebuttal Expert
• Neutral Appraiser

Standards of Value

• Fair Market Value

The price at which the property would change hands between a willing buyer and a willing seller, when the former is not under any compulsion to buy and the latter is not under any compulsion to sell, both parties having reasonable knowledge of relevant facts. (Rev, 59-60). Used in gift and estate tax, ESOPs, marital dissolution cases, and financial acquisitions.

• Fair Value (Legal Context)

Applies to specific circumstances. Can be different from state to state based on statutes and case law. Used in dissenting shareholder cases, shareholder oppression cases, and certain fraudulent conveyance cases.

Standards of Value

• Investment Value

Specific value is an investment to a particular investor based on individual investment requirements. Reflects circumstances of a particular buyer. Used in mergers and acquisitions involving strategic buyers.

• Fair Value (Accounting Context)

Defined in SFAS No. 141, 142, and 157 as the amount at which that asset or liability could be bought or sold in a current transaction between willing parties, that it, other than in a forced or liquidation sale. Not to be confused with Fair Value in a Legal Context.

Levels of Value

The level of value considers ownership characteristics such as the degree of control or lack of control assumed as well as the degree of marketability assumed.

• Synergistic, Marketable
• Control, Marketable
• Non-Controlling, Marketable
• Non-Controlling, Non-Marketable

Valuation Approaches

Valuation Approaches

• Asset-Based Approach
• Income Approach
• Market Approach

Asset Based Methods

• Adjusted Net Asset Value Method

 Balance sheet is adjusted to reflect fair market

value of assets and liabilities, on a going concern basis

• Liquidation Value (Orderly or Forced)

 Balance sheet is adjusted to reflect fair market

value of assets and liabilities, assuming liquidation of the business

Income Methods

• Capitalization of Earnings

 Uses historical benefit stream

• Discounted Cash Flow

 Uses projected benefit stream

• Excess Earnings

 A hybrid approach that is not commonly used

Market Methods

• Guideline Publicly Traded Company

 Uses multiples from comparable publicly traded

companies

• Guideline Comparative Transactions

 Uses multiples from private or public transactions

involving comparable companies

• Subject Company Prior Transactions

 Arms length?

Valuation Synthesis

• Valuation methods utilized should

be reconciled and appropriately weighted resulting in a valuation conclusion

Adjustments, Subjective Areas, and Common Errors

Discounts

• Discount for Minority Interest (DMIN)/

Discount for Lack of Control (DLOC)

• Discount for Lack of Marketability (DLOM)
• Other

 Key Man Discounts  Blockage Discounts

Levels of Value - Discounts

Synergistic Value Control Value Non-Controlling, Marketable Value Non-Controlling, Non- Marketable Value

Control Premium Minority Interest Discount Marketability Discount Strategic Premium Fundamental Adjustment

Subjective Valuation Areas

• Normalization Adjustments

 Related Party Transactions  Excessive Compensation

• Benefit Streams

 Net Income, EBIT, Net Cash Flow

• Discount Rates

Subjective Valuation Areas (cont’d)

• Growth Rates
• Capitalization Rates (Multiples)
• Control Issues (DLOC/DLOM)

Common Errors

• Failure to clearly identify and adhere to

the applicable standard of value

• Reliance on Rules of Thumb as a

primary valuation method

• Indiscriminate use of Price/Earnings

Multiples

• Failure to make normalization

adjustments when valuing a controlling interest

Common Errors (cont’d)

• Failure to match capitalization rate with

earnings base

• Not adjusting for market compensation for

the owner.

• Failure to apply tax rates correctly
• Failure to understand and apply the

appropriate standards (USPAP, AICPA, IRS, etc.)

• Utilizing an inappropriate premise or

standard of value based on the valuation – specific facts and circumstances

Common Errors (cont’d)

• Failing to consider the guideline

public company method when valuing smaller companies

• Creating new valuation theories
• Creating new valuation methods
• Failing the competency standards
• Justifying the unjustifiable
• Applying boiler plate too thickly
• Diluting the opinion with caveats

Goodwill Issue

• Enterprise or Corporate Goodwill

 Brand – Name Recognition  Larger Organizations  Longevity of Enterprise

• Personal Goodwill

 Key Man Issue  Unique Know How  Rainmaker

Working with a BV Expert

Selecting a BV Expert

• Curriculum Vitae
• Credentials
• Education and Training
• Experience
• Communications Skills

Credentials

• ASA – American Society of Appraisers
• ABV – American Institute of CPAs
• CVA – National Association of Certified

Valuation Analysts

• CBA – International Business Brokers

Association

• For more information: http://www.nacva.com/pdf/08_1stQtr_chart_x1a.pdf

Litigation

• Objective Initial Assessment

 Valuation, Economics

• Guide Through Process

 Offense and Defense Positions  Mediation

• Valuation Report

 Stand-alone Report Versus Rebuttal Report

• Expert Witness Testimony

Advocacy

The attorney is an advocate for the

• client. The valuation expert is an

advocate for their report.

Case Study

Adjusted Net Asset Value

ABC Company Balance Sheet Assets Actual Adjustments Adjusted Cash $100 $100 Receivables 500

• 50

450 Inventory 400

• 75

325 Current Assets $1,000

• $125

$875 Machinery & Equipment 250

• 50

200 Real Estate 650 400 1050 Total Assets $1,900 $225 $2,125 Liabilities Accounts Payable 400 400 Bank Debt 350 350 Total Liabilities $750 $0 $750 NET ASSET VALUE $1,150 $225 $1,375

Capitalization of Earnings

ABC Company Profit & Loss Statement Revenues $3,500 Cost of Sales 2750 Gross Profit $750 SG&A Expense 500 Operating Profit $250 Income Taxes

• 100

Net Income $150 Add Backs: Excess Compensation 100 Net Cash Flow $250 Divided By 20% Capitalization Rate INDICATED VALUE $1,250

Comparable Transaction Method

ABC Company Comparable Transactions Price to Revenue Net Income Company 1 40% 5.10 Company 2 55% 4.60 Company 3 37% 4.20 Company 4 42% 6.00 Company 5 39% 4.50 Median 40% 4.60 ABC Company $3,500 $250 ABC VALUE = $1,400 $1,150 INDICATED VALUE Average $1,275

Valuation Synthesis

ABC Company Valuation Synthesis Valuation Method Indicated Value Weighting Weighted Value Net Asset Value $1,375 20% 275 Capitalization of Earnings $1,250 40% 500 Comparable Transactions $1,275 40% 510 Total Value $1,285

Application of Discounts

ABC Company Control Marketable $1,285 DMIN 15%

• 193

Minority Marketable $1,092 DLOM 30%

• 328

Minority Non-Marketable $765 Combined Discount 40.5%

Contact Us

• S. G. Brooke Tucker, ASA

Managing Director O 410-472-0370 F 410-472-0371 2403 Benson Mill Road Sparks, MD 21152 brooke@tuckerandmeltzer.com Mark W. Norris, CPA/ABV, CVA, CFFA, ASA Director O 443-519-0007 F 410-522-5889 2400 Boston Street, Suite 102 Baltimore, MD 21224 mark@tuckerandmeltzer.com Anne R. Meltzer, CPA/ABV Managing Director O 410-998-2085 F 410-654-8514 816 Queens Park Drive Owings Mills, MD 21117 anne@tuckerandmeltzer.com Jennifer Poland Rosenberg, CPA Associate O 410-925-6656 jennifer@tuckerandmeltzer.com Robin Duffy, CPA Associate O 443-695-2767 robin@tuckerandmeltzer.com