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 Strategic Fundamental Premium Adjustment Control Value Control Minority Interest Premium Discount Non-Controlling, Marketable Value Marketability Discount Non-Controlling, Non- Marketable Value

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 $1,275 INDICATED VALUE Average

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

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