This October, I will celebrate my 12^th year as an Accredited Senior Appraiser (ASA) in Business Valuation with the American Society of Appraisers (also ASA). ASA members meet every year for an International Conference to discuss current topics and to share knowledge and best practices. I attended the most recent Conference in Portland, OR. A presentation entitled “The AI Revolution – Why it Matters to Appraisers & Application Strategies” by Greg Endicott of Strategic Value Group, LLC summarized a BVResources Survey on AI as follows:

 

1.  Adoption: About 48% of business valuation (BV) firms are using AI, primarily for researching economic or industry conditions.

 

2.  Popular Tools: ChatGPT is the most popular AI tool, used by70%of respondents. Other tools include Copilot, Bard (now Gemini), and Grammarly.

 

3.  Concerns: 52%of firms are not using AI due to trust issues, data confidentiality concerns, and fear of AI “hallucinations.”

 

These takeaways were based on a survey of Business Valuation firms, not the general public. So, if about half of the BV firms surveyed are using AI, what can someone looking for a valuation get from asking a simple question into an AI engine?

 

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Here is the free answer a business owner gets from ChatGPT:

The “rule of thumb” in valuing a business as a multiple of EBITDA generally follows broad guidelines, depending on the business’s size, industry, and growth potential. Here’s a quick overview of common multiples based on these factors:

 

Rule of Thumb by Business Type/Size

1.  Small Businesses (less than $10 million in revenue):

o  3x – 5x EBITDA: Small businesses with modest revenue and growth potential usually command lower multiples due to higher perceived risks and less scalability.

 

2.  Medium-sized businesses ($10 million – $100 million in revenue):

o  5x – 7x EBITDA: These companies tend to attract higher multiples as they are more established, often with stronger growth prospects and greater market presence.

 

3.  Large Businesses (over $100 million in revenue):

o  7x – 10x EBITDA or more: Larger, well-established companies with stable cash flows, competitive advantages, and strong management teams often get higher multiples. These businesses are usually more attractive to institutional investors or private equity firms.

 

Rule of Thumb by Industry

1.  Low-Growth or Capital-Intensive Industries:

o  3x – 5x EBITDA: Industries like manufacturing, construction, and retail, which often have higher fixed costs and lower growth potential, typically have lower multiples.

 

2.  Moderate-Growth Industries:

o  5x – 7x EBITDA: Businesses in sectors like healthcare services, logistics, or consumer products generally attract mid-range multiples due to their stable but moderate growth prospects.

 

3.  High-Growth Industries:

o  8x – 12x EBITDA or more: Technology, software, and biotech companies with high growth potential and scalable business models can see much higher multiples, sometimes exceeding 12x EBITDA, especially if they have recurring revenue models.

 

Simplified Rule of Thumb:

For most small and mid-sized businesses in stable industries, a 4x to 6x EBITDA multiple is a common rule of thumb.

So, does this artificial intelligence have it right? Sort of. However, the above ranges and rule of thumb come with the implied caveat, “it depends…”

1.  It depends on the industry;

2.  It depends on the size of the revenue;

3.  It depends on the amount of EBITDA;

4.  It depends on the future growth of the Company and

5.  It depends on the risk in achieving this growth.

 

Historical Data in Support of ChatGPT Multiples

In testing these ChatGPT multiples, we looked at a database of actual transactions of lower middle market deals over the past few years. Below is a summary of rolling average EBITDA multiples for real deals up from the 4^th quarter of 2020 through the 2^nd Quarter of 2024. The data is compiled by GF Data, which collects and provides data primarily from private equity (PE) sponsors and other deal professionals involved in middle-market mergers and acquisitions (M&A). The data covers a range of metrics, including transaction multiples, leverage levels, and other deal terms, and is generally vetted and aggregated to protect the confidentiality of individual transactions while providing a robust data set for market analysis.  

As databases go, this one is pretty good. It has a statistically significant dataset populated and used by dealmakers. I like to use these multiples often to value businesses with significant EBITDA of at least $2 million or more. Here are the average multiples for all industries based on transaction enterprise value (TEV), by industry and by EBITDA size.

 

 

Based on the above charts, GF Data does a good job supporting ChatGPT’s “rule of thumb” estimates for medium to large companies of 5x to 12x. However, because GF Data’s multiples are averages, they don’t specify outlier deals with lower and higher multiples than the 6.4x to 8.6x multiple ranges by industry.

 

For smaller deals,  we have used the Business Reference Guide as a strong “pricing guide” as our first iteration of value when discussing with a potential client a rough estimate of the value of their small businesses.

Conclusion

 

My conclusion is that ChatGPT does of job of cobbling together a starting point for a discussion on the value of your business, but it doesn’t do the job of a business valuation appraiser or M&A advisor. Use ChatGPT like you use Zillow.com to value your house. The multiples above will give you a very rough estimate of the value of your business. However, this first iteration will not suffice for compliance (litigation as well as gift, estate, or income tax) or strategic (exit planning, assessment for sale, or merger) purposes.

 

Exit Strategies values control and minority ownership interests of private businesses for tax, financial reporting, and strategic purposes. If you’d like help in this regard or have any related questions, you can reach  Joe Orlando, ASA, at 503-925-5510 or jorlando@exitstrategiesgroup.com.

 

Exit Strategies values control and minority ownership interests of private businesses for tax, financial reporting, and strategic purposes. If you’d like help in this regard or have any related questions, you can reach  Joe Orlando, ASA, at 503-925-5510 or jorlando@exitstrategiesgroup.com.

For business owners of privately held companies seeking a seamless and impactful way to contribute to charitable causes, Donor-Advised Funds (DAFs) have emerged as a philanthropic and tax-efficient solution. These vehicles offer a flexible and tax-efficient way to manage charitable donations, allowing donors to make contributions to a fund and then recommend grants to their favorite charities over time. Many people have successfully used DAFs to support the causes they care about, and there are numerous success stories available online.

According to the 2023 DAF report, contributions to DAFs reached an all-time high of $85.53 billion in 2022. These contributions have grown at a double-digit compound annual growth rate (CAGR) over the last five years, as detailed below.

Source: National Philanthropic Trust. 2023 Donor-Advised Fund Report

Even though DAFs are an effective tax-efficient vehicle to make contributions, special attention, and professional advice are required to obtain such tax benefits and contribute to a good cause. (NOTE: Exit Strategies does not provide tax advice but will work with your tax advisors to help value the assets contributed to a DAF.)

Contributions of Private Securities

Most of the valuations we perform for the transfer of equity to DAFs are associated with the transfer of private equity securities. These transfers into DAFs frequently occur immediately before a pre-arranged stock sale.

In these situations, the donor hopes to claim a charitable deduction for the full fair market value of the gifted stock. However, because the sale of private securities always has risk, a qualified appraiser must pay special attention to discounts associated with a lack of liquidity (or a lack of control and marketability) that lowers the value of the donation to the Fair Market Value at the date of the gift rather than the anticipated timing of the income to the DAF. The appraiser must analyze related documentation of the donation, such as the private company’s by-laws, an operating agreement, or a buy-sell agreement, to see if there are any transfer restrictions in support of these discounts.

Form 8283

The IRS requires Form 8283[1] to be filed with a tax return in support of the resulting tax deduction for the donor. This form needs to be signed by the donor and the recipient, as well as the certified appraiser, along with a thorough, USPAP-compliant report required by the IRS for their review.

IRS-Compliant Report

The IRS considers several factors while reviewing a business valuation report, including the completeness of the report, whether it adequately discloses the methodologies applied, and the information necessary for a reader to understand the report. The IRS assesses whether the appraiser possesses the necessary skills and credentials to conduct the business valuation.

If you are planning to contribute private equity or other illiquid assets to a DAF, professional advice and planning is critical. A team of advisors, including a tax attorney and your accountant, will help you navigate this process. ESGI would welcome the opportunity to be part of that team as the valuation expert who opines on the value of these donations. Our team of appraisers includes professionals with the ASA designation (an Accredited Senior Appraiser) issued by the American Society of Appraisers[2], and our opinions meet strict IRS requirements and have been successfully defended in IRS review.

Exit Strategies has certified appraisers who value control and minority ownership interests of private businesses for tax, financial reporting, and strategic purposes. If you’d like help in this regard or have any related questions, you can reach  Joe Orlando, ASA, at 503-925-5510 or jorlando@exitstrategiesgroup.com.

[1] https://www.irs.gov/pub/irs-pdf/f8283.pdf

[2] https://www.appraisers.org/credentials/business-valuation

So what is an expert and, more importantly, are you one? The term “expert” has many definitions. For anyone who has written a wedding toast or sat through a valedictorian’s speech you know how the next sentence starts…Webster defines an Expert as “one with a special skill or knowledge representing mastery of a particular subject.” If you click through the link you will notice an obsolete definition for the adjective: experienced.

This distinction is important to understand who can hold themselves out as experts in a particular field. In my field, Business Valuation, I consider myself both experienced and an expert. My certification as an Accredited Senior Appraiser through the American Society of Appraisers allows me to separate myself from other experts. For example, in valuing a business, a business broker may hold themselves up as an expert by applying pricing tools to determine the appropriate value of a business in a hypothetical transaction.

However, without the proper training and credentials, a business broker may rely on summary information for market multiples (i.e. the Business Reference Guide) and ignore the details of a transaction search. Without proper valuation training, they may also decide to exclude an income approach as a methodology better suited for a business generating strong cash flows. While the ASA, AICPA, and IRS standards dictate that my work as a credentialed appraiser meets the requirements of their compliance in opining to a value, anyone holding themselves up as an expert needs to follow a Federal Rule of Evidence Rule 702: Testimony by Expert Witnesses which states that;

A witness who is qualified as an expert by knowledge, skill, experience, training, or education may testify in the form of an opinion or otherwise if:

• the expert’s scientific, technical, or other specialized knowledge will help the trier of fact to understand the evidence or to determine a fact in issue;
• the testimony is based on sufficient facts or data;
• the testimony is the product of reliable principles and methods; and
• the expert has reliably applied the principles and methods to the facts of the case.

An Update and a Crackdown

However, an amendment to Federal Rule of Evidence 702 will take effect on December 1, 2023, to help clarify the qualifications of an expert witness. A crackdown using the terms of this amendment has already taken place with increased exclusions and reversals of a lower court’s decision to admit expert evidence. Here are the terms of the amended Rule 702 (changes either crossed out or in bold).

Amended Rule 702: Testimony by Expert Witnesses

A witness who is qualified as an expert by knowledge, skill, experience, training, or education may testify in the form of an opinion or otherwise, if the proponent demonstrates to the court that it is more likely than not that:

• the expert’s scientific, technical, or other specialized knowledge will help the trier of fact to understand the evidence or to determine a fact in issue;
• the testimony is based on sufficient facts or data;
• the testimony is the product of reliable principles and methods; and
• the expert has reliably applied expert’s opinion reflects a reliable application of the principles and methods to the facts of the case.

While the above changes may seem minor, they are having an immediate impact on expert selection by attorneys and the exclusion of experts by judges. One of the top 50 law firms in the US, Perkins Coie, suggests that:

“While the rule has not changed extensively, the amendments clarify the standards federal courts should apply to the qualification of expert witnesses…In addition, counsel preparing expert witnesses may wish to ensure that the expert is prepared to defend the principles and methods used as appropriate and reliably applied to the given case.”

A Daubert Standard

Cornell Law School’s database of legal terms defines the Daubert Standard as follows:

“The ‘Daubert Standard’ provides a systematic framework for a trial court judge to assess the reliability and relevance of expert witness testimony before it is presented to a jury. Established in the 1993 U.S. Supreme Court case Daubert v. Merrell Dow Pharmaceuticals Inc., 509 U.S. 579 (1993), this standard transformed the landscape of expert testimony by placing the responsibility on trial judges to act as “gatekeepers” of scientific evidence.”

This standard was recently triggered in a bankruptcy case in South Carolina. The judge determined that the expert was qualified in this case but these challenges continue to occur.

Conclusion

I appreciate and respect someone with knowledge and experience holding themselves up as an expert. However, without the required credentials to pass the Daubert Standard test, I believe a judge, as the “gatekeeper” for the court, is more likely than not to exclude experts without an attorney appeal going forward.

Exit Strategies ten certified appraisers value control and minority ownership interests of private businesses for tax, financial reporting, and strategic purposes…and provide expert testimony. If you’d like help in this regard or have any related questions, you can reach  Joe Orlando, ASA at 503-925-5510 or jorlando@exitstrategiesgroup.com.