Will appear on BV pages – RECENT VALUATION ARTICLES

Dental Practice Valuation Insights

/in /by Exit Strategies

It seems that every time I value a dental practice the industry has undergone or is going through significant changes. Patients and the medical community are rapidly recognizing dentists as oral health specialists which is expanding the services being offered by the dental industry. The dental professional is looking beyond the mouth. Connections between oral health and whole body health are allowing for more collaboration around sleep problems, oral cancer, facial esthetics, and periodontal health. This trend combined with increased patient education and demand is driving growth in dental consumables, equipment, and technology. Finally, young professionals buying and transforming existing practices, as well as, merger and acquisition activity continues to grow as small startup dental support organizations (DSOs) empower value driven entrepreneurs.

The National Association of Certified Valuators and Analysts March/April 2016 issue of The Value Examiner includes a three-page article entitled Valuation Insights in the Dental Industry by Maria G. Melone, CPA, CVA. Ms. Melone spent ten years working at one of the largest DSOs handling all aspects of the buy-side of dental transactions and she has helped facilitate hundreds of transactions. She offers many valuable insights including:

  1. Most sellers do not know the value of their dental practices, and as a result, rely on a broker to provide an opinion of value.
  2. Many people in the dental industry refer to the value of a practice in terms of its percentage of last year’s collections.
  3. With the influx of private equity money in the industry it is becoming more common to use a multiple of EBITDA (Earnings Before Interest Taxes Depreciation and Amortization).
  4. As it relates to dental practices, the Income Approach is the most relevant and effective method of valuation. For a majority of dental practices, the significant value lies in future earning potential and the transfer of the patient base (an intangible asset) from the seller to the buyer.

Finally, many buyers, sellers, and brokers focus on production but in today’s third-party payer systems production and collection may be very different. Comparing collection to production provides an initial and meaningful way to measure the operating efficiency of a practice. Generally speaking, a more efficient practice is a more valuable practice. The creation of DSOs is allowing dentists to maximize their practice value with the support of professional office management. The DSO model enables dentists to focus on the patient while maximizing operational efficiency.

If you are buying, selling, or need help valuing a medical practice in the dental industry please contact Kenny Pierce, MBA, CVA, MAFF at 916-724-1675 or kpierce@exitstrategiesgroup.com.

Risk and its Effect on Enterprise Value

/in , /by Exit Strategies

Investors have choices in how to allocate their investment dollars across the risk and return spectrum. Whether it be bonds, public company equity, or private company equity, an astute investor will evaluate the risk of return and expect to be compensated according to this risk.

Business valuation, whether for public or private companies, has three key variables: growth, profit margins, and risk.

Growth and profit margins are more easily understood by most business owners and generally receive the most attention. Growth and margins drive cash flow which is what a buyer is ultimately looking for when investing in a business. That is, what cash flow return can they expect on their investment. In the ubiquitous Gordon Growth valuation model, cash flow is the numerator; risk is in the denominator.

“The path of least resistance to increasing enterprise value is often to reduce business risk.”

Yet risk is often overlooked and under appreciated. Business risk can have many dimensions ranging from concentration of customers, reliance on a single product line, owner dependence, reliance on a key individual, sub-par financial reporting, competitive threats, and outdated technology, systems or equipment to name just a few.

Before attempting to sell a business or attract investors, an owner should consider ways to make their business more attractive to buyers/investors. Increasing growth and margins often requires the most time and capital. An owner thinking of an exit may not want to put more capital into the business. The path of least resistance to increasing enterprise value is often to reduce business risk. Examples of this include cleaning up the books, creating retention incentives for key employees, obtaining long term contracts with vendors or customers, and other measures.

Having a business appraised by an independent expert in advance of going to market helps the owner clearly understand existing risk factors that are penalizing business value. This helps the owner identify strategies and objectives to de-risk the business and enhance value for current and future shareholders.

For further information on buy-sell agreement business valuation or to discuss a potential need, confidentially, please one of our senior business appraisers.

Business Valuation and M&A Services for Estates and Trusts

/in , /by Al Statz

Al StatzThis article takes a look at the various situations in which trusts and estates (those that hold private business interests) need business valuation or M&A brokerage services.

Business Valuation Services

Our firm, Exit Strategies Group, regularly provides fair market value appraisals (a.k.a. valuations) of closely-held corporations, FLPs and LLCs for estate planning, gifting, estate tax, charitable donations, buy-sell transactions and succession planning. We value fractional interests in operating companies and asset holding companies using appropriate discounts. We also value intangible assets such as patents, trademarks and copyrights.

For estates containing closely held business interests, we can determine the value of a decedent’s interest, and we can provide input to the estate attorney or CPA on whether an alternative valuation date should be considered.

For trust administration, when a privately held business interest is placed in trust, our business valuation can help the fiduciary or trustee establish a baseline value and enhance their understanding of the asset’s prospects and marketability. Subsequent valuations may be ordered to assess the investment’s performance over time. An independent business valuation can also avoid potential conflict of interest, when trustee fees are based upon the value of assets managed.

When an owner gifts shares in a business, we determine value as of the date of gift. When closely held business interests are donated to a Charitable Remainder Trust, our business valuation can support the charitable deduction by the donor taxpayer.

In estate planning where a family business is one of the owner’s major assets, a valuation is often the starting point for estate planning professionals as they consider various estate planning techniques. Valuations provide a basis for the owner to evaluate potential ownership transfers and gifts; and can safeguard against future IRS challenges.

Our appraisers adhere to professional valuation standards, perform appropriate due diligence, and meet or exceed accepted reporting requirements. We are prepared to defend our work in the unlikely event of an IRS audit. Between us, we hold all major U.S. business valuation credentials (ASA, CBA, CVA and ABV).

When drafting entity agreement terms, attorneys have to balance flexibility and efficiency of operation with restricting control and marketability. During this stage, we can identify problem valuation situations or problem assets, identify the effects of estate planning alternatives on fair market value, and make recommendations on operating, shareholder and buy-sell agreement terms that impact valuation.

Part of estate planning  is business succession planning, which is emotionally charged and usually meets with resistance. Business valuation provides an objective look at many aspects of a business, including its management, marketability, inherent risks, and future prospects. The very act of going through the business valuation process with an experienced, knowledgeable and independent appraiser often provides the catalyst that owners and their families need to embark on developing succession and wealth transfer plans.

M&A Brokerage Services

In many instances, an inter-generational transfer or management buyout of a business is not the best option for business owners and their families. In some cases the children aren’t qualified or they simply aren’t interested. In others, the industry may be consolidating or an opportunity exists to sell the business for significantly more than fair market value and/or create substantial liquidity for the family to reinvest or use to pursue other interests.

Accordingly, Exit Strategies markets and sells businesses. Our professionals advise owners throughout the evaluation, prospectus preparation, confidential strategic marketing, negotiation and due diligence phases. We lead the M&A sale process and work alongside our client’s tax, legal and financial advisors to maximize proceeds and preserve wealth.

Feel free to contact us for more information on business valuation and M&A brokerage services for estates and trusts, or to discuss a current need.

Business Values: Labyrinth or Maze?

/in /by Bob Altieri

In Greek mythology, the Labyrinth (Greek λαβύρινθος labyrinthos) was an elaborate structure designed and built by the legendary artificer Daedalus for King Minos of Crete at Knossos. Its function was to hold the Minotaur eventually killed by the hero Theseus. Daedalus had so cunningly made the Labyrinth that he could barely escape it after he built it.

In English, the term labyrinth is generally synonymous with maze. As a result of the long history of unicursal representation of the mythological Labyrinth, however, most contemporary scholars and enthusiasts observe a distinction between the two. Maze refers to a complex branching multicursal puzzle with choices of path and direction, while a unicursal labyrinth has only a single path to the center. A labyrinth in this sense has an unambiguous route to the center and back and is not difficult to navigate.

Businesses are mazes!

In terms of business value, many business owners believe that their company is not difficult to navigate, “a direct route to the center” sort of philosophy, which is often why they tend to grossly overstate or understate real (market) value. Having started businesses on my own in the past, I can relate to the amount of courage, time, energy and sacrifice it takes to embark on such uncharted waters, and I can sympathize with (better understand) the concept of extraordinary intrinsic value (value to oneself).

However, no two businesses are alike, even though they may have similar revenues, profitability and industry classification; and, there is no single formula (direct route to center) for valuing them.

Even professional business appraisers have difficulty navigating the maze, which requires detailed financial, operational, economic, industry and market analysis and the application of multiple valuation approaches; to provide a reliable and defensible opinion of value based on reasonable and objective analysis.

Small businesses (say up to $5 million in value) are generally sold with an asking price based on analysis by a business intermediary (broker) or appraiser. The greater the effort to accurately price a business (not taking shortcuts) and the greater the objectivity and expertise of the person doing the analysis, the greater the probability of closing a deal without leaving money on the table.

Bob Altieri, CBA, is a senior business appraiser and broker in Exit Strategies Group, Inc.’s Roseville (Sacrament0) California office. For further information on pricing a business for sale, contact Bob Altieri, CBA.

Necessary Components in Business Valuation

/in /by Jim Leonhard
Business valuations (a.k.a. appraisals) come in many shapes and sizes depending on who has done the work and the process they have followed.  Here’s a brief checklist of what to look for in an appraiser’s engagement letter and CV prior to hiring him or her:
1. Is the appraiser competent to perform your business valuation?  Verify that he or she has a current certification from one of the accrediting organizations, such as ASA, NACVA or IBA, as well as experience with the type of valuation you need and the type of business you have.  If not, reconsider your choice.
2. Will his or her appraisal report conform to the appropriate standards, e.g. Uniform Standards of Professional Appraisal Practice (USPAP)?  While this may not be necessary for limited scope valuations done for internal planning purposes, it is for example critical for appraisals that may be subject to IRS review. The business valuator’s engagement letter should clearly specify the standards to which the report will conform, as well as clearly define:
  • The valuation date
  • The standard and premise of value
  • The purpose, use and scope of the appraisal
  • The specific business interest to be appraised
3. Will the appraiser interview management and conduct a site visit? In certain circumstances this impacts the credibility of the appraiser’s report or testimony.
4. Will the appraiser consider all three approaches to valuation namely; asset, market and income?
5. Will the appraiser’s analysis and report address the eight factors stated in Revenue Ruling 59-60?
6. If a minority business interest is being valued, how will the appraiser address discounts?
For further information about business valuation requirements, please contact Jim Leonhard, CVA MBA at 916-800-2716 or jhleonhard@exitstrategiesgroup.com.

Interest Rates Likely to Rise After December FOMC Meeting

/in , /by Louis Cionci

It is widely believed that the Federal Reserve will raise the rate it charges banks for overnight deposit lending, commonly called the federal funds rate at the December 15-16 meeting of the Federal Open Market Committee.

The Federal Reserve controls the three tools of monetary policy–open market operations, the discount rate, and reserve requirements. The Board of Governors of the Federal Reserve System is responsible for the discount rate and reserve requirements, and the Federal Open Market Committee is responsible for open market operations. Using the three tools, the Federal Reserve influences the demand for, and supply of, balances that depository institutions hold at Federal Reserve Banks and in this way alters the federal funds rate.

Changes in the federal funds rate trigger a chain of events that affect other short-term interest rates, foreign exchange rates, long-term interest rates, the amount of money and credit, and, ultimately, a range of economic variables, including employment, output, and prices of goods and services.[1]

As shown in the graph below, the federal funds rate has been below .25% since 2009, primarily as a result of the 2008 financial crisis and the lingering effects on employment and the economy.

 

More information on the Federal Reserve can be found at their website, https://www.federalreserve.gov/default.htm

[1] https://www.federalreserve.gov/monetarypolicy/fomc.htm

Terminal Value Meets the Butcher and the Skilled Craftsmen

/in /by Exit Strategies

I got involved in a friendly debate with a business intermediary the other day. He was talking cynically about how easy it is to manipulate valuation results by playing games with the cost of capital and the growth rate. “It’s easier to slap an industry multiple to it, without all the fiction of precision,” he said. Specifically, he was objecting to “terminal value” for growth companies. In growth companies, terminal value can often comprise 50%-70% of total enterprise value, so he was right to call the assumptions into question. However, according to his reasoning the whole valuation exercise is built on sketchy technical grounds. With that logic a skilled surgeon could be labeled a murderous butcher, or an accomplished poet labeled a daydreamer who never amounts to anything.

What is terminal value?

Terminal value is an attempt to capture the long term sustainable growth rate of the company and discount the company’s cash flow by its cost of capital. When a company experiences high growth, it’s certain that it will eventually mature and slower growth will ensue. The rate of slowdown is hard to predict, so it’s true that these aren’t precise calculations and they have a degree of subjectivity. However, a skilled valuation analyst will take care in applying these variables, and will use other approaches and methods to test, validate and defend his or her assumptions.

Not all companies are created equal, yet very few companies can outgrow the economy on a sustainable basis. For company risk, or its cost of capital, each company will have fundamental factors that either raise or lower its risk profile. Company growth, as mentioned above, may experience periods of non-linear growth but ultimately hit a maturation point that will be closer to the level of overall economic growth. Three to five percent is often a very defensible sustainable growth rate, depending on the company’s fundamentals and sensitivity to the broader economy.

“One advantage that Exit Strategies has over other business appraisers is that we see regular deal flow and work with actual market participants.”

Through our M&A brokerage practice, we see regular deal flow and work with actual market participants. This means that in addition to databases, we have a current market view of how companies are being valued.  This helps us to gauge our income approach risk and growth assumptions with a market based view. We also consider an asset approach and make market adjustments to book value, though this approach generally is used to provide a floor to the valuation. However, it can come into play if a company isn’t using its assets efficiently and is generating sub-par returns on invested capital.

To summarize my long-winded reply to the intermediary, a skilled craftsmen has a large tool kit, knows what tools to use, when, and how to use them in each particular situation.

Exit Strategies brings independence and over 100 years of combined valuation and transaction expertise to every engagement. For a free confidential consultation on and M&A, exit planning or valuation need, please contact one of our senior advisors. 

Monday Morning Quarterbacking in Business Valuations

/in /by Jim Leonhard
Is hindsight appropriate in retrospective valuations? 
As business valuation experts, we are often retained to provide a conclusion of value as of a date that is in the past.  For example, valuations for estate tax filings often use the date of death, which can be as much as a year in the past.  Valuation dates for litigation cases can be even further in the past.
Normally, using hindsight is discouraged in business valuations — the expert is cautioned against considering hindsight his/her conclusion of value.  The American Institute of Certified Public Accountants (AICPA) issued a Statement on Standards for Valuation Services saying: “Generally, the valuation analyst should consider only circumstances existing at the valuation date. An event that could affect the value may occur subsequent to the valuation date; such an occurrence is referred to as a subsequent event. Subsequent events are indicative of conditions that were not known or knowable at the valuation date, including conditions that arose subsequent to the valuation date. The valuation would not be updated to reflect those events or conditions.”
Of particular concern to the valuation expert is a client’s potential bias resulting from their preference for a particular outcome.  For example, if the valuation is for an estate tax filing, the client may be seeking a low valuation to avoid estate taxes.  This could cause the client to provide projections of “future” performance, subsequent to the valuation date, that are low compared to what management would have likely forecast at the time of death.  This could be exacerbated if the expert were to take into account the company’s actual performance after the valuation date which may have been negatively impacted by events that were unknown and unknowable as of the valuation date.
In litigation cases that seek a valuation for a date many years in the past, the valuation analyst must diligently guard against allowing subsequent events to influence his/her conclusion of value.
This is not to say there are no legitimate circumstances where the use of hindsight is appropriate, but that is a topic for a subsequent blog.
 
For further information on this topic call or email Jim Leonhard in our Roseville, California office.

Asset Appraisals May be Needed to Support a Business Valuation

/in , /by Jim Leonhard

I recently valued a number businesses that required the appraisal of certain tangible assets, such as real estate and equipment – in one case its was an extensive library of manuals and maintenance specifications for a service business.  At what point do we look for a appraisal specialist with particular expertise to value such assets?  

The simple answer is, it depends on materiality.  If it is clear that the business enterprise value is well above the net tangible asset value, as evidenced by the market and/or income valuation methods, we may be able to rely upon the owner’s estimates or rough calculations of the market value of tangible assets. The answer can also depend on the intended use and intended users of the business valuation.
When the asset(s) in question have very significant value  that will impact the market and/or income approaches to value, or if one of the asset approach methodologies, such as net book value or liquidation value will be relied upon, we will request that a client obtain a third party appraisal of the asset(s) in question that we can incorporate into our business valuation.
Typical  Situations Where Asset Appraisals are Recommended
  • Real Estate Appraisals
    • the business owns real estate, e.g. for agricultural enterprises or a real estate partnerships
    • the business leases real estate from a related party and we need to ensure the business is paying market rent
  • Equipment appraisals
    • the business is capital intensive
    • it has a large amount of used equipment – making rough value calculations unreliable
  • Unique assets
    • the business has a significant amount of unusual assets that are not common to most organizations
  • Non-operating assets
    • non-operating assets are items that can be removed from the business without affecting business operations, e.g. an airplane owned by a construction business, or a vacation home
For more information about how asset appraisals are used in business valuations, please contact Jim Leonhard, CVA, at 916-800-2716 or jhleonhard@exitstrategiesgroup.com. 

Vaguely Right or Precisely Wrong about Cash Flow

/in , /by Al Statz

Al StatzWarren Buffet once quoted the economist John Maynard Keynes, “I would rather be vaguely right, than precisely wrong,” in describing how he determines the appropriate cash flow measure of a company.

Indeed, determining the value of a business is not a precise exercise.  However, neither is the process random guesswork. After assessing the facts and circumstances of the business, the appraiser’s goal is to find a value that represents what hypothetical or actual market participants could be expected to pay for the business or an equity interest therein.

When it comes to understanding financial performance, privately held businesses present several challenges not present in public companies. For beginners, private companies are not held to the same financial reporting standards. Hence, financial statement quality varies widely from business to business. Business appraisers and M&A advisors must look at the reported numbers and make a series of adjustments before applying valuation methods. Valuation analysts typically make four types of normalization adjustments to arrive at a true measure of cash flow (or some other economic benefit stream).

Four Types of Normalization Adjustments

  1. GAAP related — typically for comparison with industry peers
  2. Non-recurring and extraordinary items
  3. Non-operating assets, liabilities, income and expense
  4. Control-related — adjusting owner benefits to market or reasonable replacement values

Owners, investors, CPA’s, attorneys, lenders and other market participants are often surprised how much work goes into investigating and adjusting financial statements before business valuation methods can be applied. Often, the smaller and more closely held a business is, the more normalization work will be required.

“Often, the smaller and more closely held a business is, the more normalization work will be required.”

There are other areas where the need for investigation and professional judgement increases in small business valuation. Small private companies seldom have the same quality of systems, and usually have more reliance on few products, employees or customers management, which increases uncertainty and adds to the risk analysis. And they rarely have defensible growth projections. The growth rate and risk score affects the discount or capitalization rate used in the valuation. And using valuation simplistic formulas, “rules of thumb” or hearsay are almost sure to yield precisely wrong results. Whereas, an accredited and experienced appraiser using appropriate valuation analysis, professional judgement, objectivity and common sense will give you an opinion of value that more accurately reflects market reality.

Exit Strategies brings independence and over 100 years of combined professional expertise to every business valuation engagement. Contact Al Statz with any questions or for a free confidential consultation on a potential business valuation or M&A need.