Will appear on BV pages – RECENT VALUATION ARTICLES

Business Valuation: Step one in the sale process.

/in , , /by Louis Cionci

If you are considering selling your business, I would like to let you in on an M&A (merger and acquisition) professional’s insight. I have been involved in initiating and managing M&A transactions for over 15 years and have handled deals representing over $250 million in transaction value. Those transactions ranged from $2.6 mm to $90 mm. In addition, I was on a team that helped an international client acquire a $2.6 billion industry rival back in 2000.

Whether $2.6 million or $2.6 billion, these successful transactions started with a business valuation.  The sale or acquisition of a business is a multi-step process, and the first step in a successful transaction between a buyer and seller almost always begins with a professional business valuation. Steps that follow the valuation include, marketing the company, buyer due diligence, negotiating the deal, and the closing.
A business valuation is a critical step on both sides of the deal table. Normally, the seller will do the first valuation, to get an idea of their company’s market value and then decide upon a price range that would motivate them to sell. The seller will generally share their historical and projected financial information with a vetted buyer. The buyer can then apply their own specific investment requirements to the shared information. Both sides utilize their valuations to negotiate the deal.
In my experience, no matter the size of the deal, the first step in a successful M&A transaction is a business valuation.
 
For more information on business valuation for M&A transactions, Email Louis Cionci or call him at 707-778-2040.

Valuation: Theory, Practice and Reality

/in , /by Exit Strategies

I attended a luncheon last week where a private equity firm’s panelist claimed that business valuation is too theoretical and inappropriate in the transactional world.  I instinctively question broad-based statements like this, when I hear them; however I listened attentively. The panelist correctly asserted that most valuation firms focus on compliance and litigation work as opposed to transactions. However, his criticism of valuation work was illogical and inconsistent, and offered no better alternative.

To make his case he defined enterprise value in transactional terms as: what it would take to buy 100% (equity + debt) of the company excluding cash, in an arm’s length deal. Okay, so far this was sounding a lot like the willing buyer/willing seller concept of Fair Market Value.

He went on to discuss how firms are typically valued by valuation analysts. These were his assertions:

  1. The income approach, known as discounted cash flow (DCF), is too theoretical. I disagree. This approach seeks to price businesses by assigning a risk-based rate of return to the expected future income. Strategic buyers use the DCF approach whenever they expect non-linear growth in the business. In business valuation we determine value to a strategic buyer under the Investment Value standard. Risk assessment also very similar to what bankers and insurance people do, although evaluating the risk of a going concern involves qualitative assessments that are harder to quantify. Proper application of valuation theory, tempered by common sense can provide clear insight into fundamental value.
  2. Comparable transactions are the most important. This is consistent with business valuation theory, and I agree in concept. In reality, a lack of data and inconsistent reporting of private business transactions makes accurate comparisons difficult. Therefore, this approach is often used as a reality check against income approach results.
  3. The factors used to gauge a company’s debt capacity are very similar to analyzing equity value (like customer concentration, poor systems, etc.). Agreed. Again, it’s pricing the risk of the operation.  A bank won’t lend money to a risky firm, or if they do, terms and pricing will be more stringent. The income approach he decried as “too theoretical,” works the same way.

He went on to discuss the price ranges that he sees in transactions. Typically, he said, adjusted EV/EBITDA multiples range from 3.9 to 6.9. This range can be explained by varying degrees of profit margins, expected growth and risk, as well as potential synergistic benefits. But he gave no indication how to quantify these issues.

In the end, I suspect that the panelist just didn’t understand business valuation very well, and described the world as he sees it through a narrow lens.

Two concluding points:

First, when valuing your life’s work, all reasonable valuation approaches should be considered. One approach may be more appropriate than another. All approaches lend insight into value. It’s not an all or nothing exercise.

Second, don’t trust your business to someone who lacks valuation expertise, someone with a limited point of view, or someone who may have an agenda.

Exit Strategies brings independence and over 100 years of combined valuation and M&A transaction expertise to every engagement. Contact us for a free confidential consultation with one of our senior advisors.

Your Buy-Sell Agreement: In good shape? Needs a tune up? Or Disaster waiting to happen?

/in , , /by Bob Altieri

An Ounce of Prevention is Worth a Pound of Cure

I can’t tell you how many times I’ve heard from business owners and their spouses that a key person became disabled or died and left an operating closely-held business in turmoil. What, no Buy-Sell Agreement? Ask anyone who has been selling and appraising business for a number of years and they will tell you this sort of thing is common. All businesses with more than one shareholder should have a Buy-Sell Agreement (“BSA”) in place. Even when companies have BSAs, they are poorly written, causing divisive and expensive issues down the road.

All multi-owner businesses need a well-written BSA to transfer shares in a fair and efficient manner when a shareholder dies, becomes incapacitated, is involved in a marital dissolution, quits or is fired, retires, or the company enters bankruptcy (aka,”Trigger Events”).

Exit Strategies’ accredited appraisers perform numerous business valuations each year, and because this work requires us to review corporate documents, we can say with some authority that many privately-held companies have problematic Buy-Sell Agreements from business, funding and valuation perspectives. When we come across B-S Agreements (pun intended), most often the owners didn’t want to invest the money to do it properly, or they just didn’t understand how import it was to have a viable BSA in place at the outset. Unfortunately, those who experience costly litigation, internal disputes, business erosion and family problems learn a painful lesson later on.

Shareholders have three choices when deciding on how shares will be priced when one of the aforementioned trigger events occurs:

  1. Fixed Price: Shareholders agree on a set price. Unfortunately, the price is likely years out of date and the shareholders usually have not agreed on a way to update the price.
  2. Price Formula: Shareholders agree on a formula to calculate future pricing. Chances are, no one has calculated it lately and because of changes in the company, economic and industry conditions over time, the formula price may be higher or lower than fair market value at the time of the trigger event. Also, it’s often seen where the shareholders haven’t agreed on ways to make necessary/appropriate adjustments to the formula.
  3. Valuation Process: Shareholders agree on a process employing one or more appraisers to determine the value of shares using guidelines specified in the BSA. There are two types of process BSAa: Multiple Appraiser and Single Appraiser. Multiple appraiser agreements call for the selection of two or more appraisers to develop one, two, or three appraisals whose conclusions form the basis for the final price. If that process sounds time consuming, cumbersome and expensive, IT IS!! It can also be divisive. Single appraiser agreements call for the selection of one appraiser whose valuation sets the final price. The choices are to a) select the appraiser and value upon a trigger event; b) select the single appraiser now and value at the trigger event; or c) select the single appraiser now, value now, and of course value again when a trigger event occurs.

Our Recommendation is to SELECT ONE APPRAISER NOW and VALUE NOW

  • Select Now – If the shareholders creating the buy-sell agreement name the appraiser at the time of the agreement, all parties have a voice and can sign off on the selection. Early on, when everyone’s interests are aligned, this is a relatively easy decision to make. Doing it after a trigger event, when interests have diverged, is very difficult.
  • Value Now – Once selected, the chosen appraiser provides a baseline valuation, which is a fantastic way to put all shareholders on the same (price) page. We often provide a draft report, and give everyone time to provide comments for consideration before the report is finalized.

Why selecting a single appraiser now and appraising now is the best choice for closely-held companies when creating a Buy-Sell Agreement:

  1. The selected appraiser is viewed  as independent by everyone
  2. Because the appraiser must interpret the BSA language related to valuation when conducting the initial appraisal, any issues regarding lack of clarity or inconsistency with the owners’ intentions can be resolved up front
  3. The valuation process is observed by all shareholders at the outset, so they all know what will happen when a trigger event occurs (no surprises)
  4. The concluded value establishes a baseline price (no surprises)
  5. The selected appraiser maintains independence with respect to process and renders future valuations consistent with the BSA terms and prior reports
  6. Subsequent appraisals, either annually or at trigger events, should be less time consuming and less expensive
  7. Parties will likely gain confidence in the process
  8. Parties will always know the current value for the Buy-Sell agreement, which is helpful for personal or estate planning purposes
  9. The initial valuation gives the shareholders a roadmap to increasing value if that is their objective.
  10. The appraiser’s knowledge of the company and industry grows over time, enhancing confidence for all parties
  11. Creates a means of maintaining pricing for other transactions, thereby enhancing “the market” for a company’s shares


Valuation is a key piece of any shareholder buy-sell agreement. If you need help with the business valuation provisions of your buy-sell agreement, or need a valuation for a trigger event, feel free to Email Bob Altieri or call him at 916-905-5706. 

Court Chastens Expert Over Deficient Business Valuation

/in /by Al Statz

Sometimes courts face a hard choice, having to decide between equally compelling and competent valuations. Not so in a recent fair value proceeding in which the skills gap between the testifying experts made it easy for the court to pick the winner.

Use of the Valuation: Business Divorce

The petitioner and the respondent were the two owners of a New York company that installed solar energy panels on buildings. Business boomed, and the company enjoyed an 80% market share until competition increased, cutting that share to 11%. Also, there was uncertainty over the fate of federal and state tax incentives offered to users of the panels.

The owners began to argue over the direction of the business. The respondent submitted a strategic growth plan to the board of directors that proposed expanding into new markets. The board approved it over the petitioner’s objection, who then filed for dissolution of the company. The respondent opted for a buyout of the petitioner’s shares. Both sides presented expert testimony about the fair value of the petitioner’s interest.

Key Issue: Financial Forecast

Both appraisers calculated value under the income and market approaches but used different methodologies. Under the income approach, the petitioner’s expert performed a discounted cash flow (DCF) analysis. He used the five-year projections the management board had approved but applied a company-specific risk premium to account for “forecast risk.” At the end of the forecast period, he reduced the growth rates during the remainder of the 10-year discrete forecast to only inflationary growth in the terminal value. He studied the company’s financials and corporate structure and assessed the recently adopted business growth plan. He also researched the industry and found that New York State had extended the tax credits through 2016 and had started another program to incentivize consumers to install the panels. Greentech Media, a leading source of news and analysis of green technology, forecast 60% annual growth in the industry over the next three years. Also, the company’s 2013 revenue exceeded that of the previous year by 35%. The final value, weighting results from the income and market approaches, was $3.8 million, he concluded.

The respondent’s expert, on the other hand, used the capitalization of weighted earnings method. The court noted that this approach assumes that a company has long-term stable cash flow but that the expert conceded that the company’s cash flows and earnings were not consistent during the preceding four years. He also said that the DCF was his preferred method. The court discredited his valuation. It pointed to multiple flaws, including the expert’s failure to include either a growth rate or management projections. He was unaware of the board’s growth strategy plan and did not know that the board had decided to reinvest dividends in the company to stimulate growth. According to the court, he “severely underestimated even his client’s own projections.” The court’s verdict regarding the respondent expert’s market-based analysis was even harsher. It had “severe deficiencies” that prevented calculating a credible fair value for the company, the court said.

Except for a slight adjustment for the marketability discount, the court adopted the petitioner expert’s $3.8 million value.

A full discussion of Wright v. Irish (Hudson Valley Clean Energy, Inc.), 2014 N.Y. Sup. Ct. Index No. 2111/2014 (Nov. 7, 2014) can be found in the January issue of BVR’s Business Valuation Update.

Exit Strategies’ five accredited business valuation experts use appropriate financial forecasting and valuation methods to deliver accurate and defensible valuations.  Feel free to call us for a confidential discussion of your business valuation or brokerage needs.  Contact Al Statz at 707-778-2040.

Upcoming Event: Valuing a Business for Estate Purposes

/in , /by Al Statz
Society of California Accountants North Bay Chapter Annual Estate & Trust Update
At the Sheraton Sonoma County
 
My background as a business valuation expert, M&A advisor, corporate development executive and business owner allows me to bring a wealth of knowledge and first-hand experience to closely held and family business owners as they consider their exit options and plan successful ownership transfers. I enjoy educating business owners  on these topics, and sharing my expertise with accountants, attorneys, lenders and wealth management professionals. And with baby boomer retirements on the rise, industry groups  are increasingly looking for experts to educate their members. 
 
If you want to explore booking me to speak to your group or association, Email or call me at 707-778-2040. 

The Importance of a Credible and Competent Valuation Expert

/in , /by Al Statz

Al StatzThe need for business valuation arises in many circumstances ranging from dispute resolution, to estate planning, to the sale of a business to name only a few.  As in all professional disciplines, it is important to hire a practitioner who is fully trained, able to discern relevant facts, and abreast of current best practices. Consider the following New York Supreme Court case.*

Adelstein v. Finest Food Distributing Co

Two brothers and their uncle each owned a one-third interest in a distribution business.  The brothers had offered to buy out the uncle. The uncle refused, the relationship deteriorated, and the case became a matter for the New York courts to decide.

The Brothers’ Expert

The expert for the brothers was a CPA lacking a business valuation credential, who had reportedly performed about 50 business valuations. His valuation report was three pages in length, based on a review of the company’s tax returns, and conversations with its accountant and its principals.  He chose an income approach, using the capitalized income method.  His rationale for using just one approach was that he couldn’t find comparable market transactions and that the company was not public. Normalizing adjustments produced an income stream of $206,000. A derived 20% capitalization rate was based upon company-specific risk factors such as customer concentration and limited management; applied a 20% discount for lack of marketability. He concluded the uncle’s one-third interest was worth $230,000.

The Uncle’s Expert

The uncle’s expert was a credentialed business appraiser.  His review included tax returns, general ledger, bank statements, and sales reports.  He found sales had doubled, gross margin declined, while officer compensation increased from $0 to $500,000. Further due diligence revealed 20% of sales were cash payments not recorded on the books. Analysis of sales reports found unrecorded sales of almost $1 million.  Additionally, he imputed industry gross margins of 35% versus 25% company reported margins.  The income approach produced a normalized income stream of $486,000, a 12% capitalization rate, a 5% discount, and a $4,050,000 value. As a sanity check, he applied a market approach using transaction data commonly accessed by professional business appraisers. In applying market multiples for sales, gross profit, and EBITDA he found a range of values between $3,990,000 and $4,191,000. He gave a 70% weight to the income derived value; 10% weight to each market derived value.  He concluded the uncle’s one-third interest was worth $1,287,000.

The Court’s Decision

The court affirmed the uncle’s expert citing his “credibility and reliability of valuation methods.”  Specifically, the court noted his qualifications, the use of more than one valuation method, and more objective and rigorous due diligence to support his conclusion.  Importantly, the uncle’s expert also demonstrated an understanding of state law on the applicability of minority discounts.

This case illustrates the wide range of business valuations and experts found out there in the real world.  More often than not, relying on a cursory review of an entity’s operations and a single method of valuation will omit key value determinants.

Accurate valuation requires an understanding of professional valuation standards and a rigorous analytical process that can be clearly explained and understood. Whatever the intended use of a business valuation, working with a trustworthy, experienced and accredited valuation professional usually provides the most accurate and defensible result.

* Adelstein v. Finest Food Distributing Co., 2014 N.Y. App. Div. LEXIS 2542 (April 16, 2014); Matter of Adelstein v. Finest Food Distributing Co., 2011 N.Y. LEXIS 5956 (Nov. 3, 2011)

Exit Strategies’ team of accredited business valuation experts have over 100 years of combined experience.  Please contact us for a frank, confidential discussion about a potential business valuation, sale, merger or valuation need.

Upcoming Event on Valuation of Ag and Food Businesses

/in , /by Al Statz

Al Statz of Exit Strategies Group will be a panelist for the American Society of Appraisers (ASA) Northern California workshop —Working with a Going Concern: Valuation Issues Related to Ag-Food Processing Facilities, on Saturday, May 31, 2014, in Fairfield, California.

A Message From Al:

My passion is helping baby boomer business owners exit right and retire well. My background as a valuation and M&A professional, business owner and corporate development executive allows me to bring a wealth of knowledge and real-world experience to help closely held and family business owners understand their options, maximize value and achieve successful ownership transfers.
 
I enjoy speaking to groups of business owners on these topics. I also regularly speak to advisers to business owners – accountants, attorneys, lenders, wealth management professionals and industry associations. With baby boomer retirements on the rise, these groups are increasingly looking for experts to educate their constituents. Well look no further! If you own a business or advise business owners and want to explore booking me to speak to your group, Email or call me at 707-778-2040. Thank you.

– See more at: https://webcache.googleusercontent.com/search?q=cache:HnnS5z8O5O4J:exitstrategiesgroup.com/blog.html%3Fbpid%3D3943+&cd=1&hl=en&ct=clnk&gl=us#sthash.FYoxOdVu.dpuf

Is it too early to have my business valued?

/in , /by Roy Martinez

A potential client has been dragging his feet on having a business valuation done. Most recently, he asked, “Is it too early to have my business valued?” A better question may be, is it too late?

This baby boomer wants to exit his business and retire in the next 2-5 years. He said, if the business isn’t worth much, he would probably hold on to it and transition management of the business to a group of employees over time. If the business is worth a lot, he would sell now and retire as soon as he had transitioned the business to the buyer. Inherent in that discussion is the fact that he really doesn’t know how much his business is worth.

As I pointed out in my blog post of February 26, 2014, “Why Should I Get My Business Valued”, for most business owners, their business in one of their biggest assets (often their biggest). Every month you know what your securities portfolio is worth. You can go to Zillow.com for an estimate of your home’s value. Similarly, you can go to Loop.net to get an idea of the value of your commercial real estate holdings. But where can you find the value of your biggest asset? The only ways are: 1) to market and sell your business or 2) to have your business valued by a qualified valuation expert.

My response to this business owner was:

“No, it is not too early. If you end up deciding to transition the business to your employees, it will take time. Doing it right can take 3-5 years or more. If you want to retire in 3-5 years, you already may be behind the game. And…if the business is worth enough for you to retire now, what are you waiting for?”

Most likely his business is worth somewhere between the two extremes that are occupying his mind. An accurate and well-documented business valuation will help him make better decisions with respect to managing the business and exiting in the right manner and in the appropriate time frame.

  1. Roy Martinez is a Certified Valuation Analyst (CVA) and business broker/M&A adviser. He can be reached at jroymartinez@exitstrategiesgroup.com or 707-778-2040.

What is Fair Market Value?

/in /by Al Statz
You’ve heard the term Fair Market Value many times. Fair Market Value is indeed the most common standard of value used in business valuations, but what does it actually mean?
Fair Market Value is typically defined as “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 having reasonable knowledge of relevant facts.”  (Source: Treas. Regs. §20.2031-1(b) and §25.2512-1; and Rev. Rul. 59-60, 1959-1 C.B. 237)
You’ll see many slight variations on the Fair Market Value standard, but the above is the most broadly used and accepted definition.
Users of business valuations should be aware that the term Fair Market Value generally carries with it several basic assumptions that can have significant influence on the value analysis and concluded value:
  • Both the buyer and seller are hypothetical people
  • The buyer is at arms-length, able and willing to trade, prudent and seeking a fair return
  • Generally a financial buyer without benefits attributable to synergies
  • The business would be held on the market for a reasonable period
  • The business would sell for cash or equivalent
  • Both parties are well informed about the business and the market; the effect of business and financial risk, control and marketability characteristics on value; and the returns available from alternative investments.
Business owners, shareholders, attorneys, CPA’s and other users of valuations should also know that while Fair Market Value is applicable for many of the typical uses of business valuations, it isn’t always appropriate. Some other common standards of value in business valuation are listed in the following table:
Standard of ValueDefined by:
Fair Value  (dissenting SH, minority oppression cases)Minority oppression statutes, California Corporations Code §2000.  Study case law to determine how interpreted.
Fair Value  (financial reporting)FASB, SEC.
Investment ValueInternational Glossary of BV Terms.  When the buyer is known (not hypothetical).
Most Probable Selling PriceInternational Business Brokers Association.
It is critical that the correct standard of value be used in your next business valuation.  For more information or help with a current business valuation need or exit strategy, contact Al Statz at 707-778-2040 or alstatz@exitstrategiesgroup.com.

Why Should I Only Retain a Certified Valuation Expert?

/in /by Jim Leonhard
If you’re thinking of using a non-certified or non-credentialed individual to value a business, consider the following recent judicial ruling.
The United States Tax Court ruled on February 11, 2014** that a valuation conducted by a non-valuation credentialed individual used for an estate tax filing was materially deficient.  The individual who prepared the valuation was both a CPA and a CFP (certified financial planner), had written 10-20 valuation reports, and had testified in court.  However, he lacked a business appraisal certification.
In brief, the court found that the estate had used an inappropriate valuation method (Capitalization of Dividends) versus the Commissioner’s expert (Net Asset Value) which led it to “substantially understate” the value of the estate as it was less than 65% of the Commissioner’s expert’s value.  As a result, the court found “that the estate has not demonstrated that it acted with reasonable cause and in good faith in reporting the value of the decedent’s interest in PHC on the estate tax return.” As a result, the Commissioner’s imposed an accuracy-related penalty in addition to the increased tax due.
The court stated that “in order to be able to invoke ‘reasonable cause’ in a case of this difficulty and magnitude, the estate needed to have the decedent’s interest in PHC appraised by a certified appraiser.  The estate relied on the valuation by [a non-certified appraiser], but did not show that he was really qualified to value the decedent’s interest in the company.” Furthermore, the court asserted that “we cannot say that the estate acted with reasonable cause and in good faith in using an unsigned draft report prepared by its accountant as its basis for reporting the value of the decedent’s interest … on the estate tax return.”  The Tax Court dismissed his valuation, determined that the estate owned an additional $2.8 million, plus a 20% accuracy-related penalty of over $1.1 million dollars.
** CLICK HERE for the details of the case: UNITED STATES TAX COURT, ESTATE OF HELEN P. RICHMOND, DECEASED, AMANDA ZERBEY, EXECUTRIX, Petitioner v. COMMISSIONER OF INTERNAL REVENUE, Docket No. 21448-09.
While this particular case involved an estate tax filing, most business valuations should be performed by a certified valuation professional to ensure accuracy and credibility.
For a certified business valuation or advice on exiting a company, please contact Jim Leonhard in the Sacramento, California area, 916-800-2716.