Will appear on BV pages – RECENT VALUATION ARTICLES

Fair Market Value — is it really fair?

/in /by Bob Altieri

In the business valuation profession, one determines Fair Market Value through analysis of the company and its management structure, the industry in which it participates, economic conditions and trends present in the industry, competitive environment, and any other factors that help to define the risk of investing in the enterprise. This analysis of risk is what many in the appraisal profession term as the subjective part of the valuation analysis, or “the art” of appraisal analysis.

The other part, which is the “science” component, is the financial analysis of the company. A proper financial analysis includes looking at the historic income statements, balance sheets and financial ratios to identify trends and see how the company performs relative to its peers in the industry. The next step is to normalize these financial statements to remove non-operating items, non-recurring items, and to adjust the compensation and perquisites of the owner to market rates (also known as control adjustments).

When these analyses are completed, the analyst usually determines a base year sales, earnings and cash flow forecast to capitalize (income approach) and apply market-derived multiples (market approach) to obtain indications of value. The last step in the process is to reconcile the various indicated values into a conclusion of value based upon the analyst’s confidence level in each of the methods used in the analysis.

I regularly appraise small businesses ($1 to 10 million revenue) for SBA 7(a) business acquisition loans, where the buyer and the seller are usually individuals or families. In doing this work I see the transactions that made it through the lender’s screening process, and I see the original asking price and the actual price paid. In most of these deals a business broker did a good job helping the seller set and achieve a fair price. Successful business brokers undertake the same steps that I outlined above to advise their clients before the sale.

I also see some of the deals rejected by lenders and I get to dissect past deals that no lender or appraiser ever touched. What I have observed is that sellers who sell a business on their own or work with a broker who short cuts the valuation process, often end up frustrated. They either leave money on the table, or end up financing most of the transaction and don’t get paid, or they waste valuable time and energy trying to sell for an unreasonable price.

When this sort of thing occurs the price paid or offered usually did not equate to Fair Market Value.

And sellers understandably have a difficult time evaluating brokers because they have no training or experience in this area.  Like any major financial transaction, we usually receive more in the end when we rely on qualified and experienced advisors from the very beginning.

For further information or to discuss a current need, Email Bob Altieri, CBA, or call him at 530-478-9790.

Update on Estate and Gift Tax Changes Coming in 2016

/in /by Louis Cionci

Proposed rule changes would limit the practice of discounting the value of stakes in family businesses for estate and gift tax purposes—an update regarding IRS timeline.

The U.S. Treasury Department and the IRS are planning to introduce new regulations aimed at estate and gift transfers of closely held family businesses. The new rules would limit the practice of discounting minority stakes in closely held family owned businesses because of restrictions on an owner’s ability to sell their piece of the business.

The Wall Street Journal on August 19, 2016 reported that the IRS is accepting comments on the new proposals, and a hearing is scheduled for December 1, 2016, and some experts think the current administration will push to finish the proposed changes before a new president takes office.

A brief window of opportunity exists as the proposed changes will likely not take effect until 30 days after the rules are made final. Implementation of wealth transfers can easily take 2 to 4 months to complete, depending on the complexity of the entities and estates involved. Therefore, we urge you to talk with your estate, legal and tax advisors now to evaluate how the proposed regulations could impact your business succession and wealth transfer plans. Those who can take advantage of current rules will need to act immediately.

Exit Strategies performs valuations of family-owned operating businesses and holding companies for estate planning, gifting and other purposes. We value fractional interests using appropriate discounts.  If you have any business valuation questions or have a current need you can reach Louis Cionci at 707-781-8582.

Buried in the Corporate Archives – a Valuation Case Study

/in , /by Exit Strategies

A lot of our valuation work is done for the purpose of internal share transfers of private businesses, or buy-sell transactions. In doing this work, we often see that owners have overlooked or neglected to keep important documents up to date. One such document is the buy-sell agreement, which articulates important legal, tax, valuation and financing issues that are important to ensuring smooth share transfers and business continuity.

We recently evaluated a holding company with a fair market value of approximately $40 million dollars. Two shareholders each owned a 50% interest in the company, a C Corporation, and one wanted to sell their stake to the other. The client said during our initial conversations that there was no buy-sell agreement in place, so we proceeded with developing a Fair Market Value opinion of a 50% interest. Just to be safe we requested a copy of “any agreements governing  or restricting the sale of shares”.

Guess what? Just as we were wrapping up the valuation, the client came across a type-written copy of the corporate buy-sell agreement executed in 1982. The owners and officers had been unaware of its existence. Hence, it hadn’t been updated and they certainly weren’t aware of its terms and provisions. As we reviewed the agreement, we found that it prescribed that any transfer of company shares would be at book value. In this case, book value was less than $1 million dollars.

A buy-sell agreement is a legally enforceable contract.

In the 2011 New Jersey Appellate Court case of Estate of Cohen v. Booth Computers, the partnership (buy-sell) agreement stated that value would be “net book value, plus $50,000, on the most recent financial statement.” When Cohen passed away this formula generated a value of $178k. Cohen’s heirs had the business appraised for $11.5 million. The Court upheld the $178k value based on the terms of the partnership agreement!

For our client, this was a nightmare waiting to happen. Imagine what would have happened had our clients not had a great relationship — the seller could have received less than $1 million for a $40-million-dollar asset! Fortunately, the owners were committed to a fair deal and they agreed to set aside the buy-sell agreement.

To assure that your company shares will transfer for an appropriate price when your buy-sell agreement is triggered or to put a buy-sell agreement in place, contact a business appraiser who is experienced in valuing company shares for buy-sell transactions. When you bring in a seasoned business valuation expert early on to interpret the pricing mechanism and other terms of your existing buy-sell agreement, they can recommend changes that will ensure that the agreement will operate the way the shareholders intend. And the sooner the better. It’s an easy discussion while all shareholders interests are aligned. Later on, as shareholders becomes buyers and sellers, their interests diverge and in most cases making changes to these agreements become far more difficult.

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

Estate and Gift Tax Changes Coming in 2016?

/in /by Louis Cionci

New rules would limit the practice of discounting value of minority stakes in family businesses.

The Wall Street Journal, Wednesday August 3, 2016, page A3 reported that the U.S. Treasury Department and the IRS are planning to introduce new regulations aimed at estate and gift transfers of closely held family businesses. The new rules would limit the practice of discounting minority stakes in closely held family owned businesses because of restrictions on an owner’s ability to sell their piece of the business. Estate and gift taxes apply at a top rate of 40% above the $5.45 million per person exclusion, and $10.9 million lifetime exclusion for married couples.

According to the WSJ article, Republican presidential candidate Donald Trump wants to eliminate the estate tax, and Democratic presidential candidate Hillary Clinton says she would propose returning to an estate tax exclusion of $3.5 million per person and a $1 million gift tax exemption and a 45% tax rate.

Stay tuned and we’ll let you know how this plays out.

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