As an expert consultant, the valuation professional is engaged to develop information that will be used by the attorney in a variety of ways, including settlement negotiations with the opposing side. In these instances, the valuation professional is usually not expected to testify or to develop an opinion of value that will be entered into the court records. The documents created by the valuation professional may be protected by attorney-client privilege. In this situation, the valuation professional is working as the client’s advocate. Continue reading
Buy-sell agreements for privately-held companies provide the shareholders with a mechanism by which the interest of a deceased or withdrawing shareholder may be liquidated through a repurchase agreement, a cross-purchase agreement, or a hybrid agreement. Providing for how the value of the shares is established is critical for a successful buy-sell agreement. Generally, there are three methods through which the value of the shares may be established: 1) specific formula approach based on a financial metric such as book value, earnings, etc., 2) negotiation between the parties, 3) independent outside appraisals. While the value determined by a specific formula may be manipulated by the controlling shareholders who have some discretion over how the financial statements are reported and the negotiation between the parties may fail when the parties are unable to agree on terms, an independent outside valuation conducted as part of an annual valuation program provides a clear means of establishing the value of an interest over time.
Rules of Thumb are generally expressed as multipliers. A common example would be that some particular type of business will sell for .75 to 1.50 times annual revenues. Another popular multiple is a multiple of discretionary earnings. For example, a particular type of business is said to sell for X times Seller’s Discretionary Cash Flow (SDCF), or Owner’s Cash Flow (OCF). There may also be other rules of thumb relating to some measure of physical volume, such as X dollars times each keg of beer sold per month. Continue reading
An Accredited Valuation Analyst (AVA) is a valuation professional who has completed specialized advanced training in business valuations through the National Association of Certified Valuation Analysts (NACVA) and who has also completed a comprehensive examination and submitted a complete written valuation report to examiners. AVAs receive continuing education in valuations each year and observe the ethics, reporting standards, and practice standards of NACVA. Continue reading
Goodwill is defined as the intangible asset arising as a result of name, reputation, customer loyalty, location, products, and similar factors not separately identified. The notion of goodwill has existed since mankind first entered into commercial activity. In ancient Egyptian bazaars, merchants knew the location closest to the city gates would provide the best opportunity to sell goods. In theory, merchants with the best locations could sell their businesses for a higher price. Location is only one example of why an ongoing business is worth more than the sum total of its property or tangible assets. Other elements might include reputation for good products and service, established customers, profitable history, reliable workforce, etc. Tax courts have held that goodwill represents the price paid for a business in excess of the value of tangible assets. But in many cases, determining the value of goodwill is not cut and dried and great differences of opinion will exist as to the value of goodwill.
Yes! Business valuations are a must for estate and gift tax purposes. Estate valuation principles relating to business interests are in Regs. 20-2031-2 (f) and 20-2031-3. Gift tax valuation principles relating to gifts and bargain sales of a business interest are in Reg. 25.2512.3. Valuations for estate tax purposes are critical because the valuation determines the extent of federal estate taxes and tax basis of the business interest for the beneficiaries of the estate. Court cases have emphasized the need for contemporaneous valuations before filing gift and estate tax returns! These same cases stress the need for having a valuation professional with experience, training, and credentials. Upon IRS challenge, a professional valuation provides strong evidence of the value of a given interest established using widely-accepted methodologies.
Generally there are two discounts considered in the valuation of a closely held business: 1) Lack of Marketability (Liquidity) and 2) Minority Interest (Lack of Control). The marketability (or liquidity) discount will apply in most valuation situations of privately-held companies. The data used in developing the appropriate discount or capitalization rate applicable to the subject company’s cash flow measure is based upon empirical evidence associated with publicly traded companies. Continue reading
In its simplest form, the Capitalization of Earnings Method provides an estimate of value of a company by converting the future income stream into value by dividing by a capitalization rate that incorporates a required rate of return for risk assumed by an investor along with a factor for future growth in the earnings stream being capitalized. This results in a value based on the present value of the future economic benefits that the willing buyer will receive through earnings, dividends, or cash flow. The capitalization method is based on the Gordon constant growth model which uses a single period proxy of future earnings to determine the present value of the asset. This method is usually employed when a company is expected to experience steady financial performance for the foreseeable future and when growth is expected to remain fairly constant. Extreme caution should be used when attempting to use this method, as applying a capitalization rate to the wrong “type” of earnings could spell disaster.
One of the most difficult considerations for an entrepreneur is the risk/return analysis of the potential business venture. An incomplete or poorly-reasoned risk/return analysis on the part of the entrepreneur may lead a savvy financial investor to turn down a potential investment in the business in favor of an apparently less risky opportunity. Continue reading
Planning for too little growth and trying to play catch up when growth exceeds expectations creates a number of challenges, such as the need to expand operations and capacity and the resulting requirement for capital expenditures and potentially, additional financial resources. However, planning for too much growth is just as bad, if not worse, in that overinvestment in equipment and materials reduces asset efficiency and return. Continue reading