|
Mediation-Valuation Gives
Parties Chance to Settle
Parties
”work-through” Valuation to Reach Compromise
Many attorneys call to ask for a “ball-park number”
on the value of a small business or professional practice.
After explaining that professional standards do not permit
appraisers to give “ball-park” estimates of
value, we can often offer an alternative to complex and
expensive full-blown appraisals. Where the parties are emotionally
and financially ready to settle the dispute, the trained
and credentialed business appraiser can often offer a combination
of mediation, teaching, and facilitated discussion that
can lead to a workable solution.
Mediation-Valuation is Cost Effective.
We call this process mediation-valuation. There are several
useful models. One model involves a day-long program that
can be effective and inexpensive ($3,000 to $4,000) The
appraiser-mediator never discloses an opinion of value to
the parties. His job is to explain to the parties and counsel
how the various aspects of the business – its financial
condition, the value of its assets, its future prospects,
etc. – all factor into how much a prospective purchaser
would pay for the business. When explained in a neutral
and non-threatening way by a knowledgeable and effective
facilitator-appraiser, the parties buy into the result because
they arrive at the value number themselves.
Day-long Session Gets Results Fast. In
one day-long controlled session, the participants receive
a tutorial on business valuation, present their own ideas
of value and are given constructive criticism on them, complete
a revealing break-out assignment, and examine sales of comparable
companies. In private caucus with the appraiser-mediator,
they are individually probed for real underlying issues
and are made intimately aware of their options if no value
is agreed to. Finally they are encouraged to retain control
of the outcome of what may be the most important financial
decision of their lives and to avoid turning the decision
over to a third party. When this process works, the outcome
is effective compromise on their agreed value.
Advantage to Counsel. Counsel is often skeptical
in the beginning, but we can provide peer references who
have been a part of a mediation-valuation, some of whom
were initially reluctant to use this tool. The most frequent
question from counsel the day after a mediation-valuation
session is “Where did the number come from?”
This usually suggests that the parties have achieved a successful
result, because the final agreed number wasn’t perceived
as either party’s number, rather it was truly the
result of compromise.
Here’s How it Works. Here are the
key features of a method we know works well. First, we conduct
initial interviews (often by phone) separately with each
party and counsel. Next, we coordinate schedules for one
available full-day, allowing time for production of materials.
We then prepare the engagement letter and materials request,
assigning production dates and clear responsibility, and
collect a nonrefundable fee. During each hour of the session,
the appraiser-mediator must focus on particular activities
or issues.
First Hour Focus on Neutrality. In the
first hour or so, the focus is generally on three activities:
• Establishing our neutrality and independence:
getting everyone comfortable.
• Reviewing ground-rules on decorum and
completing the process.
• Acknowledging that to maintain objectivity
and avoid conflicts of interest, we will not accept
an engagement to appraise the business if the session fails
to result in an agreement on the value
of the community-owned business.
During the second hour we usually present a basic tutorial
on business valuation, covering the primary approaches to
business appraisal. Next, we facilitate a discussion about
the business, its earnings history, projections and prospects
for the future, owner compensation and perks, etc. When
this is done, each side makes a short presentation of its
idea of fair market value, which is followed by questions
and criticism from the mediator and the other side.
Working Lunch. Participants receive lunch-hour
assignments, which vary according to circumstances. For
a business, there is a “shoot-out” in which
each side picks a number at which they would buy or sell.
For a professional practice, the parties are told, “Pick
your real peer’s earnings if you can” from compensation
studies.
Getting to Conciliation. Compromise usually
comes into the picture during hours five and six and when
debriefing of the lunch assignments begins. The debriefing
is followed by a review of the balance sheet and calculation
of adjustments for an orderly liquidation as a floor value.
In these hours, we explain how the expected rate of return
is directly proportional to the risk of receiving that return.
Using the T-bill rate, the S&P 500, and company-specific
indicia of the subject’s risk, together we very methodically
develop a discount rate and capitalization rate specifically
applicable to the subject business.
Excess Earnings Aren’t “Excess”.
If a small-business is being valued, we sometimes avoid
using the excess-earnings method, a method designed only
to measure the value of goodwill, explaining why that method
may not work very well. If a professional practice is being
valued and the participants insist on considering an excess-earnings
method calculation, we show that it requires a careful analysis
of the professional’s work-hours and responsibilities
because the true “peer” will very likely not
be “Mr. Average.”
Next
we normalize earnings, measure the stability, examine pro
forma statements, and apply discount or capitalization rates
where their remaining options and understand that we are
unavailable to appraise the subject entity in any capacity
except as a stipulated joint expert.The concept of using
the appraiser’s skills as a mediator and facilitator
can be an effective and appropriate. Then we consider comparable
sales of similar businesses (where that information is available),
using “determining a selling price for your residence”
as a metaphor, discussing and either distinguishing and
eliminating comparables or accepting a suitable number of
comps and then applying a price/revenue or price/earnings
ratio to obtain a measure of value for the subject company.
Assuming there are good comparables available, this easy
to understand market method usually results in serious compromise
(finally) and we call for a break for the parties to consider
this method. This sets the stage for one-on-one caucuses.
Individual Caucus Sessions. Hours seven
and eight are devoted to caucuses in separate rooms. We
meet separately with each party to discuss each party’s
strong points and weak points. We explore for the “real
underlying issue” that is blocking compromise. Usually
some obscure issue, frequently involving a third person,
keeps parties from compromise in dissolution matters.
Fish or Cut Bait Caucus. During the caucus,
we encourage the parties to identify their options should
the process fail (for example, the cost of two appraisals,
the cost of a trial, and the prospect that a judge may decide
their fate). We try not to leave the caucus room before
obtaining a compromise of some kind, even if small. Finally,
we bring the parties back together when an agreement is
reached or when fifteen minutes are left, whichever occurs
sooner.
Agreement Comes at the End. Most agreements
are reached in the last fifteen minutes. If counsel is not
present or the parties are not represented, we prepare a
simple bullet-point memo that includes very specifically
what was valued and what issues, if any, were not settled;
the agreed value, terms and signature lines for the parties.
If they are represented, one of the lawyers prepares the
stipulation memorandum and in either event the memo is executed
by both parties. If there is no agreement at this point,
we make certain the parties fully appreciate the consequences
of cost-efficient way to bring parties to agreement on the
value of community-held businesses and professional practices.
Is
This the Time to Sell a Business?
Intermediary
is Key to Preparing Business for Sale
Buying or selling a business in today’s
environment is like rolling dice on a moving table - it’s
an uneven proposition at best. Both buyers and sellers are
uncertain about the values of small and closely-held businesses
and wonder whether they are likely to get value for their
dollar. There is broad feeling afoot that the volatility in
U. S. equity and capital markets during the past several years
has caused major shifts in shareholder value for both public
and privately held companies. It’s simple enough for
shareholders of publicly traded shares to test this by reading
the Wall Street Journal.
It Depends! The answer to the question “Is
this a good time to buy or sell a business?” is, “It
depends.” Both buyers and sellers should be aware of
the prevailing financial climate. Interest rates, driven downward
by falling market prices and economic uncertainty meant that
buyers have to put more equity into acquisitions, making it
harder for sellers to find buyers with adequate capital to
purchase their businesses.
Consolidation Alters Market. Another factor
that plays a role in timing your sale is consolidation. Smaller
businesses are often targets for larger competitors who want
to expand or diversify their markets and achieve economies
of scale in their overhead. In a climate where there have
been many entrants and demand for products or services is
falling or remaining constant, many companies cannot continue
to expand in their own market areas and must either buy or
die. Industry conditions and the effects of global marketing
can also affect timing for sales or acquisition.
Sellers should examine their motives for selling.
The seller must also carefully consider his motivation for
selling. Many business-owners are selling to cash-out after
a purchasers, and will spend as much time as needed to understand
your business or the long career in their businesses. Preparing
a business for sale, and positioning it so that it’s
presented to prospective purchaser at peak-value can take
time. Locating investors and bringing good values to long-cycle
markets can consume many months. In some cases sellers have
not allowed themselves enough time to market their businesses
adequately. The time to start is now!
Intermediaries Know How to Present Your Business for
Sale. No matter what the economic climate though,
one thing is certain: the buyer and seller will both need
professional assistance to make sure their decision-making
is sound. Accounting advice may be necessary to ensure that
the financial statements are accurate and fairly depict the
condition and performance of the firm, and to identify important
tax issues that can make-or-break a deal. Legal counsel will
certainly be required to ensure that no laws are violated
and that any agreements between the parties protect the rights
of all involved.
Business Intermediary is Key. But just as
important, it will be necessary to retain a top-notch business
intermediary. This is the guy we used to call a broker. These
days selling a business is a lot more involved than just putting
a classified ad in the newspaper.
The intermediary will be your counselor and marketer if your
are the seller. If you are the buyer he will be your own personal
corporate acquisition department. Because he is experienced
and knowledgeable he will know just how to highlight the best
features of your business for a prospective purchaser, and
how to negotiate the best deal with a seller.
All good intermediaries are experts at preparing the “book”
or offering memorandum that describes your business to prospective
business you are seeking to purchase.
Good
Business Intermediaries Can Attract the Right Investors
Institutional Capital can help owners create
significant value that might not have been achieved otherwise.
Many intermediaries have access to many investor groups. This
allows them to assess the best fit for your company. Getting
the best deal for your business means putting your company’s
best foot forward with prospective purchasers. Usually the
intermediary develops the offering memorandum, which becomes
the primary marketing tool for your business.
A key step in doing this is in selecting the right people
to assist you with the preparation of a high-quality offering
memorandum that highlights the strong points of your business.
An experienced and capable intermediary can help you prepare
your documentation and contact investors best suited to your
company’s circumstances. The experienced intermediary
should be able to discuss his track record of sales, explain
how he will gather information about your company, describe
in his own terms the strength of your company, and list the
contacts he will use to secure your purchaser.
Marketability
Misconceptions
Marketability = Liquidity.
The notion of a discount to value based on the marketability
of the subject property has been around for a long time, and
is based in fundamental proposition that the market craves
liquidity and loathes the absence of it. All else equal, a
liquid (marketable, as if freely traded) investment should
be worth more than an illiquid (less marketable, not freely
traded) one. Actual performance of the market clearly demonstrates
this phenomenon.
Marketability = Risk. The concept of a marketability
discount seems to suggest the value of the subject business
should be less because no one would want to buy it. The managing
spouse often protests that the business should have a marketability
discount because it’s not making money. But technically,
this is incorrect: the desirability of the subject business
as an investment should be addressed in the required rate
of return (i.e. the capitalization rate or the discount rate).
Less desirable businesses are riskier investments, so investors
would require a higher rate of return on the expected income
stream, irrespective of the size or velocity of the marketplace.
Discount Always Relative. For the business appraiser,
marketability discounts, (more properly, adjustments for lack
of liquidity or for difference of marketability) are critical
to the accuracy of the valuation result. But the key thing
to remember is that the marketability discounts are always
relative to some reference point of value. For example, if
the appraiser relies on transactions of public stock (a common
benchmark for liquidity) as a source for the development of
the discount rate, then the resulting value of the subject
business is its value as if were as liquid as publicly traded
stocks (which it is not). Without an adjustment to match the
marketability (liquidity) of the subject business to the publicly
traded stocks that were used as the basis for the discount
rate, the value of the subject business may be significantly
over-stated.
Marketability Discount is Internal. In this
sense, the marketability discount may be said to be internal
to the methodology selected by the appraiser, and not closely
related to the characteristics of the subject business except
insofar as it is less liquid (i.e. would take longer to convert
to cash than publicly traded stocks). In the conventional
sense, the marketability adjustment only arises because the
appraiser uses the rate of return obtained by investors in
publicly traded stocks as the source for the benchmark rate
of return in his discount-rate development. Were he to use
a rate of return obtained by investors in privately-held entities
- for example buyers/holders of shares in private corporations
- as the benchmark rate of return, no such marketability adjustment
would be required because the liquidity of the source for
the benchmark rate is the same as the liquidity of the subject
ownership interest. This is a watershed change in thinking
(though not a new concept by any means) for many lay-thinkers.
Measuring the Discount. Once the decision
has been made to rely on trades of publicly traded stocks
as the source for the benchmark rate of return, the appraiser
must next take steps to measure the extent of discount from
the “as if freely traded” value that results form
the application of the benchmark-based discount rate. There
are a couple of good ways to measure the size of the discount
to apply, and we’ll address these in a future issue
More
Marketability Misconceptions
| Once the appraiser decides that an adjustment
for lack of liquidity/adjustment for difference in degree
of marketability (the marketability discount) is necessary,
the next step is to estimate the size of the discount.
Usually these discounts are expressed as a percentage
taken away from the “as if freely traded”
value of the enterprise, so a 25% marketability discount
indicates the closely held subject interest is worth
75% of its “as if freely traded” value. |
Two Common Methods. There are two commonly
applied techniques for estimating the size of the marketability
discount: 1) benchmarking, and 2) a Quantitative Marketability
Discounting Method (QMDM). Both are widely used by appraisers,
and both have their advocates and critics. Neither is perfect.
Benchmarking. The principle behind the benchmarking
method is to study the nature and extent of discounts observed
in the real-world and apply this observed benchmark data to
the subject by analogy. Most of the real-world data on marketability
discounts consists of research studies that review the price
paid for so-called restricted stock, i.e., stock that cannot
be sold for a period of time due to SEC regulations or agreement
with the issuer. A number of researchers have conducted these
studies over the years, and there is a current series of studies
available to the appraiser.
These studies might indicate, for example, an average in 2000,
shares of restricted stock sold for 65% of the freely trading
shares in the same company, on a certain date. Other studies
look at the price paid in a private transaction, and the price
paid shortly after the same stock was registered and sold
in an Initial Public Offering (IPO), this difference imputed
to reflect the increase in value attributable to the change
in liquidity. Once these figures have been observed, the appraiser
applies these benchmarks, sometimes with qualitative or subjective
adjustment, to the subject shares.
QMDM. The QMDM is a theoretical method that
requires the appraiser to estimate the period of time between
the date of valuation and the time the subject stock would
likely be sold, and with this information, calculate the present
value of the stock. The discount for the amount of time between
the date of valuation and the likely sale date is said to
reflect the cost of illiquidity relative to immediately liquid
shares.
Neither Method is Perfect. Both of these
methods have some degree of difficulty. The benchmarking method
relies on an analogy that may apply better in some circumstances
than others. The QMDM requires the appraiser to know when
in the future the owner of the closely held shares will sell
them, and how much he will sell them for at some distant time
in the future. It’s the appraiser's job to select the
better method for the particular assignment, and to follow
the most objective procedure for applying it to the closely-held
subject property.
What’s
Up with Revenue Ruling 59-60?
Revenue Ruling 59-60 is the primary ruling providing guidance
f or the valuation of closely held common equity interests.
When issued in 1959, the ruling specifically referred to valuing
“… the stock of closely held corporations where
market quotations are not available.”
In 1968 the following paragraph from Revenue Ruling 68-609
expanded the scope of Revenue Ruling 59-60: “The general
approach, methods, and factors, outlined in Revenue Ruling
59-60, as modified, are equally applicable to valuation of
corporate stocks for income and other tax purposes as well
as for estate and gift tax purposes. They apply also to problems
involving the determination of the fair market value of business
interests of any type, including partnerships and proprietorships,
and of intangible assets for all tax purposes.”
It is expected in the valuation community that the original
text of Rev. Rul. 59-60 will be revised by the Service in
the near future, though few expect major changes.
In
re: Marriage of Hewitson
- [142 Cal.App.3d 874, 191 Cal.Rptr. 392 (1983)]
In valuing closely-held stock appraisers
should consider each of the eight factors set forth
in Revenue Ruling 59-60.
This 1983 case asking the Second District Court of Appeal
to address the issue of determining the value of closely–held
stock that is part of the marital estate set forth several
seminal rules, not the least of which is that the trial court
may rely on “investment value” rather than “market
value” in determining the value of the marital estate
pursuant to then Civil Code §4800, though neither of
these terms is clearly defined.
The Court also decried the use of price/earnings ratios from
publicly traded stocks as the sole indicator of value for
closely held shares that are part of the marital estate, finding
that such a method is “....unreliable … to determine
the value of close corporation shares …[because] closely
held corporations possess characteristics which make them
inherently different from publicly held corporations, with
the primary difference being the lack of marketability”
(142 Cal.App.3d 886, citing In re Marriage of Lotz, 120 Cal.App.3d
at 384).
Here, the Court was presented with a trial court decision
embracing the $9 million value for the community-owned corporate
stock found by wife’s expert, who relied chiefly on
the price/earnings ratios of companies that had been acquired
by other corporations in exchange for stock in the acquirer,
rather than price/earnings ratios from stocks that are listed
on a stock exchange or over-the-counter.
Consideration of Rev. Ruling 59-60. Our discussion
here, though, is focused on another holding of the Court,
that “… the [valuation] of infrequently sold,
unlisted, closely held stock is a difficult legal problem.
Most of the cases illustrate [that] there is no one applicable
formula that may be properly applied to the myriad factual
situations calling for the valuation of closely held stock.
It is therefore, incumbent upon a court faced with such a
problem to review each factor that might have a bearing upon
the worth of the corporation and hence upon the value of the
shares. Unless there is some statutory or decisional proscription
on their use, the factors listed in Revenue Ruling 59-60 should
be consulted and used to evaluate closely held stock.”
(supra. at page 888).
Current business appraisal literature embraces this notion,
little of which existed at the time of this decision, and
most appraisers would agree that the 8 factors set forth in
Revenue Ruling 59-60 are the fundamental considerations in
appraising stock in closely-held entities. These factors are
listed in every appraisal textbook and on the lips of every
business appraiser.
The Eight Factors. The eight factors given
in Revenue Ruling 59-60 1 are:
(a) The nature of the business and the history
of the enterprise from its inception;
(b) The economic outlook in general and the
condition of the specific industry in particular;
(c) The book value of the stock and the financial
condition of the business;
(d) The earning capacity of the company;
(e) The dividend-paying capacity;
(f) Whether or not the enterprise has
goodwill or other intangible value;
(g) Sales of stock and the size of the block of stock
to be valued; and
(h) The market price of stock of similar
corporations engaged in the same or similar line of business
having their stock actively traded in a free and open market,
either on an exchange
or over-the-counter.
So in-grained in the appraisal profession are these eight
factors, that many business appraisers organize their written
reports under these eight headings and cross reference each
of their considerations to the list of factors.
In 1983, when Hewitson was published, the business appraisal
profession was in its infancy. Today, nearly 20 years later,
the literature is well developed, and much has been written
about the tenets of Revenue Ruling 59-60. Numerous texts fully
discuss the implications of each of the eight factors in the
valuation of interests in closely-held companies.
The use of publicly traded stock by analogy as a proxy for
the value of stock in closely-held corporations (or other
business entities, for that matter) is a widely accepted technique
today, notwithstanding the holding of the Hewitson Court.
The Court confuses
the matter further by misunderstanding the terms “market
value:
Fair Market Value. Court seemed to be looking
for a valuation method that generated an estimate of the Fair
Market Value of the closely-held shares, though it never clearly
indicated this. At 142 Cal.App.3d 882 the Court attempts to
identify methods that result in the market value of the shares.
It cites methods that rely on comparisons between the subject
shares and publicly traded shares. These methods are known
today as Guideline Public Company Methods, and estimate the
value of the closely-held shares by multiplying the price/earnings
ratio of publicly traded shares in similar companies by the
earnings of the subject company.
As we related in our previous issue, this 1983 case asking
the Second District Court of Appeal to address the issue of
valuing the value of closely–held stock that is part
of the marital estate set forth several seminal rules, not
the least of which is that the trial court may rely on “investment
value” rather than “market value” in determining
the value of the marital estate pursuant to then Civil Code
§4800, though neither of these terms is clearly defined.
Here, the Court was presented with a trial court decision
embracing the $9 million value for the community-owned corporate
stock found by wife’s expert, who relied chiefly on
the price/earnings ratios of companies that had been acquired
by other corporations in exchange for stock in the acquirer,
rather than price/earnings ratios from stocks that are listed
on a stock exchange or over-the-counter.
The Court also decried the use of price/earnings ratios from
publicly traded stocks as the sole indicator of value for
closely held shares that are part of the marital estate, finding
that such a method is “....unreliable … to determine
the value of close corporation shares …[because] closely
held corporations possess characteristics which make them
inherently different from publicly held corporations, with
the primary difference being the lack of marketability”
(142 Cal.App.3d 886, citing In re Marriage of Lotz, 120 Cal.App.3d
at 384).
Investment Value. Citing a bad holding in
Estate of Rowell (132 Cal.App.2d 421 [1955]) the Hewitson
Court carefully distinguished between the investment value
of shares in a closely-held company and market value, though
it did not so carefully identify the reasons why this difference
(if indeed it actually exists) was important to them.
The Court recited three approaches to value, 1) the capitalization
of earnings approach, 2) the dividend-paying capacity, and
3) the book value or net asset approach, and stated unequivocally
that the application of these methods results in the “investment
value” of the shares in the closely-held company: “The
application of these approaches… will determine the
investment value of the closely-held shares, not their market
value.” It’s unclear whether the Court believed
that “market value” and “fair market value”
mean the same thing.
Confusion Reigns. To say that the Hewitson
court was confused is understatement. Where the assumed standard
of value is fair market value - which it usually is in family
law matters - all of the methods cited by the Court normally
result in an estimate of Fair Market Value of the shares.
The notion of investment value is unrelated to the issues
before the Court in this case (see sidebar below). As the
Court acknowledged, “...the determination of the value
of infrequently sold, unlisted closely held stock is a difficult
legal problem.” Perhaps it’s a problem best left
to qualified appraisers.
Selecting
a Business Appraisal Firm
Bigger
isn’t always better
While professional appraisal credentials
in real estate appraisal have been around for decades, professional
designation in Businesses Appraisal is a more recent development.
Selecting a business appraiser for litigation, whether it’s
a family law matter, estate planning, partnership dispute,
failed transaction, or Corp.
Code §2000 case always involves making decisions and
tradeoffs. Often this centers around choosing between the
local business appraiser or the large national firm from outside
the area. This isn’t usually a simple decision, but
if the matter is analyzed, the decision should often fall
on the side of the smaller, local firm, in order to achieve
cost-effectiveness and realize the advantage of access to
professionals and the hometown expert’s credibility
in front of the local Court.
Size matters. The size of the firm
does matter, but less than might ordinarily be the case for
other consulting type arrangements. In business appraisal,
it’s important to be sure that the local appraiser has
the same access to research resources that a larger national
appraisal firm would have.
Today, virtually all of the research resources used by business
appraisers are readily available online, and every valuation
professional office has exactly the same references and resources
at its disposal as the 20-professional national appraisal
firm. And, it’s important be sure that the smaller firm
has the manpower to do the job within the planned schedule.
Often, the smaller local firm is able to respond more quickly
and efficiently to demands for quick turnarounds. Our office
can usually produce an appraisal within three weeks of receiving
the information requested from the subject Company.
It’s the individual. In business valuation,
the appraisal is always performed by an individual. This is
an important fact, with testimony isn’t likely to be
required. In particular, the most cost-effective way to accomplish
the appraisal is to retain the smaller especially important
implications for litigation. Only individuals, not firms,
can be awarded professional credentials.
Further, all of the professional standards to which appraisers
conform require that each appraisal report be signed by the
appraiser responsible for it. In larger firms, many individuals
can sometimes get involved in an appraisal in a support role.
It’s happened many times that each of these individuals
has to be deposed and examined in order for the appraisal
to be admitted. At ABA, all valuation and forensic work is
performed by the individual signing the report.
This is an advantage in depositions and trials as the individual
performing the work is the same person who is being deposed
or providing the testimony. Ultimately, it is the credibility
of the individual who signs the appraisal report that carries
the day.
Cost is Always a Consideration. Cost-effectiveness
should always be a consideration in selecting an appraisal
firm, not just for expert testimony, but any kind of appraisal.
Appraisal fees vary widely from firm to firm. For example,
two appraisal professionals, both with the exact same senior
credentials may charge different hourly rates.
The larger firm, with larger overhead, might have to charge
$450 to $750 per hour for the professional. A smaller firm,
with lower overhead might charge less 50%-75% of that amount.
This is a real example, not a hypothetical worst-case. Our
hourly rates are often 60-75% of the rates charged by large-overhead
firms. So long as the individual signing the appraisal is
qualified, the work-product from the larger more expensive
firm will be no better than the one from the smaller firm.
The Same Things Apply to Non-litigation Assignments.
All of these same considerations in the selection of an appraiser-expert
apply to assignments where expert professional firm that can
give counsel or the estate planning professional the most
personalized service for his clients.
Forensic
Accounting in Divorce Matters.
Divorce is unique in that the motivations to be less than
honest are often more complicated than the typical financial
crime motivated purely by financial gain. In a divorce, a
spouse may have the desire to “cheat” his or her
spouse out of their “fair share” of the marital
property or humiliate, emotionally overwhelm or otherwise
damage their spouse.
The most common cheating by divorcing spouses is to understate
assets and income in a closely held business. An owner has
the ability to manipulate situations in ways limited only
by their imagination. However, there are recurring patterns
of activity in the understatement of income and assets. They
involve personal use of business assets (automobile, club
dues, payment of personal living expenses by the business,
petty cash abuse, inventory abuse) self-dealing with related
parties (relatives of business partners), sudden decrease
in revenues, revenue deferment, new or hidden bank accounts,
unnecessary bad debt reserves or write-offs and unreported
cash transactions.
In order to successfully uncover the actions of a dishonest
spouse requires a level of tenacity and “thick skin”,
not only by the forensic accountant, but also by the entire
litigation team.
When a divorce requires a business valuation it is a good
idea to engage a practitioner who is not only skilled in business
valuation, but forensic accounting as well. The hiding of
income and assets not only impacts the amount of alimony and
child support ultimately paid to the “out spouse”
but may also have a material impact on the value of the business.
Though such engagements are distinct and separate an expert
with experience in both business valuation and forensic accounting
is the most cost effective method of dealing with a business
valuation and related fraudulent activity.
In the normal course of the preparation of a business valuation
ABA has uncovered numerous instances of cheating schemes,
even when the “out spouse” had no idea “something
was wrong”. A business valuation professional without
forensic expertise might not have discovered the systematic
looting of the company by the “in spouse.
Standard
of Value is Everything!
Standard
of Value Represents the Key Assumption of the Appraisal
The Standard of Value (archaically called the Definition of
Value) assumed by the appraiser is the fundamental assumption
under which the valuation proceeds. It represents the most
basic instruction from the client to the appraiser, and tailors
the valuation analysis to the requirements of the users of
the appraisal. There are several typical standards of value
commonly used by business appraisers: Fair Market Value, Fair
Value, Investment Value, and a few specialized standards of
value.
Fair Market Value. This is the typical “willing
buyer-willing seller” kind of value, expressed as cash
or cash equivalent. It assumes that both the buyer and seller
are knowledgeable and are in possession of all pertinent facts,
are risk averse and possess competency in the operation of
the business. This value represents a composite of all financial
buyers, but excludes strategic buyers (buyers who will obtain
synergy value by buying the subject property). This standard
of value is typical in most kinds of litigation, and illustrates
the price at which the business would transact in an open
market.
Fair Value. There are many notions of Fair
Value, but the most common standard is the same as Fair Market
Value but the subject interest is valued as though it were
a controlling interest, i.e. without taking a minority discount.
This assumption is usually present in statutory appraisals
pursuant to shareholder oppression litigation. (i.e. Corp
Code §2000.
Investment Value. Investment Value is nothing
more than the value of the subject interest to a particular
named person or entity, and usually includes the value of
the business the buyer will obtain through synergies with
his own existing business entities.
Variations on the Theme. There are many variations
on the theme, of course. One such variation is the legal requirement
that the appraiser not give effect to a buy/sell or partnership
agreement where the agreement is construed by law to unfairly
penalize the non-owner spouse in the division of community
property. Partners might, for example, draft a partnership
agreement that makes the partnership interest valueless for
purposes of distribution of community property, but the law
in that jurisdiction might require that the appraiser to not
give voice to that provision and appraise the partnership
interest as though the agreement did not exist.
Why
is the Date of Valuation Important?
In fact, in our experience, it seldom is. But when there are
unusual circumstances, the date of valuation can be as critical
as the Standard of Value imposed.
From time to time we see a case where the managing spouse
has taken covert or overt steps to adversely affect the value
of the community-owned business. The dentist, for example
who reduces his case-load voluntarily, or the contractor who
delays signing contracts until after the trial to divide the
community. Other times, we see the case discussed by the Court
in Duncan, where the value of the business increases owing
to the efforts of the managing spouse. In these fairly rare
circumstances, the value of the company can vary substantially
between separation and trial.
As a practical matter, it is a good idea to have your appraisal
expert value the company at both dates of valuation, especially
where the date of value has not been decided in advance.
In
re: Marriage of Duncan
Use
of Alternative date of valuation under Family Code §2552(a)
proper where professional post-separation
efforts result in increase in value of community-owned business.
This 2001 case out of San Diego addressed the question
of whether an alternative date of valuation under Family Code
§2552(a) requires that the change in value be related
entirely to the post-separation efforts of the managing spouse.
The parties were married when they formed a pension investment
firm in 1990. The company was managing over $1 billion in
assets when the parties separated in 1994. Husband continued
to operate the investment business after the date of separation.
The trial court did not hear the valuation issues until 1997,
by which time the investment portfolio of the company had
increased substantially. Husband argued that because the increase
in the size of the firm was due to his own post-separation
efforts, the business should be valued as of the date of separation
instead of the date of trial.
Wife asserted on appeal that the trial court’s use of
the alternative date of valuation was improper because the
post-separation increase in value was due to factors other
than husband’s personal efforts.
In its analysis the appellate court reviewed the state of
the law in California regarding the application of the alternative
date of valuation provided for in Family Code §2552(a).
“Case law has established that good cause generally
exists for a professional practice to be valued as of the
date of separation.” (Marriage of Kilbourne (1991) 232
Cal.App.3d 1518 [valuation of law practice]; Marriage of Green,
(1989) 213 Cal.App.3d 20 [valuation of law practice].)
This exception applies because the value of such businesses
“is primarily a reflection of the practitioner’s
services and not capital assets… Because the earnings
and accumulations following separation are the spouse’s
separate property, it follows that the community interest
should be valued as of the date of separation - the cutoff
date for the acquisition of community assets.” (Marriage
of Stevenson (1993) 20 Cal.App.4th 250, 253-254). Further,
“[t]he rationale for the general exception is not limited
to law practices. It applies with equal logic to other small
businesses that rely on the skill and reputation of the [managing
spouse].” (Marriage of Stevenson 20 Cal.App.4th at 254
[small general contracting business].) Thus an alternative
date of valuation may apply to a business when its value “...devolves
largely from the personal skill, industry and guidance of
the [managing spouse].” (Ibid.)
Here the community company manifested all of the attributes
of a professional practice, including performing a service
for a fee, offering specialized knowledge and experience,
being licensed and regulated, and having asset
that consist mostly of office equipment, accounts receivable,
and work-in-progress.
Thus the value of the company derived not from its capital
assets, but rather from the professional investment advisory
services that husband provides to it. Nothing in Family Code
§2552(a), the Court held, requires the trial judge to
find that the entire post-separation change in value was due
exclusively to the personal efforts of the operating spouse
in order to apply an alternative valuation date.
Why
do we take a Minority Discount?
Value of Minority Interest
is Lower Because of Lack of Control
It comes as a surprise to many that a minority interest
in a privately held company is worth less than its proportionate
share of the company taken as a whole. These people often
think that a 15% interest in a company that is worth $1,000,000
should be worth $150,000. This is a sometimes hazardous notion.
Well-trained appraisers and experienced investors know that
minority interests (often called non-controlling interests)
are worth less—substantially less—than their proportionate
share of the value of the company. Controlling shareholders
enjoy many benefits that are not available to non-controlling
shareholders.
Benefits of Control. Among the benefits
reserved for controlling owners are:
• The ability to appoint or change management;
• The ability to control the Board of Directors;
• The ability to set management compensation
and perquisites;
• The ability to liquidate, sell-out, or
recapitalize the company;
• The ability to pay (or not pay) dividends
to shareholders;
• The ability to acquire, lease, or liquidate
business assets;
• The ability to negotiate mergers and acquisitions;
and
• The ability to control the operation and
course of the company’s business.
Majority Controls Dividends. From a practical standpoint,
the owner of a less-than-controlling interest in the company
is at a severe disadvantage compared to the owner of the controlling
interest. The controlling shareholder/manager is under no
obligation to pay any portion of the profits to other shareholders.
Where the controlling shareholder is also the manager or president
of the company, he will sometimes set his own compensation
so high that no profits are left over to pay to other shareholders
as a return on their investment.
Other times controlling shareholder/managers will hire family
members and pass on to them as compensation the profits that
might otherwise go to non-controlling shareholders. Far from
the exception to the rule, this is a common occurrence in
many small privately owned companies.
No access to Value of Assets. Many
minority shareholders believe that because the assets of the
company have value, that the value of their share is protected
by the value of the underlying assets. This is seldom the
case. Ownership of stock in a company does not grant the shareholder
any portion of the ownership of the underlying assets. In
the first place, the creditors of the company will always
be in line ahead of shareholders if the company is liquidated,
and the controlling shareholder can control the liquidation
of the assets.
For all of these reasons, it’s well-settled law that
a non-controlling interest is in most cases worth less per
share than a controlling interest.
Unfortunately there isn’t a book where the extent of
the minority discount that should be applied can be looked
up by the appraiser. It depends on the nature and extent of
the infirmity suffered by the controlling shareholder. This
infirmity, the opposite of the advantage enjoyed by the controlling
shareholder, depends on such factors as the relative sizes
of the blocks held by the controlling shareholder and the
non-controlling shareholder; the rights and benefits set forth
in the shareholders’ agreement, rights and duties of
controlling shareholders set forth in law, and the attitude
and historical patterns of the controlling shareholders in
paying dividends out to minority shareholders.
Many Appraisers Rely on Benchmarks. In many
cases, business appraisers rely on benchmarks for minority
discounts derived from control premia paid by acquirers of
controlling interest in other companies. The implied minority
discount is the inverse of the control premium paid by the
acquirer. There are many reasons why this is an imperfect
measure of the minority discount, but it is about the best
source of observed market data available. According to recent
compilations of these control acquisitions, the median implied
minority discount is about 30% from the value of the stock
(for large companies).
Minority Discount for Smaller Companies May be More.
For small companies the discount can be very much greater
than this figure because the typical controlling shareholder
in a small business has far greater power than management
of the size companies typically acquired. Some appraisers
believe that non-controlling interests in small privately
held companies are entirely worthless.
What’s
the Difference Between a Control Premium and a Minority Discount?:
Both the Control Premium and the Minority Discount are really
internal calculations used by the appraiser to match the control
characteristics of the subject property (i.e. whether or not
it comprises a controlling interest) to the source of information
from which the value is determined.
For example, if the appraiser is valuing a minority interest
in a small business and relies on sales of controlling interests
of such businesses - the kind of comparable sales information
gotten from business brokers - he will have to adjust for
the difference in control power between the subject (that
has no control) and the buyers of the comparable companies
(who enjoyed complete control).
In this case, he would apply a minority discount or discount
for lack of control. Conversely, if he derived his value estimate
from non-controlling transactions - such as those observed
in the stock market - and he were appraising a controlling
interest, he might apply a control premium in respect of this
difference.
What
is “Fair Value” Anyway?
The definition of value is critical to the correct application
of the law, especially in the case of shareholder dissent
or minority oppression actions. Fair Value has seldom been
defined clearly in statute, and can vary from jurisdiction
to jurisdiction.
The revised Model Business Corporation Act defines Fair Value
as “The value of the shares just before the effectuation
of the corporate action to which the shareholder objects,
excluding any appreciation or depreciation in anticipation
of the corporate action unless exclusion would be inequitable.
California has not adopted this definition officially. In
most applications Corp Code §2000 in interpreted to require
the appraisers to apply most of the common elements of the
Fair Market Value standard - willing knowledgeable seller,
willing knowledgeable buyer - but to value the shares without
regard to their minority status. In other words to use the
same per share value as a controlling interest would have.
Mart
v. Severson - [2002 DJDAR817]
Appraisers should assume
reasonable terms in sale of Company as a going-concern in
liquidation.
This 2002 case out of the First Appellate District
(San Francisco) speaks to the assumptions applied by business
appraisers in a Corp. Code §2000 valuation, and clarifies
the proper role of the trial Court in setting the price to
be paid by the controlling shareholders to the unhappy minority
shareholders.
Pursuant to the election by the majority shareholder to have
the corporate stock appraised under the provisions of Corp.
Code §2000, the panel of three appraisers considered
the value of the corporation in a piecemeal liquidation of
its assets, but concluded that this method did not apply because
the company was a profitable going concern, and more likely
to be sold under the scenario of a going concern sold in liquidation.
In developing their unanimous opinion of value the appraisers
adopted methods that relied on the income stream of the company
as the best indicator of its value.
This resulted in a value of $5.6 million, as compared with
the value of $1.48 million if the assets were sold piecemeal
in liquidation. In applying this going-concern methodology
the appraisers relied on the assumption that a willing seller
would give the willing buyer a covenant not to compete at
the time of the hypothetical sale. The trial Court adopted
the lower value on the basis that no such covenant not to
compete was in place at the date of valuation so the appraisers’
reliance on it was improper. Minority shareholder appealed
hoping that the appellate Court would find the appraisers’
assumptions proper and force the controlling shareholder to
pay the higher price for minority shareholders’ stock.
On appeal the Court clearly differentiated between the covenant
not to compete that may or may not issue as between the parties
to the litigation, and the hypothetical covenant not to compete
that a willing seller would freely give to a willing buyer
as the result of the negotiation of reasonable terms of the
sale. In most appraisals, appraisers usually assume such an
agreement will issue since it circumscribes the substance
being sold to the buyer: if the seller takes the goodwill
with him, the buyer has bought nothing.
The Court held that the appraisers properly applied Corp.
Code §2000 by assuming that a hypothetical willing seller
would execute a covenant not to compete with the corporation,
after the sale; even though the actual parties may not have
done so. The Court embraced the notion that the standard of
value, here Fair Value, requires the appraisers to contemplate
a hypothetical sale scenario; a sale of the entire corporation,
in a liquidation setting, on the date of valuation.
This is consistent with California case law: in Abrams, the
Court held that appraisers who conducted a Corp. Code §2000
fair value determination acted properly by assuming that the
owners of the corporation would have agreed not to compete
with the corporation after it was sold as a going concern
in liquidation. [Abrams v. Abrams-Rubaloff & Associates
(1980) 114 Cal.App.3d 240]. Under the statute the appraisers
are not only entitled, but required to consider the manner
in which the [hypothetical] parties to such a hypothetical
sale are most likely to maximize their return. [Id. at 249].
Thus the question posed by the statute is whether the entire
corporation could have been sold as a going-concern in liquidation.
The appraisers answered the question by considering hypothetical
reasonable buyers and seller in a hypothetical forced-sale
environment.
The appellate Court found that the trial Court misinterpreted
§2000 in requiring that the appraisers give weight to
the fact that the parties might not have granted the covenant
not to compete. Interestingly the Court went on to conclude
that the statue contains a procedure for establishing a fair
value price for the minority shareholders’ stock. However,
the statute does not govern or even address covenants not
to compete or any other tem of the sale pursuant to which
the buying party can buy-out the minority shares. Nor does
it authorize the trial court to dictate any of the terms of
that sale other than the sale price. Section 2000 doesn't
give the trial court authority to require a party to execute
a covenant not to compete or to evaluate the validity of such
a covenant. The Court held that the trial court should not
have gotten involved in negotiations pertaining to that sales
term.
ABCs of Appraiser
Credentials
Not
all Appraisal Designations are Created Equal.
While professional appraisal credentials in real estate appraisal
have been around for decades, professional designation in
Businesses Appraisal is a more recent phenomenon. It’s
been less than thirty years since the Institute of Business
Appraisers (IBA) was formed and since the American Society
of Appraisers (ASA) officially recognized business valuation
as a separate appraisal discipline. Since that time a number
of other organizations, likely seeking to capitalize on the
emergence of BV as a fee-producing technical specialty and
hoping to siphon off some of the fee revenues to the troubled
Public Accounting profession, have jumped into the alphabet
soup of professional designations.
Credibility Counts. It’s certainly
true that not all credentialed appraisers are equally qualified,
and in a given case the lesser credentialed appraiser can
sometimes do as good a job as the one holding the more senior
designation. But in a world of experts, high quality credentials
mean high quality credibility, and in every case in every
trial, credibility carries the day. Further, it’s often
the quality of the credentials that gets the case settled
and avoids the costly trial.
CPAs Suddenly Become Appraisers. Most recently
into the melee with the ASA and IBA are the National Association
of Certified Business Analysts (NACVA) and the American Society
of Certified Public Accountants (AICPA), both of which created
alphabetic monikers (CVA & ABV) for their members.
Though there is certainly a lot of turf guarding in the industry,
it’s fair to say that the two most senior credentials,
and the most difficult to obtain are those awarded by the
American Society of Appraisers and the Institute of Business
Appraisers, Accredited Senior Appraiser (ASA) and Certified
Business Appraiser (CBA), respectively. But these guys are
rare commodities: only about 400 individuals are credentialed
as CBAs, and about 700 as ASAs, so they are not always easy
to find.
Experience Requirements Prove-up Skills.
Both the American Society of Appraisers and the Institute
of Business Appraisers are unique in that they require that
designation applicants have a minimum amount of actual hands-on
business appraisal experience, and require that applicants
submit a sample of their actual work product to a committee
of reviewers for approval. Both the ASA and the IBA require
each successful applicant must have completed 5 years of full-time
practice exclusively in the performance of business appraisals.
By contrast, NACVA has no requirement that the applicant have
ever performed an actual appraisal for a client, and the AICPA
only requires that the applicant have “involvement”
in ten business appraisals.
Some Written Exams are Easier. Both of the
professional appraisal societies and the other credentialing
entities require that applicants pass a written examination,
though the rigor of the examination is likely not equivalent
among the organizations. The IBA written examination is a
four-hour objective and case study test, proctored by the
IBA several times throughout the year.
The ASA conducts its proctored examination a little different
allowing any applicant who meets all of the requirements to
sit for the open group examination, or to take and pass four
examinations given at the end of their four main Appraisal
Principles courses. The pass rate for these exams has been
running about 50%. The AICPA recently developed a written
examination for its accountant members - applicants must be
CPAs to take the examination - the AICPA doesn’t announce
what the pass rate is for its examination. The process used
by NACVA is different from the rest: its examination is an
open-book take-home, mail-in exam and case study. We’re
not aware of any applicant who has failed the NACVA take-home
examination.
Summary. In a world where the nature of the
work product is so technical, the imprimatur of credibility
is the mantle of success. Your clients’ cases are best
placed in the hands of the most skilled and credentialed business
appraiser available — those recognized as Certified
Business Appraiser (CBA) and Accredited Senior Appraiser (ASA).
Both the IBA and ASA publish directories of their credentialed
members and maintain websites to assist in locating qualified
business appraisers. Both Mr. Eggers and Mr. Laversin are
credentialed CBA & ASA appraisers. They are two of what
is likely less than 100 U.S. appraisers who hold both of these
advanced professional designations, as well as CPAs.
“Core Earnings” Measure Alters Landscape
New
Measure of Profitability will bring honesty to Corporate Earnings
In late May of 2002 Standard & Poor's published a set
of new definitions it will use to evaluate corporate earnings.
At the center of Standard & Poor's effort to return transparency
and consistency to corporate reporting is a focus on what
it refers to as Core Earnings, or the after-tax earnings generated
from a corporation's principal business or businesses. Since
Standard & Poor's believes that there is a general understanding
of what is included in As Reported Earnings, its definition
of Core Earnings begins with As Reported and then makes a
series of adjustments.
Included in Standard & Poor's definition of Core Earnings
are expenses for employee stock options grant expenses, restructuring
charges from on-going operations, write-downs of depreciable
or amortizable operating assets, pensions costs and purchased
research and development. Excluded from this definition are
cash flows generated by impairment of goodwill charges, gains
or losses from asset sales, pension gains, unrealized gains
or losses from hedging activities, merger and acquisition
related fees and litigation settlements.
For too many years CEOs have been more concerned about the
price of the shares they hold in the Company, and far too
unconcerned about the long-term success of the core business
itself. Too many executives have gotten rich in a bull market
on money made on mergers and acquisitions, and too few on
producing useful products for consumers who need them.
To be sure, there is a place for compensating managing officers
with stock in the Company, and stock options can be an important
incentive tool. But it is this long-term perspective that
will in the end hand the advantage to the Asian businessman
who plans and operates in terms of generations, not quarters.
S&P’s move to report the “core earnings”
as a measure of the success of the management team in running
the business is a giant step toward honesty and integrity
in the world of business - both large and small, and will
do much to improve the competitive health of future U.S. business.
We here applaud it.
What
is USPAP?
Following the failure of the savings and loans institutions
in the mid-80s, which Congress blamed partly on unethical
real estate appraisers, the several real estate appraisal
societies formed the Appraisal Foundation for the purpose
of self-governance of the appraisal profession. The Foundation
promulgated the Uniform Standards of Professional Appraisal
Practice (USPAP), which cover not only real estate appraisal,
but all appraisal disciplines, as well, setting forth minimum
ethical and performance standards for appraisers. Compliance
is mandatory for all members of professional societies who
are members of the Foundation, and optional for other appraisers.
As a member of the American Society of Appraisers, we are
bound to comply with all applicable USPAP provisions for every
appraisal assignment. Michael J. Eggers is a Certified Instructor
and co-chairman of IBA’s Qualification Review committee
and has had the opportunity to teach these provisions of USPAP
to other Appraisers.
How
much Should a Business Appraisal Cost?
Price
Driven by Purpose of the Appraisal, Professional Standards,
Appraiser Overhead
Like any other professional service, such as legal services,
medical care, financial advisory services, or accounting services,
the price of appraisal services to the ultimate user should
always be one consideration in selecting the professional
or professional firm. However, it’s usually not appropriate
to shop for the lowest priced vendor, or to use competitive
bidding to obtain the lowest price. The heart patient whose
life may depend on the skill and judgment of his surgeon,
wouldn’t be smart to put his surgery out to bid. Similarly,
the client whose financial fortunes may rely on the quality
of work or the effectiveness of testimony by his valuation
expert should probably not make a decision on hiring an appraiser
based primarily on lowest fees.
That said, the relationship between quality of services and
fees is not linear: there are factors unrelated to the quality
of the services that affect the fees demanded for them. For
example, the basic amount of work the appraiser has to perform
for an appraisal is driven by the professional standards he
must follow in conducting the appraisal. The emergence of
the Uniform Standards of Professional Appraisal Practice (USPAP)
as the controlling rules for appraisal engagements has increased
the amount of work appraisers must do, even for simple appraisal
assignments.
The largest single driver of appraisal cost though, is the
purpose to which the client desires to put the appraisal result.
Appraisals for use as informal pricing guides for sellers
or buyers require the least amount of work on the continuum
of effort, and appraisals done for use in contentious litigation
probably require the most effort. In between these extremes
are appraisals for other purposes, such as buy/sell agreements,
partnership agreements, estate planning, asset allocation,
etc.
Preliminary Analyses Value Studies - $2,000 to $10,000.
These kinds of less-than-comprehensive valuation efforts can
be well-suited for situations where a client needs a ball-park
estimate of value, perhaps as a starting point for sales negotiations,
or to achieve a better understanding of the value drivers
in his company. Often this type of assignment is begun with
a Value Study to identify the value drivers of the subject
business entity, and followed-on with consulting over a period
of time to prepare the business and the owner for subsequent
sale. Where we are involved in negotiation, packaging, or
presentation of the business entity there may also be a success
fee payable to our firm.
Limited Partnership Appraisals - Value in Real Property
Assets Only -Discount Study - $3,000 to $10,000.
The typical setting for this kind of appraisal is a Family
Partnership formed to protect real property assets from estate
taxation. Usually the partnership has no income distributions
to the limited partners, and all of the profit is paid to
the General Partner. The value of the entity is based on its
assets, and the values of the real property assets are provided
to us by the real estate appraiser. Our assignment is to estimate
the value of small minority limited partnership holdings in
the entity, and to assign marketability and minority discounts
from the enterprise value, if applicable. These projects typically
involve only a summary report.
Comprehensive Appraisal - Summary Report - $10,000-
$25,000. This is the most common type of assignment,
and calls for the application of a full complement of appraisal
procedures. This is the type of engagement suitable for most
kinds of litigation, including family law, partnership disputes,
shareholder oppression litigation, forced buy-outs, business
torts, contract disputes, etc. The chief reason that appraisal
engagements for litigation cost more is because the analysis
and reporting must be performed to a standard of thoroughness
that will allow them to survive rigorous cross-examination
by opposing counsel. This takes time and costs money, just
as all of the other components of litigation. The appraisal
is not the place to cut corners.
All of these pricing guidelines are predicated on the availability
of good bookkeeping and accounting records. Forensic accounting
is often required in litigation matters the fees are usually
billed separately for these services. Generally, the appraiser
cannot commence the engagement until there are good financial
statements (income statements and balance sheets) available.
These need not be uncontested, of course, but where the income
of the entity or the values of the assets are in question,
the appraiser must be given an instruction as to what assumptions
to use in his appraisal.
What
is Investment Value Anyway?
The International Glossary of Business Valuation Terms defines
Investment Value as “The value to a particular investor
based on individual investment requirements or expectations.”
The Guide to Business Valuation Glossary adds the phrase “...as
distinguished from the concept of market value, which is impersonal
and detached.”
The idea of investment value is that it is not based on a
hypothetical purchaser who represents a composite of all purchasers
for value, but instead on the value to a specified individual
with a specified set of investment criteria and especially
those with the potential for synergistic value. It arises
mostly where the appraiser is asked to estimate the value
of a business entity to a potential purchaser who is known
and identified at the outset. This might be the value, perhaps,
of shares in a target company to its acquirer, where the merger
of the acquirer and the target together will result in a combined
value greater than the sum of the individual values.
Mediation-Valuation
gives parties opportunity to “work-through” valuation
to reach compromise
Many attorneys call to ask for a “ball-park number”
on the value of a small business or professional practice.
After explaining that professional standards do not permit
appraisers to give “ball-park” estimates of value,
we can often offer an alternative to complex and expensive
full-blown appraisals. Where the parties are emotionally and
financially ready to settle the dispute, the trained and credentialed
business appraiser can often offer a combination of mediation,
teaching, and facilitated discussion that can lead to a workable
solution.
Mediation-Valuation is Cost Effective. We
call this process mediation-valuation. There are several useful
models. One model involves a day-long program that can be
effective and inexpensive ($3,000 to $4,000) The appraiser-mediator
never discloses an opinion of value to the parties. His job
is to explain to the parties and counsel how the various aspects
of the business – its financial condition, the value
of its assets, its future prospects, etc. – all factor
into how much a prospective purchaser would pay for the business.
When explained in a neutral and non-threatening way by a knowledgeable
and effective facilitator-appraiser, the parties buy into
the result because they arrive at the value number themselves.
Day-long Session Gets Results Fast. In one
day-long controlled session, the participants receive a tutorial
on business valuation, present their own ideas of value and
are given constructive criticism on them, complete a revealing
break-out assignment, and examine sales of comparable companies.
In private caucus with the appraiser-mediator, they are individually
probed for real underlying issues and are made intimately
aware of their options if no value is agreed to. Finally they
are encouraged to retain control of the outcome of what may
be the most important financial decision of their lives and
to avoid turning the decision over to a third party. When
this process works, the outcome is effective compromise on
their agreed value.
Advantage to Counsel. Counsel is often skeptical
in the beginning, but we can provide peer references who have
been a part of a mediation-valuation, some of whom were initially
reluctant to use this tool. The most frequent question from
counsel the day after a mediation-valuation session is “Where
did the number come from?” This usually suggests that
the parties have achieved a successful result, because the
final agreed number wasn’t perceived as either party’s
number, rather it was truly the result of compromise.
Here’s How it Works. Here are the key
features of a method we know works well. First, we conduct
initial interviews (often by phone) separately with each party
and counsel. Next, we coordinate schedules for one available
full-day, allowing time for production of materials. We then
prepare the engagement letter and materials request, assigning
production dates and clear responsibility, and collect a nonrefundable
fee. During each hour of the session, the appraiser-mediator
must focus on particular activities or issues.
First Hour Focus on Neutrality. In the first
hour or so, the focus is generally on three activities:
• Establishing our neutrality and independence:
getting everyone comfortable.
• Reviewing ground-rules on decorum and completing
the process.
• Acknowledging that to maintain objectivity
and avoid conflicts of interest, we will not accept
an engagement to appraise the business if the session fails
to result in an agreement on the value of
the community-owned business.
During the second hour we usually present a basic tutorial
on business valuation, covering the primary approaches to
business appraisal. Next, we facilitate a discussion about
the business, its earnings history, projections and prospects
for the future, owner compensation and perks, etc. When this
is done, each side makes a short presentation of its idea
of fair market value, which is followed by questions and criticism
from the mediator and the other side.
Working Lunch. Participants receive lunch-hour assignments,
which vary according to circumstances. For a business, there
is sometimes a “shoot-out” in which each side
picks a number at which they would buy or sell. For a professional
practice, the parties are told, “Pick your real peer’s
earnings if you can” from compensation studies.
Getting to Conciliation. Compromise usually
comes into the picture during hours five and six and when
debriefing of the lunch assignments begins. The debriefing
is followed by a review of the balance sheet and calculation
of adjustments for an orderly liquidation as a floor value.
In these hours, we explain how the expected rate of return
is directly proportional to the risk of receiving that return.
Using the T-bill rate, the S&P 500, and company-specific
indicia of the subject’s risk, together we very methodically
develop a discount rate and capitalization rate specifically
applicable to the subject business.
Excess Earnings Aren’t “Excess”.
If a small-business is being valued, we sometimes avoid using
the excess-earnings method, a method designed only to measure
the value of goodwill, explaining why that method may not
work very well. If a professional practice is being valued
and the participants insist on considering an excess-earnings
method calculation, we show that it requires a careful analysis
of the professional’s work-hours and responsibilities
because the true “peer” will very likely not be
“Mr. Average.”
Next we normalize earnings, measure the stability, examine
pro forma statements, and apply discount or capitalization
rates where appropriate. Then we consider comparable sales
of similar businesses (where that information is available),
using “determining a selling price for your residence”
as a metaphor, discussing and either distinguishing and eliminating
comparables or accepting a suitable number of comps and then
applying a price/revenue or price/earnings ratio to obtain
a measure of value for the subject company. Assuming there
are good comparables available, this easy to understand market
method usually results in serious compromise (finally) and
we call for a break for the parties to consider this method.
This sets the stage for one-on-one caucuses
Individual Caucus Sessions. Hours seven and
eight are devoted to caucuses in separate rooms. We meet separately
with each party to discuss each party’s strong points
and weak points. We explore for the “real underlying
issue” that is blocking compromise. Usually some obscure
issue, frequently involving a third person, keeps parties
from compromise in dissolution matters.
Fish or Cut Bait Caucus. During the caucus,
we encourage the parties to identify their options should
the process fail (for example, the cost of two appraisals,
the cost of a trial, and the prospect that a judge may decide
their fate). We try not to leave the caucus room before obtaining
a compromise of some kind, even if small. Finally, we bring
the parties back together when an agreement is reached or
whatever time parties have left, whichever occurs sooner.
Agreement Comes at the End. Most agreements
are reached in the last 30-45 minutes. If counsel is not present
or the parties are not represented, we prepare a simple bullet-point
memo that includes very specifically what was valued and what
issues, if any, were not settled; the agreed value, terms
and signature lines for the parties. If they are represented,
one of the lawyers prepares the stipulation memorandum and
in either event the memo is executed by both parties. If there
is no agreement at this point, we make certain the parties
fully appreciate the consequences of their remaining options
and understand that we are unavailable to appraise the subject
entity.
In most represented cases a formal voir dire is conducted
and the settlement outline can be used to enforce the agreement.
In some instances partners agree upfront to “Med-Arb”.
That is if at the end of the session there are 2-3 issues
that are not agreed, we simply “make the call”
and agreement is readied. There are, many variations on this
theme.
What
is Forensic Accounting?
The term “forensic” conjures images of pathologists,
crime scenes and the morgue. Forensic accountants and forensic
criminologists do, have a common denominator … the pursuit
of evidence that will stand the scrutiny that the rules of
evidence and procedure demand for admission as evidence before
a court. The forensic pathologist examines and probes and
reviews evidence to determine the cause of death and to answer
the question “What happened?” Similarly, a forensic
accountant digs through a financial problem to determine “What
happened to the money” ?
Forensic accounting can be broadly classified into two categories
encompassing investigative accounting and litigation.
Litigation support—Providing assistance in areas of
finance and accounting in a matter involving existing or pending
litigation, arbitration or mediation, with a primary focus
on issues relating to the quantification of economic losses
or damages in such areas as shareholder and marriage disputes,
personal injury or death, eminent domain, financial crimes;
claims for warranty, product liability, intellectual property
and insurance; insolvency litigation, missing assets and breach
of contract.
The forensic accountant analyzes the transaction through such
services as accounting reconstruction, accounting analysis,
business valuation, share and option valuation, contract analysis,
revenue recognition, commercial damage calculations, economic
loss calculations, investigation of fraud, conversion, embezzlement,
fraudulent transfers, due diligence examinations, contractual
compliance assessment, royalty audits, and asset tracing.
Investigative accounting– Concern with transaction of
a criminal nature. These crimes might include employee theft,
securities fraud, insurance fraud, kickbacks, advance fee
frauds or even the hiding of assets by one spouse from the
other … often tracing cash transactions by transaction,
bank account by bank account and entities by entity. | |
|
|
