Many attorneys call to ask for a “ballpark 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 an 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 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 the cost-efficient way to bring parties to the agreement on the value of community-held businesses and professional practices.