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BUSINESS VALUATION IN TRANSACTIONAL DOCUMENTS: FORMULAS, COMPS & THE MARKET First Run Broadcast: May 7, 2015 1:00 p.m. E.T./12:00 p.m. C.T./11:00 a.m. M.T./10:00 a.m. P.T. (60 minutes) Virtually every transaction of a closely held company requires a valuation. The company may be selling itself or some of its assets, obtaining a loan or placing equity with investors, its owners may be engaged in a buy/sell transaction, or estate planners may need it for planning purposes. But valuing a closely held company is much art as science because there is no regular market matching buyers and sellers. This makes valuation highly contentious as parties argue over add-backs, discounts and premiums, and methodologies. This places significant pressure on transactional attorneys to understand the many intricacies of valuation. This program will provide you a real-world guide to valuation methodologies, how the purpose of the valuation effects the outcome, common points of contention, and drafting tips to avoid costly disputes.
• Guide to closely held company and asset valuation and drafting issues for transactional lawyers
• How purpose of valuation impacts the valuation – business combinations, minority discounts in buy-sell agreements, estate and gift taxes, charitable giving, martial dissolution
• Valuation methodologies depending on the type of business or asset involved – asset-based, cash flow, market comparables, and intrinsic value
• Drafting to avoid common and costly mistakes in transactional documents and how to reduce risk of dispute
• Understanding valuation premiums and discounts and the difference between “fair market value” and “fair value”
• What you need to know about how valuations are actually derived – objective factors v. professional judgment
Speaker: Ronald L. Seigneur is a partner in Seigneur Gustafson LLP, a CPA firm located in Lakewood, Colorado, where he provides valuation, tax and retirement planning, and litigation support services. He has published over 80 articles on business valuation and is co-author of “Financial Valuation: Applications and Models,” (2nd Ed.), a treatise on business valuation published by John Wiley & Sons. He is a Certified Valuation Analyst with the National Association of Certified Valuation Analysts (NACVA) and holds the American Institute of Certified Public Accountants’ specialty designation of Accredited in Business Valuation. He is an Adjunct Professor of Law at the University of Denver College of Law, where he teaches financial, management and leadership courses. Mr. Seigneur earned his B.A. from Michigan State University and a MBA from the University of Michigan.
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Business Valuation in Transactional Documents:
Formulas, Comps & the Market Teleseminar May 7, 2015
1:00PM – 2:00PM 1.0 MCLE GENERAL CREDITS
PAYMENT METHOD:
Check enclosed (made payable to Vermont Bar Association) Amount: _________ Credit Card (American Express, Discover, Visa or Mastercard) Credit Card # _______________________________________ Exp. Date _______________ Cardholder: __________________________________________________________________
VBA Members $75
Non-VBA Members $115
NO REFUNDS AFTER April 30, 2015
Vermont Bar Association
CERTIFICATE OF ATTENDANCE
Please note: This form is for your records in the event you are audited Sponsor: Vermont Bar Association Date: May 7, 2015 Seminar Title: Business Valuation in Transactional Documents: Formulas, Comps & the Market
Location: Teleseminar - LIVE Credits: 1.0 MCLE General Credit Program Minutes: 60 General Luncheon addresses, business meetings, receptions are not to be included in the computation of credit. This form denotes full attendance. If you arrive late or leave prior to the program ending time, it is your responsibility to adjust CLE hours accordingly.
Business Valuation:
A Case Study Approach toUnderstanding Business Valuation
Ronald Seigneur
Seigneur Gustafson LLP - Lakewood, Colorado
(303) 980-1111 (ex. 213)
1© 2015 Ronald L. Seigneur. All Rights Reserved.
Ronald L. SeigneurCPA/ABV/CFF, ASA, CVA, CGMA
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Ron is a partner in Seigneur Gustafson LLP, a CPA and consulting firm located inLakewood, Colorado. He holds the AICPA specialty designations of Accredited inBusiness Valuation (ABV), Certified in Financial Forensics (CFF), and is a CertifiedValuation Analyst (CVA) with the National Association of Certified Valuation Analysts.Ron is also a Senior Appraiser in Business Valuation from the American Society ofAppraisers (ASA).
He has published over 100 articles on business valuation, commercial damages,leadership, and related subjects. Ron has developed & taught a number ofintermediate and advanced business valuation courses for the AICPA, NACVA, stateBar Associations. Ron regularly consults and advises ownership and their advisorson appraisal and performance related matters. He has been an adjunct professor atthe University of Denver Sturm College of Law for over 20 yeas, where he teachesApplied Leadership and Management Theory. Ron is a past Chair of the ColoradoSociety of CPAs and currently chairs their 2020 strategic planning committee.
Ron has been qualified and provided testimony as an expert witness in several jurisdictions on a wide range ofissues ranging from complex business valuations, forensic investigations, and various forms of economicdamages. Ron has served appointments as trustee, mediator, arbitrator, special master of the court, as well asserving as an expert for the Colorado State Board of Accountancy and Colorado Attorney General. Ron wasinducted into the AICPA Business Hall of Fame in 2006 and is a Fellow in the College of Law Practice
Management.
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Seigneur Gustafson LLP CPAsColorado Front Range: 300 Union Blvd., Suite 600
Lakewood, Colorado 80228-1535
15950 Main Street, Suite 201
Parker, Colorado 80365
Washington State: 87 Calder Road
Elma, WA 98541
303.980.1111 voice
303.308.6969 fax
www.cpavalue.com
Ronald L. Seigneur,ASA CPA•ABV•CFF CVA CGMA
Kevin R. Yeanoplos, CPA/ABV/CFF, ASA
Ronald L. Seigneur, ASA CPA•ABV•CFF CVA CGMA
www.YSAdvisory.comwww,CannaValuation.com
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Objectives
IntroductionLimited time requires we move quickly through slides/contentTime for Q&A and follow up
Briefly review the fundamental concepts that drive thevalue proposition for a closely held business
Overview of the valuation processDefining the proper Standard and Premise of ValueValuation methodologies for closely held businesses
Case Studies of three valuation targets
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Objectives
Analyzing/Positioning the Deal/OpportunityMotivations of Buyers and Sellers
Key financial considerationsThe quality of earnings and the world of EBITDA multiples
Key non-financial considerations
The Value PropositionThe key areas requiring subjective judgment:
Financial statement adjustments
Unsystematic Risk/Capitalization & discount rates/Market multiples
Discounts and premiums
Reasons for Valuing a Closely HeldBusiness or Professional Practice
Mergers & acquisitions
Estate planning and reporting
Marital dissolution
Disputes between ownership
Insurance and economic loss issues
Buy-sell arrangements
Other: cost segregation, easements,profitability planning, etc.
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Elements of a Valuation
Applicable date
Standard – Definition of value
Premise – Status of the business
Methods – How value is calculated
Reconciliation of value indications
The business appraisal report
Business appraisal as part of the largerprocess and objective
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Standard andPremise of Value
May 6, 2015 10
What does the word Valuemean?
“All values are anticipations of the future” Justice Oliver Wendell Holmes, 1904.
Without consensus as to the standard of value, theresulting valuation conclusion is without meaning.
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Fair Market Value
defined as the price in terms of cash at which aproperty would change hands between a willingbuyer and a willing seller, both with full knowledgeof the relevant facts and neither being undercompulsion to buy or sell.
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Fair Market Value - OtherConsiderations
A reasonable time is allowed for exposure in the openmarket
Price represents normal consideration for the propertysold, unaffected by special or creative financing orsales concessions.
Fair market value is specific to a particular valuationdate and not to any other date.
Most probable price versus highest value.
The willing buyer and willing seller arehypothetical persons dealing at arm’s length ratherthan any ‘particular’ buyer or seller.
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Fair Value
fair value is employed under the laws of moststates as the statutory standard of valueapplicable in valuing dissenting stockholders’appraisal rights.
In those states, if a corporation merges, sells out, or takescertain other major actions and the owner of a minorityinterest believes that he or she is being forced to acceptinadequate consideration for the stock, the owner has theright to have the shares appraised and to receive fair valuein cash.
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Investment Value
Investment value is the specific value to aparticular investor for individual investmentreasons. Unlike the fair market value buyer, the investment value
buyer is not a hypothetical investor dealing at arm’s length,but rather is a specific investor with specific investmentmotivations. Specific buyers have numerousconsiderations that may influence the price they might bewilling to pay for a property and cause it to be differentfrom fair market value.
May 6, 2015 15
Investment Value - InvestorAttributes/Perceptions
Differences in estimates of future earning power.
Differences in perception of degree of risk.
Differences in tax status.
Synergies with other operations owned or controlled.
Investment value is usually the appropriate standard ofvalue in merger and acquisition analysis.
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Going Concern Premise
Going concern is not a standard of value. Theterm going concern refers to a business beingvalued as an ongoing operation, as opposed tobeing valued under a premise of liquidation.Going concern value provides a basis for valuingan entity under the premise of fair market value,fair value or investment value.
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Liquidation Premise
A Liquidation premise refers to the assumption thatthe business is going to be closed and the assetssold off. Assemblage of assets looks at value of the mass asset
assemblage, although not in current use.
Orderly liquidation provides liquidation values assuming areasonable time to sell, trying to obtain the best price for eachasset.
Forced liquidation provides liquidation values assuming theassets are sold as quickly as possible, frequently all at one timeat an auction sale.
May 6, 2015 18
Overview of BVFundamentals
Understanding Value‘Value” as a mathematical formula:
I
R-G
I = Income
R = Risk
G = Growth
Value = Free cash flow (FCF)
Cost of capital (CofC) – Growth in FCF
Value =
Or
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Valuation Methods
Asset based methods
Rarely used for operating business enterprises
Useful for patents, trademarks, license rights
Real estate holding companies, etc.
Often requires specialized expertise to augmentthe business appraisal process
May 6, 2015 21
Valuation Methods
Market based methods
Rev Rule 59-60 advocates market based methods
Guideline company method
Often with reference to the public markets
Comparable transactions method
Availability of database transactions
Rules of Thumb, dangerous but used a lot withsmall enterprises and in certain industries
May 6, 2015 22
Valuation Methods
Income based methods
Capitalization of earnings
Useful when dealing with a steady economic benefitsstream
Discounted future earnings
Becoming more accepted by IRS
Allows for measurement of varying growth patterns
Allows flexibility for start up losses and hyper growthopportunities
May 6, 2015 23
Valuation Methods
Excess Earnings method (TreasuryMethod)
Hybrid of an asset/income method
Widely used in divorce courts
Initially advocated in 1920 with ARM 34, subsequentlyrestated with Revenue Ruling 68-609
Fundamental problems in application
FMV and rate of return on tangible assets
Rate of return on “excess earnings”
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Rules of Thumb
Not a valuation method, per se
Can be industry benchmark indicators of value
Often used as a test for reasonableness
May 6, 2015
Lack ofMarketability
Discount
Total of minorityinterest and lackof marketabilitydiscount equals atotal discount of58% from value ofcontrol shares.
$12 per share
$10 per share
30%
$7 per share
40%
$4.20 per share
Synergistic value
Value of control shares
Value of marketable minority shares
ControlPremium
Value of non-marketable minorityshares
Minorityor Lack ofControlDiscount
SynergisticPremium
Levels of Value
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Discounts & Premiums
Minority Interest/Lack of Control Discount
Applicability of this discount is dependent on thestandard and premise of value
Availability of empirical evidence, such asMergerstat and Houlihan Lokey studies, suggestmedian discounts around 25 to 40%
May 6, 2015 27
Discounts & Premiums
Lack of Marketability Discount
All other things being equal, an interest in abusiness in worth more if it is readily marketableor, conversely, worth less if it is not.
Lots of empirical evidence to support the discountfor securities in a closely held enterprise, withmedian discounts in the 20 to 40% range
May 6, 2015 28
Discounts & Premiums
Control Premium
Not quite the inverse of a minority interestdiscount
Almost all the difference in control versus minorityvalue in the income approach is found in thenumerator - the expected economic income -rather than in the denominator - the discount orcapitalization rate
Case Studies in the Valuation ofa Closely Held Business
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Case #1:Denver Industrial Widgets
Initially engaged to value a 50% ownershipinterest for estate tax purposes
Fair market value standard
Date of death = May 2010
Personal representative also interested indetermining value for sale to remaining 50%owner
Investment value standard
Transaction consummated = July 2012
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Case #2:Rocky Mountain Products
Initially engaged to value 10% ownershipinterest for transfer to key employee
January 2011
Fair market value standard
Follow up engagement to assist controlowner/founder to enhance value
Focus on risk mitigation tactics
Focus on value drivers
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Risk mitigation tactics
Succession plan
Real estate lease
Environmental issues
Customer contracts
Operations manual
Recapitalization
Technology issues
Case #2:Rocky Mountain Products
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Case #2:Rocky Mountain Products
Normalization adjustments
Control owner salary
Control owner perks
Family vehicles, cell phones, health benefits
Related party rents on real estate
Shareholder loans
Other
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Case #3:American Household Works
Closely held fabricator of X approached byforeign publically held with offer to acquire
Retained by control owner and legal counsel toevaluate EBITDA based offer
Use of creative definition of adjusted EBITDA
Extensive representations and warranties
Hold back for contingencies
80% offer/20% option
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Value Creating Characteristics
Sustainability is a function of:
1. Quality of management
2. Strength of market position
3. Effectiveness of product development
4. Effectiveness of executive compensation policies
5. Level of customer satisfaction
6. Quality of investor communication
7. Quality of products and services
8. Strength of corporate culture
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Key Financial Considerations
Quality of earnings Quality of assets
Unrecorded assets & liabilities
Tax status
Customer/supplier linkage
Personal vs. Enterprise Goodwill Sustainability
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Key Non-FinancialConsiderations
People issues
Leadership
Entrepreneurial “zest”
Customer/supplier relationships
Intellectual capital
Human resources generally
Emotional issues
Personal needs and objectives
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Analyzing/Positioningthe Deal/Opportunity
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The Three Types of Buyers
Entrepreneurial Buyers
Often looking for a lifestyle, image or outlet fortalent
Financial Buyers
Seeking an acceptable economic return
Strategic Buyers
Typically brings specific motivations, such as acompetitor or even a customer
May 6, 2015 39
Types of Sellers
Sellers of a Closely Held Business can be:
Financially motivated
Focused on family values/key personnel
Entrepreneurially grounded
Emotional/Irrational
All of the Above!
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Analysis of theExternal Environment
May 6, 2015 42
Analysis of the Industry
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Analysis ofUnsystematic Risk
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Professional Standards forClosely Held Business and
Intellectual PropertyAppraisal Assignments
May 6, 2015
AICPA Statement on Standards forValuation Services No. 1 (SSVS1)
Six+ years for the process
Discussed with 11 AICPA groups, IRS, SEC,FASB and others
Broad perspectives representing 330,000 AICPAmembers
Listened to how valuation services integrate withother CPA services (e.g., tax, PFP)
Learned from others experienced in writingprofessional standards
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Applicability of SSVS1
Covers any service that estimates the valuea: business,
a business ownership interest,
security or
intangible asset, and
Uses valuation approaches/ methods andprofessional judgment in applying them
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SSVS1 Valuation Analysis
Engagement calls for the valuation analyst toestimate the value of the subject interest
The valuation analyst is free to apply thevaluation approaches and methods he/shedeems appropriate in the circumstances
Valuation analysis results in a conclusion ofvalue, either a single amount or a range ofvalue
May 6, 2015
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SSVS1 Calculation Analysis
The valuation analyst and the client agree onthe specific valuation approaches or methods tobe used or the extent of the valuationprocedures the analyst will perform and
The valuation analyst estimates the value incompliance with the agreement
The results are expressed as a calculatedvalue, either as a single amount or as a range
May 6, 2015
Type of Service
“ValuationEngagement”
“CalculationEngagement”
Writtenreport
“Detailed Report”
“Summary Report”
“CalculationReport”
Oral report allowed allowed
SSVS1: Types of Servicesand Reports
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Professional Organizationsand Credentials for
Business Appraisers
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Professional Organizations
American Society of Appraisers (“ASA”) American Institute of Certified Public Accountants
(“ABV”) National Association of Certified Valuation Analysts
(“CVA”) Institute of Business Appraisers (“CBA”) Other Appraisal Foundation/USPAP IRS CFA Institute International Organizations
May 6, 2015
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Valuation Credentials
American Institute of Certified Public Accountants
Accredited in Business Valuation (~3,200/~75)
National Association of Certified Valuation Analysts
Certified Valuation Analyst (~6,000/~300)
American Society of Appraisers
ASA BV discipline (~800/25)
Institute of Business Appraisers
Certified Business Appraiser (~400/5)
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Common Errors inBusiness Valuation
May 6, 2015
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Common Errors in BusinessValuation
Errors due to lack of attention to detail:
Incorrect Standard of Value
Incorrect Premise of Value
Wrong Valuation Date
Wrong Portion of Equity Interest
Incomplete Understanding of Facts
May 6, 2015
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Common Errors in BusinessValuation
Errors due to insufficient effort/budget/expertise:
Inadequate Qualitative and Quantitative Analysis
Insufficient Industry and Economic Analysis
Lack of Support for Normalization Adjustments
Not Identifying/Segregating Non-operating &Excess Assets
May 6, 2015
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Common Errors in BusinessValuation
Other errors:
Improper/Indiscriminate Use of TransactionalData
Improper Application of Discounts &Premiums
Failure to Reconcile Value Indications
Improper Reporting of Facts and Opinions
May 6, 2015
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Costs and Logistics ofBusiness Appraisal
Assignments
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Costs and Logistics
Conclusion of Value Comprehensive Report - $6,000 to $15,000 Summary Report - $5,000 to $10,000 Oral Report
Calculation of Value Summary Report - $3,000 to $6,000
The primary drivers of cost and time are the complexity of the enterpriseand the condition and completeness of the required documentation
Are site visits and management interviews necessary? Are records up to date and complete? Are third party appraisals necessary (e.g. real estate,
specialized equipment, patents/trademarks, etc.)
May 6, 2015
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Recommended Resources
Financial Valuations: Applications and Models, James Hitchnerand Ronald Seigneur, 3rd Edition, 2011, John Wiley & Sons.
Valuing a Business: The Analysis and Appraisal of Closely HeldCompanies, 5th Edition, Shannon P. Pratt, Robert R. Reilly & RobertP. Schweihs, Irwin.
Understanding Business Valuation, 2nd Edition, Gary Trugman,AICPA.
Guide to Business Valuation, Shannon Pratt, Jay Fishman,Practitioners Publishing Company.
www.bvresources.comwww.valuationresources.com
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Financial Valuations: Applicationsand Models
Consensus opinions of 24 nationally recognizedbusiness appraisers
Deals with controversial issues
Provides examples of reports and methodologies
Supported by comprehensive workbook for exam prep
1300+ pages – John Wiley & Sons, 3rd Edition, 2010
May 6, 2015
