Business Valuations: Fundamentals, Techniques and Theory

National Association of Certified Valuation Analysts 1111 Brickyard Road, Suite 200 Salt Lake City, Utah 84106 (801) 486-0600 www.nacva.com

Business Valuations:

Fundamentals, Techniques and Theory

2008 National Association of Certified Valuation Analysts 2008.v1

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20081995 NACVA 1111 Brickyard Road, Suite 200, Salt Lake City, UT, 84106 ALL RIGHTS RESERVED.

This publication is designed to provide authoritative and accurate information about the subject covered. It is sold with the understanding that the copyright holder is not engaged in rendering legal, accounting, or other professional service or advice. If legal or other expert advice is required, the services of an appropriate professional person should be sought. Although information contained in this publication has been carefully compiled from sources believed to be reliable, the accuracy of the information is not guaranteed. The authors specifically disclaim any personal liability, loss, or risk incurred as a consequence of the use, either directly or indirectly, of any information or advice given in these materials. The instructors opinion may not reflect those of NACVA, its policies, other instructors, or materials. Material may not be reproduced, including photocopying, in whole or in part in any form whatsoever. The contents of this course and the exhibits herein are designed for educational purposes only. Each occurrence and the facts of each occurrence are different. Changes in facts and/or policy terms may result in conclusions different than those stated herein. It is not intended to reflect the opinions or positions of the authors and instructors in relation to any specific case, but rather to be illustrative for educational purposes. The user is cautioned that this course is not all inclusive. 20081995 NACVA 1111 Brickyard Road, Suite 200, Salt Lake City, UT, 84106 ALL RIGHTS RESERVED.

National Association of Certified Valuation Analysts 1111 Brickyard Road, Suite 200 Salt Lake City, Utah 84106 (801) 486-0600 www.NACVA.com

Business Valuations: Fundamentals, Techniques and Theory

Contributing Authors

Garth Tebay, Team Leader Mel Abraham

Marc Bello Shelley Brown Steve Degnan

Rick Gray Chris Hamilton

Mark Kucik Derald Lyons

Pat Perzel Jason Pierce

2008 National Association of Certified Valuation Analysts

TABLE OF CONTENTS Fundamentals, Techniques and Theory

19952008 National Association of Certified Valuation Analysts Table of Contents 1 2008.v1

Table of Contents INSTRUCTOR BIOS .................................................................................................................................. i COURSE EVALUATION FORM.......................................................................................................... xxi ON-SITE SUPPORT EVALUATION FORM ..................................................................................... xxv CHAPTER ONE Introduction to Business Valuation........................................................................................................... 1

I. EVOLUTION OF BUSINESS VALUATION............................................................................. 1 II. REGULATORY BODIES............................................................................................................ 3

III. PROFESSIONAL ORGANIZATIONS ....................................................................................... 8 IV. OVERVIEW OF THE BUSINESS VALUATION INDUSTRY............................................... 10 V. PURPOSES OF VALUATIONS................................................................................................ 12

VI. VALUATION CONCEPTS ....................................................................................................... 17 VII. HOW VALUATION PURPOSE AFFECTS THE ESTIMATE OF VALUE............................ 22

VIII. VALUATOR VERSUS ADVOCATE ....................................................................................... 23 IX. IRC SECTION 6662 ACCURACY RELATED PENALTIES (TAX VALUATIONS)............ 24 X. THE EQUITY INTEREST AS AN INVESTMENT ................................................................. 25

XI. KEY FINANCIAL VARIABLES .............................................................................................. 27 CHAPTER TWO Financial Statement Analysis & Calculation of Financial Ratios........................................................... 1

I. FINANCIAL RATIO (TREND) ANALYSIS SUMMARY ........................................................ 1 II. COMMON-SIZE ANALYSIS ..................................................................................................... 2

III. RATIO (TREND) ANALYSIS .................................................................................................... 2 IV. KEY FINANCIAL RATIOS ........................................................................................................ 4 V. COMPARATIVE ANALYSIS................................................................................................... 11

CHAPTER THREE Generating Economic/Normalized Financial Statements........................................................................ 1 I. GENERATING ECONOMIC/NORMALIZED FINANCIAL STATEMENTS ......................... 1

II. GAAP ACCOUNTING VERSUS ECONOMIC ACCOUNTING .............................................. 4 III. CONSTRUCTING ECONOMIC/NORMALIZED BALANCE SHEETS ................................ 11 IV. CONSTRUCTING ECONOMIC/NORMALIZED INCOME STATEMENTS ........................ 13 CHAPTER FOUR Defining and Estimating the Future Benefit Stream ............................................................................... 1

I. DEFINING AND MEASURING THE FUTURE BENEFIT STREAM ..................................... 1 II. USING HISTORICAL VS. PROJECTED ECONOMIC INCOME TO ESTIMATE FUTURE

BENEFITS.................................................................................................................................... 6 III. METHODS USED TO CALCULATE THE ESTIMATED FUTURE BENEFITS .................... 8 IV. VALIDATING YOUR CALCULATION OF ESTIMATED FUTURE BENEFITS................ 14

Fundamentals, Techniques and Theory TABLE OF CONTENTS

2 Table of Contents 19952008 National Association of Certified Valuation Analysts 2008.v1

CHAPTER FIVE Capitalization/Discount Rates.................................................................................................................... 1

I. OVERVIEW................................................................................................................................. 1 II. PROPER CAPITALIZATION/DISCOUNT RATES .................................................................. 2

III. IBBOTSON BUILD-UP METHOD............................................................................................. 7 IV. CAPITAL ASSET PRICING MODEL (CAPM) ....................................................................... 15 V. EQUITY RISK PREMIUM: DUFF & PHELPS, LLC RISK PREMIUM REPORT ................ 19

VI. WEIGHTED AVERAGE COST OF CAPITAL (WACC) ........................................................ 22 VII. MARKET MULTIPLES ............................................................................................................ 27

VIII. LESS FREQUENTLY USED SMALL BUSINESS BUILD-UP MODELS ............................. 29 IX. RATES DEVELOPED FROM VALUE DERIVED MODELS ................................................ 38 X. COMMON ERROR ................................................................................................................... 40

XI. CONVERTING PRE-TAX RATES TO AFTER-TAX RATES................................................ 40 CHAPTER SIX Commonly Used Methods of Valuation .................................................................................................... 1

I. OVERVIEW................................................................................................................................. 1 II. ASSET BASED APPROACH...................................................................................................... 2

III. INCOME APPROACH ................................................................................................................ 5 IV. MARKET APPROACH ............................................................................................................. 12 V. OTHER APPROACHES: INCOME/ASSET APPROACH....................................................... 17

VI. APPLICATION OF METHODS FOR VALUING INTANGIBLE ASSETS ........................... 21 VII. SANITY CHECKS..................................................................................................................... 26

VIII. TAX AFFECTING PASS THROUGH ENTITIES.................................................................... 29 CHAPTER SEVEN Valuation Discounts and Premiums .......................................................................................................... 1

I. OVERVIEW................................................................................................................................. 1 II. CONTROL PREMIUM AND MINORITY INTEREST BASICS .............................................. 5

III. MINORITY DISCOUNTS FOR FAMILY TRANSFERS ........................................................ 15 IV. DISCOUNT FOR MARKETABILITY (DLOM) ...................................................................... 17 V. THE MANDELBAUM DECISION AND ITS EFFECTS ON MARKETABILITY ................ 33

VI. JUDICIAL DEVELOPMENTS AND DISCOUNTS FOR LACK OF MARKETABILITY .... 37 VII. QUANTITATIVE MARKETABILITY DISCOUNT MODEL ................................................ 37

VIII. BUILT-IN CAPITAL GAINS TAX ADJUSTMENT................................................................ 40 IX. A BRIEF LOOK AT DISCOUNTS IN FAMILY LIMITED PARTNERSHIPS ...................... 42 X. A BRIEF LOOK AT ESOP VALUATIONS ............................................................................. 44

XI. A LOOK AT OTHER DISCOUNTS ......................................................................................... 45 CHAPTER EIGHT NACVA Professional Standards................................................................................................................ 1 CHAPTER NINE Defining the Valuation Engagement & Obtaining the Necessary Information..................................... 1

I. DEFINING THE VALUATION ENGAGEMENT ..................................................................... 1 II. OBTAINING THE NECESSARY INFORMATION ................................................................ 14

CHAPTER TEN Search for Adjustments .............................................................................................................................. 1

I. SEARCH FOR ADJUSTMENTS ................................................................................................ 1

TABLE OF CONTENTS Fundamentals, Techniques and Theory

19952008 National Association of Certified Valuation Analysts Table of Contents 3 2008.v1

CHAPTER ELEVEN Practice Case Workshop ......................................................................................................................... 1

I. VALUATION ASSIGNMENT.................................................................................................... 1 II. COMPANY BACKGROUND ..................................................................................................... 1

III. YOUR ASSIGNMENT ................................................................................................................ 2 APPENDIX I Daubert and Kumho Tire APPENDIX II IRS Pronouncements FAS Statement Summaries APPENDIX III IRS Business Valuation Guidelines Approved 2006 APPENDIX IV Comprehensive Business Valuation Development Checklist APPENDIX V Comprehensive Business Valuation Reporting Checklist for Detailed Reports APPENDIX VI Organization Comparisons APPENDIX VII Economic Studies: Furniture Industry APPENDIX VIII Federal Rules of Practice and Procedure APPENDIX IX Other Methods to Project Earnings APPENDIX X Duff & Phelps, LLC Risk Premium Report 2005 APPENDIX XI FT&T Answers to Chapter Review Questions APPENDIX XII Instructions for Self-Study Participants INDEX

Fundamentals, Techniques and Theory TABLE OF CONTENTS

4 Table of Contents 19952008 National Association of Certified Valuation Analysts 2008.v1

PARTICIPANT NOTES

Fundamentals, Techniques and Theory INSTRUCTOR BIOS

19952008 National Association of Certified Valuation Analysts Instructor Bios i 2008.v1

Instructor Bios

INSTRUCTOR BIOS Fundamentals, Techniques and Theory

ii Instructor Bios 19952008 National Association of Certified Valuation Analysts 2008.v1


19952008 National Association of Certified Valuation Analysts Instructor Bios iii 2008.v1

Mel Abraham is a Certified Public Accountant with two decades of experience as a financial expert, valuation expert and business and success strategist. Mel is a Master Results Coach and Master Practitioner in Neuro-Linguistic Strategies. Mel is regularly sought after for valuation engagements around the country such as family limited partnerships, co-tenant interest valuations, operating businesses as well as various entities. These projects have ranged from small family owned businesses to large $1.7 billion companies. He has also represented the Internal Revenue Service as their valuation expert in numerous cases and was jointly retained by taxpayer and Internal Revenue Service under the authorization of the U.S. Tax Court to provide a valuation of numerous entities that was binding on all parties. Mel is a member of the esteemed National Speakers Association and the recipient of the Certified Speaking Professional designation (less than 10% of the speakers who belong to the International Federation for Professional Speakers hold this professional designation and only two other CPAs hold the designation). A recognized forensic expert witness in business financial issues, he is also a nationally recognized and award-winning speaker addressing professional conferences on a local, state & national level. He provides strategies in risk management, threat management and self protection to clients across the country. Mel is one of the primary instructors of the NACVA's National Training Team as well as an Adjunct Professor at the University of San Diego Law School. Mel has been a guest lecturer for Tax Court Judge the Honorable David Laro, at his LLM program at the University of San Diego Law School on valuation issues. Mel has being a featured presenter at numerous State Tax Institutes around the country, Internal Revenue Service Continuing Education Conferences and at the NACVA National Annual Valuation Conferences as well as at the AICPA Annual Business Valuation Conference in 2001 through 2005. Further, Mel is the recipient of NACVA's 1998 Circle of Light Award (NACVAs highest instructor distinction), Instructor of Exceptional Distinction (ten consecutive years 1997 through 2006), 1997 Instructor of the Year Award as well as the 1996 Outstanding Member Award. Mel was awarded the Volunteer of the Year Award in 2005 by the AICPA and was voted one of the Top 25 CPAs by the San Fernando Valley Business Journal. Mel was the Chairman of the 2003 and 2005 AICPA Valuation Conference. He is the Founder and President of The SAVE Foundation, a non profit charitable organization that provides programs and funding to assist those that have been or may be victims of abuse and violence as well as raise the public awareness to the problem and educate them in prevention . He is the creator of the much in demand program, Bulletproof Boundaries Safety & Success Strategies for an Unsafe World. This educational program provides the intellectual tools for living with confidence and security in a risky world through awareness and recognition of threatening situations. This dynamic program addresses both personal safety and corporate security & financial crimes. He has received numerous speaking awards and authored numerous articles. His authoritative book, Valuation Issues and Case Law UpdateA Reference Guide, has been released in a 5th edition. Recently, he was co-author of the business valuation industrys best selling book, Financial Valuation: Applications and Models, released by John Wiley & Sons, Inc. and two additional books A Healthier You, (with Deepak Chopra and Billy Blanks) and Masters on Success, (with Ken Blanchard, Jack Canfield and John Christensen) released in 2005. He is also the creator of various multi-media digital educational programs including the industrys best-selling course - Family Limited Partnerships Self Study Course found on www.ValuationEducation.com

National Association of Certified Valuation Analysts Consultants Training Institute 1111 Brickyard Road, Salt Lake City, Utah 84106 P: (801) 486-0600 F: (801) 486-7500 Internet: www.nacva.com

Mel AbrahamCPA, CVA, ABV, ASA

Mel Abraham, CPA, CVA, ABV, ASA 543 Country Club Drive, Suite B543 Simi Valley, California 93065 P: (805) 578-1515 F: (805) 293-8950 E: [email protected]


iv Instructor Bios 19952008 National Association of Certified Valuation Analysts 2008.v1

NACVA Instructor of: Business Valuation Training Center: Fundamentals, Techniques & Theory (FT&T) Applications and Calculations of the Income and Asset Approaches Advanced Case Law Update Advanced Valuation & Case Study Workshop

Aug 2007


19952008 National Association of Certified Valuation Analysts Instructor Bios v 2008.v1

Dr. Stephen A. DegnanCPA, CVA, DBA

Degnan & Associates, CPA 110 Ryan Industrial Court, Suite 12 San Ramon, California 94583 P: (925) 838-9960 F: (925) 838-9081 E: [email protected]

EDUCATION Doctorate in Finance, Golden Gate University, San Francisco, 2002. Dissertation Topic: Valuation of Intellectual Property. MBA in Finance, Golden Gate University, San Francisco, 1987.

Bachelors in Accounting, University of Nevada, Reno, 1973. PROFESSIONAL Certified Public Accountant (CPA) California and Nevada, CERTIFICATES Certified Valuation Analyst (CVA),

Certified Fraud Examiner (CFE) SUMMARY OF Expert witness testimony in Federal and State courts in over 80 matters. EXPERIENCE Qualified as a damage and valuation expert in accounting, finance, intellectual property

and business valuations. Past clients include AMD, BioRad, Cisco, Genentech, Hewlett-Packard, IGT, Intel, Johnson & Johnson, Round Table Pizza, Symantec and Xilinx.

WORK Degnan & Associates - Founder and Owner, 1996 to present. EXPERIENCE IFS Ventures, LLC - Founder/Managing Member, 1997 to 2000.

Hunter Paine - Acting CFO, 2000 to 2004 Media Switch - Acting CFO, 2000 to 2001. Arthur Andersen - Partner, 1991 to 1996.

Harry, Evans & Degnan - Partner, 1987 to 1991. Price Waterhouse - Senior Manager, 1979 to 1987. Itel Corporation - Assistant Controller, 1978 to 1979. Peat, Marwick & Mitchell - Senior Accountant, 1975 to 1978. Castle & Cooke - Senior Accountant, 1973 to 1975.

OTHER Adjunct Senior Professor, Golden Gate University, 1988 to 2000 EXPERIENCE Subjects: Business Valuation; Advanced, Cost, and Litigation

Accounting; and Financial Auditing. Special Investigator, California Board of Accountancy, 1990 to 1992 President and Trustee, San Francisco Chamber Orchestra, 1982 to 2001

First Lieutenant, U.S. Army, Republic of Vietnam, 1966 to 1969 Two Purple Hearts and a Bronze Star.



vi Instructor Bios 19952008 National Association of Certified Valuation Analysts 2008.v1

PROFESSIONAL National Association of Certified Valuation Analysts: Instructor AND BUSINESS Business Valuation Instructor 2005 to present. AFFILIATIONS Licensing Executive Society California CPA Society: Member, Board of Directors, 1992 to 1998 Chair, Accounting Principles & Auditing Standards, 1991 to 1994 Chair, Litigation Consulting Conference, 1990 Chair, MAS Committee, 1984 to 1985 CPA Educational Foundation, Vice President and Trustee, 1994 to 1997 PUBLISHED Intellectual Property Damages, Price Waterhouse Training Manual. ARTICLES Dollars at Stake in IP Litigation, The GC Advisor, Spring 94. A Survey of Licensing Royalties, les Nouvelles, June 97. Using Financial Models to Get Royalty Rates, les Nouvelles, June 98. Macro View of the U.S. R&D, Licensing, les Nouvelles, December 98. The Licensing Payoff, Research Technology Management, March 99. Patent and Technology Licensing, Licensing Desk Book, Aspen 99.

Evaluation Factors in Patent Technology Transfer, UMI, July, 02. SEMINARS & How to Perform Business Valuations PRESENTATIONS Valuation of Intangible Property CONDUCTED Valuing Intellectual Property in Marital Dissolution

Business Valuation Fundamentals, Techniques & Theory Running Royalties in the Real World A Survey of Licensing Royalties A Primer on Calculating Lost Profits Using Statistics in Business Litigation Angels and Venture Capitalists The Yellow Book and Governmental Accounting and Auditing

Effective Business Presentations Calculating Damages in Construction Litigation How to Detect Fraud in Your Business Damages in Patent, Trademark and Copyright Matters Present and Future Valuing of Cash Flows Damages in Business Interruption Matters Obtaining Financing for Alternative Energy Technologies Damages in Personal Injury, Wrongful Death and Employment

The Theory of the Time Value of Money The Role of the Accountant in Business Litigation

Effective Selling of Consulting Services Accounting and Audit Updates Senior Consultant Training at Price Waterhouse Accounting for Non-Profit Entities Accounting Malpractice What It Is and How To Avoid It

Cost Accounting for Businesses Effective Auditing of Businesses The Role of the Accountant in Bankruptcy Recent Trends in Licensing of Technology 2003 Host BusinessAmericaRadio, Intellectual Property & You 2003-2004 REPRESENTATIVE - Performed business valuations on over 200 commercial businesses for a VALUATION large California bank. EXPERIENCE - Performed business valuations and cash flow analyses on over 100 commercial and

industrial businesses for a large national bank. - Assisted over 20 start-up companies with business and stock valuations, and licensing

matters.


19952008 National Association of Certified Valuation Analysts Instructor Bios vii 2008.v1

- Determined the discount needed in a valuation of seven tenants-in-common real estate properties.

- Valuation of minority stock ownership rights in several partnership dissolution matters. - Special Court-appointed master in a Section 2000 valuation of a business. - Valuation of a restaurants name for the business partners. - Assisted manufacturer with valuation of trademark and intangibles licenses with

Paramount and Lucas Films. - Assisted two professional societies with valuation of their name and trademarks. - Performed valuations for CD-ROM producer in negotiations with the NFL Properties

and Players Association. - Assisted owner of a software company in the valuation and negotiation of potential

licensing and proprietary trade secrets. - Licensing and financial advisor to a sports memorabilia company.

- Financial valuation advisor to pharmaceutical company on skin-care patent. - Licensing and financial advisor to a start-up accelerometer company.

- Assisted integrated circuit (IC) manufacturer in the valuation of the appropriate licensing royalty rate with competitor.

- Assisted in the development of a licensing stream securitization arrangement. - Assisted in the valuation of a software company which was dissolved as a result of a

breach of contract. - Assisted in the valuation of a division of a large networking company as a result of a

faulty application specific integrated circuit (ASIC) being supplied.

REPRESENTATIVE - Valuation of damages, including lost profits and reasonable royalties, from lost TESTIMONY machine sales, lost accessory sales and damages from the decrement in selling price in EXPERIENCE a case involving a patent on a mass spectrometer.

- Valuation of a limited partnership interest in a sports facility. - Computed lost profits and unjust enrichment in a case involving a software

development company. - Evaluated plaintiffs lost profits and defendants unjust enrichment profits in a

trade dress infringement case involving apparel products. - Compiled information and testified on infringing units sold, average selling price and

reasonable royalty damages in a case involving a patent on the copper vapor laser. - Calculated lost profits for the defendant in a legal malpractice case arising from an

infringement of the patent projection aligners used in chip manufacturing. - Determined infringing sales and calculated incremental revenues, costs and damages

from lost follow-on sales in a case involving a patent on monoclonal antibodies and high pressure liquid chromatography (HPLC) instruments.

- Determined lost profits and reasonable royalties from infringing United States sales regarding a patent on a tape winding machine for video and audio cassette tapes.

- Calculated incremental profits and infringing sales for the alleged patent infringer on a tape recording device.

- Computed lost profits in a matter involving a trade secret on a check processing machine.

- Summarized potential damages in a case involving a trademark infringement on home security alarm systems.

- Determined the proper reasonable royalty on a process patent related to an ophthalmic product.

- Determined the number of infringing units sold and incremental profits on a trade name case involving footwear.

- Determined past and future lost unit sales and lost profits in a case involving an infringed brand name of an apparel company.

- Assessed lost profits on a trade secrets dispute involving the importation of products from overseas into the United States.

- Compiled information for a trademark licensee on the incremental costs and lost profits stemming from the owner of the trademark making similar goods.


viii Instructor Bios 19952008 National Association of Certified Valuation Analysts 2008.v1

- Determined the unrealized incremental profits from lost machine sales in a case involving the Velo-Bind patent.

- Calculated the unjust enrichment by a Nevada bank resulting from its infringement of a trademark held by a major California bank.

- Calculated lost profits, reasonable royalties and price erosion damages allegedly due a major wheelchair manufacturer resulting from a breach of a patent license.

- Determined market-share, lost profits and reasonable royalties allegedly due the manufacturer of blood glucose monitoring devices resulting from a patent infringement.

- Determined lost profits arising from allegedly stolen trade secrets in the gaming industry.

- Determined the appropriate reasonable royalty and corrective advertising due when one family member misappropriated the businesss trademarked name.

- Calculated plaintiffs lost profits and defendants profits resulting from the alleged misuse of a printer cartridge manufacturers trademark.

- Calculated and testified to market share, lost incremental profits and reasonable royalties in a case involving a gaming machine patent.

- Calculated market-share, reasonable royalty and lost profits in a case involving inter-oral dental cameras.

- Calculated reasonable royalties in a semiconductor manufacturing matter involving flash memory chips.

- Performed a business valuation on the value of a restaurants name. - Prepared a report for settlement purposes in a legal malpractice matter which alleged

failure to timely file patent applications. - Calculated the defendants profits and a reasonable royalty in a service mark

infringement matter. - Calculated potential breach of royalty agreement damages in a patent matter regarding

the manufacture of athletic footwear. - Determined an appropriate royalty that would have been negotiated between a willing

licensee and willing licensor for a patent involving state-of-the-art semiconductor manufacturing equipment.

NACVA Instructor of: Business Valuation Training Center: Fundamentals, Techniques and Theory (FT&T) Applications and Calculations of the Income and Asset Approaches


19952008 National Association of Certified Valuation Analysts Instructor Bios ix 2008.v1


Richard Gray CPA/ABV, CVA, ASA

Richard Gray, Certified Public Accountant (CPA)/Accredited in Business Valuation (ABV), Certified Valuation Analyst (CVA), and Accredited Senior Appraiser (ASA) is a Senior Manager in the Business Valuation Group of Daszkal Bolton LLP in Florida. Rick is a former auditor and consultant with over twenty years of relevant experience. He received a Bachelor of Science degree from the University of Maryland in 1978 and a Masters degree in Business Administration from Loyola College in Baltimore in 1982. After a number of years in the health care industry, Rick decided to enter public accounting and successfully completed the Certified Public Accountant exam in 1988. He became an auditor and consultant with Deloitte & Touche and, in 1994 after joining a regional firm in the mid-Atlantic area, began specializing in business valuation and litigation support services. Rick is currently licensed as a CPA in both the states of Florida and Maryland. He is a member of the American Institute of Certified Public Accountants (AICPA), the National Association of Certified Valuation Analysts (NACVA), and the American Society of Appraisers (ASA). He is a member of both the Florida Institute of Certified Public Accountants and the Maryland Association of Certified Public Accountants. Since 1988, Rick has been an instructor for the BeckerConviser Professional Review Course, instructing candidates in the preparation of both the CPA and CFA examinations. Since beginning his specialization in the area of business valuation and litigation support, Rick has performed numerous business valuations and analyses for various entities and purposes and has qualified as an expert witness for litigation. Rick has made a number of presentations and has authored articles in the areas of business valuation and litigation support. He is active in NACVA at both the state chapter and national level. Rick was elected to the NACVA Valuation Credentialing Board in 2003 and became its Chair in June 2005. In addition to his Board duties, Rick is a member of NACVAs Speakers Bureau, the Examination Grading/Mentoring Team and serves as an instructor for both the Business Valuation Training Center and the Advanced Valuation and Case Study Workshop. Rick has been a discussion leader at his state chapter meetings and has served as a moderator for the NACVAs Case Preparation Review Case Analysis by Phone for CVA/AVA candidates. NACVA Instructor of: Business Valuation Training Center: Fundamentals, Techniques & Theory (FT&T) Applications and Calculations of the Income and Asset Approaches Advanced Valuation & Case Study Workshop Valuation of Capital Intensive Industries Workshop August 2007

Daszkal Bolton LLP 2401 NW Boca Raton Boulevard Boca Raton, Florida 33431 P: (561) 953-1468 F: (561) 750-3236 E: [email protected]


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19952008 National Association of Certified Valuation Analysts Instructor Bios xi 2008.v1

Chris Hamilton is a principal of Arxis Financial, Inc., Arxis Technology, Inc., and Arxis Wealth Management, LLC. These firms are involved in tax and accounting consulting, business valuation, litigation consulting, technology consulting and financial planning. The firms are located in Simi Valley, California. Chris is a Certified Public Accountant, Certified Fraud Examiner, Certified Valuation Analyst, and a Diplomate with the American Board of Forensic Accounting. He is a licensed life and disability insurance agent and a General Securities Representative. Most of his professional time is spent in the areas of business valuations, forensic accounting and litigation related engagements. He has served as an expert in civil, criminal, probate and family court matters. Chris has presented courses at national conferences, training institutes and seminars around the country. He has presented sessions at national NACVA conferences on topics including The Affect of Asbestos Litigation on the Valuation of a Business; Executive Compensation and the Value of a Closely Held Company and other topics including the preparation of engagement letters and selecting capitalization/discount rates. Chris is part of the team teaching the Advanced Business Valuation courses around the country for NACVA as well as Fundamentals Techniques and Theory. He is also an instructor with the NACVA Consultants Training Institute (CTI) and the Business Valuation and Certification Training Centers. He is regularly asked by civic and business groups to speak on a variety of topics related to his experience and expertise. Chris was named a 2004 Instructor of Exceptional Distinction by NACVA. Chris Hamilton has published valuation related articles in several publications including The Forensic Examiner; Los Angeles Lawyer; The Valuation Examiner; Valuation Strategies and the Journal of Forensic Accounting. Additionally, he wrote the course material for NACVA titled, Capitalization/Discount Rates: Assessing the Alternatives and Advanced Case Law Update. He currently serves on the editorial board and is a regular contributor to the NACVA publication, Insights on Valuation. He has also been asked to co-author Financial Valuation Application and Models, 2nd edition published in 2006. Chris lives in Simi Valley, California with his wife and three daughters. NACVA Instructor of: Business Valuation Training Center: Fundamentals, Techniques & Theory (FT&T) Applications and Calculations of the Income and Asset Approaches Advanced Valuation & Case Study Workshop Capitalization/Discount Rates: Assessing the Alternatives August 2007

National Association of Certified Valuation AnalystsConsultants Training Institute 1111 Brickyard Road, Salt Lake City, Utah 84106 P: (801) 486-0600 F: (801) 486-7500 Internet: www.nacva.com

Chris Hamilton CPA, CVA, CFE, DABFA

Arxis Financial, Inc. 2468 Tapo Canyon Road Simi Valley, California 93063 P: (805) 306-7890 F: (805) 306-7891 E: [email protected]


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19952008 National Association of Certified Valuation Analysts Instructor Bios iii 2008.v1

Mark G. Kucik is founder of The Kucik Valuation Group, LLC, of Chicago, Illinois, specializing in business valuations of family-owned and closely held securities for use in estate tax planning, financial statement reporting, estate tax returns, gift tax returns, buy/sell agreements, purchase/sale transactions, ESOPs, economic damages, matrimonial and shareholder disputes. Mr. Kucik served as past Chair of the NACVA Executive Advisory Board, past Chair of the NACVA Standards Committee, a member of the International Glossary Task Force, a member of the North American Business Valuation Standards Council, an instructor on NACVAs Training Development Team and served on NACVAs Education Board. He has over 22 years of professional experience, 12 years specialized in business valuation. Mr. Kucik was awarded NACVAs Outstanding Member Award, NACVAs Outstanding Instructor award, and Instructor of Great Distinction Award, and NACVAs Circle of Light Award. He also presents valuation seminars throughout the Chicago area. Mr. Kucik is a Certified Public Accountant (CPA), Certified Valuation Analyst (CVA) and Certified Mergers and Acquisitions Analyst (CM&AA). He is a member of the American Institute of Certified Public Accountants (AICPA), and the Illinois CPA Society (ICPAS). Mr. Kucik is a graduate of Loyola University of Chicago. NACVA Instructor for: Business Valuation Training Center: Fundamentals, Techniques & Theory (FT&T) Applications and Calculations of the Income and Asset Approaches Advanced Valuation & Case Study Workshop Working Through the Business Valuation Standards Maze August 2007


Mark G. KucikCPA, CVA, CM&AA

The Kucik Valuation Group, LLC 211 East Ontario Street, Suite 1800 Chicago, Illinois 60611 P: (312) 283-3045 F: (708) 422-9703 E: [email protected]


iv Instructor Bios 19952008 National Association of Certified Valuation Analysts 2008.v1



19952008 National Association of Certified Valuation Analysts Instructor Bios v 2008.v1

Derald Lyons is President of Lyons & Seacrest, P.C., CPAs. He has been a practicing CPA for over 30 years and has specialized in business valuations for much of that time. Deralds valuation specialties include: marital dissolution (including separate property tracing), tax (gift, estate, income tax, purchase price allocations, and S elections), dissenting shareholder actions, economic loss calculations, and mergers and acquisitions. He has been qualified as an expert witness and provided testimony regarding valuations and other financial matters on numerous occasions. Derald is a nationally recognized author and presenter on valuation matters. He has also been recognized with numerous awards for his presentations. He is one of the primary instructors and contributing authors for the National Association of Certified Valuation Analysts (NACVA) Training Development Team. In this capacity Derald teaches Business Valuations: Fundamentals, Techniques & Theory (two days) and Applications and Calculations of the Income and Asset Approaches (one day), as a requirement of NACVAs five-day valuation credentialing program. He is also an instructor for NACVAs 3 day Advanced Valuation & Case Study Workshop. Derald is a co-author of the nationally recognized valuation treatise, Financial Valuation Applications and Models, Second Edition, Wiley, 2006. Derald is the recipient of NACVAs 2003 Circle of Light Award (NACVAs highest instructor distinction), the Instructor of the Year Award in 2002, Instructor of Exceptional Distinction in 1999, 2001, 2002, 2003, 2004, 2005 and 2006, and Instructor of Great Distinction in 1998 and 2000. In addition, Derald recently received NACVAs Outstanding Member Award. Derald is a past President of the Colorado Society of CPAs (1997 to 1998) and a Council Member for the AICPA (1996 to 2000). The Denver Business Journal has also recognized him in Whos Who in Professional Services in the Denver accounting profession, annually from 1998 to 2004. NACVA Instructor of: Business Valuation Training Center: Fundamentals, Techniques & Theory (FT&T) Applications and Calculations of the Income and Asset Approaches Advanced Valuation & Case Study Workshop August 2007


Derald Lyons MT, CPA, CVA

Lyons & Seacrest, P.C., CPAs 4401 S Quebec Street, Suite 100 Denver, Colorado 80237 P: (303) 662-0487 F: (303) 771-1242 E: [email protected]


vi Instructor Bios 19952008 National Association of Certified Valuation Analysts 2008.v1



19952008 National Association of Certified Valuation Analysts Instructor Bios vii 2008.v1

Patricia A. Perzel, CPA, CVA, CFFA, CFD is the founder of Perzel & Lara Forensic CPAs, P.A., and co-chairs the firms litigation support department. Her extensive experience in providing a broad spectrum of professional services including forensic accounting, auditing, tax, pension and estate planning, provides the technical foundation required to excel as a certified business valuation analyst (CVA), Certified Forensic Financial Analyst (CFFA) and Certified Fraud Deterrence Analyst (CFD). Twenty-six years as a certified public accountant, and seventeen years of providing business valuations, forensic and fraud prevention services, expert witness, and litigation support has propelled Patricia Perzel to the top of her profession as a highly recognized business valuation, expert witness and litigation support professional. Attorneys rely on her technical abilities to unravel complicated financial issues. The court has appointed her as receiver over business assets in contempt cases. Clients depend upon her business valuation recommendations in the areas of divorce, mergers and acquisitions, buy-sell agreements, partner and stockholder agreements, damage losses, and succession and estate planning. Pats experience includes valuation services for medical and professional practices, retail stores, service businesses, construction, manufacturing, etc. Her varied background in working in many industries as well as her thirst for up-to-date technical information keeps her on the forefront of business valuation issues. Pat has also earned the premier NACVA designations of Certified Forensic Financial Analyst (CFFA) and Certified Fraud Deterrence Analyst (CFD). She uses this additional training in forensic accounting to investigate and uncover financial fraud, management fraud and employee embezzlement as well as construct fraud prevention programs. Her ability to excel on the witness stand and effectively defend the sound principles utilized in her business valuations, fraud engagements and litigation testimony, qualifies her as a top professional in her field. Pat also teaches nationally for NACVA, the fundamentals and techniques of business valuations for certification of CVA candidates, and fraud prevention and detection training to CFD (Certified in Fraud Deterrence) candidates.


Patricia A. Perzel CPA, CVA, CFFA, CFD

Perzel & Lara Forensic, CPAs, P.A. 2105 Drew Street Clearwater, Florida 33765 P: (727) 466-0777 F: (727) 443-2600 E: [email protected]


viii Instructor Bios 19952008 National Association of Certified Valuation Analysts 2008.v1

Professional: -Certified Public Accountant, Ohio (CPA) -Licensed Series Seven Stockbroker -Certified Public Accountant, Florida (CPA) -Licensed in Insurance and Annuities -Certified Valuation Analyst (CVA) -Member of Florida Institute of CPAs -Certified Forensic Financial Analyst (CFFA) -Member FICPA Valuation and Litigation Section -Certified in Fraud Deterrence (CFD) -Member Institute of Business Appraisers -Member of NACVA Executive Advisory Board

-Member of National Association of Certified Valuation Analysts including the Quality Enhancement Committee; Valuation Exam & Grading Committee; State Chapters Committee; Course Review Committee; Ideas & Technology Committee; and Practice Development Committee

Additional Professional Experience:

-Instructor of Fundamentals, Theory and Techniques of Business Valuations, Fraud Deterrence, the foundation and Natural Disasters Workshop for NACVA

-Becker CPA Review Course Past Lead Instructor for four years -Guest speaker to various Bar Associations and Matrimonial Trial Advocacy Seminars. -Guest lecturer to various FICPA, Financial and Business Associations

NACVA Instructor of: Business Valuation Training Center: Fundamentals, Techniques & Theory (FT&T) Applications and Calculations of the Income and Asset Approaches Fraud Deterrence Training Center Forensic Accounting A to Z Academy


19952008 National Association of Certified Valuation Analysts Instructor Bios ix 2008.v1

Mr. Tebay is a practicing Certified Public Accountant, Certified Valuation Analyst, and Certified in Mergers & Acquisitions with over 33 years of experience. He is the founder and Managing Partner of Value Defined, LLC, a business valuation and litigation support firm in Maumee, Ohio. He is also the Managing Partner of Tebay Mosley Associates, LLC, full service accounting, tax, and consulting firm in Maumee, Ohio as well as Managing Director of Source Companies Great Lakes Region, LLC (an affiliate of Source Companies, LLC in Pennsylvania) which provides value growth consulting and investment banking services to owners of medium-sized businesses. Mr. Tebay received his Bachelor of Science in Accounting in 1972 from Findlay College in Ohio. He then received certification as a Public Accountant in 1975. In 1997, he became a Certified Valuation Analyst, and was awarded the CM&A (Certified in Mergers & Acquisitions) in 2001. He is a member of the Ohio Society of Certified Public Accountants, the American Institute of Certified Public Accountants (Tax Division and Consulting Services Division), the Alliance of Merger and Acquisition Advisors, National Association of Certified Valuation Analysts, through which he is a member of the NACVA Standards Committee (provide interpretations and expand upon technical standards), the NACVA Training Development Team, member of NACVA Mentor Support Group, the NACVA Ethics and Oversight Board Chair, and the NACVA Speakers Bureau, as well as many other local memberships. Over the years, Mr. Tebay has held offices and served on many boards for local organizations. In 1989, he formed Tebay Mosley Associates, LLC, which has experienced steady growth in servicing small to medium sized business with nearly every aspect of their personal and business financial needs. Mr. Tebays primary focus within the firm is management consulting services, which includes business valuations, litigation support, and mergers and acquisitions. Prior to founding Tebay Mosley Associates, LLC, Mr. Tebay was a Partner at Brell, Tebay, Holt & Dettinger, Inc., and was CFO & Director of Westhaven Services. Mr. Tebay and his staff have performed hundreds of valuations since 1980. Mr. Tebay has also been qualified as an expert witness in various municipal and federal courts and has given testimony in divorce cases, personal injury cases, lost profits, economic damages, shareholder disputes, and federal bankruptcy court. He is often called upon to consult in various valuation matters and has handled numerous merger and acquisition transactions. In addition, Mr. Tebay has also served as an arbitrator for the American Arbitration Association. As an instructor for the National Association of Certified Valuation Analysts, Garth has taught the Fundamental Techniques & Theory (FT&T days 1 and 2) course as well as Case (day 3) at NACVA Training Centers since 2001, presented the program for the Internal Revenue Service, the Small Business Administration (SBIC Division), The Korean Valuation Association, presented to the National College of District Attorneys, wrote instructional materials for NACVA program Business Valuation Fundamentals for the CPA (2005), co-authored instructional materials for NACVA programs Fundamentals, Techniques & Theory & Case (2005), and has been recognized with the Member of the Year award (2005) from NACVA as well as their awards Instructor of Exceptional Distinction in 2003, 2004, 2005 and Instructor of Great Distinction in 2002. In addition to authoring portions of the training curriculum, Mr. Tebay has presented numerous seminars on the topic of business valuations. April 2007


Garth M. TebayCPA, CVA, CM&AA

Valued Defined, LLC 6455 Wheatstone Court Maumee, Ohio 43537 P: (419) 865-4478 F: (419) 861-1121 E: [email protected]


x Instructor Bios 19952008 National Association of Certified Valuation Analysts 2008.v1

NACVA Instructor of: Business Valuation Training Center: Fundamentals, Techniques & Theory (FT&T) Applications and Calculations of the Income and Asset Approaches Business Valuation Fundamentals for the CPA Workshop

NACVA COURSE EVALUATION FORM

Course Evaluation Form xi

COURSE TITLE: Business Valuation: Fundamentals, Techniques & Theory Monday INSTRUCTOR: LOCATION: Your assistance will allow us to continue to provide you with the highest quality learning experience and to more closely satisfy your professional needs and expectations in the future. Thank you. NACVA Member Number

INSTRUCTOR N/A Poor Fair Good Very Good Excellent

How would you rate the Instructors overall presentation/teaching skills? 0 1 2 3 4 5 Were the learning objectives clearly explained and met by the Instructor? 0 1 2 3 4 5 Were questions encouraged, and if so, was the response clearly explained? 0 1 2 3 4 5 Was adequate time spent on each subject matter throughout the course? 0 1 2 3 4 5 How well did the Instructor present and/or explain information? 0 1 2 3 4 5 How would you rate the instructors knowledge of the subject matter? 0 1 2 3 4 5

COMMENTS:

COURSE N/A Poor Fair Good Very Good Excellent

Did this course meet your expectations? 0 1 2 3 4 5 Did the materials contribute to your learning experience? 0 1 2 3 4 5 How would you rate the overall quality of the course material? 0 1 2 3 4 5 If advanced preparation was necessary, did you find that material helpful? 0 1 2 3 4 5

COMMENTS: Would you recommend this course to your colleagues and/or other professionals? T Yes T No

If not, why not? In what other ways could this course be improved or made more valuable to you? Which aspect(s) of this course did you enjoy / value the most? Rate your experience in the field of Business Valuation. None T Nominal T Modest T Seasoned T Extensive T NACVA What can NACVA do in the future to assist you in your career / professional development? May we use your comments? T Yes T No

NACVA COURSE EVALUATION FORM

Course Evaluation Form 13

COURSE TITLE: Business Valuation: Fundamentals, Techniques & Theory Tuesday INSTRUCTOR: LOCATION: Your assistance will allow us to continue to provide you with the highest quality learning experience and to more closely satisfy your professional needs and expectations in the future. Thank you. NACVA Member Number

INSTRUCTOR N/A Poor Fair Good Very Good Excellent

How would you rate the Instructors overall presentation/teaching skills? 0 1 2 3 4 5 Were the learning objectives clearly explained and met by the Instructor? 0 1 2 3 4 5 Were questions encouraged, and if so, was the response clearly explained? 0 1 2 3 4 5 Was adequate time spent on each subject matter throughout the course? 0 1 2 3 4 5 How well did the Instructor present and/or explain information? 0 1 2 3 4 5 How would you rate the instructors knowledge of the subject matter? 0 1 2 3 4 5

COMMENTS:

COURSE N/A Poor Fair Good Very Good Excellent

Did this course meet your expectations? 0 1 2 3 4 5 Did the materials contribute to your learning experience? 0 1 2 3 4 5 How would you rate the overall quality of the course material? 0 1 2 3 4 5 If advanced preparation was necessary, did you find that material helpful? 0 1 2 3 4 5

COMMENTS: Would you recommend this course to your colleagues and/or other professionals? T Yes T No

If not, why not? In what other ways could this course be improved or made more valuable to you? Which aspect(s) of this course did you enjoy / value the most? Rate your experience in the field of Business Valuation. None T Nominal T Modest T Seasoned T Extensive T NACVA What can NACVA do in the future to assist you in your career / professional development? May we use your comments? T Yes T No

NACVA On-Site Support Evaluation Form

On-Site Support Evaluation Form xv

NACVA ON-SITE REPRESENTATIVE DATE: LOCATION: Your assistance will allow us to continue to provide you with the highest quality learning experience and to more closely satisfy your professional needs and expectations in the future. Thank you.

N/A Poor Fair Good Very Good Excellent

Representatives availability (at sign-in table each morning, at breaks, at NACVA sponsored lunches, at class end): 0 1 2 3 4 5

COMMENTS:


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Daily introductory comments and explanations: 0 1 2 3 4 5 COMMENTS:


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To what degree were the software preview(s) useful: 0 1 2 3 4 5 COMMENTS: May we use your comments? T Yes T No If yes.Name NACVA #:

Fundamentals, Techniques & Theory INTRODUCTION TO BUSINESS VALUATION

19952008 National Association of Certified Valuation Analysts Chapter One 1 2008.v1

CHAPTER ONE

INTRODUCTION TO BUSINESS VALUATION

Everybody is ignorant, only on different subjects. Will Rogers (18791935)

American Philosopher, Author I. EVOLUTION OF BUSINESS VALUATION

How much is this business interest worth? This question is not one that is easily answered. The answer depends on 1) economic factors (these can be local, regional, national, and international); 2) the premise and standard of value selected; 3) appropriate valuation method applied; and, 4) interest being valued, to name just a few factors. In this course, all of the above factors are discussed in detail.

Historically, the valuation of a closely held company was more of an art than a science; there was some guidance provided by the IRS and minimal reporting standards. Accordingly, many in the business valuation profession served as advocates for the client, rather than as an expert (or advocate for the conclusion of value). The growth and diversity within the valuation profession, improvement in software, growing sophistication of the judiciary1 and availability of data through the Internet has transformed the profession and practice. There is now less guesswork and more scrutiny. If the value of a company were determined by a sample of inexperienced or unqualified valuation professionals, the distribution of Opinions or Conclusions of Value (terms defined in NACVAs Professional Standards) can be illustrated by the following bell curve. This bell curve depicts a wide range of values demonstrating valuation as more of an art than science:

1 See Daubert et. ux. v. Merrell Dow Pharmaceuticals, Inc., 509 U.S. 579 (1992) (Court held that the Federal Rules of Evidence, not Frye, provide the standard for admitting expert scientific testimony in a federal trial; nothing in the rules gives any indication that general acceptance is a necessary precondition to the admissibility of scientific evidence. The trial judge has the task of ensuring that an experts testimony both rests on a reliable foundation and is relevant to the task at hand) and Kumho Tire C. v. Carmichael, 526 U.S. 137 (1999) (Daubert standard applies to scientific, technical or other specialized knowledge; Rule 702 imposes a special obligation upon the trial judge to ensure testimony is relevant and reliable; reliability assessed by considering if methodology has been tested, subject to peer review, has error rates, and/or is acceptable in the relevant scientific or technical community). A summary of both cases is included in Appendix One.

y

x

Extreme Low Value Extreme High Value

INTRODUCTION TO BUSINESS VALUATION Fundamentals, Techniques & Theory

2 Chapter One 19952008 National Association of Certified Valuation Analysts 2008.v1

Observation

Business valuation is not for the faint at heart!

The distribution of values, obtained from a sample of experienced valuation professionals, illustrates two important things:

1. The curve is relatively flat, indicating a broad range of opinions of values 2. The range or spread between the highest and lowest estimate of value would be relatively large

A vast difference in values is considered detrimental to the credibility of professionals involved in business valuation activities. Consequently, valuation analysts must attempt to explain the difference between their different conclusions of value (the term conclusion of value is an important term defined in NACVAs Professional Standard 2.1). One of the primary purposes in this course is to place more emphasis on the science of performing valuations of closely held companies. That said this does not mean the course is intended to teach a prescribed format or preferred methodology. As valuation theory and practice evolve, one expects the bell curve to evolve and appear as follows:

This illustration reflects a situation where the various conclusions of value are more similar and the range between the highest and lowest value is smaller. NOTE: During the first two or three days of this program you may find studying this topic more than a little frustrating compared to other financial disciplines with which youve been involved. We urge you to remain patient. As the program is fully laid out youll begin to see the big picture of the topic.



II. REGULATORY BODIES

Business valuation practice and theory have evolved significantly in the last decade, but many believe this field is still in its relative infancy. Valuation theory in the areas of intellectual property, venture capital, and limited partnerships is still emerging. A strong theoretical foundation is essential in any field, and the valuation professional can look to the following professional and regulatory bodies for guidance.

A. INTERNAL REVENUE SERVICE (IRS)

1. Catalyst in the Development of Standards

The Internal Revenue Service has substantially contributed to valuation theory and is regarded by many as a primary theoretician in the field of valuation of closely held businesses. The IRS has issued numerous rulings and pronouncements on this subject, and in 2002 the IRS issued new Business Valuation Guidelines, which were updated in 2006 (see Appendix III). Revenue Rulings do not have the force of law, but they do present the position of the IRS on specific tax matters, such as the valuation of businesses or equity interests. Beginning in the 1920s, the IRS published Appeals and Revenue Memorandum 34 (ARM 34, see Appendix III) in response to the Eighteenth Amendment, which enacted Prohibition laws. The purpose of ARM 34 was to establish guidelines and methodologies for determining the amount of loss sustained by a taxpayer as the result of the new laws on Prohibition. Since then, many positions taken by the IRS in Revenue Rulings were rooted in legal disputes. The resolution of these disputes by the courts has established case law precedent. Some of the most important Revenue Rulings (RR) related to business valuations are:

RR 5960 Valuing Closely held Stock RR 68609 Formula Method RR 83120 Valuation of Preferred Stock RR 9312 Allowance of Minority Interest Discount in Family Owned Business

Any discussion of valuation theory must include an analysis of IRS pronouncements to understand some basic regulatory premises. IRS pronouncements began with the issuance of ARM 34 in 1920 and continue to the present day.

Observation The Internal Revenue Service (IRS) was and remains an important body in the development and transformation of valuation theory. Rev. Ruling 59- 60 is among the most important and often cited revenue rulings; participants are urged to read and understand this revenue ruling. In this section the evolution of business valuation theory, as developed in various Revenue Rulings, is introduced.



IRS pronouncements are discussed in the following text as they relate to business valuation theory. It is extremely important for the valuation analyst to become knowledgeable of the relevant issues in these pronouncements. It is highly recommended that you take the time to study these pronouncements carefully (copies of the following IRS pronouncements are provided in Appendix III of this manual).

a) 1920 ARM 34 (See Appendix III)

(1) Issued in 1920 (2) Resulted from the enactment of Prohibition (3) Issued as the result of the enactment of Prohibition, to assist taxpayers in

determining the amount of intangible value lost by businesses previously involved in the alcoholic beverage industry

Methods prior to ARM 34 Very few owners of businesses understood that their businesses might have had intangible value; therefore, many businesses were sold and transferred at tangible asset values only.

ARM 34 introduced two key concepts:

Goodwill exists if a business has excess earnings Goodwill value is determined by capitalizing the excess earnings

ARM 34 also introduced two key problems:

What are excess earnings?

ARM 34 says that excess earnings are the earnings of the company in excess of earnings above the norm of companies with similar activities and size.

What is an appropriate capitalization rate?

ARM 34 failed to define an appropriate capitalization rate. However, it gave approximate ranges for tangible and intangible assets. A discussion of these rates will be presented in Chapter 5.

b) 1959 Revenue Ruling 5960 (See Appendix III)

(1) Issued in 1959 (2) Regarded as the single most important piece of valuation literature (3) Outlined methods and factors to be used in valuing closely held businesses (4) Involved itself with Estate and Gift Taxes (5) Is widely accepted for tax and nontax purposes



(6) Provided for a series of valuation formulas or methods

(a) The various formulas are not alternatives to one another; all of its methods should at least be considered

(b) Many formulas are tied to earnings rather than excess earnings (c) Earnings are multiplied or capitalized by certain industry factors or public

company comparable factors

(7) Realized that due to certain circumstances other methods could be used (8) Recognized that if comparable factors are not available, other methods could

be used (9) The key 5960 methods are:

(a) Comparable price methods (just a few of the many)

i) Price/earnings ratio ii) Dividend paying capacity iii) Price/book value

(b) Asset method (c) Income method (d) Combined method

(10) Refer to Revenue Ruling 5960, Section 7, Average of Factors, which states:

Because valuations cannot be made on the basis of a prescribed formula, there is no means whereby the various applicable factors in a particular case can be assigned mathematical weights in deriving the fair market value. For this reason, no useful purpose is served by taking an average of several factors (e.g., book value, capitalized earnings and capitalized dividends) and basing the valuation on the result. Such a process excludes active consideration of other pertinent factors, and the end result cannot be supported by a realistic application of the significant facts in the case except by mere chance.

c) 1965 Revenue Ruling 65193 (See Appendix III)

(1) Modified Revenue Ruling 5960 (2) Deleted a portion of Section 4.02(f) of Revenue Ruling 5960 (3) Concerned with separately valuing tangible and intangible property. Section

4.02(f) of Revenue Ruling 5960 states that:

In some instances it may not be possible to make a separate appraisal of the tangible and intangible assets of the business. The enterprise has a value as an entity. Whatever intangible value there is, which is supported by the facts, may be measured by the amount by which the appraised value of the tangible assets exceeds the net book value of such assets.



d) 1966 Revenue Procedure 6649 (See Appendix III)

(1) Issued January 1, 1966 (2) Provided information and guidelines relative to appraisals of contributed property

for federal income tax purposes (3) Required properly prepared appraisals by qualified individuals (4) Provided guidelines regarding proper appraisal reports

e) 1968 Revenue Ruling 68609 (See Appendix III)

Sometimes referred to as the excess earnings method or treasury method, this Ruling introduced a formula method to determine values for intangibles, specifically goodwill. Revenue Ruling 68-609 required that adjusted net assets be considered in deriving the total value of a business and discussed the possible use of the following ranges of capitalization rates (generally assumed to be after-tax): (1) Tangible Assets 8% to 10% (2) Intangible Assets 15% to 20%

f) 1977 Revenue Ruling 77287 (See Appendix III)

(1) Issued in 1977 (2) Amplified Revenue Ruling 5960 relative to discounts for lack of marketability (3) Specifically recognized criteria for determining discounts for lack of

marketability (4) Provided direction on discounts for publicly traded securities restricted under

federal securities laws

g) 1981 Revenue Ruling 81253 (See Appendix III)

(1) Issued in 1981 (2) Added to Revenue Ruling 5960 (3) Stated that:

Absent family discord, no minority interest discount will be available for blocks of stock transferred to family members when the family as a group owns a controlling interest in the company.

(4) Superseded by Revenue Ruling 9312

h) 1983 Revenue Ruling 83120 (See Appendix III)

(1) Issued in 1983 (2) Amplified Revenue Ruling 5960 (3) Contained guidelines for valuing preferred stock (4) Specified factors to be considered on valuing common and preferred stock for

gift and other tax purposes in a recapitalization of a closely held business



i) 1993 Revenue Ruling 9312 (See Appendix III)

(1) Issued in 1993 (2) Superseded Revenue Ruling 81253 (3) Stated that:

A minority discount will not be disallowed solely because a transferred interest, when aggregated with interests held by family members, would be a part of a controlling interest.

j) 1998 Revenue Procedure 9834 (See Appendix III)

(1) Issued in 1998 (2) Sets forth a methodology to value certain compensatory stock options (3) Followed similar approach, as does FASB 123

k) Internal Revenue Code 2703

IRC Code 2703 states for estate, gift and other tax purposes, the value of any property is determined without regard to any right or restriction relating to the property. Key issues for a valuation analyst to be aware of:

(1) An exception exists for any option, agreement right or restriction which, (a) is a

bona fide business arrangement, (b) is not a device to transfer property for less than its fair market value, (c) is comparable to similar arms length arrangements, and (d) these safe harbors must be independently satisfied.

(2) The mere showing that a right or restriction is a bona fide business arrangement is not sufficient to establish the absence of a device.

(3) Each right or restriction must be tested separately. (4) A right or restriction is considered to meet the three safe harbor requirements if

more than 50 percent of the applicable property is owned by individuals who are not members of the transferors family.

(5) Property owned by nonfamily members must be subject to the same rights or restrictions.

For more information of these and other Rulings, see Appendix III.

B. UNITED STATES DEPARTMENT OF LABOR (DOL)

The Department of Labor issues regulations specifically pertaining to business valuations for Employee Stock Ownership Plans (ESOPs). Similar to IRS Revenue Rulings, DOL regulations do not have the force of law. Instead, the regulations represent the DOLs stance as it relates to certain issues. The United States Department of Labor (DOL) issues regulations that are unique to Employee Stock Ownership Plan (ESOP) valuations. These regulations are not included or tested in this course, since the topic is considered advanced.



C. FINANCIAL ACCOUNTING STANDARDS BOARD (FASB)

On June 2001, the FASB weighed into the valuation field with the issuance of Financial Accounting Statements 141, Business Combinations, and 142, Goodwill and Other Intangible Assets. FAS 141 superseded APB Opinion No. 16, Business Combinations, and FASB Statement No. 38, Accounting for Pre-acquisition Contingencies of Purchased Enterprises. FAS 141 requires the use of the purchase method which records the subsidiarys balance sheet at fair value as of the date of acquisition. FAS 142 superseded APB Opinion No. 17, Intangible Assets, and addressed how intangible assets that are acquired individually or with a group of other assets (but not those acquired in a business combination) should be accounted for in financial statements upon their acquisition. FAS 142 also addresses how goodwill and other intangible assets should be accounted for after they have been initially recognized in the financial statements. Hence, FAS 142 addresses the testing for impairment of goodwill and other intangible assets. The effect of the aforesaid statements is that Goodwill is recorded as the excess of the purchase price over the fair market value of all identifiable tangible and intangible assets acquired, net of all liabilities, and that Goodwill is no longer amortized under U.S. GAAP. FAS 141 and 142 combined require, as various times, application of modern valuation techniques to measure the fair value of intangible assets in order to determine whether or not there has been any impairment to the values of those assets.

III. PROFESSIONAL ORGANIZATIONS

A. THE NATIONAL ASSOCIATION OF CERTIFIED VALUATION ANALYSTS (NACVA)

In 1990, the idea to establish an association to support the needs of CPAs and other business professionals in their pursuit to provide business and intangible asset valuation and litigation consulting services was conceived. The idea and dream to have such an association came at the suggestion of numerous professionals throughout the country, who, while attending business valuation seminars offered by the subsequent founders of the National Association of Certified Valuation Analysts (NACVA), took the time to express their thoughts and pledge their support to an effort such as NACVA. Since then, NACVA has garnered the loyal support of thousands of valuators in building the Association and expanding its reach. NACVAs membership of approximately 6,000 professionals is comprised of CPAs and other valuation and consulting professionals, all of whom are pursuing business valuation, litigation

Observation The Financial Accounting Standards Board (FASB) is another body that impacts the valuation profession, along with the International Accounting Standards Board (IASB).

Observation NACVA, ASA, IBA, AICPA, and IACVA are other accredited bodies impacting professional and ethical standards for business valuation. One other accrediting organization in North America is the Canadian Institute of Chartered Business Valuators (CICBV). While it, too, has impacted the valuation profession, it is not discussed here.



forensics consulting, fraud deterrence, and various other types of related services serving the legal and business communities. Of the total membership, about 80% have obtained the Certified Valuation Analyst (CVA), Accredited Valuation Analyst (AVA), Certified Forensic Financial Analyst (CFFA), or Certified Fraud Deterrence Analyst (CFD) designation. You will find our membership comprises some of the most intelligent, dynamic, and innovative people in the professional financial/accounting community. NACVAs members are an elite group of people. As you learn about NACVA, you will discover we have taken many steps to bring together our wealth of resources in order to facilitate the networking of knowledge and theory in the fields of valuation, litigation, fraud deterrence, and related disciplines. Thousands of organizations and individuals throughout the USA and other parts of the world have an interest in our professional expertise. We are a substantial group of professionals all with unique expertise, who, by and large, are the most qualified group in the country to serve the needs of the users of valuation, litigation and fraud deterrence services. NACVAs members are all very well educated; most are experienced in accounting, tax, and financial analysis; and all certified members are required to obtain at least 36 hours of Continuing Professional Education (CPE) in these disciplines of focus every three years. The integrity of the Association is furthered by NACVAs rigorous certification programs which require a complete understanding of the process. We believe our valuation, litigation, and fraud certification programs are the countrys most objective for specialists in these areas because they emphasize a solid and broad base of knowledge which a professional can build. NACVA is a progressive organization. The Association consciously pursues goals to attain and disseminate knowledge, develop better theory, increase public awareness of the profession, encourages strategic alliances within the accounting, legal, and business communities, and expands benefits and services to members. NACVA is the premier organization of professionals representing the dominant force in the valuation, litigation forensics and fraud consulting communities. NACVAs mission is to provide resources to members and enhance their status, credentials, and esteem in the field of performing valuations and other related advisory services. To further this purpose, NACVA will advance those services as an art and science, establish standards for admission to the Association, provide professional education and research, foster practice development, advance standards of ethical and professional practice, enhance public awareness of the Association and its members, and promote working relationships with other professional organizations. To achieve these purposes, NACVA carries out numerous activities, including but not limited to the following:

1. Advancement, communication, and enforcement of standards of ethical and professional practice 2. Development and presentation of quality educational and training programs 3. Certification of practitioners on the basis of professional competence, ethics, independence, and

objectivity. This includes the establishment of criteria for certification as a Certified Valuation Analyst (CVA), Accredited Valuation Analyst (AVA), Certified Forensic Financial Analyst (CFFA), and Certified Fraud Deterrence Analyst (CFD)

4. Fostering public awareness that a credentialed member has met and continues to abide by standards of ethical conduct, objectivity, and independence and performs his or her services at the highest level of professional competence

5. Promoting and enhancing collegial and professional relationships among members of the Association and among the Association and other professional organizations



B. INTERNATIONAL ASSOCIATION OF CONSULTANTS, VALUERS AND ANALYSTS (IACVA)

The International Association of Consultants, Valuers and Analysts (IACVA), a NACVA subsidiary, is the first and only international association established to provide continual worldwide training through Charters to business valuation consultants and allied consultants. The training emphasizes the fundamentals of business valuation and the valuation of intangible and intellectual property for tax, M & A, and litigation purposes. IACVA forms partnerships with local and regional valuation groups (Charters) and assists them in the certification and training process and strives to encourage the various Charters to network amongst themselves. IACVA offers a credentialing program leading to the designation of Certified Value Analyst (CVA). To earn the credential one must meet certain prerequisites, complete a prescribed training program and pass a rigorous certification exam. The CVA credential is a statement to users that the analyst has met the minimum requirements for competency and professionalism established by an international body and that as a CVA, the analyst is committed to quality in the performance of valuation and consulting services and adheres to ethical and professional standards as set forth by the Association.

C. OTHER ORGANIZATIONS

Other professional organizations for business valuators include the Canadian Institute of Chartered Business Valuators (CICBV), the Korean Valuation Association (KVA), the German Association of Consultants Valuation Analysts (GACVA-IACVA), IACVA-Ghana, IACVA-China, and the ESOP Association. There are a number of other international organizations such as Royal Institute of Chartered Surveyors (RICS) (a UK organization), the International Valuation Standards Committee (IVSC) and The European Group of Valuers Associations (TEGoVA), which have issued non-binding Guidance Notes; these two latter organizations serve a broad array of industries, such as real property, plant and equipment/machinery, and to a lesser extent closely held business valuations.

IV. OVERVIEW OF THE BUSINESS VALUATION INDUSTRY

In the first decade of the 21st century, certain key factors will continue to fuel the need for valuations of closely held companies.

A. HISTORY

The valuation of closely held businesses first became a formal issue during the 1920s when the Eighteenth Amendment instituting Prohibition was enacted. Businesses involved in the alcoholic beverage industry were forced to close and found it necessary to value their businesses in order to determine the extent of their losses. ARM 34 discussed earlier was issued to assist in valuing these businesses. Since the 1920s, closely held businesses have been valued for a variety of reasons, resulting in the creation of the consulting service niche in which todays professionals play a pivotal role.



B. ECONOMIC INSTABILITY

During a recessing economy, companies of all sizes react by laying off personnel. Historically, these layoffs have involved only bluecollar workers. Past recessions have affected both bluecollar and whitecollar employees. In prior years, companies such as IBM Microsoft and Boeing, once thought of as companies that could provide unquestioned employment security, have had to lay off employees. Many employees near retirement are often encouraged to leave early with golden parachutes or similar incentives. However, other employees became victims of downsizing, which was especially true at the turn of the 21st century. Many of these individuals consider the possibility of starting their own businesses or purchasing an entire or partial interest in an existing business. Those considering a purchase of an existing business generally require a valuation of that business. Unstable economic conditions have also caused many companies to reassess their long-term objectives and strategic direction.

During the 1980s there were mergers and acquisitions of many larger companies. In the 1990s, and now currently, small- to medium-sized companies entered the M&A arena. Companies consider merging with or acquiring another company in order to:

1. Help ensure economic stability in a recessing economy through overhead sharing 2. Maintain or increase market share 3. Establish strategic alliances for growth and diversification

Presently, acquiring companies often require valuations of each company associated with the proposed combination or purchase. In addition, economic instability has resulted in increased numbers of bankruptcies. Tax and other regulations related to these bankruptcies frequently necessitate a business valuation.

C. AGE DEMOGRAPHICS

During the next 10 to 20 years, the socalled baby boomers will be retiring. In America, the 55 to 64 age group is expected to rise from 29 million in 2004 to 40 million in 2014. That is because of the explosion of births during the prosperous postwar period between 1946 and 1964. These retiring parents, who represent the wealthiest generation in history and whose major assets frequently consist of interests in closely held businesses, will need assistance with their succession planning. Succession planning entails transferring their businesses in the following ways:

1. Gift the business to their heirs 2. Sell the business to their heirs 3. Sell the business to third parties 4. Establish a charitable trust 5. Establish an ESOP 6. Issue options to key employees

Regardless of the alternative selected, a valuation is usually necessary.



D. LITIGATION ENGAGEMENTS

It has been said that ours is a litigious society; it is. When finances become strained, there is more pressure on relationships, which often leads to dissolution or a break-up amongst key employees, resulting in the need for a valuation.

1. Valuations are often required in situations involving:

a. Partner disputes b. Dissenting shareholder actions c. Fairness opinions d. Divorces2

2. Valuations are also often necessary in situations that may involve litigation3 related to the

establishment of an economic loss involved in the following types of cases:

a. Wrongful death b. Wrongful injury c. Wrongful loss of property d. Patent infringement

E. TAX PLANNING

Tax planning is associated with rights/restrictions of ownership interests in nontraditional legal entities.

1. Family Limited Partnerships and Family Limited Liability Companies 2. Limited Liability Companies

F. FINANCIAL REPORTING

Relatively new but important changes in financial reporting are also increasing the demand for business valuations. For example, Financial Accounting Standard No. 142 requires that goodwill be tested for impairment at least annually. In order to test goodwill for impairment, it is necessary to estimate the Fair Value of the acquired company or business unit.

V. PURPOSES OF VALUATIONS

A. PURPOSES FOR VALUING BUSINESS

Before valuing a company, one must know the purpose of the valuation. There are four basic purposes for valuing a business; tax, litigation, transaction and regulatory. The purpose of the valuation will affect the assumptions and methodologies used to determine value. There are many reasons to have a closely held business valued, including:

1. Mergers and acquisitions 2. Sales and divestitures 3. Buy/sell agreements

Documents

Business Valuations: Fundamentals, Techniques and Theory