Value Blog

Most informed  sellers want to sell stock and buyers want to buy assets.  The reasons are relatively simple.

From the sellers prospective, given our current tax structure, sales of stock held for more than a year are generally taxed at the preferred capital gains tax rate.  So sellers want to be able to keep more of the sales proceeds in their pockets.

The buyers side can be a little bit more complex.  Typically a buyer is also motivated by tax considerations.  If a buyer purchases the assets of a company, he or she can allocate the purchase price to the various assets and possibly depreciate them.  But there is more to the buyer’s side.  When a buyer purchases stock, he or she is purchasing all the known and unknown liabilities of that corporation.

Last post I talked about Personal Goodwill.  A name can create Goodwill for a business.  Whether that the goodwill is personal or enterprise, depends upon the circumstances of each business.

When people start their own businesses, many decide to incorporate their name into the business for all sorts of reasons.  It can make it easier to go sell and generate new business when you are selling yourself and the business as one.  For some people there is a little bit of ego involved.  For others it is a way to capitalize on their person reputations.

While these are all valid reasons to use your name in the business name, you should consider using a name the will belong to the business to build the most value.

Branding a business can be difficult because it requires that you work to market the business separate from the owner.  There are times when an owner or manager’s presence is so strong that it becomes difficult to separate the brand name from the key person.  Just look at Apple Computers and Steve Jobs.  When he announced taking a indefinite leave of absence in January, Apple’s stock went down in value.  However, in order to keep the value in the business, Apple will have to prove that the company has the ability to keep generating profits without Steve Jobs.

Likewise, business owners who understand that making themselves dispensable to the business is the best way to build value.  A business that has profits has value to the owner and potential value in the hands of others.  It is the ability to transfer the assets, including goodwill, that generates value in the hands of others.

So while it may be tempting to name your business Smith Manufacturing or Jones Consulting, consider how the name will impact the businesses ability to survive you and be passed on to others.

If you have questions about this or other valuation matters, please contact me.

©2011 Florida Business Valuation Group

When I write posts, I try to answer questions that are asked of me about valuation.  Sometimes the questions are direct and sometimes I answer the questions that should have been asked.  This is one of the questions that should have been asked.

What is Personal Goodwill?  It is the intangible value associated with the reputation of a person, rather than of the business (usually referred to as Enterprise Goodwill).  Personal Goodwill is most often an issue in divorce cases, but it can be an issue in all valuations, taking the form of a Key Person Discount.  Personal Goodwill can be attributed to a shareholder or an employee.

Personal Goodwill is easily observed in professional practices.  This reputation may result from the person’s manner, his or her technical skills or some other personal attribute.  The personal reputation of a doctor or lawyer is often obvious.

It may be harder to see in other businesses.  For example, in a manufacturing company, the key sales person is able to sell twice as much as any other sales person because she has developed a reputation in the industry for knowing what her customers need and making sure that they order based on those needs.  While the brand reputation of the product she sells, the timely delivery of the product, and the service department reliability are part of Enterprise Goodwill, her personal reputation and resulting profit generated from the additional sales she is able to make above and beyond other sales people in the organization may be attributable to Personal Goodwill. This is the case if the value she brings to the business resulting from the additional sales is greater than the additional commissions she receives.

So how do you distinguish between Personal Goodwill and Enterprise Goodwill?  The easy answer is to project what would happen to the business if the key person left?  Would the company be able to continue generating the same level of revenue and profits?  Could a replacement be hired?

So why does this matter? In valuing a business, the value is just that: the value of the business.  If the business has not entered into contracts to retain personal goodwill , it does not belong to it and is usually not included in value.  (Divorce law varies by state and is beyond the scope of this post.)

However, in valuations that are not for divorce, Personal Goodwill takes the form of a Key Person Discount, which reduces the value of the company for the economic impact of a key person leaving.  As a business owner, there are ways to minimize the impact of Personal Goodwill on the value of a business through various types of contracts with key employees.

Employment contracts can tie an employee to a company for a period of time, maximizing the company’s ability to profit from the relationship.  An employment agreement can also limit an employee’s ability to compete with the company once he or she leaves.  An employment law attorney can assist you in drafting an agreement to safeguard your company to the fullest extent allowable by the law, minimizing the impact of a key employee on the value of the company.

As a business owner, the objective is to increase the value of a company.  Understanding how the reputation of a company and its employees impacts value is a step to safeguarding the value created by Goodwill.

If you have questions about this or other valuation matters, please contact me.

©2011 Florida Business Valuation Group

In the world of valuation, all too often, appraisers answer valuation questions with “it depends”.  Unfortunately, the answer to the question, “what period of time is a valuation valid?” really is “it depends”.

Let me explain.  The value of an interest in a business appraisals is date specific.  It is easy to understand that the value of stock changes over time when we look at publicly traded stocks.  Rarely do prices remain the same from hour to hour, let alone day to day.  While the value of the stock of privately held companies usually do not change so quickly, the value can change.

Events and time can cause the value of a company to change.  In fact, most business owners count on the value of their investment in their businesses increasing over time.

So, depending upon the events and trends impact a particular company, the value can change over any given time period.  Changes in value can be caused be increases or decreases in sales and profitability, increases or declines in the value of assets owned by the Company, or any one of a number of factors.  For example, stock in a company which owns real estate in a market that is recovering from the recession will most likely change in value as the real estate market recovers and the real estate increase in value.  The increase in value can be compounded if the company is also recovering and has increased sales a profitability.

There is no absolute estimate for the period of time that a valuation will be valid.  If you are relying on an old valuation, the more recent it is,  the better the chances are the valuation will be valid.  Depending upon what you are using the value for, you may want to consult with your business appraiser to determine if an update is advisable.

If you have questions about this or other valuation matters, please contact me.

©2011 Florida Business Valuation Group

In my last post, I talked about the types of buy-sell mechanisms in agreements. In this post I want to focus on how to identify the appraiser and how to define value in a buy-sell agreement. For more information on buy-sell agreements, you can purchase Buy-Sell Agreements for Closely Held and Family Business Owners.

The Appraiser
Not all appraisers are the same, and not all CPAs are appraisers. It is a good idea to specify in your buy-sell agreement that an appraiser with a certification from a recognized appraisal organization will be selected. The generally recognized designations are ABV (American Institute of CPAs), ASA (American Society of Appraisers), CVA/AVA (National Association of Certified Valuation Analysts) and CBA (Institute of Business Appraisers). You can also clearly identify the selection process. Remember that the more appraisers that are involved, the higher the cost and the longer the process will take.

The danger of specifying that the company’s accountant will determine the value of the company is that the company’s accountant may have no valuation experience. You would not go to your internist for heart surgery. Why would you go a general accounting practitioner without valuation training for valuation services? Credentialed appraisers have had training in valuation and usually have met some sort of experience requirement.

Applicable Standards
Each of the appraisal organizations has a code of ethics and professional standards. You can specify that the appraiser will perform the valuation in compliance with those standards. (Generally accepted accounting standards (GAAP) have nothing to do with valuation.)

Defining Value
Stock transferred for gift or estate purposes is valued for the tax reporting at fair market value: What a willing buyer would pay a willing seller, neither under compulsion to act, and both being informed of relevant facts. The fair market value of a minority (non-controlling) interest will usually have discounts for lack of control and lack of marketability, making it equal to less than a pro rata portion of the total company value.

Since the buy-sell agreement is your agreement, you can have the provision state whatever you choose. If you want the value to be a pro rata portion of the total company value, you just have to define value that way. (For shareholder disputes, depending upon the state, discounts for small companies are ignored.) Another option is to specify that discounts will not exceed a certain percent of value. The point is you can define value any way you want. You should understand the consequences of the definition that you use.

If you need assistance in understanding how the value stated in a buy-sell agreement will impact your company, please contact me.

©2010 Florida Business Valuation Group

In my last post, you read about Chris Mercer‘s Buy-Sell Agreement triggers.  In this post, I want to highlight some different buy-out valuation mechanisms.

1. Fixed price agreements –these type of agreements have a dollar amount for a buyout.  The actual price is stated in the agreement.
2. Formula agreements –these type of agreement have a formula for determining value.  The formula can be as simple as stating the value is equal to book value on the day of the buyout or as complex as five times EBITDA plus cash and account receivable as of the last day of the month immediately before the buyout.
3. Shotgun agreements – these type of agreements provide that the exiting shareholder offers the remaining shareholder(s) an offer to buy the shares and then the remaining shareholder(s) have the option to either choose to buy or sell his or her shares.
4. Process agreements – agreement provides that an appraiser(s) determine the value of the interest at the time of the triggering event.

There are pros and cons to using each of the types of agreements.  If you are drafting an agreement you need to keep in mind what will happen if you have to buy or sell your interest under the agreement.  For example, in a shotgun agreement, will you have the funds to buy out the shares if the remaining shareholder elects to sell rather than buy?  More to the point, if the buy-sell were to be triggered by your disability, would you want to buy the shares?  If you are going to be purchasing life insurance to fund the buyout, it may be important to know what the value of the business really is.  A formula agreement makes it relatively easy to determine the price under the agreement, but the price may not equal the value.

The process agreement provides for the determination of the value when shares transfer hands.  However, care must be used in drafting these type of agreements.  There are a few options. The agreement can provide for each side to pick an appraiser and if the values of each appraiser are with 10% of each other, use the average.  If they are more than 10% apart, a third appraiser is selected by the two original appraisers.  While this methodology is fair, it takes a long time to have the appraisals finished, and can be very expensive.  A simpler alternative for the process agreement is to select an appraiser jointly when the agreement is signed, allow a neutral third party to select one appraiser, or have both sides submit names and agree to an appraiser when the time comes.  By only using a single appraiser, you can cut time and cost from the buy-out process and end up in the same place as using three appraisers.

My next post will address defining the value used in a buy-sell agreement.

©2010 Florida Business Valuation Group

In August, Chris Mercer, the author of Buy-Sell Agreements for Closely Held and Family Business Owners, spoke in Ft. Lauderdale. He graciously is allowing me to summarize information from his presentation in this post.

Most business owners do not think of the various events that could cause a buy-sell agreement to be triggered.  Chris lists the 20 “Ds” that shareholders can be addressed in their buy-sell agreements (including events which trigger the buyout provisions):

• Departure – Trigger event, the shareholder quits his job with the company
• Discharge – Trigger event, the shareholder is fired
• Death – Trigger event, the shareholder dies
• Divorce – Trigger event, the shareholder gets divorced resulting in the transfer of an interest
• Disability – Trigger event, the shareholder is disabled (should address what constitutes a disability and the length of time before this event triggers a buy-out)
• Default – Trigger event, a shareholder’s interest is transferred due to personal bankruptcy or other involuntary transfer
• Disqualification –Possible trigger event, a shareholder loses his license or regulatory approval to work in the business or to hold his or her shares
• Disaffection – A shareholder becomes dissatisfied with the company and needs to be terminated from employment (Chris indicates that this may seem like a stretch.)
• Disagreement – Shareholders reach a deadlock, the buy-sell agreement should address how to resolve the deadlock, whether it be a way to break the deadlock or the trigger of the buy-sell provisions
• Disclosure – Provisions for preserving the assets of the company, including trade secrets, customer lists and other confidential information
• Dispute resolution – Address the process for settling disputes, whether it be mediation or arbitration, and who will pay for the process
• Dilution – Can additional shares of stock be issued and will existing shareholders’ interests be protected from dilution?
• Dividends – Specifying a dividend payment policy can provide minority shareholders with the right to receive cash from the company, when profitable.  It can also provide that the company withhold dividends to pay for capital projects or to repay debt.  In any case, a policy can eliminate disagreements between minority and control shareholders.
• Distributions – For pass-through entities, profits and losses are taxed at the individual level.  In addition to clarifying the distribution process to protect minority shareholders, a distribution policy can guaranty that enough cash is distributed to pay income taxes on profits.
• Drag-along rights  - When a controlling shareholder receives an offer to purchase stock, drag-along rights can force the remaining minority shareholders to sell their stock.  (Tag-along rights provide that minority shareholders can force a controlling shareholder to sell the minority shares with the control shares.)
• Double entities – When separate companies are used for other aspects of operations, such as owning real estate, leasing employees or offshore sales, it may be appropriate to have similar provisions in each of the agreements, and have trigger events coincide with each other.
• Differential pricing – Since shareholders determine the price for buy-sell agreements, they can decide on different pricing for different events.  For example, upon death or disability, 100% of the price may be paid, whereas on termination with cause, only 75% of the price may be paid.
• Don’t compete agreements – Non-compete agreements may be separate documents, however, a buy-sell agreement can require a departing shareholder to sign a non-compete agreement or a non-solicitation agreement when his or her shares are purchased.  (Consult an attorney regarding the terms and enforceability.)
• Donate – The buy-sell agreement may restrict transfer to certain parties such as spouse, lineal descendants, siblings, trusts or charities.
• Distributions after a trigger event – Buy-sell agreements can address what happens to dividends and distributions after the trigger day, since it can often take months or years to resolve disputes.

There are numerous other provisions that could (or should) be included in a buy-sell agreement depending upon the nature and structure of the company.  Consult your attorney to write your buy-sell agreement.  It is a legal document which will affect your rights should a trigger event happen.

There are online tools if you want to take a stab at looking at your buy-sell agreement such as http://buysellagreementsonline.com/buy-sell-agreement-audit-checklist/.

If you have questions on how the different events affect value or the price you will get under a buy-sell agreement, please contact me.

©2010 Florida Business Valuation Group

The transaction databases that I use in the process of valuing businesses generally reflect that there is a discount for all cash deals.  Sellers are usually willing take less money if they get it up front.  I discussed with Marty Fishman, a business broker with Transworld Business Brokers, whether the way a buyer pays for a business changes the price.

There are generally three ways that a buyer can finance a transaction:

• Pay cash,
• Lender financing with some buyer cash, or
• Seller financing with some buyer cash.

The lender financing is financing from a bank based on the business operations and its assets, usually through an SBA program.  When buyers use home equity loans to finance businesses, the sellers view the transaction as a cash transaction.

Even though a seller receives the purchase price in cash in lender financed deals, the buyer does not usually receive a discount.  This is because the types of businesses that qualify for lender financing are sound businesses with good records.  The businesses may even have tangible assets which are part of the deal such as equipment or inventory.  Many of these businesses are even pre-qualified for financing, making them more in demand and more marketable.

So what does this mean in terms of the price that a buyer will pay for cash?  Cash deals are discounted between 5% and 20% according to Mr. Fishman.  The amount of the discount depends upon a number of factors.  Perhaps top of the list is the motivation of the seller.  Motivated sellers are willing to lower the price to sell the business quicker.  Cash deals will often close quicker than financed deals, with less risk of the deal falling apart.   The better businesses have lower discounts;  businesses with poorer records or that have been experiencing downward trends will have higher discounts for cash buyers than more profitable businesses with good records.

The bottom line is that buyers who get a discount for offering cash can negotiate based on the condition of the business and how motivated the seller is.  Good negotiators may get a better deal by understanding the business.

©2010 Florida Business Valuation Group

Within the valuation community the trend has been to refer to “minority” interests as non-controlling interests.  The issue is really whether an owner has control, not how much of a company he owns.  In determining whether an interest is in fact a controlling or non-controlling interest I consider both the rights granted by agreement and by law, as well as what goes on in the business.

Some of the benefits of having control include:

• The ability to elect directors and appoint management
• Determine management compensation and benefits
• Set policy and change the course of business
• Acquire or liquidate assets
• Make acquisitions of other companies
• Liquidate, dissolve, sell out or recapitalize the company
• Sell or acquire treasury shares
• Register the company’s stock for public offering
• Declare and pay dividends or make distributions to owners
• Change the articles of incorporation or bylaws

While some owners feel that control over dividends or distributions is one of the most important aspects of control,  it is not the only aspect which can impact ownership.

In evaluating whether an interest is controlling or non-controlling, I consider how much not having these benefits impact a non-controlling interest.  A few examples may illustrate when a non-controlling interest could be impacted:

• A partnership receives an above market offer for a piece of real estate it owns.  The partner who wants to sell owns 51%.  However, the partnership agreements provides that in order to sell the assets, at least 75% of the ownership must agree to the sale.  The other partners owning 49% refuses to sell.  The opportunity may be lost because the 51% partner does not have control.
• A 10% shareholder works for a company.  He has been paid a salary in the past.  However, his position and salary are eliminated by the management of the company.  He remains a shareholder, but does not have the control necessary to reinstate his position or pay himself a salary.
• An S Corporation, which passes through its income to its shareholders, had profits, but management refuses to disburse money for the owners to pay taxes.  The shareholders agreement says that management at its sole discretion will determine annual distributions.  A non-controlling shareholder cannot force a distribution.

These situations represent real life scenarios where controlling shareholders have been at a financial disadvantage as a result of their lack of control.  In some cases, owners who have more than 50% of the equity may still not have control.  In others, shareholder agreements can give owners with less than 50% ownership control over a company in the form of being appointed as management, the right to hold seat(s) on the board or by virtue of by other shareholders not having voting rights.

In general, non-controlling interests are worth less than controlling interests.  Depending upon the standard of value and purposes of the valuation, a discount for lack of control may apply.

©2010 Florida Business Valuation Group

After speaking to Marty Fishman, a business broker with Transworld Business Brokers, about what buyers are looking for he had the following insights: “Most buyers approach the purchase with a certain level of skepticism. Buyers want solid facts and believable information that a business opportunity is a solid investment. They want information: financial documents, business operation and facility information. Some of this information will be provided prior to an offer and some of it once there has been an executed purchase agreement with contingencies such as the complete and satisfactory review of property, books and records.”

This is in line with the things that I evaluate as a business appraiser that support the value of a business.  Those businesses with good records and documentation of business operations are worth more than businesses that are lacking.  I will go a step further to say, businesses with limited records are significantly less marketable than businesses with good records.

Since buyers approach businesses with skepticism, consistent records are also important.  As a consultant, I advise clients to rely upon tax returns that have been filed with the IRS under penalty of perjury, over hand written documents that track sales.  In cases where cash sales were not reported on a business’s income tax return (or sales tax returns), there may be inadequate documentation of the amount of unreported cash, leaving the buyer with the difficult decision of accepting the seller’s representations on faith.  I advise clients to consider that if a seller was less than truthful in reporting income to the IRS or other taxing authority, how does one know he or she will be truthful in the amount of unreported cash to the buyer.

Mr. Fishman pointed out “The selling and buying of a business is a very complex process. It involves many aspects that most successful business people are not exposed to in day-to-day operation of a company. Both parties should rely on experts trained in the sale of businesses.”

It is important to keep in mind that when you are buying or selling a business, the price is often based on a number of factors, and the buyer and seller may value the business differently.

©2010 Florida Business Valuation Group