Value Blog

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

It may seem like a cop-out for me to answer most valuation questions “it depends”.  The reality is it really does depend.  It depends upon the facts and circumstances surrounding the particular question.  Each businesses is different.  They are different because they have different organizational structures, they do different things and they have different people (with different skills) running them.

Those are not the only differences that I must consider as business appraiser.  I have to start out with the basics of valuation – what type of value is necessary for the purpose of the valuation.  Then I have consider the interest being valued – is it a controlling interested or a non-controlling (minority) interest?  All of these factors impact my conclusion of value.

You are a potential client and you call and ask, “Can I use a 1 times revenue to value my business, since that is the industry rule of thumb?” In order to begin considering my answer I need to find out what type of value you are trying to establish, the purpose of the valuation, the interest being valued and information about your company to determine if it is average for the industry.  Then you tell me,  “I only need a rough estimate.” For your protection and the integrity of the business appraisal industry, I can’t give an rough guess based on a few facts.

An opinion is an opinion,  I must develop it in accordance with generally accepted appraisal standards.  These standards provide that I need to understand your both your business and the industry that you operate in reaching an opinion of value.

While I would love to be able to give quick short answers, I usually can’t.  I am not trying to be difficult.  Think of it this way, would you want your doctor to give you a clean bill of health without every doing a physical examination or running any tests?  Probably not.

©2010 Florida Business Valuation Group

The value of a business generally includes the value of all of the tangible and intangible assets owned by the business. Whether the value of the business includes all of the assets (and liabilities) of the business will depend upon a few things.  First, either the equity (stock or other ownership interest) that owns the business can be valued or the assets used in the business can be valued.  The general rule is: buyers want to buy assets and sellers want to sell stock.  Sellers want to sell the stock or other ownership interest mostly for tax purposes.  Whereas, buyers want to buy assets for tax purposes, but also to avoid potential liability associated with the entity.

The purposes of a valuation will often dictate what is included in the value. For estate and gift tax purposes, the value is of the stock or equity interest owned.  For transactions, the value may or may not include all the assets and liabilities.  In transactions, the purchase agreement usually specifies which assets and liabilities are included in the transaction.

It is important to distinguish between what is included in the value and what is included in different multiples based on market methods methods.  For example, the multiples from BIZCOMPS®, a transaction database, are assumed to be asset sales which exclude cash, accounts receivable, accounts payable and inventory.  Other operating assets such as the equipment used in the business are included in the value arrived at using BIZCOMPS® multiples.  Multiples from the Pratt’s Stats® database, on the other hand,  are for both asset and stock sales, as indicated for each transaction.  Some transactions include the working capital of businesses while others do not.  Transaction multiples from the Pratt’s Stats ® database need to be examined for the details of each transaction.

Within industries, there are often rules of thumb used by business brokers to estimate the value of business.  Different industries treat the assets differently. Beer taverns, according to the Business Reference Guide, sell for 6 times monthly sales plus inventory OR 1 to 1.5 times annual earnings before interest and taxes OR 55 percent of annual sales plus inventory.  Other types of establishments that sell alcohol have different multiples and treat the assets differently.  Rules of thumb for cocktail lounges either add inventory back, add liquor license and inventory, OR add fixtures, equipment and inventory.  As illustrated, different multiples from different sources result in values that need adjustments for different assets and/or liabilities.

So what does all this mean?  A business valuation will clearly state whether the stock or equity interest in a company or the net assets are being valued. If a business valuation has not been done, understand the value from the multiples you chose.  If necessary adjust for assets and/or liabilities which are not included.

©2010 Florida Business Valuation Group

Unfortunately, this is true.  There are times with a business is worth more dead than alive.  The value of a business can be divided between its tangible and intangible assets.  Tangible assets are the physical assets used in business operations such as equipment, real estate and inventory.  Intangible assets include things such as the goodwill and customer lists.

In general, a business is usually worth at least as much as its net assets (assets less liabilities).  A profitable business is usually worth more than its net assets.

Typically, healthy businesses produce a return on both the tangible and intangible asset in the form of profits and cash flow.

When a business is operating at a loss, it may indicate that the intangible assets have little or no value.  However, losses can arise from situations other than diminished goodwill, such as the current recession.

If a company does not have prospects of operating profitably in the future, a rational owner would choose to close the business and sell the assets. At a loss, the company is not producing a return on its tangible or its intangible assets (assuming there are intangible assets.)  However, if the company is expected to rebound, the business can still have value.  In other words, loss companies can still have value.

The challenge is to determine what value a loss company has in excess of its assets.

©2010 Florida Business Valuation Group

I recently earned the ABAR (Accredited for Business Appraisal Review)  designation from the Institute of Business Appraisers.   The ABAR process is not a valuation, but a review of the valuation process.  The resulting business appraisal review opinion states whether the valuation report is credible.

The valuation process  is based on a body of knowledge and generally accepted appraisal practices.  The appraiser applies his or her informed judgment, based on the facts and circumstances related to the business to arrive at an opinion or conclusion of value.  The appraiser then documents the relevant information and explanations, supporting his or her conclusions in a valuation (or appraisal) report.

The business appraisal review process examines the credibility of the valuation work product, looking at the information in the report and the methodologies used.   If a report fails to disclose sufficient information, has analytical gaps or misapplies methodology, it may be found to lack credibility.

There are three types of review opinions:  a finding of concurrence, a finding of non-concurrence and a finding of no opinion.    A finding of concurrence indicates that the report is credible.  When there is insufficient information for the reviewer to issue a review opinion, a finding of no opinion will be issued.

A business appraisal review is not an opinion regarding the value of a business.  It cannot take the place of a full appraisal as a second opinion.

If you have questions regarding when a business appraisal review is needed, you can post or question or email me.

© 2010 Florida Business Valuation Group

Simply, yes.  When you create systems that will allow your business operations to be transferable with minimal interruption , you create value.  A business has value only when the ability to keep generating cash flow can be transferred.  Read more about business plans from Julia Aquino of The HOW Factor, Inc. (www.howfactor.com) below.

Julia writes:

The “Hit By a Bus” Plan

No one plans to be hit by a bus, of course, but what if a sudden, unexpected event occurred in your life? Accidents do happen, as do other significant events that require a business owner to be away from the business for a lengthy period of time. If this happens to you, who will be running your business bright and early the next morning?

If the answer to that question is that the doors would close, maybe not the next day, but soon, then it is time for you to have a plan. In this tightening economy, most businesses could not afford to shut down for even a short time without losing customers and suffering devastating financial consequences.

Whether it is just you running your business or you have a team of loyal employees, someone is depending on your business to continue to operate should the unthinkable happen. What would happen to your family and the families of your employees if no one else were able to run your business in your absence?

The key to business continuation is having a detailed Operations Manual with instructions for “how things are done.” It should cover all of the different systems you have in place and descriptions of the different positions employees hold in your company. If someone can step in and have a written guide to how the business is run, even if they are unfamiliar with the day-to-day processes, then your business has a chance of surviving, and thriving.

An Operations Manual is the master plan for how your business operates, and should cover all of the “steps” you keep in your head. The content of a manual will vary from business to business because the systems that each business uses are different, but the basic structure of an Operations Manual should be consistent. Even the simplest things should be included, like passwords to access the computers and accounts.

If you have no employees, it is just as critical to have a manual so that your family, friends, or other designated individual can step in and answer clients’ questions, retrieve their projects and information, and keep the bills paid until you are able to return to the helm. In fact, having an Operations Manual can be a selling point for solo practitioners when pitching the company to clients. They may wonder who will handle their work or their concerns if you are temporarily away from the business.

An Operations Manual means the difference between a business that can run while you are out of the office, and one that cannot. It will alleviate the stress of wondering what will happen to your company if you are “hit by a bus.”

© 2010 Florida Business Valuation Group

I get so involved in dealing with valuation issues that I forget to write about them. I have had the same issue come up a number of times in the past few months: Clients want to know if they can use a valuation for a number of different things. The answer is generally no, because Valuation reports are date specific and purpose specific.

So what does that mean? Date specific is easier to explain. A valuation is a snapshot of a particular type of value as of a specific date. Most people can understand that they would not necessarily buy or sell publicly traded stock based on a price from three months ago. They would make their decision based on today’s price. While the value of a private company may not change significantly over time, it also could change. The value is determined based on the known or knowable facts as of the valuation date. It does not take into consideration changes in the economic climate after the valuation date, or increases or decreases in revenue. Either of these factors could result in a change in value from one date to another.

Valuations are also purpose specific. Some different purposes could be gifting an interest, the value of a business for a divorce or the value for a dispute with a shareholder. Since different types of value may be used for different purposes, the resulting values may be different. For example, a gift of a 10% interest (minority and non-marketable) could not be used to estimate the value of 55% interest of the company (control and non-marketable) for purposes of a shareholder. The minority interest may have been reduced by discounts for lack of control, whereas a 55% interest would usually not have a minority discount applied. The discount for lack of marketability for a 10% interest could be different than for a 55% interest, and in some shareholder disputes, state statutes may dictate that no adjustment be applied. This example also indicates that two interests, a minority and a controlling interest could have different per share values based on other factors as well. Appraisal reports state that they are for a specific valuation date, valuating a specific identified interest and for a specific purpose. This is so that an uniformed user would not mistakenly misuse the valuation report and reach an inappropriate conclusion.

© 2010 Florida Business Valuation Group