Value Blog

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

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

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

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

The straight answer is you may not.  Unless the transaction is between family members or will be financed with an SBA loan, a valuation is usually not required.

The advantage to a business valuation is it provides the user with the value of a business or interest in that business.  The advantage to a business valuation is also the major limitation.  The business appraiser will usually provide a single value, based either on fair market value or investment value.  (See blog post here)

Value is a range, though, and there are many different types of value within that range.  As a buyer, you are only concerned with the lowest value within that range that you can pay.  If you can negotiate a lower price than fair market value, you will.

Valuations can be expensive.  If one is not necessary for you to negotiate a deal, you should not pay for one.

The seller has established a starting price for your negotiation.  What you need to determine is whether the cash flow from the business can support that price.

Each buyer has different criteria for whether a deal will work for him or her and there is no right answer.  The things that buyers should consider include:

• What is your risk tolerance?
• What is your required rate of return?
• How long are you willing to wait to get your investment back?
• Will cash flow from the business be sufficient to pay off any debt used to buy the business?
• Will cash flow from the business be sufficient to pay your salary if you are working in the business?

These questions will provide you will the information to determine if the asking price meets your criteria as a buyer.  A business may be worth $100,000, but a particular buyer may not be able to afford the asking price.

Price is the negotiated amount for a particular transaction.  While you need information to make an informed decision, a valuation will not necessarily give you that information.  Your financial professional should be able to assist you in determining whether the asking price of a business meets your criteria.

© 2009 Florida Business Valuation Group

The conceptual background behind the market approach is to use the behavior of buyers and sellers to arrive at a multiple which reflects the market.  Market methods can be divided into two basic groups: guideline public companies and private company transactions.

There are some major distinctions between the underlying data used for each method.  The public guideline company method uses information from publicly traded companies that are most similar to the company being valued.  The appraiser’s analysis of comparability may include factors such as type of business, size, geographic operations, growth prospects, past historical operating performance and any other factors which may be appropriate.  The appraiser identifies the most comparable companies and then derives valuation multiples based on the trading prices of the guideline companies’ stock as of the valuation date.  This data is based on marketable, minority interests in the guideline companies.

Private company transaction methodology is generally based on the theory that a sufficient number of private transactions will emulate the market for that type of company.  There are a number of databases which track private transactions of companies.  The information is collected from business brokers and intermediaries involved in the transactions, who report the information to the database services.  Each database contains different amounts of information regarding the companies.  The information about these companies represents a non-marketable, control interest in the transaction companies.

So what is the difference?  The public company transactions are evidence of the market value based on a large number of transactions which have been completed between buyers and sellers.  That is the reason that a large number of public companies is not required in order to use the methodology to arrive at valuation multiples.  Each company alone is evidence of the market.

Private company transactions may or may not take place at market value. Buyers and sellers have their own motivations for entering into transactions.   There is only one transaction for each company, unlike with public companies where you could have anywhere from under one million to over 250 million trades in a single day.  The concept behind private company transaction methodology is that with a sufficient number of transactions, the average or mid-point will represent what the market looks like.  That is why more transactions are necessary under the private company transaction methodology.  A few transactions may not be sufficient to represent the market.

What is important to understand is that each valuation is different. Applying any methodology is based on the facts and circumstances particular to the company being valued and the valuation date.

©2009 Florida Business Valuation Group

When businesses are valued, the real estate is usually appraised separately by a real estate appraiser and then that value is used by the business appraiser in arriving at a value for the company.  Most business appraisers are not qualified or licensed to appraise real estate.

The value of an operating business includes the assets used in its operations to generate revenue and profits.   Real estate is usually considered separately from the operating business because investors have different return expectations for real estate, which is considered a less risky investment than ownership in a business enterprise.

In South Florida the cap rates for real estate are currently just over 7% according to a recent article in the South Florida Business Journal.  In contrast the rates for closely held businesses are much higher and can be well over 15% depending upon the business industry, the history and the future expectations for a company.

If the real estate were not segregated from the operating business in the valuation process, the real estate would be undervalued.   Businesses are generally riskier than owning real estate, so investors require higher returns.  The higher the rate, the lower the value.  Generally, real estate that generated $1,000 of cash flow would be worth more than a business that generated $1,000 of cash flow. 

When valuing a business, you may want to check with the business appraiser so that you can properly budget for any real estate appraisals that may be necessary as part of the valuation process.

© 2009 Florida Business Valuation Group

There is no way to shortcut a valuation.  If you are on a budget, you can make choices that will keep your fee down.  However, if you budget it too small, you may be better off with not spending money on a low cost appraisal.

Clients decide to have appraisals done to meet a need.  Usually it is to have documentation to provide that they made a transfer at fair market value.  The appraisal could be required by the IRS or the courts depending upon the purpose.  If an appraiser knows that you will be relying on his or her opinion to provide proof, the appraisal should be done to meet that purpose in compliance with appropriate appraisal standards.

Valuations done in compliance with appraisal standards take time.  So what do you do when your budget is not large enough for an appraisal?

You may be able to reduce your fee by asking for a summary report.  Shorter reports take less time to write.  However, just because you are getting a shorter report does not mean the appraiser will do less work to reach his or her opinion.

Another option is to get a calculation of value rather than a conclusion (or opinion) of value.  The disadvantage to a calculation of value is you will not get the same level of assurance that the number is accurate.  A calculation of value is a limited scope appraisal, where the appraiser and the client agree to limit the amount of work done with the understanding that if all the work was done, the resulting value could be different.  This type of report will not necessarily satisfy the requirements of the IRS or courts, but may work for negotiations.

The bottom line is that appraisals are not inexpensive.  There are some online “valuation calculators”, but the resulting information will usually not constitute an appraisal.  If your budget is too small for an appraisal, you may want to see if you can do without one rather than spending money on something that will not satisfy your requirements.  In any case, make sure to ask questions so that you understand that the report you are getting will meet your needs.

© 2009 Florida Business Valuation Group