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

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 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

Different appraisal organizations’ standards refer to reports that express conclusions (opinions) of value by different terms.

The American Institute of CPAs (AICPA) and the National Association of Certified Valuation Analysts  both provide for Detailed or Summary Reports.  The American Society of Appraisers provides for Comprehensive Reports.  The Institute of Business Appraisers Standards allow for Formal  Reports.   Uniform Standards of Professional Appraisal Practice (USPAP) provides for an Appraisal Report.  While the standards for each organization is slightly different for the different types of reports, they basically require the same minimum information in reports.

The AICPA standards  provide for the following minimum disclosures in a Detailed Report:

• Identity of the client
• Purpose and intended use of the valuation
• Intended users of the valuation
• Identity of the subject entity
• Description of the subject interest
• The business interest’s ownership control characteristics, if any and its degree of marketability
• The valuation date (effective date)
• The date of the report
• The type of report
• The premise of value used in the report
• The standard of value used in the report
• The sources of information that are the basis for the conclusion of value reached in the report
• Assumptions and limiting conditions applicable to the report
• The scope of work or data available for analysis including any restrictions or limitations
• Any hypothetical conditions used in the report and the basis for their use
• If the work of a specialist was used in the valuation, a description of how the specialist’s work was used, and the level of responsibility, if any, the business appraiser is assuming for the specialist’s work
• The valuation approaches and methods used (other standards require disclosure of valuation approaches and methods rejected)
• Disclosure of subsequent events in certain circumstances
• Any application of jurisdictional exception
• Representation (also referred to as Certification) of the business appraiser
• Signature of the business appraiser or the appraiser’s firm (some standards require the business appraiser to sign the representation)
• A section summarizing the reconciliation of the estimates of value and the conclusion of value
• A statement that business appraiser has not obligation to update the report for information that comes to his or her attention after the date of the report.

The USPAP includes most of the items is the AICPA standards and also require that business appraisals must:

• clearly and accurately set forth the appraisal in a manner that will not be misleading;
• contain sufficient information to enable the intended user(s) to understand the report; and
• clearly and accurately disclose all the assumptions, extraordinary assumptions, hypothetical conditions and limiting conditions used in the assignment.

While the different appraisal organizations have slightly different requirement as to what must be included in a report, the above list is a general list of what should be in a report.

Whatever the case, the appraiser is required to follow the standard for the organization to which he or she belongs.   Standards can be viewed online at the organizations’ websites. Links to those standards are also available in my previous post.

© 2009 Florida Business Valuation Group

Each appraisal organization has business valuation standards that apply to its members.  Standards can generally be classified as related to the developmental and reporting.   The different standards are posted online at:

• American Institute of Certified Public Accountants, Statement on Standards for Valuation Services No. 1:  AICPA Standards
• American Society of Appraisers,  ASA  Business Valuation Standards
• Institute of Business Appraisers, Business Appraisal Standards
• National Association of Certified Valuation Analysts, NACVA Professional Standards
• Appraisal Society, Uniform Standards of Professional Appraisal Practice  Standards 9 and 10

The standards are not uniform.   The appraisal oranizations did agree to uniform defiinitions of certain terms, the International Glossary of Business Valuation Terms.   When the AIPCA published its valuation standards in 2008, it added additional definitions.  While the details in the standards are different, the objectives are the same:  to ensure that appraisers do sufficient work to support their work, and that the work be reported in a manner that provides the user with enough information to understand.

© 2009 Florida Business Valuation Group

There are many different types of value. Below are a number of the types of value and examples of when they may apply.

• Fair Market Value: This type of value is used for estate and
gift tax reporting purposes, valuations for contributions to charities, valuation of ESOPs and other compliance purposes. Revenue Ruling 59-60, which is the definition used by the IRS, defines fair market value as “the amount at which the property would change hands between a willing buyer and a willing seller, when the former is not under any compulsion to buy, and the latter is not under any compulsion to sell, both parties having reasonable knowledge of relevant facts.”

• Fair Value: There are two different types of fair value, one
for litigation purposes and one for financial accounting reporting purposes.

•• Statement on Standards for Valuation Services issued by the AICPA
defines fair value for financial reporting as “the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date.” This is the type of value used by companies when adjusting their assets or liabilities to fair value on their balance sheets under Generally Accepted Accounting Principles.

•• Fair value for litigation purposes is defined in each state either
by statute or through case law. This type of value is used to value interests in legal disputes between shareholders, partners or members.

• Intrinsic Value: This type of value is defined by the
International Glossary of Business Valuation Terms as “what an investor considers, on the basis of an evaluation of facts, to be the ‘true’ or ‘real’ value that will become the market value when other investors reach the same conclusion. Investors and analysts use this type of value to determine if stocks are selling at their true value.

• Investment Value: This type of value is defined by the
International Glossary of Business Valuation Terms as “the value to a particular investor based on individual investment requirements and expectations.” Each buyer and seller has his or her own value based on specific investment objectives.

• Net Book Value: Net book value is synonymous with the net
worth (or shareholders’ equity) of the business. It is the total net assets less the total liabilities as stated on the balance sheet of the business. The assets and liabilities are stated at historical cost, which may not be reflective of their current values.

There are other types of value as well. Rob Slee in his book Private Capital Markets, defines other types of value including economic value, insurable value, collateral value, owner value, and market value to name some others.

Sometimes the type of value is not as clear would seem. For example, in a divorce, some states use fair market value, while others may lean
towards the litigation type of fair value.

For more information on standards of value and the valuation process, please click here.

© 2009 Florida Business Valuation Group