CBIZ MHM Executive Education Series Top Ten Common
CBIZ & MHM Executive Education Series™ Top Ten Common Errors in Valuation Tami Bolder June 12, 2019 Questions? Email cbizmhmwebinars@cbiz. com 1
About Us • Together, CBIZ & MHM are a Top Ten accounting provider • Offices in most major markets • Tax, audit and attest and advisory services • Over 2, 900 professionals nationwide A member of Kreston International A global network of independent accounting firms MHM (Mayer Hoffman Mc. Cann P. C. ) is an independent CPA firm that provides audit, review and attest services, and works closely with CBIZ, a business consulting, tax and financial services provider. CBIZ and MHM are members of Kreston International Limited, a global network of independent accounting firms. Questions? Email cbizmhmwebinars@cbiz. com 2
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CPE Credit This webinar is eligible for CPE credit. To receive credit, you will need to answer polling questions throughout the webinar and be joined for the entire webinar time. External participants will receive their CPE certificates via email within 15 business days of the webinar. Questions? Email cbizmhmwebinars@cbiz. com 4
Disclaimer The information in this Executive Education Series course is a brief summary and may not include all the details relevant to your situation. Please contact your service provider to further discuss the impact on your business. Questions? Email cbizmhmwebinars@cbiz. com 5
Presenters Dr. Bolder specializes in business valuation and litigation consulting services for CBIZ Valuation Group, LLC. She oversees business valuation engagements for estate and gift tax, exit planning, SBA loans, purchase price allocations, goodwill impairment testing, domestic relations, and other litigation purposes. She has also prepared and reviewed analyses and reports TAMI BOLDER, CPA/ABV, ASA, MBA, DBA Senior Manager CBIZ Valuation Group both determining economic damages and assessing the propriety of other expert’s reports. 330. 670. 7237 • tmbolder@cbiz. com Questions? Email cbizmhmwebinars@cbiz. com 6
Agenda 01 Valuation Basics 02 Top Ten Common Errors 03 Questions? Email cbizmhmwebinars@cbiz. com 7
BUSINESS VALUATION Some Basics Questions? Email cbizmhmwebinars@cbiz. com 8
Business Valuations: Some Basics Questions? Email cbizmhmwebinars@cbiz. com 9
Business Valuations: Some Basics There are some universal attributes regarding how valuation experts are retained and how valuation opinions can be used that are not always obvious: § Valuation opinions are typically performed in accordance with industry and professional standards – depending on the context; professional standards promulgated by the ASA, AICPA, FASB, etc. must be followed. § Valuation experts need to be independent – valuation experts need to maintain independence and objectivity, and follow professional standards; a valuation expert’s fee arrangement cannot be contingent on the outcome of the valuation; the valuation expert cannot have an interest in the company or assets being valued. Questions? Email cbizmhmwebinars@cbiz. com 10
Business Valuations: Some Basics • Valuation opinions have a “shelf-life” – opinions are issued as of a “Valuation Date” (value is a function of time); shelf-lives may vary depending on the business or asset being valued, but as an extreme example, you would not expect an opinion to be valid 3 years after the Valuation Date. • Valuations are performed for a specific client purpose – the use of a valuation opinion prepared for financing purposes may not be appropriate for tax purposes. Questions? Email cbizmhmwebinars@cbiz. com 11
TOP TEN COMMON ERRORS Questions? Email cbizmhmwebinars@cbiz. com 12
Top Ten Common Errors 1. 2. 3. 4. 5. 6. Mathematical errors Flawed valuation models Incorrect application of appropriate standard of value Flawed projections Mismatching control adjustments with interests being valued Mismatching capitalization or discount rates with measures of economic income 7. Mismatching economic income measure and interest bearing debt 8. Assuming an inappropriate capital structure 9. Utilization of private comparable transactions with little or no follow up research 10. Overreliance on rules of thumb Questions? Email cbizmhmwebinars@cbiz. com 13
# 1 - Mathematical Errors § Difficulty in discerning mathematical errors § Worth the time to recalculate § Effect on the credibility of the expert § If for litigation purposes - dig into the error § Often an expert who makes errors, makes them in more than one area Questions? Email cbizmhmwebinars@cbiz. com 14
# 2 – Flawed Valuation Models § Failure to forecast “expected” case or multi-scenarios when warranted § Failure to include working capital Flawed Valuation Model § Incorrect treatment of taxes § Failure to consider NOLs § Failure to adjust for non-operating asset values and off-balance sheet liabilities § Flawed and/or subjective treatment of risks Questions? Email cbizmhmwebinars@cbiz. com 15
# 3 - Incorrect Application of Appropriate Standard of Value § Investment Value § Present value of an asset to a specific owner § Intrinsic Value § “True worth” of the asset § Fair Value (GAAP and Litigation definitions) § Normally considered to be a pro-rata share of 100% ownership interest VALUE § Fair Market Value § Willing buyer & seller § No compulsion to buy or sell § Knowledge of relevant facts § Orderly Liquidation Value § Seller is compelled to sell § Forced Liquidation Value § Seller is compelled to sell in a compressed time frame Questions? Email cbizmhmwebinars@cbiz. com 16
# 3 - Incorrect Application of Appropriate Standard of Value Fair Market Value § "The price at which the property would change hands between a willing buyer and a willing seller, neither being under a compulsion to buy or sell and both having reasonable knowledge of the relevant facts. “ Investment Value § Specific buyer, strategic § Value to a specific investor based on individual investment Questions? Email cbizmhmwebinars@cbiz. com 17
# 3 - Incorrect Application of Appropriate Standard of Value Fair Value Financial Reporting/Acquisitions ASC 820 "Fair value is 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. ” Dissenting Shareholder Actions – Statutory Fair Value § Determined by state law Questions? Email cbizmhmwebinars@cbiz. com 18
# 4 - Using Flawed Projections § Growth rates § Market-based? § Comparison to historical performance § Primary drivers of growth § Long-term growth assumption § Projected margins § Capacity constraints Questions? Email cbizmhmwebinars@cbiz. com 19
# 5 – Mismatching Control Adjustments With Interests Being Valued Control Adjustments Type 1 Normalization Adjustments The first type are adjustments that eliminate one-time gains or losses, other unusual items, non-recurring business elements, expenses of non-operating assets and the like. Questions? Email cbizmhmwebinars@cbiz. com 20
# 5 – Mismatching Control Adjustments With Interests Being Valued Must consider the size of, and level of control associated with, the Subject Interest in determining whether to make Type 2 Control Adjustments. § The use of minority cash flows in the income approach produces a minority interest value. § Minority cash flows are those cash flows without any adjustments for prerogatives of control by the controlling shareholder (e. g. excess compensation and perquisites). Questions? Email cbizmhmwebinars@cbiz. com 21
#6 - Mismatching capitalization or discount rates with measures of economic income In general, valuation can be summarized in one simple formula: Value = Cash Flow/Risk Discount rates and capitalization rates are representative of the risk used to discount future cash flows to a present value Questions? Email cbizmhmwebinars@cbiz. com 22
#6 - Mismatching capitalization or discount rates with measures of economic income Rates are derived for equity and weighted average cost of capital (WACC) WACC includes both debt and equity components WACC will typically be lower than an equity rate § Debt is typically secured by assets and paid first, and as a result, it is less risky Questions? Email cbizmhmwebinars@cbiz. com 23
#6 - Mismatching capitalization or discount rates with measures of economic income Capitalization Rate Build Up Method - Example Risk Free Rate Equity Risk Premium Small Stock Premium Industry Risk Premia Other Risk Considerations Discount Rate 5. 00% 5. 00 6. 00 5. 28 6. 00 27. 28% Capitalization Rate = Discount Rate Less Long Term Growth Rate - Typically about 3%. Cap Rate would be 24. 28% Compare to Current Prime Rate which is approximately 5. 50%. Questions? Email cbizmhmwebinars@cbiz. com 24
#6 - Mismatching capitalization or discount rates with measures of economic income WACC v. Equity Rate is 24. 28%. Debt rate is 5. 25% WACC: Debt Equity Total = WACC Rate of Return 5. 25% 24. 28% Percentage of Financing 50% Weighting 2. 63% 12. 14% 14. 77% Questions? Email cbizmhmwebinars@cbiz. com 25
#6 - Mismatching capitalization or discount rates with measures of economic income Typical Capitalization Model Questions? Email cbizmhmwebinars@cbiz. com 26
#6 - Mismatching capitalization or discount rates with measures of economic income Errors arise when Analysts mismatch rates: Questions? Email cbizmhmwebinars@cbiz. com 27
#6 - Mismatching capitalization or discount rates with measures of economic income Errors arise when Analysts mismatch rates: Questions? Email cbizmhmwebinars@cbiz. com 28
#7 - Mismatching economic income measure and interest bearing debt Cash flows to invested capital include economic income available to both equity and debt holders. § Must properly account for interest and interest bearing debt § Especially if the company is highly leveraged. Questions? Email cbizmhmwebinars@cbiz. com 29
#7 - Mismatching economic income measure and interest bearing debt Questions? Email cbizmhmwebinars@cbiz. com 30
#7 - Mismatching economic income measure and interest bearing debt Questions? Email cbizmhmwebinars@cbiz. com 31
#8 – Assuming an inappropriate capital structure § Controlling Interests § Ability to control the capital structure § Market capital structure is generally more appropriate § Minority Interests § Limited or no control § Company’s existing capital structure Questions? Email cbizmhmwebinars@cbiz. com 32
#9 – Utilization of Private Comparable Transactions with Little or No Follow-Up Research § Important to review the details of each transaction § Revenue size and profitability of the companies § Stock sale vs. asset sale § Assets sales – what was included § Could be a major issue if used as a final conclusion of value § Databases may contain information related to strategic acquisitions Questions? Email cbizmhmwebinars@cbiz. com 33
#9 – Utilization of Private Comparable Transactions with Little or No Follow-Up Research § Report should contain a detailed discussion of the analysis and the process § Good resource for determining reasonableness compared to other valuation methodologies § Similar issues with the use of guideline public company multiples § Size and level of risk Questions? Email cbizmhmwebinars@cbiz. com 34
# 10 – Overreliance on Rules of Thumb The result of years of observation of market transactions by accountants, business brokers, bankers, appraisers, and trade associations, among others Examples: § 3 times EBITDA § 20% of revenue Two companies with $15 M in revenue may have attained that revenue in different manner Possibility of non-operating assets Questions? Email cbizmhmwebinars@cbiz. com 35
# 10 – Overreliance on Rules of Thumb § Typically are more like investment value § Rarely are the terms cash equivalent (i. e. not FMV) § Particularly problematic for minority interests § Pros § Ease of use § Cons § Not reliable § Do not consider operational or time period differences § No consideration of geographical differences § Nevertheless, if they are commonly referred to, they should not be ignored Questions? Email cbizmhmwebinars@cbiz. com 36
Final Thoughts Treatment of risks Check for internal inconsistencies Diagnose and test for reasonableness Questions? Email cbizmhmwebinars@cbiz. com 37
? QUESTIONS Questions? Email cbizmhmwebinars@cbiz. com 38
If You Enjoyed This Webcast… Upcoming Courses: • 06/25: Oddities in Leasing: Don’t Let These Provisions Be the Odd Thing Out of Your Implementation Plan • 07/09: Second Quarter Accounting and Financial Reporting Issues Update Recent Publications: • State & Local Tax Alert: Oregon Enacts the Corporate Activity Tax • The 2020 Campaign and Taxes Part 4: Tax Credits for Low Income Housing • Recent Developments in UBTI for Not-for-Profits • Transfer Pricing Trends in 2019: A Snapshot of Q 1 Developments Questions? Email cbizmhmwebinars@cbiz. com 39
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