Representing Small Business Clients Valuations for Your Clients

Representing Small Business Clients Valuations for Your Clients and Your Practice

Definition of a Business Valuation The process of reducing the activities of a business entity to a numerical value or value range based on a standard of value applicable to the particular facts and circumstances.

Purpose of A Valuation Ø Estate v Planning FLP, Gift, Trust Ø Corporations v ESOP, M&A, Options, FAS, Buy-Sell Ø Litigation v Damages, Minority Interests, Disputes Ø Family v Law Divorce, Alimony

Valuation Roles Ø Valuation Expert Ø Consultant Ø Rebuttal Ø Neutral Expert Appraiser

Standards of Value Fair Market Value Investment Value Fair Value (Litigation) Shareholder Agreement

Standards of Value Fair Market Value: The price 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 he latter is not under any compulsion to sell, both parties having reasonable knowledge of the relevant facts. (Rev, 59 -60)

Approaches to Value Ø Cost Approach Ø Income Ø Market Approach

Cost Methods Ø Adjusted Ø Net Asset Value Method Asset Value Ø Liquidation forced) Value (orderly or

Net Asset Value ABC Company Balance Sheet Assets Cash 31 -Dec Adjusted $100 Receivables 500 -50 450 Inventory 400 -75 325 $1, 000 -$125 $875 Machinery & Equipment 250 -50 200 Real Estate 650 400 1050 $1, 900 $225 $2, 125 Current Assets Total Assets Liabilities Accounts Payable 400 Bank Debt 350 Total Liabilities NET ASSET VALUE $750 $0 $750 $1, 150 $225 $1, 375

Income Methods Ø Capitalization Ø Discounted Ø Excess of Earnings Cash Flow Earnings

Capitalization of Earnings ABC Company Profit & Loss Statement Revenues $3, 500 Cost of Sales 2750 Gross Profit $750 SG&A Expense 500 Operating Profit $250 Income Taxes -100 Net Income $150 Add Backs: Excess Compensation 100 Net Cash Flow $250 Divided By 20% INDICATED VALUE $1, 250 Capitalization Rate

Market Methods Ø Guideline Publicly Traded Company Ø Guideline Comparative Transactions

Comparable Transaction Method ABC Company Comparable Transactions Price to Revenue Net Income Company 1 40% 5. 10 Company 2 55% 4. 60 Company 3 37% 4. 20 Company 4 42% 6. 00 Company 5 39% 4. 50 Median 40% 4. 60 ABC Company $3, 500 $250 ABC VALUE = $1, 400 $1, 150 Average $1, 275 INDICATED VALUE

Valuation Synthesis ABC Company Valuation Synthesis Method Value Weighting Weighted Net Asset Value $1, 375 20% 275 Capitalization of Earnings $1, 250 40% 500 Comparable Transactions $1, 275 40% 510 Value $1, 285

Discounts Ø Discount for Lack of Marketability (DLOM) Ø Discount for Minority Interest (DMIN) Ø Discount for Lack of Control (DLOC) Ø Key Man Discounts Ø Blockage Discounts

Levels of Value - Discounts

Application of Discounts ABC Company Control Marketable DMIN 15% Minority DLOM Minority Total Discount Marketable $1, 285 -193 $1, 092 30% -328 Non-Marketable $765 40. 5%

Subjective Valuation Areas 1 Ø Normalization Adjustments Related Party Transactions v Excessive Compensation v Ø Benefit v Streams Net Income, EBIT, Net Cash Flow Ø Discount Rates

Subjective Valuation Areas 2 Ø Capitalization Rates (Multiples) Ø Growth Rates Ø Control Issues (DLOC/DLOM)

Common Errors Ø Failure to clearly identify and adhere to the applicable standard of value Ø Reliance on Rules of Thumb Ø Indiscriminate use of Price/Earnings Multiples Ø Failure to make normalization adjustments when valuing a controlling interest

Common Errors Ø Failure to match capitalization rate with earnings base Ø Not adjusting for market compensation for the owner. Ø Failure to apply tax rates correctly

Common Errors Ø Creating new valuation theories Ø Creating new valuation methods Ø Failing the competency standards Ø Justifying the unjustifiable Ø Applying boiler plate too thickly Ø Diluting the opinion with caveats

Key Issues Today Ø Effects of the Economy Ø Buy-Sell Agreements Ø IRS Scrutiny Ø Proper application of methods Ø Personal vs. Corporate Goodwill

Goodwill Issue Ø Enterprise or Corporate Goodwill Brand – Name Recognition v Larger Organizations v Longevity of Enterprise v Ø Personal Goodwill Key Man Issue v Unique Know How v Rainmaker v

Selecting a BV Expert Ø Curriculum Vitae Ø Credentials Ø Education and Training Ø Experience Ø Communications Skills

Credentials Ø ASA – American Society of Appraisers Ø ABV – American Institute of CPAs Ø CVA – National Association of Certified Valuation Analysts Ø CBA – International Business Brokers Association

Litigation Ø Objective v Initial Assessment Valuation, Economics Ø Guide Through Process Offense and Defense Positions v Mediation v Ø Valuation v Report Fact and Calculation Ø Expert Witness. Testimony

Advocacy The attorney is an advocate for the client. The valuation expert is an advocate for their report.

Contact Us S. G. Brooke Tucker Anne R. Meltzer Mark W. Norris Managing Director O 410 -472 -0370 O 410 -998 -2085 O 443 -519 -0007 F 410 -472 -0371 F 410 -654 -8514 F 410 -522 -5889 2403 Benson Mill Road 816 Queens Park Drive 2400 Boston Street, Suite 102 Sparks, MD 21152 Owings Mills, MD 21117 Baltimore, MD 21224 brooke@tuckerandmeltzer. com anne@tuckerandmeltzer. com mark@tuckerandmeltzer. com