2About Anchor PlanningSpecialized firm based in Illinois with a national reputation and client base, designed to deliver clients focused services not available from general CPA or consulting firmsProvides business planning and valuation services to primarily small to medium size businessesRecruits the best staff through an extremely selective process which requires maintaining their professional education through industry organizations and turning business valuations from an expense into an assetValued business transactions ranging from $10,000 to in excess of $100 millionClient industries include: Automobiles, Banks, Savings & Loans, Information Services, Insurance, Medical, Dental, Metals and Metal Fabrication, Retail, Healthcare, and third parties such as attorneys and accountants
3About Your Presenter John W. Hayes, Managing Director Representative Accomplishments:Undergraduate degree in Finance from DePaul University and MBA from the University of Notre DameActive in the valuation profession for more than 20 years, professional designations include: CPA/ABV, ASA, CVA, CFE, CrFAFrequent speaker and writer on valuation topics for the AICPA and the Illinois CPA SocietyDirected and prepared appraisals for the purposes of financial accounting, tax reporting, financing, strategic decision making and litigation support
5What Is Business Valuation? The act or process of determining the value of a business enterprise or ownership interest thereinGeneral introduction to business valuation
6When Is A Valuation Needed? LitigationBankruptcyMarital DissolutionDamages caused to businessComplianceDetermination of Estate & Gift taxesEmployee Stock Ownership Plans (ESOP)Purchase Price Allocation (PPA)Goodwill Impairment TestingStrategicPurchase/Sale of business or sharesFairness OpinionsDiscuss reasons a valuation might be needed; why it’s relevant
7Why Use An Appraiser? Specific knowledge of methods Experience determining valueCertified and complies with accepted industry standardsContinuing professional education requirementsLitigation supportDiscuss personal areas of expertise, certifications and experience
8BV Professional Standards Uniform Standards of Professional Appraisal Practice (USPAP)National Association of Certified Valuation Analysts (NACVA)Institute of Business Appraisers (IBA)American Institute of Certified Public Accountants (AICPA)American Society of Appraisers (ASA)The Appraisal FoundationCanadian Institute of Chartered Business Valuators (CICBV)Internal Revenue Service (IRS)John, let me know if you’d like to add or delete any of the listed professional standards
10What Is Value? Value = Worth, Utility, Desirability The purpose of this slide is to introduce the viewer to the basic concept of value, which is the foundation of business valuation.Value = Worth, Utility, DesirabilityThe value of an assetis the benefit you receive from that asset
11. . . is worth more than a dollar tomorrow A Dollar Today…. . . is worth more than a dollar tomorrowDue to factors such as:Opportunity CostsInflationThe purpose of this slide is to introduce the income approach and the reason for discounting future cash flows.
12Definitions 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 the latter is not under any compulsion to sell; both parties having reasonable knowledge of relevant facts (Revenue Ruling 59-60)Family law courts tend to be very inconsistent in the use of definitions of value. Regardless of the definition of value as stated in the opinion, the attorney (and/or the appraiser) needs to read the precedential case law to discover what (if any) is the accepted definition of value in the jurisdiction.
13Other Definitions Of Value Fair ValueInvestment ValueIntrinsic ValueFair Value has different definitions for legal and financial reporting purposes. For legal purposes, fair value is heavily determined by prior case law and is typically used in dissenting stockholder and minority oppression cases. Investment Value is the value to a particular investor. Intrinsic Value is the amount that the investor considers to be “true” or “real value” and is based on analysis of all the fundamentals factors inherent in the business.
14Sources Of Authority For Definition Of Value Statutory lawLegally binding rules and regulationsContractual definitions of valueNon-legally binding administrative rulesPrecedential court decisionsDirection from the courtDirection from the lawyerUse of IRS authority in non-tax situationsOpinions of other lawyers and appraisers
15Premises Of Value Going concern – value in continued use Assemblage of assets – value in place, but not in current use or as a going concernOrderly disposition – value in exchange on piecemeal basis given a normal time to sellForced liquidation – value in exchange on piecemeal basis given less than normal time to sellBy premise of value, we mean an assumption as to the status of the business under which a transaction would be expected to take place.
16Overview of Accepted Approaches, Methods & Procedures
17Overview Of Accepted Approaches, Methods, And Procedures Hierarchy of Approaches, Methods, and ProceduresApproach is the broadest of the three termsMethod refers to general ways to implement approachesProcedures means the specific calculations, data used, and other details involved in a specific method
18Business Valuation Approaches Income Approach – valuing the business based on some form of economic income streamMarket Approach – valuation by reference to other transactionsAsset-Based Approach – valuation on the basis of assets and liabilitiesThis slide is an overview of the approaches to value. These approaches will be discussed more in-depth further into the presentation.
19Business Valuation Methods Income ApproachDiscounting methodCapitalizing methodMarket ApproachGuideline public company methodGuideline merged and acquired company methodAsset-Based ApproachAdjusted net asset value methodExcess earnings method
20Financial Statement Basics Basic Financial StatementsIncome StatementBalance SheetLevels of Financial Statement PresentationAudited: Independent auditor expresses opinionReviewed: Accountant expresses limited assuranceCompiled: Management’s representations presented in the form of financial statements
21Income Approach“Value today always equals future cash flow discounted at the opportunity cost of capital.”1Discounting Method - a method within the income approach whereby the present value of future expected economic benefits is calculated using a discount rateDiscount Rate - an opportunity cost; the rate of return available to investors in the market on investments of comparable risk1Richard A. Brealey and Stewart C. Myers, Principles of Corporate Finance, 7th ed., p. 75
22Income Approach$1,000 to be received at the end of each of the three yearsDiscount Rate is 8%Year Year Year 3PV = $1, $1, $1,000PV = ( ) ( ) ( )2PV = $ $ $793.83PV = $2,577.10
23Income Approach Note how discounting is the opposite of compounding: $ x 1.08 = $1,000$ x 1.08 x 1.08 = $1,000$ x 1.08 x 1.08 x 1.08 = $1,000
24Income ApproachCapitalization Method - a conversion of a single period of economic benefits into value.Concept of capitalizing: shortcut version of discountingAssumptions:Amount of income capitalized will remain constant each year in perpetuityORAmount of income being capitalized will either increase or decrease at some constant annually compounded rate into perpetuity
25Constant Income Capitalization Model Income ApproachConstant Income Capitalization Model(a.k.a. Gordan Growth Model):Assume:Dividend = $5.00Capitalization rate = %$5.00Present Value (PV) = = $50.00The above example (which is unique), the capitalization rate equals the discount rate. This is only true where the amount of expected income is constant in perpetuity.
26Income Capitalization Growth Model Income ApproachIncome Capitalization Growth ModelAssume:Prior period income ( i ) = $10.00Sustainable growth rate ( g ) = %Discount rate ( k ) = %Di $10.00 x $10.30PV = k - g = = = $103.00Di = income expected at the end of future year
27Market ApproachMarket Approach – a method of determining a value indication of a business asset by using one or more methods that compare the subject to similar businesses that have been soldReasonable basis for similar businesses:Similar qualitative and quantitative investment characteristicsSufficient amount of available, verifiable dataTransacted in arm’s-length deal, opposed to forced or distressed sale
28Market ApproachValuation Multiple – a fraction in which a value or price serves as the numerator and financial, operating, or physical data serves as the denominator (e.g. Sales Price/EBITDA)Assume:Similar company Sales Price/EBITDA multiple = 3.0Subject company Last 12 Months EBITDA = $10,000,000Subject Company Value = 3.0 x $10,000,000 = $30,000,000
29Market ApproachGuideline Public Company Method – share prices of similar, actively- traded publicly owned companies are applied to the subject company through valuation multiplesStrengths of method:SEC filing requirementsActive tradingDaily tradingLarge amount of analytical informationSEC filing requirements leads to a great deal of verifiable and generally reliable information available for each company. Active trading results in a consensus of value by informed investors, on an arm’s-length basis. Daily trading results in observations as of the actual effective valuation date.
30Market Approach Sources for guideline public company method: SEC Filings10-K annual report10-Q quarterly report8-K special events filingYahoo! FinanceDaily stock prices
31Market ApproachGuideline merged and acquired company method: Transaction prices of similar, public or privately-owned companies are applied to the subject company through valuation multiplesStrengths of method:Large amounts of available data on small businesses and practicesTransactions in more industries than guideline public company methodTransactions are for controlling interest; no additional control premium needed
33Asset-Based ApproachAsset-Based Approach - a general way of determining a value indication of a business, business ownership interest, or security using one or more methods based on the value of the assets net of liabilitiesMethod most appropriate for the following businesses:Real estate holding companiesInvestment companiesFinance companiesManufacturing companies heavily invested in fixed assetsThe asset approach is less applicable to minority interests and businesses that have large amounts of intangible value (such as service businesses, software companies, many retail operations, and some distribution businesses).
34Asset-Based Approach Adjusted Net Asset Value Method Steps: Obtain or develop an accrual basis balance sheetDetermine which assets and liabilities on the balance sheet require valuationIdentify any off-balance sheet assets or liabilitiesValue the items identified in steps 2 and 3Construct a market value-based balance sheet using the adjusted values
35Asset-Based Approach Excess Earnings Method Steps: Estimate (A) a normalized level of operating earnings, (B) the operating tangible asset value, and (C) a reasonable rate of returnMultiply the reasonable rate of return by the value of tangible assets to arrive at the reasonable dollar return on tangible assetsDetermine excess earnings by subtracting the return on tangible assets from normalized earningsThe Excess Earnings Method was originally used in 1920 to measure the value of goodwill that breweries and distilleries lost because of prohibition.“The (excess earnings) approach may be used only if there is not better basis available for estimating the value of intangible assets.” (Revenue Ruling )
36Asset-Based Approach Excess Earnings Method Steps (continued): Determine the capitalization rate appropriate for the excess earningsDetermine the value of intangible assets by dividing the capitalization rate into the excess earningsAdd the value of tangible assets to the value of intangible assetsCommon errors associated with the excess earnings method: Undefined earnings stream, unsupported normalized earnings stream, failure to allow for owner’s compensation, unsupported net tangible asset value, unsupported or unrealistic required rate of return on tangible assets, unsupported or unrealistic capitalization rate for excess earnings, using rates that are not currently supportable rates, claiming that the IRS recommends use of the excess earnings method.
37A Word On Approaches and Methods Approaches and Methods Not Totally DiscreteThere is some overlap among approaches and methods. How much overlap there is depends on the procedures used in each method.Business appraisers generally prefer to avoid overlaps to the extent possible in order to form independent indications of value by each approach.
38Discounts and Premiums Often the largest money issue is not the base value, but theapplicability and/or magnitude of discounts and/orpremiums to be applied to the base valueAdjustments may need to be made to arrive at the fair market value of the interest being appraised. These adjustments may arise due to differing characteristics between the subject company and the comparable companies or to the inherent nature of the quantity of shares being appraised.
39Benefits Of Control An Investor Likes Control Because: Effect an acquisition/mergerPursue own business interestsInfluence management selection and policiesDetermine capital structureManage operationsDiscretion over new stockholders or partnersAcquire or liquidate assets
40Minority Versus Control Degrees of minority versus control ownership:100 percent controlSlightly less than 100 percent controlLess than a supermajority where a supermajority is required for certain corporate actions50 percent interest“Swing vote” minority blockHigh enough percentage to bring a minority oppression dissolution action
41Entity Level Discounts Entity Level Discounts affect all shareholders:Significant risk factorsKey person, size, lack of geographic diversificationPortfolio discountTrapped-in capital gains discountEnvironmental or litigation risk
42Shareholder Level Discounts Shareholder level discounts have different impacts on different shareholders:Minority versus controlLack of marketabilityVoting versus nonvoting sharesBlockage discount
43Discounts For Lack Of Marketability [DLOM] The concept of marketability:“The ability to convert the business ownership interest (at whatever ownership level) to cash quickly, with the minimum transaction and administrative costs in so doing and with a high degree of certainty of realizing the expected amount of net proceeds.”22. Valuing a Business: The Analysis and Appraisal of Closely Held Companies, 4th ed., p. 393.
44DLOM Degrees of marketability or lack thereof: Registered with the SEC and with an active trading marketRegistered with the SEC and fully reporting, but with a somewhat thin trading marketPrivate company with frequent private transactionsPrivate company with few or no transactionsPrivate company with ownership interest absolutely prohibited from transfer
45Levels Of Value In Terms Of Characteristics Of Ownership Source: PPC’s Guide to Business Valuations, Exhibit 8.8 in 16th Edition
46The “Mandelbaum” Factors In Mandelbaum v. Commissioner3 (1995), a federal Tax Court case, Judge Laro details the factors to consider in determining discounts:Financial Statement AnalysisCompany’s Dividend PolicyNature of the Company (History, Position in Industry, Economic Outlook)Company’s ManagementAmount of Control in Transferred SharesRestrictions on Transferability of StockHolding Period for StockCompany’s Redemption PolicyCosts Associated with Making a Public Offering3. Mandelbaum v. Commissioner, 1995 Tax Ct. Memo LEXIS 256 (1995) (Laro, J.)
47Evidence Quantifying DLOM Restricted Stock StudiesPre-IPO Studies“(The IRS’s expert) should have considered the…data reflected in those pre- IPO studies because they, together with the restricted stock studies, would have provided a more accurate base range and starting point for determining the appropriate lack-of marketability discount…”4 - Tax Court4. Davis v. Commissioner 110 T.C. 530, 110 T.C. No. 35, June 30, 1998
48Sources For Quantifying Discounts And Premiums Control Premium/Minority DiscountMergerstat®/Shannon Pratt’s Control Premium Study™Lack of Marketability DiscountFMV Restricted Stock Study™Valuation Advisors’ Lack of Marketability Discount Study™All databases available at
49Reconciliation Of Value Weighting of valuation method resultsFinal value estimateReview of appraisal processDid the analyst appraise the right thing?Did the analyst appraise the right thing in the right way?Explicit weighting – assigning a percentage weight to each method.Implicit weighting – discussing qualitatively the relative aspects of methods without assigning a mathematical weight to eachFinal value estimate – can be a point estimate or range of value
50Courtroom Tips for the Expert Watch Out for these Questions:Would you buy this company for what you've valued it?Have you actually ever sold a business? Because if not, you really don't have a clue what real buyers and sellers consider, do you?You have arrived at a specific dollar value in your report—but value is a range, isn't it? If so, what is an “acceptable” range, plus or minus? Within what range does your value fall?Q: Would you buy this company for what you've valued it? A: “When attorneys ask this question,” Hawkins notes, “they usually act as if…they've caught the business appraiser like a deer in the headlights.” But you can step out of the glare by explaining that the values stated in your report arise from the company's unique circumstances, taking into account the actual market conditions of what others are paying for similar companies. Moreover, you never recommend what a buyer ought to pay; that decision must reflect the buyer's personal view of the market, tolerance for risk, etc.Q: Have you actually ever sold a business? Because if not, you really don't have a clue what real buyers and sellers consider, do you? A: Of course, the answer must be unique to every business appraiser and his/her experience. Hawkins has a background in financing mergers and acquisitions, and his current practice is “intimately involved with” many buy-sell scenarios. “Sadly, though, the level of expertise among business appraisers varies greatly,” he observes. The most vulnerable will be those who live “solely in the world of theory but have little common sense about how buyers and sellers in the real world would size up a situation.”Q: You have arrived at a specific dollar value in your report—but value is a range, isn't it? If so, what is an “acceptable” range, plus or minus? Within what range does your value fall? A: “This is almost always a trick question designed to get the appraiser to admit that the value could therefore be X or Y,” instead of the stated value.
51Courtroom Tips for the Expert Does your report contain any math errors? Because if it does—then it would be unreliable, correct?Do you consider Shannon Pratt to be an authority in the field of business valuation?Q: Does your report contain any math errors? Because if it does—then it would be unreliable, correct? A: It's an unfortunate truism that valuation reports are rarely error-free, even though they've been through several stages of quality control. (Keep this in mind when reviewing the opposing party's report for possible weaknesses.) “Never, ever accept anything at face value,” Hawkins says. Or citing the words of an ex-President: “Trust, but verify.”Q: Do you consider Shannon Pratt to be an authority in the field of business valuation? A: Of course you do—as you do many of the best-known leaders in the valuation industry. The red flag here: Watch out for the questions that follow, as the attorney will usually ask you to read a passage from said leader, which—on its face—would seem to contradict your own assumptions, calculations, or conclusions. These passages are usually selective, taken out of context, and/or offer only one opinion on a subject about which reasonable experts could disagree, including the one cited. Finally, just because a book says “that is how you should do it” doesn't mean “that is how you do it” today. It's appropriate to demonstrate where a business appraiser has in fact made a mistake or is truly out of sync with the industry.
52Thank You John W. Hayes Anchor Planning & Valuations, Ltd Thank You John W. Hayes Anchor Planning & Valuations, Ltd Jorie Blvd., Suite 380 Oak Brook, IL Phone: (630) Fax: (630)
53Additional ResourcesFlexibility is at your fingertips with this additional resources slide library. Add slides on specific topics for special audiences, or store slides you do not want to use for a particular presentation. The customizing possibilities are endless!
54Additional Resources Association web sites: American Institute of CPAs (AICPA),American Society of Appraisers (ASA),Institute of Business Appraisers (IBA),International Business Brokers Association (IBBA),National Association of Certified Valuation Analysts (NACVA),
55Uses of Business Valuation Reports Related to Buying / SellingSale of a BusinessMergers & AcquisitionsDivestitureInitial Public OfferingsAllocation of Acquisition PriceBuy/Sell AgreementsFranchise Valuation or EvaluationSplit-ups/Spin-offs
56Other Than Buying/Selling Adequacy of Life InsuranceGifting ProgramsEstate and Gift TaxesCharitable ContributionsEminent Domain
57Other Than Buying/Selling Employee Stock Ownership Plans (ESOP’s)Fairness OpinionsLease versus BuyMediation & ArbitrationSuccession Planning
58Litigation Support Dissenting shareholder actions Divorce Economic Loss AnalysisDisruption of BusinessPartner DisputesWrongful Death
59Types of Clients Business Owners Attorneys Judges Creditors Financial Institutions and PlannersInsurance CompaniesReal Estate AppraisersOther Business Valuators
60Who Can Be A Qualified Valuator? EconomistsInvestment BankersBusiness BrokersFinancial AnalystsCertified Public Accountants (CPA’s)
62Professional Designations American Society of Appraisers (ASA)Accredited Senior AppraiserInstitute of Business Appraisers (CBA)Certified Business AppraiserNational Association of Valuation Analysts (CVA)Certified Valuation Analyst
63Professional Designations American Institute of Certified Public Accountants (ABV)Accredited in Business ValuationCanadian Institute of Chartered Business Valuators (CBV)Chartered Business ValuatorAssociation for Investment Management and Research (CFA)Chartered Financial AnalystsOriented primarily to public companies, includes material on private company valuation, and several hundred CFA’s specialize
64USPAP Professional Standards Uniform Standards of Appraisal Practice (USPAP)Established in 1987 by The Appraisal FoundationConsists of eight (8) appraisal organization and ten (10) non-appraisal organizations interested primarily in real estate appraisalsThe most widely cited and recognized set of professional standards for appraisals is the Uniform Standards of Professional Appraisal Practice (USPAP), published by The Appraisal FoundationThe Foundation is located at 1029 Vermont Ave., NW, Suite 900, Washington, D.C., 20005, ph: (202)USPAP is updated each year in November, to be effective the following January 1It covers appraisal for all disciplines, including real estate, personal property, and appraisal of businesses, business interests, and intangible assetTwo (2) of USPAP’S ten (10) standards apply to business valuations and were added due to the number of members performing business appraisals
65Professional Standards Standards published be each of the above organizations are somewhat more detailed than USPAPHowever, none of them are in conflict with USPAPAll of these organizations’ standards are available at no charge
66Professional Standards Summary All Organizations Require:EthicsCompetencyConsideration of all recognized valuation approachesClear and accurate reports
67Selection of a Valuation Professional EducationTraining & Continuing Education in Business ValuationTechnical training, accreditation and certificationASA, CBA, CVA, ABV, CBV and CFAExperienceCertified Public AccountantSpecific Industry Experience - Skills and expertise in tax treatments, IRS regulations, financial analysis, and business valuation experience
68“Top Ten” List for Attorneys Define the projectUnderstand the standard of valueInvolve the appraiser early onDistinguish between a business appraisal and a real estate appraisalEstablish a reasonable time frame
69“Top Ten” List for Attorneys Insist on an appraiser with experience and credentialsKnow the primary business valuation methodsThe appraisal is the first line of defenseLitigation support issuesExpect the best
70Definitions Fair Market Value The price at which an asset would change hands between a willing buyer and a willing sellerEnterprise and Invested CapitalThe sum of debt and equity capitalEquityThis is the value to all shareholders
71Definitions Majority vs. Minority Control premium – the premium, over the minority price, that a buyer would pay to gain controlDiscount for lack of control – the amount by which the majority value is reduced to obtain a minority valueMarketability DiscountThis reduction in value accounts for the stocks lack of a liquid market
72Definitions Standards of Value Fair Market Value IRS Ruling “…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 ValueDefined by individual states and is based upon the case law precedents involving dissenting stockholder actions
73Definitions Investment Value Value of a business asset to a particular buyer as compared to a population of willing buyersThe purpose and function of the business valuation is to determine the proper standard of value used in a valuation
74Definitions Premise of Value Going Concern – The value of a business enterprise that is expected to continue to operate into the futureThe intangible elements of Going Concern Value result from factors such as having a trained work force, an operational plant, and the necessary licenses, systems and procedures in place
75DefinitionsLiquidation Value – the net amount that can be realized if the business is terminated and the assets are sold piecemealLiquidation can be either “orderly” or “forced”Orderly:Liquidation value at which the asset or assets are sold over a reasonable period of time to maximize proceeds receivedForced:Liquidation value at which the asset or assets are sold as quickly as possible, such as at an auction