Akron Business Valuation

This month's issue of Valuation & Litigation Advisory Insights includes the following articles:

• New Expert Discovery Rules Should Reduce Litigation Costs
• Zubulake Revisited: New Guidance on E-Discovery
• How the Recession Has Impacted Business Valuation

New expert discovery rules should reduce litigation costs         

This article discusses proposed amendments to the Federal Rules of Civil Procedure that will likely have a big impact on the attorney-expert relationship. One of the most significant changes is amended Rule 26, which will extend attorney work-product protection to draft reports by testifying experts and, with certain exceptions, to communications between experts and retaining counsel. It’s hoped that this will avoid needless discovery costs.

Click here to read this article.

Zubulake revisited: New guidance on e-discovery

A recent court case shows that sanctions can not only be awarded for deliberate destruction of discoverable data, but also when a party is grossly negligent. The court found that "failure to issue a written litigation hold constitutes gross negligence…." A sidebar to this article lists specific examples of gross negligence.

Click here to read this article.

How the recession has impacted business valuation

Should businesses that were valued on the eve of the economic downturn be revalued in light of subsequent events? This article looks at a Florida marital dissolution case in which a restaurant valued in December 2007 lost value during the recession that followed. This case confirms that, when valuing a business, appraisers generally shouldn’t consider events that take place after the valuation date. A sidebar examines Financial Accounting Standards Board standards regarding the treatment of subsequent events for accounting purposes.

Click here to read this article.

Prior issues are available in the E-Newsletter Archive of our Valuation & Litigation Advisory Services Resource Center. If you would like to subscribe to this free, monthly, business valuation and litigation support e-newsletter, send an email to info@skodaminotti.com.

If you have any questions about any of these articles, post a comment below or please contact our Valuation & Litigation Advisory Services Group at 440-449-6800.

This month’s issue of Valuation & Litigation Advisory Insights includes the following articles:

• Nonqualified Deferred Conpensation: Independent Appraisals Offer Protection Against 409a Challenge
• Damage Control: Surviving a Business Interruption
• Fair Value in a Troubled Economy
   

Nonqualified deferred compensation: Independent appraisals offer protection against 409A challenge         

Businesses that provide employees with stock options, stock appreciation rights (SARs) and other types of nonqualified deferred compensation have been subject to Internal Revenue Code Section 409A for years. As you can imagine, compliance is particularly challenging in the current economic environment. To avoid Sec. 409A problems, options and SARs must be issued at or above fair market value, so accurate valuations are critical. It’s important to know what Sec. 409A requires and how to establish fair market value. Three "presumptive" valuation methods are discussed.

Click here to read this article.

Damage control: Surviving a business interruption

Whether it’s minor, such as a lightning strike that shuts down production for a day, or major, such as a lengthy labor strike, a business interruption not only reduces income, but also simultaneously creates new expenses. The key to surviving a business interruption is to restore normal operations as quickly as possible. Insurance plays a critical role. This article explains business interruption insurance, how to file a claim, what to do to mitigate loss, and how to establish a loss period. A sidebar addresses scope-of-coverage issues.

Click here to read this article.
 
"Fair value" in a troubled economy

Last year, Financial Accounting Standards Board (FASB) Statement of Financial Accounting Standards (SFAS) No. 157 took effect. The statement, entitled Fair Value Measurements, provides guidance on measuring fair value for purposes of several accounting standards, and establishes a "fair value hierarchy" that emphasizes market-based valuation methods. This article explains how it works. A sidebar discusses a few opportunities to explore in this down economy.

Click here to read this article.


Prior issues are available in the E-Newsletter Archive of our Valuation & Litigation Advisory Services Resource Center. If you would like to subscribe to this free, monthly, business valuation and litigation support e-newsletter, send an email to info@skodaminotti.com.

With apologies to all of you non-basketball fans out there, this blog entry will once again focus on LeBron James and his impending free agency.  After all, it is the primary (only?) sports story in Cleveland this summer.  As my colleague wrote in a previous entry, LeBron’s decision to stay or go this summer will have a dramatic impact the value of the Dan Gilbert’s investment in the Cavaliers.  Here’s another perspective on how LeBron’s decision might be illustrative of the value of your business. 

The concept of the “key person discount” is often bandied about in valuation circles.  The idea is that a certain employee of the subject company, typically the owner-operator and founder, creates value due to his or her unique ability to run the business, enhance performance, or generate revenue.  One might ask, "Why would that be considered a reason to discount the company’s value?"  It seems as though such an individual creates a competitive advantage, and thus, a higher value.  The key person discount contemplates the impact of the potential exit of that individual from the business, and the resulting sustainability (or lack thereof) of the business after that exit.  In other words, the key person discount is a component of risk due to the fact that the success of the company is inordinately tied to a single person. 

To get back to the LeBron analogy, think of the “stay” or “go” scenarios and the impact on the Cavaliers’ ability to perform with or without him.  Take it one step further, and consider what the odds makers in Vegas are thinking right now as LeBron’s future is in question.  One thing is certain – whichever team is able to sign LeBron will see a significant uptick in its likelihood to win the NBA Championship next year (i.e., improved odds).  This volatility and uncertainty is simply an added risk associated with Cavaliers’ ability to win basketball games in the future. 

In business valuations, we handle volatility through the discount rate.  Therefore, an additional component of risk would be included in our discount rate for a key person, such as LeBron is for the Cavaliers.  In the valuation world, this would drive a lower value due to the added risk of the related investment.

Of course, many subscribe to the “Ewing Theory” which was popularized by Bill Simmons.  A summary of the theory is linked above, but the basic idea is a team may be better off without its superstar and, under the right circumstances, will actually perform better if the superstar gets injured, is traded, or leaves through free agency.  In other words, it is a scenario of addition by subtraction.  Simmons offers some very compelling examples of this notion.  It is common for valuators to encounter this situation (e.g., an owner taking excessive compensation) from time-to-time, but we will hold that back for a later entry.

For more information on the key person discount, post a comment below or contact our Valuation & Litigation Advisory Services Group at 440-449-6800.

Click here to view Part 1 of our series and learn more about the stock option landscape or Part 2 to learn more about the accounting and tax ramifications of issuing stock options.

What To Do?

As discussed above, there are significant risks that a company brings upon itself if it decides to issue stock options without properly valuing the options and the equity of the company. Rather than issuing stock options, if a company wants to offer an employee the opportunity to obtain an ownership interest, the most efficient and “clean” method may be to allow the employee to purchase shares from the company or from existing owners. There is no valuation requirement in this case (unless a party wants to hire an expert to ensure that they the transaction price is fair and reasonable) which also eliminates the out-of-pocket cost for the employer. In fact, a business actually recognizes a cash inflow when an employee purchases shares directly from the company. 

I am a valuation expert and I directly benefit from work associated with the valuation of stock options, so why am I telling you to consider alternative routes of compensation? Too often, the companies that issue stock options without having them professionally valued are the same companies that will fight against having their options valued at all due to the cost associated with the valuation. I simply want to spread awareness that there are other avenues of compensating employees and giving them opportunities for equity ownership that may be more cost efficient for companies that are under the illusion that issuing stock options does not require a cash outlay.

If you take anything away from this article, remember that issuing stock options is not a “cashless” expense. Consider that there are other alternatives for compensating employees other than using stock options. Remember that there are transaction costs associated with issuing stock options, specifically, hiring a valuation expert, that will create real out-of-pocket cost for any company. Unless you are ready to comply with the valuation requirements associated with issuing stock options, you may be better off simply not using them and compensating employees in another manner. Finally, just like selling a home, if you are going to issue stock options make sure that you bring in an expert to ensure that the value of the company and options are determined and documented appropriately – and be prepared to pay the “commission” for these services.

The information in this article is not meant to represent legal or tax advice. Please consult with a Skoda Minotti business valuation professional or your tax/legal advisor regarding the applicability of these issues to your particular situation.

Visit our web site for more information on our business valuation services. Skoda Minotti is a CPA, business and financial advisory firm with offices in Cleveland and Akron.

Accounting and Tax Ramifications of Issuing Stock Options

 Click here to view Part 1 of our series and learn more about the stock option landscape.

To give you more perspective, first let us review the accounting treatment for the issuance of stock options (rest easy - this will not be too painful). When stock options are issued, an expense must be recorded based on the value of the option. A stock option’s value is derived from a variety of factors, two of which are the value of the stock as of the date of the option grant and the exercise price of the option (the price at which the option holder can purchase a share of stock). Determining the value of a company’s stock is not difficult when it is publicly traded, but privately-held companies do not have readily available market prices, which necessitates the services of a valuation expert. Unless the option is properly valued, a company cannot correctly record the associated compensation expense. If a company is unable to correctly record the results of its operations, it may find obtaining a clean audit opinion to be a difficult, if not impossible, task.

Now that I have warned you about the headaches that you may encounter on the “accounting” side of issuing stock options, let me further alarm you with the tax ramifications. If a company sets the stock option exercise price lower than the fair market value of its stock on the grant date, the stock option could be deemed to be deferred compensation according to Internal Revenue Code 409A. Under 409A, such deferred compensation would be immediately taxable to the employees receiving the grant and subject to regular income tax rates plus 1%. Perhaps even more distressing, a 20% penalty plus interest would also be triggered. In addition, employers would be responsible for withholding income taxes for employees on these types of option grants, which if not done, could result in additional tax penalties. The immediate taxability, penalty and withholding requirements do not apply when the stock option exercise price is equal to or greater than the fair market value of the company’s stock on the grant date. It is impossible to compare the exercise price of a stock option to the fair market value of a company’s stock unless a valuation of the company’s stock has been performed. In addition, when a valuation has been performed to establish the fair market value of a company’s stock, the burden of proof shifts to the IRS to disprove the appraised value. Therefore, unless there is documentation to support the fair market value of a company’s stock near the option grant date, there could be significant tax issues in addition to the accounting issues alluded to earlier.

The information in this article is not meant to represent legal or tax advice. Please consult with a Skoda Minotti business valuation professional or your tax/legal advisor regarding the applicability of these issues to your particular situation.

Visit us tomorrow for Part 3: What to Do?

In the meantime, visit our web site for more information on our business valuation services. Skoda Minotti is a CPA, business and financial advisory firm with offices in Cleveland and Akron.
 

When selling your home, it is common to use an agent to list, promote and show the property. In exchange, you pay a portion of the sales price as a commission to the agent. The benefits of using an agent include: 1) the listing of your home in a database so that homebuyers can access information about it; 2) the agent acting as your middleman during the negotiation process; and 3) the incentive it gives the agent to sell your home quickly (so that her or she can earn their commission). 

Some people choose to sell their home by owner and forego using an agent. These are typically the homes that have “For Sale” signs in their yards for many months, sometimes even years (you know the ones), before they are actually sold. These people often believe that the benefit of not having to pay an agent commission on the sale of their home is worth the prolonged period it will likely take to sell the property. 

What does the choice of hiring a real estate agent or selling your home by owner have in common with private companies issuing stock options? The strange answer is: Much more than many of us realize. 

The Stock Option Landscape

More and more private companies are issuing stock options as part of their key employees’ compensation plans. This may be driven by the ideas that: 1) stock options don’t “cost” anything to the company; 2) stock options will positively influence employees’ performance; or 3) since public companies issue stock options, it must be a good idea and private companies should follow suit. Regardless of the motivation, what most private company owners and executives do not realize is that accounting for stock options, for both tax and financial reporting purposes, may actually have an out-of pocket cost that is greater than the value of the options themselves.

In order to value stock options issued by private companies, there are two major steps that must be undertaken:

1. Determining the value of the company’s equity (which is a key input to valuing a stock option)

2. Determining the value of the stock option

There are not many privately-held companies with the in-house resources or expertise necessary to perform either of the requirements above, both of which are essential in accounting for the issuance of stock options. This often puts accountants in the awkward position of trying to explain to business owners the “unseen” costs and accounting ramifications associated with issuing stock options.

Back to our analogy, hiring a valuation expert to determine the value of stock options is much like hiring a real estate agent to sell your home. A valuation expert is able to perform both of the tasks identified above that are necessary to value the stock options issued by a private company, much like a real estate agent takes care of the necessary steps to sell your home. This work is not free, however, and depending on the complexity of the company and the options issued, the cost to value a private company’s stock options can range in cost from thousands to tens of thousands of dollars. When private companies issue stock options, they often do not consider the “commission” that they will have to pay to a valuation expert to ensure that the options are properly valued. Unlike real estate agent commissions, however, which are based on the sale price of the home, valuation fees are relatively fixed. 

Just like selling a home “by owner,” some companies will issue stock options and try to determine the value themselves (or even worse, not value them at all). By not using a real estate agent, homeowners often find themselves making no headway in the sale of their home. Similarly, by not hiring a valuation expert to value the stock options that they have issued, private companies create the risk that their auditors will not sign off on their financial statements. Maybe even more importantly for business owners and employees, unsubstantiated option values leave both companies and their employees in danger of stiff tax consequences.

The information in this article is not meant to represent legal or tax advice. Please consult with a Skoda Minotti business valuation professional or your tax/legal advisor regarding the applicability of these issues to your particular situation.

Visit us tomorrow for Part 2: The Accounting and Tax Ramification of Issuing Stock Options

In the meantime, visit our web site for more information on our business valuation services. Skoda Minotti is a CPA, business and financial advisory firm with offices in Cleveland and Akron.

This month’s issue of Valuation & Litigation Advisory Insights includes the following articles:

• Lucent Sheds Light on Patent Infringement Damages
• Valuing Pass-Through Entities vs. C Corps
• What’s Behind the Veil? Digging for the Truth in Alter-Ego Cases

Lucent Sheds Light on Patent Infringement Damages

Courts are generally loath to disturb a jury’s verdict on damages. But an appeals court threw out a $350 million patent infringement award that wasn’t supported by substantial evidence. This case illustrates the need for detailed expert testimony, which will establish credible evidentiary facts and conclusions and, thus, support a claim for patent infringement damages.

Click here to read this article.

Valuing Pass-Through Entities vs. C Corporations  

Valuing interests in pass-through entities can be deceptively complex. This complexity stems from a mismatch between the data commonly used to value privately held companies and the tax benefits associated with pass-through entities. But, in recent years, several analytical models have been developed which provide a more accurate picture of a pass-through entity’s economic benefits.     

Click here to read this article.

What’s behind the veil? Digging for the truth in alter-ego cases 

When a plaintiff can’t collect a judgment from a corporation and seeks to obtain it from the corporation’s owners, it may try to show that the corporation and its shareholders lack separate identities — that is, the corporation is the owners’ alter ego. Key factors in determining an alter-ego relationship include not only this lack of separateness, but also financial dependence of the corporation upon its shareholders or parent, and undue influence upon a corporation.

Click here to read this article.

Prior issues are available in the E-Newsletter Archive of our Valuation & Litigation Advisory Services Resource Center. If you would like to subscribe to this free, monthly, business valuation and litigation support e-newsletter, send an email to info@skodaminotti.com.

This month’s issue of Valuation & Litigation Advisory Insights, includes the following articles:

• Struggling Economy Presents Business Valuation Challenges
• Nonpublic Information Considered in Valuing Securities
• Are Valuations Recyclable?

Struggling Economy Presents Business Valuation Challenges     

In bad times, appraisers may face a disconnect between the income and market approaches, creating a wide gap between valuations. The challenge becomes reconciling these differences. This article explains how to approach valuation for both profitable and distressed companies, and notes that the purpose of a business valuation can have a big impact on the valuation methods that are used. A sidebar looks at one case in which a court rejected the uses of the discounted cash flow method by both the creditors’ and the debtors’ experts.

Click here to read this article.

Nonpublic Information Considered in Valuing Securities

In one recent case, a district court held that it was reasonable for a jury to conclude that material nonpublic information possessed by the defendants affected the fair market value of certain securities. The case is significant because it seems to offer a novel interpretation of the phrase "reasonable knowledge of relevant facts" in the definition of fair market value. The decision suggests that even nonpublic information can be a "relevant fact."     

Click here to read this article.

Are Valuations Recyclable?

The paper a valuation report is printed on may be recyclable, but in most cases the content is not. This article points out that recycling valuations poses two major problems: First, the value of a business or other asset can change dramatically over time — in some cases, overnight. Second, a valuator’s methods depend to a large extent on the valuation’s purpose.  The article discusses the problems that can ensue when business owners are tempted to stretch their valuation dollars by using a single valuation for several different purposes.

Click here to read this article.

Prior issues are available at our E-Newsletter Archive. If you would like to subscribe to this free monthly e-newsletter, send an email to info@skodaminotti.com.

This month's issue of Valuation & Litigation Advisory Insights includes the following articles:

• IP Valuation Using the Relief From Royalty Method
• Valuation Critical Under New M&A Rules
• Putting a Price on Technology

Click here to read this article.

Valuation Critical Under New M&A Rules  

Sweeping changes to the accounting rules for mergers and acquisitions (M&A) will start affecting many companies that are closing deals this year. FASB SFAS No. 141(R), Business Combinations, was issued in late 2007, but it applies to deals closing on or after the first day of the first annual reporting period beginning after Dec. 15, 2008. This article explains how many of the changes prescribed in this 358-page document increase the importance of having accurate valuations.      

Click here to read this article.

Putting a Price on Technology

Valuing technology-related intellectual property (IP) can be an enormous challenge for lawyers and valuation experts. It considers the degree of legal protection associated with technology IP as well as the economic benefits a company is expected to derive from that protection. Typically, valuation experts analyze the various economic benefits associated with a technology IP asset separately, and will use different approaches depending on whether  a patent is associated with developed technology, in-process research and development, or future technology. There are a variety of contexts in which the need to value technology IP can arise.

Click here to read this article.

Prior issues are available at our E-Newsletter Archive. If you would like to subscribe to this free monthly e-newsletter, send an email to info@skodaminotti.com.

If you have any questions about any of these articles, post a comment below or please contact our Valuation & Litigation Advisory Services Group at 440-449-6800.

This month's issue of Valuation & Litigation Advisory Insights includes the following articles:

• Constructing a Claim for Lost Productivity Damages
• Marketability Discounts
• Clues Abound

Constructing a Claim for Lost Productivity Damages           

Quantifying the cost of lost productivity when a construction project is disrupted through no fault of the contractor is a difficult challenge. An unanticipated disruption of the project typically causes the contractor to work less efficiently, which can lead to additional labor, equipment and material costs. This article explains that appraisers can use several methods when quantifying lost productivity damages, depending on the particular job’s facts and circumstances and also notes that lawyers and damages experts need to work together closely to establish lost productivity and measure it appropriately.

Click here to read this article.

Marketability discounts: Appraisers relying less on empirical study averages 

With the widespread availability of public market databases, spreadsheet software and other analytical tools, valuators are no longer relying solely on empirical study averages to determine marketability discounts. They’re now placing greater emphasis on how to identify what truly affects marketability and how to better match empirical data to the specific attributes of each subject company. However, though pre-IPO and restricted stock studies may be somewhat under siege, their data is still worthwhile. Research has generated several insightful hypotheses.     

Click here to read this article.

Clues abound: The tax return as an investigative tool

Tax returns can be a highly effective investigative tool in fraud and divorce cases, shareholder litigation, and other situations in which a defendant may have hidden assets. In fact, virtually every page of a tax return can provide clues to hidden assets. Income from wages, taxable refunds of state or local taxes, and retirement plan distributions are just a few of the items on a 1040 that a valuator will review.
 
Click here to read this article.

Prior issues are available at our E-Newsletter Archive. If you would like to subscribe to this free monthly e-newsletter, send an email to info@skodaminotti.com.

If you have any questions about any of these articles, post a comment below or please contact our Valuation & Litigation Advisory Services Group at 440-449-6800.

If you asked my Grandpa what the rate of return on his investments is, he would probably scratch his head and say, “Huh?” The only return that he knows (even though he doesn’t necessarily understand it) is the .5% that he earns on his savings account with the local bank. If you asked my Dad the same question, he might say that he earns a few percentage points per year. His investments are being allocated in a more conservative fashion as he nears retirement. In my case, most of my retirement investments are in equities. My investments have much greater risks than my Dad and Grandpa’s, but they also present opportunities for much greater returns.

Out of my family’s three generations of investments, the “safe” savings account investment of my Grandpa (which could be debated in light of the wave of bank failures over the past year), has the lowest levels of both risk and return. My Dad’s investments have a higher level of risk, but a correspondingly higher rate of return. Finally, my investments have the highest rate of return out of the group, but also the most risk that the return will not be realized (leaving me with less money than I invested).

The concept of risk vs. return is important in the valuation of any business. The lower the risk associated with an investment, the lower the required returns. In contrast, the riskier that an investment is, the higher the return it should provide to an investor. The value of an ownership interest in a company typically moves opposite of the level of risk and required return, as summarized below:

High Risk = High Required Returns = Lower Company Value

Low Risk = Low Required Returns = Higher Company Value

One of the abilities that a valuation analyst brings to the table is his or her ability to determine an appropriate rate of return for an investment in a company. As discussed above, once the rate of return is determined (as a function of the level of risk), it plays a key role in concluding on the value of a business. Keeping in mind the general relationship between risk and return can help anyone better understand the value of a business, regardless of their level of valuation experience. 

Looking for business valuation assistance in Cleveland or Akron? Contract our Business Valuation Group at 440-449-6800 for more information.

This month's issue of Valuation & Litigation Advisory Insights includes the following articles:

• Finding the Appropriate Valuation Standard
• How Valuators Assess the Rising Risk of Fraud
• Lost Profits or Lost Value?

Finding the Appropriate Valuation Standard           

Valuation isn't static and can change depending on the purpose of the valuation. This article looks at the three most common standards of value: fair market, investment and fair. It briefly defines each standard and discusses the circumstances in which one standard may be more appropriate than another. The article points out that identifying the appropriate valuation standard up front can minimize confusion down the road. The goal is to arrive at a reasonable and supportable value conclusion in light of all the surrounding facts and circumstances.

Click here to read this article.

 
How Valuators Assess the Rising Risk of Fraud

The current economic downturn has produced an upswing in incidents of occupational fraud, so it's imperative for businesses to step up efforts to deter and detect it. An important part of the valuation process is identifying potential risks and gauging whether management has taken appropriate action to mitigate those risks. This article explains how valuators evaluate internal controls and corporate culture, tailoring their analyses of fraud risks based on the subject company's size, complexity, industry and goals.    

Click here to read this article.
 

Lost Profits or Lost Value?

Lost profits and lost business value are common measures of damages in commercial litigation. They're also a common source of confusion. What do they have in common? How are they different? Can a plaintiff recover both? This article addresses these questions. A basic understanding of the similarities and differences between lost profits and lost business value can help build a case for business damages or challenge an opponent's calculations.

Click here to read this article.


Prior issues are available at our E-Newsletter Archive. If you would like to subscribe to this free monthly e-newsletter, send an email to info@skodaminotti.com.

If you have any questions about any of these articles, please contact our Valuation & Litigation Advisory Services Group at 440-449-6800.

There are many tales behind the origin of the phrase “rule of thumb”, some of which are more realistic than others. The story that is the most widely accepted is that woodworkers used to use the width of their thumb, rather than rulers, for quick measurements.  Regardless of how the phrase got its start, a rule of thumb is considered to be an imprecise, yet convenient measurement standard. Relying solely on a rule of thumb to value a business, however, can lead to unreliable valuation conclusions.

Rules of thumb used for valuing businesses are often industry specific and are stated as multiples of revenues, EBITDA, net income, or some other metric. Rules of thumb often have their foundation in industry hearsay mixed with multiples derived from actual transactions for similar companies (although which transactions and companies are anybody’s guess). Considering the unprecedented economic environment today, older rules of thumb may no longer be reliable regardless of their predictive power of value in previous years. In addition, rules of thumb often do not take into consideration the profitability of the company being valued, the industry outlook, the depth of management, and many other factors that are considered when a full business valuation is being prepared. Finally, nearly every professional valuation association (if not all of them), does not allow for a rule of thumb to be used as the primary valuation methodology. As a result, relying on a rule of thumb alone to value a business will result in a value that will not be defensible before the IRS or in litigious situations.

Although using a rule of thumb is frowned upon as a primary valuation method, rules of thumb may still be beneficial to business owners and valuation analysts.  For business owners, rules of thumb offer quick and dirty estimates of value that can be useful for high-level strategic planning.  For valuation analysts, rules of thumb can be used a reasonableness check for the value of a company determined by asset, income, and market-based approaches.

The important thing to remember is that a rule of thumb is a great shortcut for a business owner to use to determine the value of his or her company for strategic planning. If a defensible value is required, however, a rule of thumb should be used as no more than a cross-check against the more traditional valuation methods, such as the capitalization of earnings/cash flow method, discounted earnings/cash flow method or private company transaction method.

Looking for business valuation assistance in Cleveland or Akron? Contract our Business Valuation Group at 440-449-6800 for more information.

When you think of a crystal ball, what types of people come to mind? Prophets? Magicians? Shady fortune tellers? While all of these people are associated with the act of attempting to predict the future using a crystal ball, there is another group of people who still today rely on their figurative crystal balls whether they know it or not: business owners.

Every day, business owners must make estimates and guesses about the future of their companies with the intent to position themselves to take advantage of whatever opportunities may arise. Whether through preparing budgets for next year or creating 5 year projections for use in business planning, business owners often need to gaze into their crystal balls and attempt to predict the future.

Getting business owners to dust off their crystal balls is essential during the business valuation process. Owners or management are often hesitant to provide projections or estimates to business valuation analysts, sometimes under the notion that if the analyst has access to the company’s historical financial statements, they have all that they need to properly determine the company’s value. While historical financial statement analysis is a key component of any reliable business valuation, it is the future operating expectations of a company that truly drive its value.

Imagine being presented with the option to invest in either of two companies for the same price. Company A generated $10 million in annual cash flow up to the valuation date, but due to changes in the industry, is only expected to generate $1 million in annual cash flow going forward. Company B only generated $1 million in annual cash flow up the valuation date, but is expected to generate $10 million in annual cash flow going forward due to the development and release of a new product. Which company would you rather invest in? Obviously, considering the limited facts presented, the rational investor would choose to invest in Company B due to its superior operating expectations compared to Company A.

Value is driven by future operating expectations, not historical results. Only in cases in which management’s expectations are that future results will mirror the company’s historical operations can historical results reasonably be relied upon to determine a company’s value. Historical results can also be relied upon to determine the reliability of a company’s projections.

Therefore, if a business owner is in need of a business valuation, it is important that he or she dust off their crystal ball and spend some time thinking about the operating expectations for their company. While none of us can predict the future with any certainty, obtaining some sort of expectation for a company’s future operating results is essential to the development of any properly performed business valuation.

Looking for business valuation assistance in Cleveland or Akron? Contract our Business Valuation Group at 440-449-6800 for more information.

As a kid, baseball and football trading cards were my life. I would absorb the stats on the back of each card and rattle them off at school like it was a homework assignment. I have boxes and boxes of cards that I accumulated over the years, as I am sure that may of you do (if your mom hasn’t tried to throw them away yet). What do baseball cards have to do with the value of your business? More than you think.

Magazines such as Tuff Stuff and Beckett quote estimated prices for nearly every sports trading card available. These prices are representative of what we in the valuation world would call “fair market value”. This is the price at which a willing buyer and a willing seller, with all material facts about the card known to them, would likely transact. A majority of business valuation engagements, including those for IRS gift and estate tax reporting purposes, divorce proceedings, and as directed by many operating agreements, require fair market value to be used as the standard of value. Fair market value typically contemplates that the purchaser is a “financial” buyer (someone who is making an investment in the business with no means to create synergies or other economies of scale), unless certain circumstances dictate otherwise.

When many business owners contemplate the value of their business, however, they often think of a larger company similar to their own paying a premium for their business. The assumption made by the business owner is that the purchaser will be able to recognize certain post-transaction efficiencies, which will allow the acquirer to pay more for the business than a “financial” buyer. This is called “strategic value” or “investment value” (the value to a specific buyer), which is not the standard of value required to be adhered to in many business valuation engagements.

For example, I have a 1994 Kenny Lofton Upper Deck card that has a quoted value of $.10 according to Beckett. Someone who has the entire 1994 Upper Deck set except for the Kenny Lofton card that I own may be willing to pay a premium above the card’s $.10 “fair market value” because that owner can derive additional value by completing their set. This premium price is the “strategic value” or “investment value” to that specific owner, but is not reflective of the card’s “fair market value” in the general marketplace. 

While a business’ underlying assets are the drivers its value, the perspective from which that value is determined can have a significant impact on the final number. When business owners are in need of valuation services, it is important that all of the parties understand what standard of value is being used, whether it is “fair market value” or something different, so that the value of the business is considered in the correct context. 

Looking for business valuation assistance in Cleveland or Akron? Contact our Business Valuation Group at 440-449-6800 for more information.

As I surfed around on the internet the other night searching for Black Friday deals (who goes to stores nowadays, anyway?), I couldn’t help but wonder – how can companies sell products at just a fraction of previously listed prices?  The answer isn’t terribly complicated.  Retailers cut prices to increase interest in products and fan the flame of pent up consumer demand.  This concept, coupled with most businesses being closed on this day, results in stores being flooded with consumers on the “biggest shopping day of the year.”  In doing so, the retailer generates exorbitantly high levels of volume and, in turn, maximizes bottom line profit.  The retailer also expects that it will benefit over the course of shopping season by generating interest and momentum on this all important day.  These are all unique factors that are specific to the consumer environment on Black Friday.  There’s a lesson here that can be applied to the value of your business.  Stay with me…

In any valuation engagement, one of the first questions we ask our client is, “what is the valuation date for our work?”  Trust me, we’re not asking this question just so we can have a date on our report.  This is a hugely important factor not only from an administrative and logistical perspective, but also from a valuation perspective.  To illustrate, consider your 401(k) balance compared to that of 18 months ago.  Most of us have felt the pain of significant dilution of our investment values.  Our share holdings in those investments may not have changed much during that time, but the underlying values have changed significantly due to the economic downturn.  In other words, facts and circumstances change all the time, and with those changes, values fluctuate.

The technical valuation underpinning of the illustrations above is the concept of “known or knowable.”  That is, the valuation analyst can only consider facts and circumstances that were known or knowable as of the valuation date.  This can cause some interesting challenges and conflicts for the valuation analyst.  For example, consider a scenario where the subject company loses its best customer on March 1, 2009.  For the sake of argument, say that this customer provided 85% of the subject company’s revenues, the loss of which eventually sent the company into bankruptcy.  Also assume that the valuation date was February 1, 2009.  By the time the valuation analyst is engaged, the company may be well into bankruptcy proceedings.  However, as of the valuation date (February 1), the company may not have been showing any signs of financial difficulty.  At that time, the now lost customer was generating revenues consistent with historic levels.  Therefore, the valuation analyst cannot consider the fact that the customer was lost at a date subsequent to February 1.  However, the valuation analyst can (and should) consider the substantial risk of having such a concentrated customer base.  As such, most valuation analysts will include an additional risk factor in the discount/capitalization rate (i.e. the risk rate of return for the company).  However, even the application of a very strong risk factor will not bring us to the reality that the company is now worthless.  The fact of the matter is, while the company may be worthless (in bankruptcy) at the time the analyst performs his work, it was probably not worthless at the all important valuation date.

This is just one example of a factor that can highlight the importance of the valuation date.  However, all of the following (among other things) are considered in the same light: economic environment, the industry, capital structure of the subject, financial outlook, and even turnover of key management personnel.  The lesson here is that when you are considering undertaking a valuation engagement, do not take the valuation date lightly.  In can make a huge difference in the results of the valuation analysis.  Like prices on Black Friday, the value of a given company has very much to do with unique external factors that exist as of the valuation date.

Looking for business valuation assistance in Cleveland or Akron? Contact our Business Valuation Group at 440-449-6800 for more information.

‘Tis the season… Whether it was Monte Kiffin of the famed “Tampa 2” defense or Buddy Ryan of the ’85 Bears, NFL defensive coordinators have strived to invent new ways to confuse opposing quarterbacks. Typically they utilize a “base” defensive formation and build upon it by constructing complicated blitzing schemes. While these blitzing schemes are often complex, the “base” defense still must be considered by the opponent. 

Within the valuation arena, much like blitzing schemes, complicated valuation methods are often used to determine a subject company’s value. However, since multiple valuation methods (discounted cash flow, capitalized earnings, private and public company market methods, adjusted net asset, etc.) are available to determine a company’s value, determining the appropriate methodology for an engagement can be confusing. One of the common oversights by parties to a valuation engagement is not considering a floor value when determining the value of a company.

In the event that a company is poorly performing, the present value of its future cash flows may indicate that it does not have much value from an income or market approach. In this event, a valuation analyst should consider whether an adjusted net asset approach would provide a more reliable measure of value. This method (a balance sheet approach) values a business based on the difference between the fair market values of the company’s assets, both tangible and intangible, and its liabilities. The company should not be worth less than the amount that would remain if all the assets were liquidated and the liabilities were satisfied. Therefore, the adjusted net asset method is considered to be a company’s floor value.

No matter how complicated the defensive blitzing scheme, the base defense should always be considered. The same holds true for valuation engagements.   No matter how complicated the valuation methodology may appear to be, the adjusted net asset approach should determine the subject company’s floor value. 

Looking for business valuation assistance in Cleveland or Akron? Contact our Business Valuation Group at 440-449-6800 for more information.

Due to the unprecedented economic conditions of the past year and a half, many companies had to take a challenging look at whether their goodwill was impaired during their last audit or review. For those companies that did not record any impairment of goodwill in 2008, continued economic pressures in 2009 may make avoiding impairment two years in a row a difficult proposition. 

In the whirlwind of goodwill impairment discussions, however, impairment testing for other intangible assets seems to have been thrown on the back burner. When the accounting for many business combinations is executed, intangible assets are also often recorded (customer lists, non-compete agreements, trademarks, etc.), sometimes in excess of the recorded goodwill. Therefore, testing intangible assets other than goodwill for impairment can be just as, if not more, important than testing goodwill for impairment depending on a company’s asset composition.

Part of the reason for the reduced focus on intangible asset impairment testing may be the fact that intangible assets with finite lives are only considered to be impaired if the undiscounted future cash flows associated with these assets are lower than their net carrying values. This is the same “high hurdle” rule that governs whether fixed assets are impaired. As a result, the cash flows associated with an intangible asset typically need to have deteriorated significantly in order for an impairment to be recognized. Keep in mind that indefinite-lived intangibles do not have the same “high hurdle”, undiscounted cash flow test. Rather, the fair value of indefinite-lived intangibles must be determined each year, similar to goodwill, and the intangible would be written down to its fair value if it is determined to be less than its current net carrying value.

The materiality of the assets along with the risk appetite of a company’s auditors will determine the required extent of testing for the impairment of intangible assets. It should be noted that a company’s auditors are not permitted to prepare the intangible asset testing, which would result in the auditors auditing their own work. Rather, the company’s management or a third-party firm must prepare the analysis, which the auditor can then audit. 

Business owners and operators need to keep in mind that increased emphasis will be placed on the testing of intangible assets, including goodwill, during the 2009 year-end audit season. The testing of intangible assets for impairment is something that should be discussed with your auditors sooner rather than later so that a plan of attack can be developed that will address the issue to your auditor’s satisfaction and save any ugly surprises from popping up late in an engagement related to impairment concerns.

Looking for business valuation assistance in Cleveland or Akron? Contact our Business Valuation Group at 440-449-6800 for more information.

Many of us probably remember Harvey Dent, aka “Two-Face,” from our childhoods as one of Batman’s arch enemies. He looked like a normal guy from one perspective, but from the other side, he was a bizarre-looking villain. While normalizing adjustments in business valuation may not be quite as exciting as watching Batman battle Two-Face, they bear a similarity to this comic book character.

The results of many companies as reported in financial statements or tax returns do not always reflect economic reality. Therefore, normalizing adjustments are required when business valuations are performed to present a company’s income statements and balance sheets at their true economic levels, without distortion from accounting rules or the owners’ operational preferences. A company’s value can look completely different after normalizing adjustments have been made – it is almost like spinning Two-Face around to look at one side as opposed to the other. 

For example, an owner may be taking a very large salary in an effort to reduce taxable income and income taxes, effectively eliminating any net income. When employing an earnings-based approach in valuing such a company, a normalizing adjustment would likely be necessary to adjust owner’s compensation downward to an appropriate fair market value, effectively raising net income and the resultant value of the company. 

It is important to note that normalizing adjustments can both increase, or decrease, net income. Another common normalizing adjustment occurs when a related party rents property to the company being valued at a monthly cost lower than the property’s fair market rental value. In this case, the valuation expert would increase the company’s rent expense to fair market value, effectively reducing net income and lowering the company’s value. 

While valuation experts are trained to identify normalizing adjustments through trend analysis and management inquiry, business owners and advisors can make the valuation process run more smoothly by bringing potential adjustments to the attention of their valuation expert. It is ultimately up to the valuation expert’s judgment as to what normalizing adjustments are appropriate for a given company, but when a business owner is prepared to answer questions regarding potential adjustments, it can lead to a more efficient valuation engagement.

Looking for business valuation assistance in Cleveland or Akron? Contact our Business Valuation Group at 440-449-6800 for more information.