Valuation Strategies - 2020

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Equity Compensation Valuations (IRC 409A)

IRC 409A valuations are uniquely relevant to private companies since public companies have traded market prices that determine the fair market value of the stock used to set the option exercise price. 409A valuations determine the fair market value of the common stock to price options on common stock and should come from qualified and independent appraisers. The IRS defines fair market value as the price at which a willing buyer and a willing seller, both under no compulsion to buy or sell, each with sufficient knowledge enter into a  transaction to buy or sell an asset. As a  company reaches its milestones, the periodic nature of these valuations ensures that the business’s fair market value is accurate and up to date. 

Financing - SBA Loans

We determine the fair market value of your company for the purpose of securing a loan from a private lender, bank, or SBA (A) rules and regulations.

Exit Planning

We determine the fair market value of your company for the purpose of ESOP transactions in compliance with Departement of Labor and Internal Revenue Service.

Gift & Estate Valuations

Estate planning is not just about minimizing taxes, it gives you control over how your assets are to be passed down to your heirs. A clear and concise plan is crucial, which means you need a well-executed valuation.


Estate and gift taxes are levied by the federal government on property transfers from one person to another at death (estate tax) or while the giver is alive (gift tax). Several states also impose estate taxes.


Due to the heavy scrutiny imposed by the IRS and regulators, it is vital to value a business or other property that may be needed for estate planning purposes to determine the probable amount of estate or gift taxes as an aid in planning before the death of a business owner. Valuation of a business, business interest, or other property owned by the estate of a deceased person is often necessary to prepare and file an estate tax return.


Portfolio Valuations (ASC 820)

Portfolio valuations are a necessary step in running a fund, especially when there are limited partners involved. In our experience, there are benefits for everyone. US GAAP, for one, requires fair value measurement in financial reporting. Limited partners rely upon accurate estimates of value for their illiquid investments. And fund managers gain a third-party perspective on valuations that can assist them in allocation, risk assessment, and the monitoring of their holdings.

Under ASC 820, private equity funds, venture capital funds, hedge funds, pension funds, and other institutional investors must periodically report the values of their portfolio investments to their investors. Although many asset managers can perform this “mark to market” analysis themselves, many investors, funds, and regulators commonly prefer to use an independent valuation firm to prevent the appearance of a conflict of interest.

Purchase Price Allocation Services (ASC 805)

Business owners are often expected to complete a PPA for tax and financial reporting purposes after completion of a successful acquisition. For tax purposes, both the buyer and the seller must report their understanding of the PPA and assure they each report the same fair market value information since the IRS audits both parties. For financial reporting, assets acquired and liabilities assumed must be marked to market following the laws of the relevant jurisdiction (typically GAAP or IFRS) to allocate the purchase price amongst the tangible and intangible assets acquired, including goodwill.

Valuation Basics - 2020

The Basics of Business Valuation

Business valuation is similar to valuing your home for sale. We obtain market comps, and we look at the particular enhancements to value such as high-quality equipment and the high volume of cash flows to the owner. 

Value of Revenues

We look at the value of top-line revenues before expenses and compare those to the marketplace to see what other buyers have paid in the same or similar industry as your company.


To do this, we use a company called Deal Stats,  which is a privately managed database of completed transactions. Information in this database comes from business brokers. We may also consider the Business Reference Guide published by Business Brokerage Press.


You may be able to find similar information in journals and articles that are specific to your industry. 


If you have a business for sale all us today for a business valuation or business and management consultant services.

Value of Cash Flows

We look at the bottom-line cash flow after expenses to compare those to the marketplace to see what other buyers have paid in the same or similar industry as your company.


To do this, we use a company called Deal Stats, which is a privately managed database of completed transactions. Information in this database comes from business brokers. We may also consider the Business Reference Guide published by Business Brokerage Press.


When valuing cash flows, we also use a direct build-up method where we compare the risk of investing in your company to the risk of investing in other assets such as U.S. Government treasuries, large company stock, and small company stock. The risk variable increases at each level until we get your company, which is likely much riskier than a publicly-traded stock.


You may be able to find similar information in journals and articles that are specific to your industry. 


Call us today for an overview or a deep dive into the value of your company.

Value of Business Goodwill

Can you leave the company for several days or weeks and have it run quite well by itself?  The time you can spend away is an important consideration in valuing a company. The more time you can spend on the beach, in the mountains, or traveling, the higher the overall value of your firm.

  

Non-Compete and Personal Goodwill

Our two-column analysis of goodwill reveals the percentage of significance or presence of (1) enterprise goodwill and (2) combined personal goodwill and non-compete agreements. 


Historically, it was said in Florida courts of law, “if there is a non-compete, there is no enterprise value.” That statement is an affront to anyone who has bought or sold a medical practice, CPA firm, or law firm. Professional practices are bought and sold daily, which means business valuation analysts should quantify the limited breadth and scope of personal goodwill, lest we short change the non-moneyed spouse.


Asset Approach - How to Value a Business

Adjusted Book Value Method

A method within the asset approach whereby all assets and liabilities (including off-balance sheet, intangible, and contingent) are adjusted to their fair market

values.

Income Approach - How to Value a Business

Income-Based Approaches to Business Valuation

A general way of determining a value indication of a business, business ownership interest, security, or intangible asset using one or more methods that convert anticipated economic benefits into a present single amount

Capitalization of Benefits Method

A method within the income approach whereby expected future benefits (for example, earnings or cash flow) for a representative single period are converted to value

through division by a capitalization rate.

Discounted Cash Flow Method

A method within the income approach whereby the present value of future expected net cash flows is calculated using a discount rate.

Discounted Future Earnings Method

A method within the income approach whereby the present value of future expected economic benefits is calculated using a discount rate.

Market Approach - How to Value a Business

Market-Based Approaches

A general way of determining a value indication of a business, business ownership interest, security, or intangible asset by using one or more methods that compare the

subject to similar businesses, business ownership interests, securities,

or intangible assets that have been sold.

Guideline Public Company Method

A method within the market approach whereby market multiples are derived from market prices of stocks of companies that are engaged in the same or similar lines

of business and that are actively traded on a free and open market.

Merger and Acquisition Method

A method within the market approach whereby pricing multiples are derived from transactions of significant interests in companies engaged in the same or similar

lines of business.

Guideline Company Transactions Method

A method within the market approach whereby market multiples are derived from the

sales of entire companies engaged in the same or similar lines of business.

Liquidity and Marketability - Get it Right

Marketability - IRS Guidance

The Uniform Standards of Professional Appraisal Practice (USPAP) Standard 9 (v) states in part, “In developing an appraisal of an interest in a business enterprise or intangible asset, an appraiser must identify the extent to which the interest is marketable and or liquid.


Subsequently, over several decades, the business appraisal industry conducted dozens of studies and came up with dozens of methods indicating discount rates ranging from 10% to 70% (see Mandelbaum case shown next). This wide percentage range, when applied to a $1m valuation results in a nonsensical discount of between $100,000 and $700,000. 


To combat this silliness, in 2009, the IRS issued a one-hundred sixteen-page Job Aid for IRS Valuation Professionals in which they state, “ Report reviewers frequently see the use of DLOM studies inappropriately. What follows is the sample report language to use when these situations are encountered:”


a) Use of Pre-IPO studies to support DLOM    

b) Use of simple average or median from Restricted Stock Studies

c) Use of analytical study results without getting behind the data

d) Use of study results not supported by market data

e) Reliance solely on court decisions


Notably, the use of a DLOM of any size to an estate tax return is widely known to be an automatic IRS audit flag. As such, Gillmore Accounting Practice, P.L. uses the defensible and transparent direct-cost approach to calculating discounts for liquidity and lack of marketability.  

Marketability - Mandelbaum Factors

Appraisers are encouraged to consider the “Mandelbaum factors” when quantifying the difficulty (cost) of liquidating or transferring an investment in a subject company. In Mandelbaum v. Commissioner, a 1995 Tax Court case, Judge Laro dealt with opposing experts whom each relied on empirical studies most often cited by appraisers. Mandelbaum sought a 70% discount while the IRS came up with 30%. Ultimately, Judge Laro came back with company-specific factors that he thinks should be considered by the appraiser to adjust the averages found in benchmark studies.  


Those nine factors are shown here:

· Financial statement analysis

· Dividend policy

· Nature of the company (history, position in the industry, economic outlook)

· Company's management

· Amount of control in the transferred shares

· Restrictions on transferability of stock

· The holding period for stock

· Company's redemption policy

· Costs associated with a public offering


The result of the Mandelbaum analysis – The Mandelbaum analysis is useful to understand the economic cost drivers of going public, but it provides no dollar-value for micro-sized firms that are not contemplating a public offering. As with the empirical studies relied on by the IRS and other litigants, the blind use of Mandelbaum factors fails to reveal a transparent dollar value/ cash outlay. 


Ultimately, management time or broker fees, accounting fees, and legal fees are the economic costs most likely to be incurred in the sale of micro-sized firms such as those found frequently in a divorce setting. As such, Gillmore Accounting Practice, P.L. uses the defensible and transparent direct-cost approach to calculating discounts for liquidity and lack of marketability.


Comments on the Empirical Studies

Appraisers who cite empirical studies are guessing at the liquidation or transfer cost of a subject company. Experts will say, “this is the prescribed method adhered to in our profession” while failing to correlate any of the empirical studies to the subject company specifically. 


All of us should know that the empirical studies most often cited are based on  (1) pre-IPO activity versus market price, and (2) Restricted Stock price versus market price during the required holding period (see 17 CFR § 230). 


Most business appraisals in a divorce context are neither pre-IPO nor subject to SEC holding-period restrictions. With that in mind, how can we rely on a marketability percentage discount from those studies? 

     

Those often-cited empirical studies date back more than five decades to 1966 when the 17 CFR § 230.144 holding period was two years. The holding period decreased to one year as of February 2008 and is currently at six months. The appraiser should ask themselves, “do any of the earlier studies make sense in today’s economy” and, “how relevant is each study to the subject entity?”


At a minimum, the appraiser should consider the empirical studies that reflect a holding period similar to today's market place, such as the following.


Harris/TVA study  2007-2008 18.1%

FMV Opinions Study 1980-2010 20.7%

Pluris DLOM Study 2001-2012 22.4%

SRR Restricted Stock Study 2005-2010  9.3%

Average 17.6%


Ultimately, however, the dollar value of any estimated percentage should “make economic sense” when compared to the actual costs that can be reasonably estimated, such as management time or broker fees, accounting fees, and legal fees.  Refer to the 116 page IRS job aid and search for the term “sense.”


For transparency, the appraiser should identify the actual costs specifically, as shown next.

Liquidity and Marketability - Actual Costs

Actual Costs

The expected dollar costs of marketability and liquidity in a small non-publicly traded firm come from:

     · Accounting fees

     · Broker fees

     · Legal fees

     · Management time

     · Present Value discount from time to sell, i.e., six to twelve months

Accounting Fees

The cost of getting a company’s books cleaned up to pass a due-diligence inspection can be reasonably estimated based on company size, history of business use of personal funds, history of audits, or lack thereof, history of CPA firm overseeing the books. · $350 per hour (estimate) 

Broker Fees

The most common way to calculate broker fees on micro-size to mid-market M&A firms is known as the Modern Lehman, which estimates broker fees as follows:


     · 10% of the first $1 million, plus

     · 9% of the second $1 million, plus

     · 8% of the third $1 million, plus

     · 7% of the fourth $1 million, plus

     · 6% of the fifth $1 million, plus

     · 5% of the sixth $1 million, plus

     · 4% of the seventh $1 million, plus

     · 3% of everything above $8 million

Legal Fees

The cost of drafting and reviewing letters of intent, purchase agreements, and transfer agreements can be reasonably estimated based on company size and complexity of ownership structure, and degree of control for the subject shareholder or partner.  $550 per hour (estimate)

Owner's Time

The owner of a small firm will spend a reasonable amount of time getting the books in order and communicating with attorneys and accountants to prepare for the sale or transfer of company assets or stock. The amount of time can be reasonably estimated based on the company size, record-keeping practices, and complexity of ownership structure.  $750 per hour estimated value 

Present Value Discount

The time horizon to sell the business is estimated to be twelve months. Business owners require compensation for the inconvenience of waiting for the sale to occur even though revenues continue to flow up until the time of sale. We calculate a 2% safe-return for this inconvenience. 

Valuation Terms to Know

Symbol of American Institute of Certified Public Accountants (AICPA)

Types of Valuation Engagements

The AICPA Statement on Standards for Valuation Services (SSVS-1)defined terms that you should be aware of when looking for appraisal estimates and communicating with business valuation professionals.

Engagement To Estimate Value

Refers to an engagement or any part of an engagement (for example, a tax, litigation, or acquisition-related engagement) that involves estimating the value of a subject interest.

Fair Value

For financial reporting purposes only, 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.

Fair Market Value

The price, expressed in terms of cash equivalents, at which property would change hands between a hypothetical willing and able buyer and a hypothetical willing and able seller, acting

at arms length in an open and unrestricted market, when neither is under compulsion to buy or sell and when both have reasonable knowledge of the relevant facts.

Going Concern Value

The value of a business enterprise that is expected to continue to operate into the future. The 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.

Liquidation Value

The net amount that would be realized if the business is terminated and the assets are sold piecemeal. Liquidation can be either “orderly” or “forced.”

Service Area

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Florida - 2020

 We travel to your home or office to provide business valuation and management consulting services throughout central Florida. 

Pacific Northwest - 2020

We travel to your home or office to provide business valuation and management consulting services in Seattle, Washington  Portland, Oregon,  and Boise, Idaho.

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Gillmore Accounting Practice

2431 Aloma Avenue, Winter Park, Florida 32792, United States

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