VALUATION OF YOUR FAMILY BUSINESS

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VALUATION OFYOUR FAMILY BUSINESS
UT Center for Family BusinessMini-Forum9/25/07
J. Stephen Schult, CPAGilmore, Jasion Mahler,
Ltd.1715 Indian Wood Circle, Suite 100Maumee,
Ohio 43537419.794.2000sschult_at_gjmltd.com
Jeffrey S. Denning, CPA, ABVGilmore, Jasion
Mahler, Ltd.1715 Indian Wood Circle, Suite
100Maumee, Ohio 43537419.794.2000jdenning_at_gjml
td.com
David C. Krock, Esq.Eastman Smith, Ltd.One
SeaGate, 24th FloorToledo,Ohio
43604419.241.6000dckrock_at_eastmansmith.com
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• Why do I need to know
• the value of my business? Steve
• Steps of the valuation process Jeff
• Reasons to have your company
• formally valued Dave
• Questions

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Most Common Standard of Value
Revenue Ruling 59-60 defines fair market value
as 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.
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Common Reasons for Business Valuations

• Mergers and Acquisitions
• Many businesses are overbought
• You need to know at what point to walk away
• Selling Your Business
• Most owners have unrealistic expectations of the
  value of their business
• Divorce/Litigation
• Extreme differences of opinion regarding value of
  the business

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Common Reasons for Business Valuations
continued

• Buy-sell Agreements
• Good buy-sell agreements (BSAs) can help prevent
  future problems/issues
• Gifting of Stock
• Report of a certified appraiser required with
  gift tax return
• Estate Tax/Life Insurance Planning
• The value of a closely-held business is usually
  the largest component of an estate
• Estate taxes could force the sale of the business

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Common Reasons for Business Valuations
continued

• Other
• ESOPs
• Goodwill impairment
• Family limited partnerships
• Stock option plans

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Steps of the Valuation Process

• How
• Why
• Who
• What
• When

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Understand the Reason/Purpose for Valuation

• Who is client?
• Desired outcome
• Who will use/rely on the valuation
• A misunderstanding here would jeopardize the
  assignment
• May not be applicable for a variety of purposes

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Determine the Appropriate Standard of Value

• Fair market value
• Appropriate for
• Estate, gift income tax
• Often in BSAs
• Divorce (but)

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Fair Market Value Considerations

• The nature of the companys business and its
  history since its inception
• The outlook for the economy in general and the
  companys industry in particular
• The financial condition of the company and the
  value of its underlying net assets
• The past earnings and future earning capacity of
  the company

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Fair Market Value Considerations continued

• Prior transactions involving the companys stock
  and the size of the block to be valued
• The ability of the company to distribute earnings
• Whether the company has goodwill or other
  intangible value
• The price of stock actively traded in a free and
  open market for comparable companies in the same
  or similar line of business

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Determine the Appropriate Premise of Value

• Going concern value, or
• Liquidation value (piecemeal)
• Orderly (time to maximize), or
• Forced (auction)

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Determine the Subject Interest to be Valued

• Common stock
• Preferred stock
• Nonvoting stock
• General partner/managers interest
• Limited partnership interest
• Assigned interest

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Determine the Subject Interest to be Valued
continued

• 100 controlling interest
• Degree of control
• Review BSAs
• Other restrictive agreements
• Again, avoid misunderstandings

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Analyze the Companys Financial Information

• Cash flow analysis is key
• Enterprises cash flow or
• Cash flow to minority owner
• Normalizing adjustments
• Addback owners compensation and perks
• Rent if above market rate

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Other Information

• Site visit, interviews
• Industry research market customers
• Guideline public companies
• Comparable transactions

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Other Information continued

• Consolidators
• Private equity groups
• Economic outlook
• Competition

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Consider Valuation Approaches Methods

• Income approach
• Market approach
• Asset approach

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Income Approach

• Most appropriate for businesses anticipating
  future earnings
• Cap of cash flows method, or
• DCF (discounted cash flow) method
• Historical results analyzed adjusted to help
  estimate future cash flow
• Investors buy tomorrows cash flow
• Cap rate or multiple

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Market Approach

• Market approach appropriate for all types if
  comparable and sufficiently similar in purpose
  and circumstance
• Apply guideline company multiples (adjusted) to
  subjects cash flows, or
• Comparable deals, or
• Bona fide offers, or
• Past transactions in subjects stock

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Market-based Approach Guideline Public Company
Method

• Finding sufficiently similar public companies
• Comparison to subject company
• Application of valuation multiples (adjusted)
• Pro- specifically referred to in Rev. Ruling
  59-60
• Con- difficult to find adequate sample

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Market-based Approach Merger Acquisition
Method

• Actual sales of comparable companies
• Useful for valuations of controlling interests
• Not as useful for minority interests
• Difficulty in quantifying minority discount
• Uncertainty over motivation of parties

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Market-based Approach Past Transactions

• Actual arms length sales within a reasonable
  time before or after the valuation date are the
  best criteria of value
• Such transactions are rare yet should always be
  investigated

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Asset Approach

• Most appropriate for
• Asset holding companies
• Real estate entities
• Marginally profitable businesses
• Purchase accounting

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Asset-based Approach Liquidation Value

• Business is worth more dead than alive
• Floor value for controlling interests
• May not be applicable for minority interests who
  do not have the power to cause liquidation

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Reconcile Various Indications of Value from
Approaches

• Adjust in reconciling
• Average methods or
• Select most appropriate

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Apply Discounts or Premiums

• Lack of control
• Lack of marketability
• Lack of liquidity (controlling)
• Depends on method used to arrive at value
• Key person discount

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Benefits of Control

• Appoint or change management
• Determine compensation and perquisites
• Set operational and strategic policy
• Liquidate, or recapitalize the company
• Register companys debt or equity for an IPO

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Lack of Marketability

• The level of discount to be applied to a specific
  interest is dependent on many factors. Some of
  those factors include
• Expected appreciation
• Dividend capacity
• Probable holding period
• Prospects for liquidity

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Lack of Marketability continued

• Degree of control in the block of stock
• Restrictions on the transferability
• Companys stock redemption policy

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Write Report

• Levels of service
• Reports
• Oral Report
• Testimony

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Levels of Business Valuation Services

• Complete Appraisal
• A complete appraisal complies with binding
  USPAP standards. Also complies with any ASA and
  other organizations standards.
• Normally includes 15-20 pages of text and 5-10
  pages of financial statements.

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Levels of Business Valuation Services continued

• Complete Appraisal continued
• Includes the site visit, interviewing management,
  searching for guideline companies, might require
  real estate or equipment appraisal (extra cost).

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Levels of Business Valuation Services continued

• Complete Appraisal continued
• Commonly used for assistance in acquisitions,
  large divorce cases and for major assets in
  estate or gift returns.

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Levels of Business Valuation Services continued

• Calculation
• The objective of a calculation is to provide an
  approximate indication of value based upon the
  performance of limited procedures agreed upon by
  the appraiser and the client.
• A calculation is not an appraisal. USPAP
  standards do not apply.
• Usually includes an income approach and a cover
  letter. May include an adjusted balance sheet.

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Levels of Business Valuation Services continued

• Calculation continued
• Most of the effort centers on financial
  calculations and analysis
• Occasionally used in divorce if the numbers are
  very small. May be used in a buy-sell agreement.
  Commonly used for small gift tax returns.

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• QUESTIONS ?

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6 Reasons To Have Your Company Formally Valued

• Assist owner with determination to sell or
  transfer business
• Consideration of corporate structure to
  effectuate efficient transfer of assets to next
  generation and at the same time maintain control
• Ownership disputes following transfers
• Buy-sell agreements
• Business planning
• Employee retention

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Assistance with Determination to Sell or Transfer

• Why sell?
• No successors
• Lack energy, desire or drive to continue
• Deliberate control of family net worth
• Freeze techniques

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Corporate Structure Considerations Control

• Maintaining control may be important
• Valuation discounts
• What to do when plan isnt working

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Ownership Disputes Among Existing Owners or
Following Transfers

• Predetermined terms
• Employee shareholders vs.
• non-employee shareholders

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Buy-Sell Agreements

• Forms - Entity purchase agreements
• - Cross purchase agreements
• - Wait and see
• Liquidity - Insurance considerations
• Agreement price vs. estate or gift tax value
• How to set price
• - Annually agreed on value
• - Formula
• - Appraisal annually
• - Appraisal upon trigger event

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Business Planning

• Employee retention
• Retention of key employees
• Stock options
• Phantom stock options
• Direct sale of shares
• Future acquisitions of shares

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• QUESTIONS ?