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Attorney’s Guide to Financials and
Business Valuations
May 21, 2013
New Orleans, Louisiana
Presented By: Vanessa Brown Claiborne,
CPA/ABV, ASA
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I. Introduction to Business Valuations
II. What to Look for When Reviewing a
Business Valuation
III. Using Valuations in Your Case: Why and
How
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• Business valuation appraisers follow the
following standards and guidelines:
– American Institute of Certified Public Accountant’s
Statements of Standards for Valuation Services
No. 1 (“SSVS”);
– The Appraisal Foundation’s Uniform Standards of
Professional Appraisal Practice (“USPAP”);
– The ethics and standards of the American Society
of Appraisers; and
– The Internal Revenue Service’s business
valuation development and reporting guidelines.
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• Revenue Ruling 59-60
– Outlines the approaches, methods, and
factors to be considered in valuing shares of
stock in closely-held corporations for federal
tax purposes.
• Revenue Ruling 65-192
– Extended the concepts in Revenue Ruling 5960 to income and other tax purposes as well
as to business interests of any type.
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1. Engagement Agreement
2. Checklist
3. Site Visit
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• Rule 201A, Professional Competence, of
the AICPA Code of Professional Conduct,
states that a member shall “undertake only
those professional services that the
member or the member’s firm can
reasonably expect to be completed with
professional competence.”
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• In determining to accept an assignment, an
evaluator considers, at a minimum, the
following:
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Subject entity and its industry
Subject interest
Valuation date
Scope of the valuation engagement
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Purpose of the valuation
Assumptions and limiting conditions
Applicable standard of value
Type of valuation report
– Government regulations
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• Other factors to be considered
– Objectivity and Conflict of Interest
– Independence and Valuation
– Establishing an Understanding with the Client
– Assumptions and Limiting Conditions
– Scope Restrictions and Limitations
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• A basic information checklist includes the following:
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Historical financials of the company
Debt schedule
Schedule of fixed assets
Lease agreements for facilities or equipment
Any existing contracts
List of shareholders with shares outstanding
Budgets or projections
Details on any transactions with a related party
Company documents
Other information including list of locations, customers,
competitors, suppliers, contingent liabilities, and
regulations
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• When performing a site visit, the appraiser
should try to derive an answer to the
following:
– How does the company perceive itself?
• Strengths, weaknesses, prospects, market, etc.
– How does the company see the industry?
• Influential factors, trends, growth, competition, etc.
– Management and management compensation
• Personal expenses, market rate compensation,
etc.
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1. Reasons for a Business Valuation
2. Analyzing Qualitative Factors
3. Valuation Process
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• Merger/Acquisition/Fairness Opinions
• Family Succession Planning/Estate and Gift
Taxes
• Employee Share Ownership Plans (ESOP)
• Buy-Sell Agreements
• Executive Compensation (Options/SARS)
• Stock Repurchase or Recapitalization
• Fair Value Accounting
• Income Tax
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Relevant economic data (Global, National, Local)
Industry factors
Competition
Regulation
Product or service lines
Supplier relationships
Market position
Management and employees
Adequacy of physical facility
Operating efficiencies and inefficiencies
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• National Economic Data
• Regional and Local Economic Data
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Markets
Channels of Distribution
Technology
Sources of Industry Information
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• Existing Competition
• Potential Competition
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• Present Regulation
• Potential Changes in Regulatory
Environment
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Existing Lines
Opportunities for Related Lines
Patents, Copyrights, Trademarks
Relative Profitability of Lines
Service or Warranty Obligations
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• Continuity
• Degree of Exclusivity
• Contractual Relationships
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Reputation
Geographic Scope
Method of Marketing and Distribution
Pricing Policies
Customer Base
Customer Relationships
Market Continuity, Growth Opportunities
and Weaknesses
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Size and Composition of Work Force
Key Employees
Other Employees
Compensation
Personnel Policies, Satisfaction, Conflict,
and Turnover
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Condition
Heat, Light, Plumbing, and Other Systems
Size
Continuity of Occupancy
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• Physical Plant
• Accounting and Other Controls
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• Gather company data
• Site visit
• Research economic and industry
information
• Analyze company financial statements
• Tests of valuation
• Discounts, premiums, and value
conclusion
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• The attorney is responsible for the
following:
– Definition of standard of value
– Determination of applicability of legal
agreements of valued interests
– Decision on who the client will be
– Reading the valuation report and asking
questions
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1.
2.
3.
4.
Fair Market Value
Fair Value
Investment Value
Intrinsic Value
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• 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 arm’s
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 (ASA BVS
definition)
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• Has two different contexts:
– Fair value for legal purposes
• Usually defined by various authorities an statutes
– Fair value for financial reporting purposes
• 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 (FASB ASC 820, formerly SFAS 157)
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• Specific value to a particular investor
based on individual investment
requirements
– This extremely small and limited market is
typically characterized by a premium because
of the unique synergies the perceived
particular buyer would realize as a result of
acquiring the asset
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• Amount an investor considers to be “real”
worth of an item based on evaluation of
available facts; may be above or below fair
market value
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• There are several valuation approaches in
valuing a company:
1. Market approach
2. Income approach
3. Asset approach
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• Previous sales of or offers for the
Company’s stock
• Sales of similar companies
• Sales of stock of publicly traded
companies
• Rules of thumb
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Discounted cash flow method
Leveraged buyout model
Capitalization of earnings method
Excess earnings method
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• Liquidation model
• Net asset value
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Levels of Value
Synergistic Premium
Control Premium/Minority Discount
Lack of Marketability Discount
Layered Discounts or Discounts on Top of
Discounts
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• Reflects the value to a specific buyer
• Synergistic buyer can pay more due to
perceived earnings benefit from a merger
• Not appropriate consideration in
determining “Fair Market Value”
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• Appointment or removal of management or
determination of their compensation
• Setting policy or changing the course of business
• Acquisition or liquidation of assets
• Acquisitions of other companies
• Liquidation, dissolution, sale, or recapitalization of the
company
• Registering the company’s stock for an IPO
• Forcing the sale of the stock of the Company
• Determination of the amount and timing of any
dividends to shareholders
• Amendments to the Articles of Incorporation
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• Securities of privately owned companies
are not readily tradable on an established
exchange and may require a discount for
their lack of marketability.
• Control blocks of stocks are generally
more readily marketable than minority
blocks.
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• When going to the next entity level, does asset
allocation change or can it be changed by the
manager of that entity?
– Probably not.
• When going to the next entity level, does the manager
have the ability to affect performance/timing of sales?
– Probably not.
• Does the manager have the ability and intention to pay
distributions?
– Perhaps
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What if the entity owns other assets in addition to its
investment in the entity?
– Discounts may apply to that portion of the assets.
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• Lack of Marketability exists at all
ownership levels.
• Lack of liquidity is taken into account at
the asset holding entity.
• Is it greater at the Tier 1, 2, etc. level?
– Possibly, if there are distributions or likelihood
of asset liquidation.
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DONOR
$1,333
$2,340
Gift
10% Ownership
TIER 2
$13,333
NAV= $39,336
Distribution
Yield= 50%
$1,333
$2,340
$39,336
(15,931) 40.5% Total Discount
$23,405 x 10% ownership
33.3% Ownership
TIER 1
$40,000
NAV= $198,333
33.3% Ownership
NOI/
DISTRIBUTION
$120,000
ASSET
HOLDING
ENTITY
$1 million
Net Asset Value
$595,000
Less 40.5% Disc.
AHE to Tier 1
$354,000
Less 40.5% Disc.
Tier 1 to Tier 2
$210,000
Less 40.5% Disc.
Tier 2 to Donor
TOTAL DISCOUNT : 78.96%
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$198,333
(80,325) 40.5% Total Discount
$118,008 x 33.3% ownership
15% LOC, 30% LOM
$1,000,000 Real Estate
(150,000)
$850,000
(255,000)
$595,000 x 33.3% ownership
Total Discount: 40.5%
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• Valuation Engagement
– Detailed Report
– Summary Report
• Calculation Engagement
– Calculation Report
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• According to SSVS, a valuation analyst performs a
calculation engagement when
– (1) the valuation analyst and the client agree on the
valuation approaches and methods the valuation analyst
will use and the extent of procedures the valuation analyst
will perform in the process of calculating the value of a
subject interest (these procedures will be more limited than
those of a valuation engagement)
– (2) the valuation analyst calculates the value in compliance
with the agreement. The valuation analyst expresses the
results of these procedures as a calculated value. The
calculated value is expressed as a range or as a single
amount.
• A calculation engagement does not include all of the
procedures required for a valuation engagement
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1.
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7.
The Report
Basic Elements of the Report
Business Valuation Math
Traits to Expect in a Business Appraiser
Premise of Value
Standards of Value
Factors Specific to U.S. Gift and GST
Returns
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Cover of the Report
Math
Signatories
Standards
Assumptions
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Subject entity
Valuation date
Standard of value
Appraisers
Clear indication of value
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• A business valuation goes beyond the
math
• It’s the assessment of a business’s hard
and intrinsic assets to determine its
moneymaking power in the hands of the
same owner or a new owner years from
now
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Independence/objectivity
Confidentiality
Technical competence
Experience
Industry awareness
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• Going Concern
– Value in continued use or as a going concern business
enterprise
• Value as an Assemblage of Assets
– Value in place, as part of a mass assemblage of assets, but not
in current use in the production of income & not a going-concern
business enterprise
• Value as an Orderly Disposition
– Value in exchange, on a piecemeal basis; assumes assets will
enjoy normal exposure to their appropriate secondary market
• Value as a Forced Liquidation
– Value in exchange, on a piecemeal basis; assumes assets will
experience less than normal exposure to their appropriate
secondary market
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• Discussed earlier
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• A gift tax return must meet adequate
disclosure requirements in order for the
statute of limitations to start
• Two ways to meet disclosure requirements
are:
– Description Safe Harbor
– Appraisal Safe Harbor
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• To satisfy this requirement, the following
information is required:
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The financial data used in valuing the interest
Any restrictions taken into consideration
Detailed descriptions of any discounts
For transfers valued using the asset value method:
• The undiscounted FMV of 100%
• The pro-rata portion of the entity subject to the transfer
• The FMV of the transferred property
– For transfers of an entity that directly or indirectly
holds interest in another entity, a detailed description
of the method used to determine FMV.
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• To meet the requirements, the taxpayer
must
– Engage a Qualified Appraiser
– Submit a Qualified Appraisal
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Property Settlement
Squeeze-out of Minority Shareholder
Tax Litigation
Shareholder or Partner Litigation
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Earnings before interest expense, taxes,
depreciation and amortization
Net income
+interest expense on long term debt
+ income taxes
+depreciation and amortization
EBITDA
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• (“TEV”) = equity + long term debt
• Pricing multiple = (Equity + LT
debt)/EBITDA
• Equity = pricing multiple x EBITDA –
LT debt.
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• “Discounting” versus “Capitalizing”
• Components of a Discount Rate
• Relationship between Discount Rates and Capitalization
Rates
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• Discounting is a procedure that converts
an expected future return, or a series of
expected future returns, to a present value
using a discount rate.
• Capitalizing is a procedure that converts a
single flow of returns to an indication of
value.
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• The discount rate is the expected total rate
of return required to attract capital to the
particular investments.
• Components
– Risk-Free Rate of Return
– Premium for Risk
– Premium for Illiquidity
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• The cost of equity, either debt or equity, is
different from one buyer to another.
• For an individual buying a sole
proprietorship from another individual,
each would have about the same cost of
capital.
• For a public company, the cost of capital
would be somewhat less than the typical
small entrepreneur.
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1. Wholesaler
2. Exploration & Production Company
3. Equipment rental
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Wholesaler
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Exploration and Production
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Offshore Service Vessels
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Vanessa Brown Claiborne, CPA/ABV, ASA
vbrown@chaffe-associates.com
Chaffe & Associates, Inc.
201 St. Charles Ave.
Suite 1410
New Orleans, LA 70170
www.chaffe-associates.com
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