| EXECUTIVE
SUMMARY |
 A
CPA/VALUATOR PLAYS A PIVOTAL ROLE in
merger and acquisition (M&A)
engagements. He or she helps to organize
the transaction, mitigate trouble spots,
establish an objective marketplace value
for a client’s business and
structure the deal along with attorneys,
appraisers, bankers, financiers and
regulators. A
BUYER’S VALUATOR enters the
process early and researches purchase
opportunities, which include publicly
held and privately held companies,
divestitures from diversified companies,
purchases of partial or minority
interests, liquidations of assets and
venture capital investments.
THE THREE MAIN
APPROACHES to valuing businesses
are the market approach (what other
people have paid for similar businesses),
the asset-based approach (what the
equipment and real estate are worth) and
the income approach (how much money a
buyer could make from the business). Each
one has tangential considerations.
A TARGET MIGHT WANT
TO SELL if it lacks management
successors or needs to create liquidity
for an estate. A large company making a
divestiture—which can happen quickly
once a decision is made—usually is a
motivated seller.
CPAs ALSO PERFORM DUE
DILIGENCE, tax planning,
preparation of pro forma financial
statements, analysis and financial
projections. The trajectory of a BV
engagement offers practitioners service
opportunities at several junctures.
A MAJOR OBJECTIVE IN
STRUCTURING A DEAL is to create
a transaction that appears to meet the
seller’s price expectations, on
terms and within constraints that are
suitable to the buyer. The price will not
matter if the terms are right for the
buyer.
|
| GARY R. TRUGMAN, CPA/ABV, is a
principal of Trugman Valuation Associates
Inc., a firm specializing in business
valuation. He is the author of Understanding
Business Valuation and A
CPA’s Guide to Valuing a Closely
Held Business, both published by the
AICPA. Mr. Trugman lectures nationally on
BV topics. |
CPA/valuator familiar with merger and acquisition
(M&A) transactions can be a tremendous asset
to a client, bringing into focus facts that help
bridge the needs of both buyers and sellers. To
perform business valuation in M&A, you work
with management to research and analyze
information, prepare reports and advise on the
pros and cons of different choices. Besides
establishing an objective marketplace value for a
client’s business, you organize the overall
process, mitigate trouble spots and structure the
deal along with attorneys, appraisers, bankers,
financiers and regulators. Both buyers and
sellers hire teams of several professionals to
represent them, and the cast of characters can be
quite large. In BV, CPAs also perform due
diligence, tax planning and preparation of pro
forma financial statements, analysis and
financial projections.
This article describes what a
CPA/valuator does in the M&A valuation
advisory process from the earliest
point—primarily from the buyer’s
perspective. In doing so, it reveals junctures at
which different types of CPA skills come into
play. CPAs who want to develop BV skills need
training and credentials, available from a number
of sources (see “Train
to Be an ABV” and
“Resources”).
THE
BASICS
A buyer needs to be clear about what it hopes to
gain in a merger or acquisition. As valuator for
the buyer, your role may require you to work with
the client to refine its goals and develop a
well-defined set of criteria for suitable
candidates (see “Buyer’s Analysis Checklist”). Screening for the right target
is like pouring specifications into a giant
funnel—you start with a universe of all the
businesses in the marketplace and gradually
narrow the number to a few and then to one that
meets the client’s objectives.
| Buyers may commission a
CPA/valuator as soon as they decide to
acquire a business, or they may call in
help later. Sellers might not use one
until they get an offer. The order and
degree of effort may vary, but
here’s what you would do in a merger
or acquisition. |
| In this
article, the terms valuator/intermediary/adviser,
buyer/acquirer and
seller/target are used
interchangeably. |
|
Identify an acquisition target.
Find out whether it’s
interested.
Perform an in-depth analysis and
review.
Price the transaction.
Structure it (as a merger,
acquisition or asset swap, for example).
Negotiate the final terms.
Obtain financing.
Close the deal.
If a buyer already knows the
acquisition candidate, it may prefer to go it
alone. If not, the CPA/valuator can provide the
client with strategic information, sources of
capital, staff to dedicate to the project,
independence from in-house political
considerations and enough distance to preserve
anonymity during initial overtures. Brokers may
offer a range of prospective sellers too, so many
companies use brokers to identify deals and
advisers such as CPAs to analyze them.
| CPA/valuators charge on a
contingent, fixed-fee, hourly or per diem
basis or some combination. They find out
the scope of services the client wants
and specify the basis on which fees will
be paid and whether the arrangement is
exclusive. They draft an engagement
letter that spells out the details and
clearly defines “transaction
value” (which likely will determine
the amount they are paid). Contingent
compensation by itself can create a
conflict of interest for a seller’s
intermediary, influencing it to recommend
closing a deal too quickly. THE
HUNT
Once you know what the client wants to
accomplish, your next step is to discover
what businesses are available and rate
their suitability. There are a number of
ways to go about it.
|
 A Growing
Niche
In 1997
the number of ABV credential
holders was 520; at fiscal
yearend 2001, that number had
increased to 1,438. Source: AICPA.
|
|
Acquisition
leads. Investment opportunities
include publicly held and privately held
companies, divestitures from diversified
companies, purchases of partial or minority
interests, liquidations of assets and venture
capital investments. You can start an acquisition
search by consulting Moody’s, Standard &
Poor’s and D&B; industry publications
such as trade association directories and product
catalogs; company data such as annual reports and
SEC filings; online databases; and people
including management, sales staff, industry
specialists and others knowledgeable about
potential areas.
Databases. Most
companies are closely held, so buyers’
intermediaries use databases to identify targets.
Databases don’t necessarily have information
on the same companies, and because industrial
classification codes differ among them, data may
be organized differently for the ones they list
in common. Databases are good for early
screening, but none is perfect. Compensate by
using several. Sites such as masource.org and BVMarketData.com offer extensive leads.
Candidates. Once
you provide your client with a manageable pool of
candidates, you must rank their overall
desirability. To value essential criteria, use a
weighting system, assigning points for factors
such as a target’s main business,
geographical concentration of sales,
transportation access, reputation, sales volume,
profitability and other important features. For
example, a chemicals manufacturer that needs
storage terminals would give more points to a
facility close to a preferred rail line than to
one less desirably located.
Purchase price. This
of course depends on the individual target, where
it is in its life cycle and the health of its
industry. In general, companies sell for a
percentage of annual sales volume. For a
manufacturer this might be 30% of sales, and for
a service business, it might be 100% of sales.
Whatever the amount, the buyer should be prepared
to put down at least 20% to 25%. Transaction
costs can add more than 5%, and the buyer will
incur significant closing costs even if the deal
derails.
Regulations. Most
transactions are subject to some degree of
regulation. For smaller ones, that may consist of
little more than filing property-transfer deeds
and income tax forms. More complex deals may be
subject to the scrutiny of the SEC, Federal Trade
Commission and state or industry regulators. Be
aware of which regulations apply. (For more
information, see “Looking
at Mergers the Way Federal Regulators Do,” JofA,
Dec.99, page 59.)
| Buyer’s
Analysis Checklist
CPA/valuators
can use answers to this set of
questions as a starting point
to clarify the acquirer’s
present position and future
goals.
|
|
ANGLE OF APPROACH
It’s best if a mutual contact can introduce
you to the target’s owner. If not, you must
make contact very discreetly to ask whether he or
she would consider a sale; in many closely held
businesses, the person running the company has
devoted his or her life to it and doesn’t
want to feel vultures are circling overhead.
Publicly held companies always are careful about
M&A discussions, since the information must
be disclosed. All companies will be concerned
that rumors of a potential sale could disrupt
business, affect their stock price and be misused
or misinterpreted by customers, employees,
suppliers or competitors.
Before making an overture, you
should have reason to believe the target might
want to sell. Conditions such as a lack of
management successors or a need to create
liquidity for an estate are good indicators. A
large company that wants to divest certain
assets—which can happen quickly once a
decision is made—usually is a motivated
seller.
OPEN
WIDE AND SAY AHH…
Once the two businesses are at the table, you
need to confirm the target’s financial and
operational health (see “Profile
the Target”). This
is the due diligence phase—the essential
in-depth analysis that’s the platform for
negotiating final terms.
Before the acquirer performs
due diligence, it frequently will issue a
nonbinding letter of intent. This preliminary
agreement describes the buyer-seller
understanding on a number of important features
such as the bid price; the potential structure of
the deal (purchase, merger, stock or asset
transfer); the timing of due diligence and the
closing; the acquirer’s financing; and the
responsibility for fees and expenses. Although
buyer and seller invariably modify it as
negotiations continue, it’s the basis for
the transaction and keeps both sides moving in
the same direction.
Proceed to due
diligence. The different types of
due diligence performed in M&A engagements
include financial, operational and legal. During
this stage, your role as CPA/valuator is to
Identify items that could
break the deal (hidden liabilities).
Verify the accuracy of the
seller’s information.
Obtain a detailed understanding of
the business.
Develop information that will be
vital to negotiating the transaction, obtaining
financing, getting board approval, establishing
the tax and accounting basis of the assets and
integrating the acquired entity into the
buyer’s business.
In due diligence the
CPA/valuator searches for sufficient information
to enable the buyer to decide whether to complete
the transaction. You look for details about
appraisals, contracts, customer information, loan
agreements, accounting and other important
data—such as proprietary technology or
processes in the industry, exclusive contracts
with suppliers or customers and ISO 9000
approval. If you have questions about technical
issues such as environmental problems or pension
obligations, you may have to bring in qualified
experts to review those areas. You also may
recommend the buyer bring in auditors to review
the financial statements.
Be discreet. To
complete the due diligence process, you’ll
spend time in the seller’s workplace. Keep a
low profile. The target’s management is one
of the most overlooked assets in an acquisition
(often harder to obtain than investment
financing), and preventing needed employees from
bolting is important to a deal’s viability.
Staff members who learn their company is being
sold often assume they’ll be out of work
when the sale is complete. Talk about the
company’s plans only to those who need to
know. (Note: Management of a publicly
held company cannot protect its privacy by
deceiving the public about whether it is for
sale.)
| Sometimes a seller forbids
inquiry into certain areas, particularly
during preliminary due diligence. If the
information can wait, fine. But if a
target is unwilling to provide it even
later on, advise the acquirer to walk
away from the deal. It isn’t unusual
for a seller to have a prospective buyer
sign a confidentiality agreement before
it shares company data. It may even
insist on the return of all materials,
including notes and copies of documents,
in the event the transaction falls
through. It’s important not to sign
anything that can’t be honored.
Both sides
may need reassurance. A
detailed due diligence program can be
costly. Besides out-of-pocket expenses,
there’s the time it takes personnel
to provide and review information. For
that reason, buyers or sellers sometimes
require breakup fees to reimburse them in
the event the other party withdraws. To
discourage nonserious buyers, sellers
often ask buyers for a nonrefundable
deposit as evidence of good faith.
Conversely, some buyers may demand a
commitment fee from the seller after
signing a letter of intent. There
aren’t any set rules about this.
If you’re working
for the target company, perform due
diligence on the buyer, as well. The
seller needs to confirm the buyer has the
financial capacity and strategic
incentive to purchase the company. Look
at a buyer’s financial statements,
interview its senior management to get a
feel for its character and motives, and
tour the buyer’s facilities.
FINALLY…THE
PRICE
The standard definition of fair
market value is the cash price at
which property changes hands between a
knowledgeable buyer and a seller under no
duress. Valuation methods set price expectations,
but a business is worth only as much as
somebody is willing to pay for it. Price
ultimately depends on the negotiating
skills of the buyer and seller. The
process described so far is the
groundwork CPA/valuators use to find a
solid basis of value for the businesses
in play.
|
| Train to Be
an ABV Business
valuation (BV) and litigation
services are among the fastest
growing, most important
consulting services offered by
the top 100 accounting firms,
says a recent survey in Accounting
Today, and CPAs should
consider how to participate in
them.
When
a BV expert testifies before U.S.
Tax Court Judge David Laro, his
first consideration is the
expert’s qualifications.
Judge Laro says a CPA who intends
to practice BV should get the
credentials, education and
experience that impart
credibility. The AICPA’s
Accredited in Business Valuation
(ABV) designation is such a
credential. CPAs who get it learn
about valuations for mergers and
acquisitions, marital
dissolutions, estate and gift
taxes, damages litigation,
employee stock ownership plans
(ESOPs) and many others.
The
AICPA’s two core
courses—Fundamentals of
Business Valuation, Part I
(FBV-I) and Fundamentals of
Business Valuation, Part II
(FBV-II)—provide in-depth,
rigorous training. It’s best
to take FBV-I prior to FBV-II.
Each three-day course is taught
by valuation professionals and
offers interactive participation.
FBV-I
is an overview of the valuation
process, including the issues
associated with defining the
interest to be valued, the
standard of value, the premise of
value, who controls the business,
its degree of marketability and
other areas. The course focuses
on the income approach, valuation
research and quantitative and
qualitative information analysis.
FBV-II
covers asset-based and market
approaches to business valuation.
Participants are taught valuation
adjustments, such as discounts
and premiums, to be able to
reconcile multiple approaches and
methods and determine a final
value for a business. The program
also covers report writing and
expert-witness matters. A case
study is woven into both halves
of the FBV courses, so
participants can integrate what
they learn and apply the
information in a complex,
multipart valuation.
After
the foundation courses, ABV
candidates can take the two-day
ABV Review Course, often taught
by scholars, authors and
practitioners in the field. To
ready candidates for the ABV
exam, about one-third of the
course is devoted to knowledge
contained in the test’s
“Content Specification
Outline.” It’s the only
exam among those offered by the
nation’s leading business
valuation organizations that
defines the specific areas a
candidate must know. The
remaining two-thirds of the
program readies participants for
the test and includes a
self-study workbook of extended
mock case studies. The practice
problems simulate the ABV
exam—currently held in early
November of each year.
For
information about the ABV
credential and the exam, go to
the following AICPA Web page: http://www.aicpa.org/members/div/mcs/abv.htm.
|
|
The three main approaches
to valuing businesses are the market approach
(what other people have paid for similar
businesses), the asset-based approach (what the
equipment and real estate are worth) and the
income approach (how much money a buyer could
make from the business). These approaches
encompass a number of methods such as
guideline-company, transactional,
adjusted-book-value, capitalization-of-benefits,
discounted-benefits and leveraged-buyout methods.
Each one has advantages and disadvantages.
There’s ample guidance on widely used
valuation formulas (for more information, see
“Resources”).
When the buyer and seller agree
on price, it’s time to address the structure
of the trade. This is where differences between a
merger and an acquisition come up. In a merger,
both parties to the transaction wind up with
common stock in a single merged entity. In an
acquisition, the buyer purchases the common stock
or assets of the seller. (See “Differences
Between Mergers and Acquisitions.”)
SET
THE TERMS
A major objective in structuring a deal is to
create a transaction that appears to meet the
seller’s price expectations, on terms and
within constraints that are suitable to the
buyer. If the terms are right for the buyer, the
price will not matter. Once buyer and seller
agree on the amount and structure of the trade,
the next issue is how the buyer will compensate
the seller before handing off the business.
Payment can be cash, common stock, a special
class of common stock, preferred stock,
installment payments, earnout payments, options
or warrants and/or convertible securities.
Cash is easiest. Payment in
common stock of a closely held company raises a
valuation question: The seller must evaluate the
future prospects of the buyer. Additional
questions arise with respect to voting rights,
liquidity and rights of first refusal if
shareholders plan to sell their stock at a later
date.
Earnout payments, options,
warrants or convertible securities often are used
to bridge the parties’ different levels of
risk tolerance. Their value is linked to future
performance: The buyer makes earnout payments to
the seller in future periods if the company
achieves predefined goals based on revenues,
operating income, net income or cash flow.
Several other factors influence
the transaction. Make sure any deal covers
Terms of payout.
Employment contracts.
Management-consulting arrangements if
applicable.
Noncompete agreements.
Allowing the seller to retain a
partial interest in the company.
Agreements to lease property from the
seller or to conduct business with entities
related to the seller.
Postacquisition adjustments to
increase or reduce the purchase price, based on
factors such as audited inventory or accounts
receivable collections.
Escrow funds that are released only
on certain terms and conditions.
Indemnification provisions.
| Profile
the Target To determine
whether an acquisition candidate is right
for a buyer,
a CPA/valuator must gather information
about the following.
|
OFFER EXCELLENT SERVICE
A CPA adviser who has valuation expertise and is
familiar with the M&A process can be an
invaluable resource to a client, offering value
and security by understanding the client’s
business goals, analyzing how to attain them and
helping to steer a transaction toward a
profitable and well-structured outcome. To choose
the right methods and standards for a valuation
engagement is a responsibility that starts with
understanding the entity you represent—and
ensuring you have adequate expertise to do the
job well. The AICPA Code of Professional Conduct
requires members to provide only services they
can complete with professional competence, and
CPA/valuators also must comply with the
professional and technical standards under the Statement
on Standards for Consulting Services. Training
is the essential step to opening a door to
interesting, profitable valuation engagements.
|
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What are the motives for
the acquisition?