| EXECUTIVE
SUMMARY |
 A SPECIALIST SUCH AS A
CPA/ABV can optimize results for
owners who want to sell to an outsider
for the maximum the market will
reasonably bear. HOW THE CLENT WILL USE A
BUSINESS VALUATION (BV) determines
the procedures a CPA/ABV will follow to
produce the end result. At the outset of
the engagement, a practitioner should
know whether the valuation is for a sale
or for some other function.
MARKET VALUE IS WHAT OTHERS
HAVE PAID for comparable
businesses; asset value is how much it
would cost to acquire the operating
assets of the client’s company; and
income value is how much money a buyer
could make from the business.
A CPA/ABV SHOULD OBTAIN clients’
financial statements for five to seven
years—or even ten if the nature of
the business justifies it—and recast
them to clearly distinguish operational
business value.
A FORECAST OF THE
COMPANY’S most likely
future economic earnings is the
underpinning of its sale value. A
CPA/valuator for a selling client should
project future earnings with some level
of synergy from an industry buyer.
A BUYER ASKS FOUR KEY
QUESTIONS: What are the revenue
and income of the company? What is the
consistency of its growth? How stable is
the workforce? What’s the probable
return on investment vs. the risk of
being in that particular business?
|
| ROD P. BURKERT, CPA/ABV, CVA,
MBA, is a principal and cofounder of
Burkert Valuation Advisors, a
Philadelphia business valuation and
litigation support consulting services
firm that has performed appraisals for
companies operating in a wide variety of
industries. His Web site is www.burkertvaluation.com. |
ven the most workaholic proprietors eventually
want to take it easy, develop an exit plan and
turn their business assets into cash. The
decision to let go is a big one, and a CPA
business valuator can help the client sell the
company on the most advantageous terms by working
with the individual early in the process—a
few years in advance for a long-term client. The
value of an entity is based on a number of
factors including its financial statements,
equipment, real estate and location, and
practitioners help owners prepare for an
appraisal on several fronts. The process may
involve reducing discretionary expenses and
increasing the scope of the financial statements
by moving from a compilation to a review or a
review to an audit. This article describes some
ways CPA/valuators can improve terms for owners
of closely held businesses who prefer to sell.
WHO,
WHY AND WHEN INFLUENCE OUTCOME
To execute
a succession plan, your clients need a
business valuation (BV), an exit strategy
and some guts. Often their lives are so
wrapped up with the business they never
see themselves separating from it. So
it’s essential to get a client to
sit down and discuss the logical steps of
what he or she needs to do to prepare.
Help the owner choose an exit plan that
meets his or her personal goals and the
business’s capabilities. The top two
succession objectives of most business
owners are maximizing their financial
return and minimizing their tax
liability. Third on the list is
protecting the company’s future
viability to minimize risk to a new owner
so it continues and pays the owner’s
buyout.The three
chief approaches to valuing businesses
are the market approach (what others have
paid for comparable businesses), the
asset-based approach (essentially the
cost to recreate the operating assets of
the client’s business) and the
income approach (how much a buyer could
make from the business). A practitioner
should answer two key questions at the
outset of a BV engagement:
|
What’s
Your Client’s Market Doing?
In 2002,
U.S. central states’
printing businesses sold for an
average of 93.3% of their
asking price. The average sale
price was 53% of gross
sales.
Source: www.bizcomps.com.
|
|
Value to
whom? CPA/ABVs choose their
valuation approach based on the client’s
intended audience. Different objectives
lead—quite honestly—to different
results. A proprietor wanting to give an
ownership stake to children or whose estate has a
business that needs to be valued for tax purposes
is concerned with succession planning. The client
passing equity to a junior generation must follow
IRS revenue ruling 59-60, 1959-1 CB 237, section
2.02, which requires a gift and estate tax
valuation to be based on “fair market
value” (FMV, paraphrased as worth to a buyer
and seller under no duress). The IRS allows
family-owned and operated businesses to apply
lack-of-marketability and minority-interest
discounts that shave a fair amount off the value
for such wealth transfers.
If the client wants to sell the
business to a third party for the maximum the
market will bear, the buyer wants to know its
“investment value.” For this the owner
evaluates—and substantiates—the
company’s worth. Investment value hinges on
synergies with a buyer, so the CPA/ABV includes
the characteristics of one or more buyers in the
analysis.
| As of what date? The
seller’s company represents one of
many investment opportunities for a
buyer, so a valuation has a short shelf
life. Market conditions are fluid, and
when they change, so do interest rates
and the return on investment both buyer
and seller require. Changes in industry
conditions also can alter investors’
sentiments. For example, a valuation of a
supplier to the airline industry would be
dramatically different pre- and
post-September 11. Once you know the type of
valuation the client needs, express the
scope of the BV in an engagement letter
(see “Start
a BV Engagement the Right Way,” JofA, Aug.03,
page 35). Note: Practitioners can hold a
number of valuation-related credentials
such as an ABV, ASA, CBA and CVA (see
“AICPA
Resources,”
and “Organizations”).
THINK IT THROUGH
After the CPA/ABV chooses the appropriate
approach, he or she must make sure the
financial analysis of the business is
complete. A reasonable and defensible
interpretation of the numbers is the core
of a BV, so the practitioner must present
meticulous documentation of the
financials of the company. Clearly
explain adjustments and offer ample
support for the discount or
capitalization rate and the premium or
discount calculations as applicable.
Recast
historical financial statements. Obtain
clients’ financial statements for
five to seven years—or even ten if
the nature of the business justifies
it—and recast them to clearly
distinguish operational business value.
Some of the things a practitioner needs
to consider when recasting to determine a
business’s economic earnings
capacity and/or core operating assets and
liabilities are:
|
|
 Cost
structure. To calculate true earnings,
normalize income and expenses for unusual and/or
nonrecurring items and remove income and expenses
associated with nonoperating assets and
liabilities.
Cash flows. Working
capital requirements often far outweigh a
company’s earnings capacity. To assess a
business’s viability, most buyers’
appraisers will place a lot more emphasis on the
cash flow of the company rather than
accountant-reported earnings.
Nonoperating assets and
liabilities. Say a client that manufactures
widgets happens to have a corporate plane (not
really needed for the business) or a vacation
home. The cost of maintaining those assets, and
any interest expense on loans encumbering those
assets, are in the earnings stream. Since those
nonoperating assets and liabilities are unlikely
to be transferred in the sale of a business to a
third party, the CPA/ABV should remove them from
the income statements and balance sheets.
Marketable securities.
Check the financial statement disclosures. If the
client company is a manufacturing business with
portfolios of marketable securities, chances are
the securities have nothing to do with the
business and the seller will keep them after the
sale.
Parked cash. Some
clients have a horde of cash. A client may have
invested excess cash in a CD, at 5% or less, for
example. Assume a typical rate of return for a
small closely held business—20%. Let’s
say there’s an asset of excess cash worth as
much as $500,000, and it earns a 5% rate of
return. That’s $25,000 worth of interest
income that is classified as “other
income” in the financial statement.
If a valuator takes that
$25,000 of interest income and divides it by a
cap rate of 20%, he or she gets a value of
$125,000. Applying the same cap rate to the
interest income on a $500,000 CD that you would
to the overall business effectively cuts out
$375,000 of value.
Aggressive salaries. Often
business owners take very large salaries. Such
pay represents a return on investment that owners
don’t distribute as a dividend. They are
taking it as salary because the tax law gives a
deduction for it. If ROI is distributed as a
dividend in a C corporation, owners lose that
advantage. So another adjustment valuators
commonly need to make in a BV is to the salary.
Note: CPAs who have worked with a company for
some time and prepared tax returns deducting
those large salaries now may have some liability
if they characterize the amounts as excess salary
for a BV.
Aggressive retirement
plans and benefit plans. Those are
discretionary expenses paid by the business that
should be added back.
Related-party
transactions. If clients really took our
advice, they probably spun out business real
estate in a separate entity years ago, and the
operating corporation would have been paying rent
to a now-related partnership that holds the real
estate. The CPA/ABV should ask: Is that rent at
fair market value, or is it a disguised way of
getting more money out of the company in a
tax-advantaged manner. If it’s the latter,
correct it in the financials as you would other
discretionary income.
Use research
methods suitable for the overall BV approach. For
investment valuations—as opposed to asset or
FMV BVs—obtain data on sales of comparable
privately held entities as a benchmark. If the
business is large enough, look in the marketplace
for guideline publicly traded companies; check
their price-to-revenue, price-to-EBITDA and
price-to-earnings multiples and apply them to
revenues, EBITDA (earnings before interest,
taxes, depreciation and amortization) and
earnings of the client’s business. If the
industry is one in which there has been a lot of
consolidation for which the client’s
enterprise is a candidate—automobile
dealerships, for example—find out what those
businesses sold for. (For a list of research Web
sites, see “Business Valuation Resources.”)
 BV
RESOURCES
To order AICPA courses,
books, practice aids and other
publications, and to register for
conferences, visit www.cpa2biz.com
or call 888-777-7077. Member discounts
apply. For inquiries about the ABV
program, write to ABV@aicpa.org
or call the accreditations and membership
section hotline at 212-596-6211. To learn
more about the ABV credential, see the
AICPA Web page www.aicpa.org/members/div/mcs/abv.htm.
Video
The AICPA’s new
videocourse A CPA’s Guide to
Valuing a Closely Held Business
provides a working knowledge of how a CPA
values a closely held business for
purposes such as estate and gift tax
planning, asset allocation, mergers and
acquisitions, divorces and damage claims.
Instructors include Gary R. Trugman,
CPA/ABV, MCBA, ASA; Stacy Preston
Collins, CPA/ABV; Barry S. Sziklay,
CPA/ABV; and Linda B. Trugman, CPA/ABV,
CBA, ASA. The course includes a
120-minute VHS tape, a self-study
training manual and CPE materials. It is
suitable for individual or group study.
AICPA product code no. 181170.
Recent
books
 Understanding Business
Valuation: A Practical Guide to Valuing
Small and Medium Sized Businesses, 2nd
ed., by Gary Trugman, AICPA, 2003. AICPA
product code no. 05600.
Financial
Valuation: Applications and Models, edited
by James R. Hitchner, John Wiley &
Sons Inc., 2003. AICPA product code no.
W1061387P0200D.
Financial
Valuation Workbook by James R.
Hitchner and Michael J. Mard, John Wiley
& Sons Inc., 2003. AICPA product code
no. W1220833P0200D.
Conferences
National Business
Valuation Conference
November 16–18, 2003
JW Marriott Desert Ridge Resort & Spa
Phoenix, Arizona
Succession
Planning Conference
December 8 and 9, 2003
The Royal Pacific Resort
Orlando, Florida
Courses
Starting, novice or intermediate
practitioners of business valuation may
be interested in learning more about how
to gain an understanding of the theories
and applications of business valuation.
For a more comprehensive understanding,
enroll in the AICPA’s Fundamentals
of Business Valuation, parts I and II. To
earn professional certification, obtain
the AICPA’s Accredited in Business
Valuation (ABV) credential. The ABV
Review Course can aid in preparing for
the ABV examination. Visit www.aicpa.org/members/div/mcs/abv.htm
for more information.
|
Some situations
will be judgment calls. Valuing a real estate or
investment holding company that’s a family
limited partnership, for example, most likely
calls for an asset-based approach because the
entity’s worth derives from assets the
company holds. For an operating business,
however, a CPA/valuator will instead develop a
projection of what the company’s future
earnings (cash flow) likely will be and then
discount the forecast to present value.
| Project the future
performance of the business. A
buyer asks four key questions: What are
the revenue and income of the company?
What is the consistency of its growth?
How stable is the workforce? What’s
the return on investment vs. the risk of
being in that business? A projection of the
company’s most likely future
earnings is the basis of its sale value.
A CPA/valuator for a selling client
should project future revenue and
earnings with some level of synergy.
Someone in the same industry able to
integrate the seller’s operation to
enhance the merged businesses’
efficiency may be willing to pay more
(that is, share some of the expected
synergies with the seller to get the deal
done). Such a one-plus-one-equals-three
circumstance is strategic to liquidity.
If there’s more than one potential
buyer for the company, a separate
valuation may be required to estimate
what each buyer may be willing to pay.
Analyze the
local economy and the client’s
specific industry. Unless
it’s affected by overall changes in
interest rates, the national economic
picture may not matter much to a
valuation for a business that gets 90% or
100% of its revenues from the county
it’s located in. In this case, the
CPA/ABV should check the local economy
for unemployment figures, business
performance, rate of inflation, housing
starts and the average and median income
and ages of the population. A dour
national economic outlook may have little
relevance to a local economy that, for
whatever reason, is performing well.
|
 |
PRACTICAL
TIPS TO REMEMBER |
Get a
client to sit down and discuss
the logical steps of what he or
she needs to do to prepare to
exit the business. Help the owner
choose a strategy that meets his
or her personal goals and the
business’s capabilities.
Choose the
most appropriate appraisal method
based on the key external factors
that affect value. A real estate
or investment holding company may
derive worth from assets the
company holds, while an operating
business needs a reasonable
projection of the company’s
future earnings.
If
it’s a locally supported
business, check the local economy
for unemployment figures,
business performance, rate of
inflation, housing starts and the
average and median income and
ages of the population. The
national economic picture may not
matter much to a valuation for a
business that gets 90% or 100% of
its revenues from the county
it’s located in.
Obtain data
on selling prices of comparable
privately held entities as a
benchmark. If the business is
large enough, check in the
marketplace for guideline
publicly traded companies. If the
industry is one in which there
has been a lot of consolidation
for which the client’s
enterprise is a
candidate—automobile
dealerships, for
example—find out what those
businesses have sold for.
Make sure
the financial analysis is
complete, with clearly explained
adjustments and ample support for
the discount or capitalization
rate and the premium or discount
calculations as applicable.
Investment
value hinges on synergies with a
buyer, so include the
characteristics of one or more
buyers in the analysis.
|
|
The general, national or
regional economic impact will matter more to the
valuation if the client’s business covers a
multistate area. Eight times a year, the Fed
publishes a report known as the Beige Book that
projects economic trends for each Federal Reserve
Bank district; see “Business
Valuation Resources”
for more information about the Beige Book.
Translate the data.
The CPA/ABV takes all the
information in the major valuation steps and,
based on everything he or she has learned,
synthesizes the data to arrive at evaluation
conclusions. Communicate them to your client as
agreed upon in the engagement letter.
Caveat
To access information
about the AICPA consulting services
standards, go to www.aicpa.org/members/div/mcs/stds/index.htm.Here
are relevant excerpts:
Statement on Standards
for Consulting Services (SSCS) no. 1
states: “Integrity requires a member
to be, among other things, honest and
candid within the constraints of client
confidentiality. Service and the public
trust should not be subordinated to
personal gain and advantage. Integrity
can accommodate the inadvertent error and
the honest difference of opinion; it
cannot accommodate deceit or
subordination of principle.”
Article IV of the
AICPA Code of Professional Conduct
differentiates between objectivity and
independence as follows:
“Objectivity is a state of mind, a
quality that lends value to a
member’s services. It is a
distinguishing feature of the profession.
The principle of objectivity imposes the
obligation to be impartial,
intellectually honest, and free of
conflicts of interest. Independence
precludes relationships that may appear
to impair a member’s objectivity in
rendering attestation services.”
ET section 102,
“Integrity and Objectivity,”
states, in part: “A conflict of
interest may occur if a member performs a
professional service for a client or
employer and the member of his or her
firm has a significant relationship with
another person, entity, product, or
service that could be viewed as impairing
the member’s objectivity. If this
significant relationship is disclosed to
and consent is obtained from such client,
employer, or other appropriate parties,
the rule shall not operate to prohibit
the performance of the professional
service.”
|
MAKE A SOLID CASE
When all is said and done, there may be nobody in
a better position to do a valuation analysis than
the practitioner who has been associated with the
client and the company’s financial
statements for a long period of time. No one else
will have a better understanding of the unique
opportunities and challenges that business faces.
Nevertheless, extreme carefulness is called for.
AICPA standards define business
valuation services as “consulting,”
which is subject to the AICPA Code of
Professional Conduct and the Statement on
Standards for Consulting Services. The fifth
article of the “Principles of Professional
Conduct” in AICPA Professional Standards
(ET section 56) says, “A member should
observe the profession’s technical and
ethical standards, strive continually to improve
competence and the quality of services, and
discharge professional responsibility to the best
of the member’s ability.” (See “Caveat,” above.) Perhaps the most
important valuation standard a CPA/valuator
should adhere to is to prepare a BV report so it
will stand up in court if it has to.
Business
Valuation Resources
There are many useful Web
sites where valuators can find a range of
pertinent financial and industry
information. Here are some of them: |
| Economic
information www.conference-board.org
The Conference Board collects and
publishes information on the U.S.
economy.
www.stat-usa.gov
Stat USA is a Department of
Commerce Web site that provides economic,
business and international trade
information.
www.federalreserve.gov/fomc/beigebook/2003
Each Federal Reserve Bank gathers
anecdotal information on current economic
conditions in its district through
reports from bank and branch directors
and interviews with key business
contacts, economists, market experts and
others. The Summary of Commentary on
Current Economic Conditions by
Federal Reserve District (the Beige Book)
summarizes these data by district and
sector eight times a year.
Industry
information
www.asaenet.org
The American Society of
Association Executives (ASAE) provides a
useful search engine for locating other
trade associations.
www.bizcomps.com
This fee-based site offers small
business transaction sale data contained
in databases for Western, Central and
Eastern states. They are updated annually
with each region’s sales data over
the past 10 years.
www.corporateinformation.com
Typing in the name of a company
will bring up a list of links to related
Web sites about that particular business.
www.corptech.com
This is a free (registration
required) and fee-based site that offers
researchers information on approximately
50,000 public and private manufacturers
and developers of high-tech products.
www.entrepreneur.com
This site’s “Franchise
Zone” has information on franchises
and their rankings, business
descriptions, links to Web sites, an
annual breakdown of the number of units
since 1997, financial information and
contact information.
www.dnb.com
The D&B (Dun & Bradstreet)
Business Information Report is a
fee-based site. Its business summary
gives the company name, trade styles,
address, phone number, parent company
name and location, CEO’s name, sales
volume, net worth, number of employees,
type of business and D&B
D-U-N-S number.
|
www.forbes.com/2002/11/07/privateland.html
Forbes magazine publishes a yearly
directory of the 500 largest privately
held U.S. corporations. This site offers
information about those companies by
name, state, industry, revenue and links
to related articles, and it has a large
database of small companies dating back
to 1996. www.integrainfo.com
Integra Information Business
Profiler provides information on the
financial performance of privately held
businesses in many industries.
www.llrx.com/columns/roundup4.htm
This site shows what each state
has made available on the Web in terms of
corporate and business filings.
www.thomasregister.com
The Thomas Register of American
Manufacturers is an index of 170,000 U.S.
and Canadian manufacturers and a source
for finding out what companies do or
make. It is searchable by company name,
product or service and brand name, with
links to many catalogs and Web sites.
www.thestandard.com
Each quarter TheStandard.com
publishes who’s leaving what
company. It gives the names of former
executives, their date of departure,
their explanation for leaving, time
served and stock market reaction if the
company is public.
www.techsavvy.com
This site gives basic contact
information and a detailed description of
technical, engineering, design,
maintenance and manufacturing companies.
It will list companies that produce a
particular part.
www.vaultreports.com
Researchers can search for company
information by business name, city,
number of employees, revenue and
industry.
Other
sources of information
www.sec.gov
EDGAR (the Electronic Data
Gathering, Analysis and Retrieval system)
was established by the Securities and
Exchange Commission to provide access to
the filings of publicly traded companies.
|
| Source: Best Websites
for Financial Professionals, Business
Appraisers, and Accountants, 2nd
ed., by Eva M. Lang and Jan Davis Tudor,
John Wiley & and Sons, Inc., 2003. |
|
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