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VALUATION OF YOUR FAMILY BUSINESS

VALUATION OF YOUR FAMILY BUSINESS. UT Center for Family Business Mini-Forum 9/25/07. J. Stephen Schult, CPA Gilmore, Jasion & Mahler, Ltd. 1715 Indian Wood Circle, Suite 100 Maumee, Ohio 43537 419.794.2000 sschult@gjmltd.com.

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VALUATION OF YOUR FAMILY BUSINESS

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  1. 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@gjmltd.com Jeffrey S. Denning, CPA, ABVGilmore, Jasion & Mahler, Ltd.1715 Indian Wood Circle, Suite 100Maumee, Ohio 43537419.794.2000jdenning@gjmltd.com David C. Krock, Esq.Eastman & Smith, Ltd.One SeaGate, 24th FloorToledo,Ohio 43604419.241.6000dckrock@eastmansmith.com

  2. 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

  3. 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.

  4. 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

  5. Common Reasons for Business Valuations …continued • Buy-sell Agreements • Good buy-sell agreements (BSA’s) 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

  6. Common Reasons for Business Valuations …continued • Other • ESOPs • Goodwill impairment • Family limited partnerships • Stock option plans

  7. Steps of the Valuation Process • How • Why • Who • What • When

  8. 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

  9. Determine the Appropriate Standard of Value • Fair market value Appropriate for: • Estate, gift & income tax • Often in BSA’s • Divorce (but…)

  10. Fair Market Value Considerations • The nature of the company’s business and its history since its inception • The outlook for the economy in general and the company’s 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

  11. Fair Market Value Considerations …continued • Prior transactions involving the company’s 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

  12. Determine the Appropriate Premise of Value • Going concern value, or • Liquidation value (piecemeal) • Orderly (time to maximize), or • Forced (auction)

  13. Determine the Subject Interest to be Valued • Common stock • Preferred stock • Nonvoting stock • General partner/manager’s interest • Limited partnership interest • Assigned interest

  14. Determine the Subject Interest to be Valued… continued • 100% controlling interest • Degree of control • Review BSA’s • Other restrictive agreements • Again, avoid misunderstandings

  15. Analyze the Company’s Financial Information • Cashflowanalysisiskey • Enterprise’s cash flow; or • Cash flow to minority owner • Normalizing adjustments • Addback owner’s compensation and perks • Rent if above market rate

  16. Other Information • Site visit, interviews • Industry research – market & customers • Guideline public companies • Comparable transactions

  17. Other Information…continued • Consolidators • Private equity groups • Economic outlook • Competition

  18. Consider Valuation Approaches & Methods • Income approach • Market approach • Asset approach

  19. 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 tomorrow’s cash flow • Cap rate or multiple

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

  21. 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

  22. 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

  23. Market-based Approach – Past Transactions • Actual arm’s 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

  24. Asset Approach Most appropriate for: • Asset holding companies • Real estate entities • Marginally profitable businesses • Purchase accounting

  25. 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

  26. Reconcile Various Indications of Value from Approaches • Adjust in reconciling • Average methods; or • Select most appropriate

  27. 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

  28. Benefits of Control • Appoint or change management • Determine compensation and perquisites • Set operational and strategic policy • Liquidate, or recapitalize the company • Register company’s debt or equity for an IPO

  29. 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

  30. Lack of Marketability …continued • Degree of control in the block of stock • Restrictions on the transferability • Company’s stock redemption policy

  31. Write Report • Levels of service • Reports • Oral Report • Testimony

  32. Levels of Business Valuation Services Complete Appraisal • A complete appraisal complies with “binding” USPAP standards. Also complies with any ASA and other organization’s standards. • Normally includes 15-20 pages of text and 5-10 pages of financial statements.

  33. 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).

  34. 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.

  35. 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.

  36. 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.

  37. QUESTIONS ?

  38. 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

  39. 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

  40. Corporate Structure Considerations & Control • Maintaining control may be important • Valuation discounts • What to do when plan isn’t working

  41. Ownership Disputes Among Existing Owners or Following Transfers • Predetermined terms • Employee shareholders vs. non-employee shareholders

  42. 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

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

  44. QUESTIONS ?

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