Blog

  The upcoming audit season will bring some new challenges for auditors testing of fair value measurements for financial reporting. Some recent changes due to the Tax Cut and Jobs Act of 2018 (“TCJA”) will create valuation issues: The reduction in corporate tax rates affected the value both publicly traded investments and privately held investments; Deductibility of interest expense is now limited; Bonus depreciation will further reduce taxes for both new and used equipment purchases; Carryback of Net Operating Losses is no longer allowed and limited to 80% of taxable income; The TCJA moves U.S. taxation to a territorial system. The tax benefits of electing S-Corp. status should be revisited, if used. If relevant to an investment held or to a company acquired, the above will require valuation models to be updated, particularly when valuation is based upon a discounted cash-flow method. Companies that do business with the People’s Republic of China are and will be greatly affected by the Tariffs instituted recently.  It is uncertain how much and how long is to be factored into valuation, but pricing should consider such events. Some other changes in accounting standards also may affect valuations. Starting in 2019 under ASU 2016-02 the accounting for leases will change. The new standard will require that Companies record a liability for operating leases, if the criteria of an “embedded lease” is met. Previously, such a valuation was unnecessary.  For acquisition accounting, such leases will require a valuation, when previously no liability was recorded. The changes […]

  Last week we published the first of three installments of our Delaware Appraiser Series. We reviewed the fair value standard and some notable differences between the fair value standard used in the Delaware Chancery Court and fair market value defined in Revenue Ruling 59-60 of the Internal Revenue Code. There have been some recent developments in the Delaware Chancery Court providing further guidance on fair value. A number of these cases focus on the process used in “shopping” the subject company for sale; particularly when one side is seeking value in excess of an actual transaction. The Court has highly scrutinized or ignored the transactional value, depending on the sale process relied upon in their analysis. We leave the formal “briefing” to you, but we wanted to identify those cases that we think will be of interest. DELL INC V. MAGNETAR GLOBAL EVENT DRIVEN MASTER FUND LTD ET AL DECISION 12/14/17 https://courts.delaware.gov/Opinions/Download.aspx?id=266610 On appeal, the Delaware Chancery Court revised its opinion as to whether Silver Like Partners had perfected their appraisal rights. Silver Like Partners claimed Dell’s shares were worth more than the management buy-out price of $13.75 per share, a 37% premium to the Company’s ninety-day average unaffected stock price. The Court found that market pricings of Dell’s shares should not have been ignored and were relevant. In its original determination, the Court used a discounted cash flow method only, because the market was determined to be “inefficient.” A key finding in this appeal is summarized below: “The […]

  According to a recent Delaware Division of Corporations Annual Report, more than 66% of the Fortune 500 companies are registered in the State of Delaware.  That being said, it is not surprising that the Delaware Chancery Court is widely recognized as one of the nation’s leading courts in settling shareholder appraisal disputes. Delaware affords protection to shareholders by granting appraisal rights within Delaware §262 where fair value is defined §262(h): After the Court determines the stockholders entitled to an appraisal, the appraisal proceeding shall be conducted in accordance with the rules of the Court of Chancery, including any rules specifically governing appraisal proceedings. Through such proceeding the Court shall determine the fair value of the shares exclusive of any element of value arising from the accomplishment or expectation of the merger or consolidation, together with interest, if any, to be paid upon the amount determined to be the fair value. In determining such fair value, the Court shall take into account all relevant factors. This definition can cause an appraiser to consider alternative methodologies and/or apply discounts and premiums differently than for different jurisdictions or for tax valuations. As you may be aware, Fair market value as defined by Revenue ruling 59-60 is:  “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.” The […]

  When planning to merge with or acquire another company, a business owner needs to identify what’s actually being sold and estimate what those assets are really worth. Often the most valuable assets — such as goodwill, brand names, customer lists and patents — don’t appear on the balance sheet. A pre acquisition purchase price allocation helps an owner determine whether a purchase price is reasonable. In addition, how the purchase price is divvied up on the acquirer’s balance sheet has an impact on future earnings — thus affecting the transaction’s perceived success. Identify the assets Under Generally Accepted Accounting Principles (GAAP), companies that merge with or acquire another must allocate the purchase price among the assets and liabilities acquired according to Accounting Standards Codification (ASC) 805 (formerly covered by Statement of Financial Accounting Standards No. 141R). The first step in any purchase price allocation is to identify all tangible and intangible assets included in the deal. Examples of tangible assets are accounts receivable, equipment and inventory. To help categorize identifiable intangible assets, ASC 805 provides a framework based on whether the asset is related to: Marketing (trademarks, noncompete agreements, Internet domain names), Customers (customer lists, production backlogs), Artistic practice (copyrighted books, articles, photographs), Contracts (royalty agreements, franchises, leases, employment contracts), or Technology (patents, trade secrets, in-process research and development, computer software). The acquirer must estimate a useful life over which to amortize each intangible asset. But some intangible assets, such as brand names and in-process research and development, may […]

If I had to do it all over again, I would have placed an empty pickle jar beside my desk and thrown in a dollar every time a business owner proclaimed his/her business would be nothing without them.  At times, I feel the same way. But my education and experience tell me otherwise.  That being said, if the business owner or another individual disproportionately accounts for the business’s success, it’s important to consider whether the risk of losing such a “key person” warrants an adjustment to the company’s value. What’s a key person discount? A key person discount may be appropriate if a single owner or employee who would be difficult to replace is responsible for much of the company’s profitability and continued viability, especially when none of the company’s management team members are qualified to assume the key person’s responsibilities. The discount — usually a specific dollar amount or percentage — is taken to reflect the actual or potential departure of a key person. Instead of taking a separate, discrete discount at the entity level, some experts incorporate a key person discount into their valuation methodology. For example, under the income approach, a valuation expert might adjust the discount rate, capitalization rate or projected cash flows to reflect key person risks. Alternatively, an expert who uses the market approach might adjust the pricing multiples to reflect this risk. When are key person risks relevant? Owning a small business isn’t enough to justify a key person discount. These adjustments are […]

  As the business valuation discipline matures, judges, attorneys and other people who rely on appraisal conclusions are becoming more comfortable with the income approach. But how does a business’s perceived risk translate into a reasonable discount rate? This is one of the most subjective — and contentious — aspects of valuing a business. Breaking down the income approach Under the income approach, value is a function of a company’s expected economic benefits and its risk relative to other investment types. Valuators typically gauge expected economic benefits in terms of net cash flow. They measure risk by the company’s cost of capital, which is the expected rate of return investors require to invest in the subject company. Riskier businesses have lower values as a result of lower projected income, higher discount rates — or a combination of these. The two most common methods that fall under the income approach are the capitalization of earnings and discounted cash flow methods. Discounting future cash flow The key to both of these methods is converting expected cash flows (or other economic benefits) to present value. This requires the valuator to use a discount rate that reflects the time value of money and the degree of risk associated with an investment in the business. Put another way, the discount rate reflects the risk associated with achieving the expected cash flows. When valuing a company’s equity, valuators may estimate expected cash flows to equity investors and use the cost of equity as the discount rate. […]

  The hiring of a joint business valuation expert can often be useful. This strategy assumes that the parties will openly share information and act in good faith. But it may not be realistic in all situations, including contentious divorces and shareholder disputes. Sharing fees and information When using a joint valuation expert, the parties will only be satisfied by the outcome if there’s a mutual perception of fairness. Perceived fairness is enhanced when: • Both parties have a say in the interviewing and selection of the credentialed expert, • The expert and both parties have full access to relevant information, such as tax returns, financial statements, responses to questionnaires and notes from site visits, • The expert’s communications between the parties are shared, and • Both parties contribute to the expert’s costs. The expert should explain upfront that the valuation will be performed in an objective, unbiased manner. If either party suspects that a joint valuation expert is biased, dissatisfaction may ensue, possibly leading to appeals and additional fees. Potential upsides When the conditions are right, using a joint expert can benefit both sides. The benefits extend beyond just saving money and streamlining the valuation process. A joint expert also helps minimize disruptions to business operations from site visits, information requests and management interviews. Additionally, parties that share a valuation expert prove that they can trust each other, improving the chances of effectively working together in the future. For example, buyers and sellers who share an expert to conduct […]

Without a site visit it can be difficult for a valuation expert to gather all of the information needed to fully understand a business’s operations. This article provides insight on how these steps facilitate the valuation process and discusses a recent valuation engagement in which our request for a site visit was rejected.

  I was recently retained to prepare a valuation report for a shareholder dispute. Our office prepared a draft report utilizing the fair value standard, which is the standard to be used in New York State for such cases. Counsel invited both experts to a meeting hoping to settle the case without the need of costly litigation. The opposing expert came armed with a plethora of schedules and worksheets computing the minority shareholders interest – but to the surprise to all, the experts opinion was developed under the fair market value standard. The terms “fair value” and “fair market value” are sometimes used interchangeably. To a business valuation professional, however, they have very different meanings. Adding to the confusion, “fair value” may be statutorily defined for shareholder litigation (NYS) and divorce purposes (NJ) – and that definition may vary depending on the case’s venue. Moreover, fair value means something entirely different when it’s used for financial reporting purposes. (See “Fair value under GAAP.”) Ultimately, an expert’s conclusion can differ significantly, depending on which standard of value is appropriate. Fair market value Fair market value is probably the most widely recognized valuation standard. It’s commonly used to value businesses or business interests for sale and tax purposes. The IRS defines fair market value in Revenue Ruling 59-60 as “[T]he 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 […]

  Information presented on a company’s financial statements may not always be meaningful from a valuation perspective – even if it follows U.S. Generally Accepted Accounting Principles (GAAP). Whether financial information is obtained from business income tax returns or audited financial records, valuation experts often make adjustments to get a clearer picture of a company’s financial position, market risk and ability to generate cash flow in the future. In some instances these adjustments may be due to some nefarious actions of the business owner.  In other instances they may just be due to elections in accounting methodology or procedures.uing a business interest. Although these adjustments vary from case to case, many of them fall into one or more of the following types when valuing a business interest. Nonstandard accounting practices, Extraordinary or nonrecurring items, Hidden assets or liabilities, and/or Discretionary spending. The following is a condensed review of these common adjustments. 1. Nonstandard accounting practices A valuation expert may estimate value by using pricing multiples derived from comparable private and public transactions (under the market approach) and discount rates derived from returns on public company stocks (under the income approach). Thus, if the subject company deviates from how other companies in its industry typically report transactions, the valuator may need to make adjustments. Certain financial reporting practices may require adjustment, if the subject company’s methods differ from industry norms. Examples include differences in inventory, depreciation or revenue recognition methods. For example, if a company uses the last-in, first-out method (LIFO) […]