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Much has been written about valuing a closely-held business. A frequent topic discussed is the income approach and the application of the valuation multiple to a normalized income stream. The valuation multiple (also called capitalization rate) is comprised of a many factors, including the company’s specific risk. Risk is an expression of the business valuation analyst’s judgment, as no database can exist to measure the company-specific risk drivers. The valuation expert must identify these drivers and judge their magnitude in order to estimate the additional rate of return the market would require to offset the investor’s acceptance of additional risk. The factors will vary from company to company, among industries, and over time within the same company. These may include depth of management, importance of key personnel, stability of industry, diversification of product or service, geographic location, earnings margins, etc. Risk is categorized by: business risk, financial risk and liquidity risk. Business risk relates to all factors that may prevent the realization of forecasted earnings. Items which impact sales, cost of sales, or administrative and operating expenses, are a component of business risk. Business risk is company-specific. In evaluating business risk, the valuation specialist should obtain an understanding of the company to determine issues relating to: industry, competition, depth of management, adequate working capital, etc. Financial risk is a narrower company-specific concept. Financial risk relates to interest expense, a factor that can also diminish forecasted earnings. Financial risk may be assessed by how the company’s asset base is financed. If […]

24/7 Wall St, published, “Eight Outrageous CEO Perks” which detailed various executive perquisites, or “perks.” From Oracle’s Larry Nelson’s $1.53 million security team, to Dow Chemical’s Andrew Liveris’s $98,000 for financial planning, the article revealed some expensive perks of corporate CEOs. In the case of closely-held businesses with a single owner, perquisites provide benefits to owners and reduce business taxes. By placing some company profit into perquisites, they can not only enjoy these perks, but can deduct these costs from the business’s reported income. When valuing a business or determining the normalized compensation of the owner, it is imperative to identify these issues. Perquisites are compensation beyond a normal salary and benefits. These items are discretionary, meaning they are extra compensation and would not necessarily have to be paid to someone else with the same position. Unlike bonuses, which are a lump-sum, perquisites are often in the form of pre-paid services or goods. Perquisites generally fall into a set of common categories: Retirement Plans, Insurance Plans, Pensions, Financial planning services, Tax services, Education, Memberships, Entertainment, Automobile Expenses, Company credit cards, Family Costs, and others. Some perquisites, such as a Supplemental Executive Retirement Plan (SERP), can be rather straightforward to find within a business’s accounts. However, there are some perks are trickier. While many forms of entertainment, such as lunches, are legitimate costs, others can be in excess, or altogether unneeded. One way to examine entertainment perks is to match the costs against industry data. If an executive’s entertainment perquisites are […]

Recently released and on parole, Tyco’s former CEO Dennis Kozlowski was the epitome of excess compensation in the beginning of the millennium. Despite the fact he transformed a small enterprise into a billion-dollar giant, he was convicted of fraud for using Tyco as his “personal piggy bank.” This and other white-collar crimes have led to the creation of better monitoring parameters and resources to help define employees’ salaries, especially those of top executives. Often, owners of closely-held businesses can easily manipulate their business’s profitability by paying themselves more or less than reasonable compensation. Business valuation experts can serve as a reliable professional resource whose contribution goes beyond tests and industry-specific statistics. IRS Guidelines and Parameters Section 162(m)(4)(C) and Section 162(m)(4)(E) of the Internal Revenue Code are both used as guidelines in tracking performance-based compensation. From describing the roles of the board of directors in determining compensation, to establishing further forms of compensation, such as bonuses, these two codes give an outline for investigating an executive or owner’s proper compensation. In addition to the Revenue Code, the IRS’s Fringe Benefits Audit Technique Guide assists by listing the benefits commonly provided to executives, potential issues, and also provides steps to help examine same. Both bonuses and benefits received by owners can be complex and ambiguous depending on the case. Bonuses can be clearly recorded, or simply rely on a handshake. Benefits, similarly, can often not be taxed to the recipient, but rather recorded within the operating expenses of the business. This concept […]

Reputations and public perception are often associated with performance and adherence to rules that govern an activity.  Lance Armstrong, once the darling of cycling, is expected to lose more than $50 million dollars of future sponsorships and endorsements as a result of his admissions to violating his sport’s standards.  Many also believe that his well-documented doping activities will leave him stripped of a once untarnished professional reputation.  Armstrong is not alone; there have been many other examples of people purposely violating their professions’ standards in an attempt to gain an upper-hand. Business valuation analysts are held to certain standards established by their credentialing organizations.  Ultimately, these standards are intended to secure the credibility and quality to their work-product.  Working with a credentialed business valuation analyst that adheres to these standards is important to both attorneys and their clients. In our current whitepaper, “An Attorney’s Guide To Understanding Business Valuation Standards,” Mark S. Gottlieb outlines the organizations and premises of their professional standards.  Attorneys need to be familiar with these standards so that they can illustrate the credibility of their expert, or better understand the possible deficiencies of opposing professional opinions. Please click here to instantly obtain a free copy of this whitepaper.

Valuing the very small company can often be more challenging than valuing a large firm or corporation.  These types of valuations most commonly arise in the divorce cases, although they also are frequently present in shareholder litigation, partnership dissolutions, and similar litigation. Often, client budgetary restrictions are an overriding consideration. However, attorneys and valuation analysts can work together from the outset of an engagement to meet client budgets and provide credible valuation. Here are a few areas where communication and cooperation can be the most helpful. Valuation Standards.  Just like attorneys, accredited valuation experts are bound by standards of professional conduct. However, none of those standards distinguish between a valuation for a small business (and perhaps small budget) and a larger business. Once engaged, valuation analysts often find themselves caught between performing a complete and credible valuation, complying with the applicable standard(s), and keeping the job within a client’s budget. In litigation settings, most valuation analysts expect to be cross-examined on whether they adhered to the proper standards. If not, a lack of client funds will be no defense, and the analyst’s credibility as well as the client’s case could suffer. Managing Expectations. Proper client screening is just as important in the valuation as in the legal context. Valuation analysts can help retaining attorneys to inform the client why the appraisal is necessary, its potential costs and the benefits that will inure to the case. Clients—especially in the divorce setting—will often suffer from misplaced expectations or assumptions. These clients need to receive the proper information and guidance from their […]

Attorneys know that a credible valuation analysis requires a substantial number of hours by an analyst with a high level of expertise. When reviewing an expert valuation report, it is critical to identify the most common errors that can cause a court to discredit or even disregard a report. The following checklist serves as a quick guide for attorneys to avoid the most obvious deficiencies: Is the standard of value followed?  Has the analyst carefully disclosed and defined the applicable standard of value?  Has the standard of value been followed consistently throughout? Are all three valuation methods considered?  These include the income, market, and asset approaches. Is the internal analysis consistent?  For example: Did the analyst match pricing multiples or capitalization rates to the wrong economic income measure? Are current intangible asset operational data matched to different time periods, without appropriate adjustment? Did the analyst “normalize” financial statements without also normalizing the corresponding data for selected comparable companies? Was a “highest and best use” analysis performed? Was an “actual use” analysis also performed? Did the analyst make extraordinary, subjective, or speculative assumptions? Is there sufficient support for selected variables?  Any analyst should document the data used, the procedures performed, and the valuation conclusions reached.  There should also be sufficient tracing from the data in the quantitative analysis to the intangible asset in the owner/operator financial statement. Do the numbers add up?  Mathematical errors are more common than anyone cares to admit; check all numerical calculations for accuracy, and make sure […]