KEY ISSUES IN BUSINESS VALUATIONS FOR DOMESTIC MATTERS A VALUATION EXPERT S PERSPECTIVE. February 14 21, 2015 MSBA Punta Cana, Dominican Republic

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1 KEY ISSUES IN BUSINESS VALUATIONS FOR DOMESTIC MATTERS A VALUATION EXPERT S PERSPECTIVE February 14 21, 2015 MSBA Punta Cana, Dominican Republic Presented by: R. Christopher Rosenthal, CPA /ABV, ASA, CFF, AEP Director, Ellin & Tucker, Chartered Assistance provided by Anton A. Ermolov Suite East Pratt Street Baltimore, MD Suite Fifteenth Street, NW Washington, DC crosenthal@ellinandtucker.com aermolov@ellinandtucker.com

2 AGENDA Goodwill 3 Financial Statement Adjustments..6 Analysis of Company s Operating Agreement 7 Buy-Sell/Right of First Refusal Issues.8 Standard of Value Fair Market vs. Intrinsic Value.9 Issuing an Opinion of Value...11 Valuation Standards Which Ones Apply...12 Market Approach: Standalone Methodology..12 Optimistic Projections.14 Proceeding to Trial: Dangers of Calculations 15 Scope of the Assignment..17 Tax Issues: Divorce and Valuation

3 GOODWILL Determining and valuing the identifiable intangible assets vs. the unidentifiable intangible assets: Process of determining the identifiable intangible assets Information needed to conduct valuation analysis Valuation methods used to determine Fair Market Value of intangible assets 3

4 GOODWILL: THE VALUATION PIE BGW The Valuation Pie Tangible Assets PGW Patents TWF 4

5 GOODWILL Methods to allocate personal/business goodwill MUM Multi-Attribute Utility Model 5

6 FINANCIAL STATEMENT ADJUSTMENTS Adjustments to financial statements: Personal expenses Owner s perks Excess owner s compensation and other family member s compensation Non recurring expenses Normalize expenses to market levels (Ex: Rent, Note Receivable, and Notes Payable) 6

7 ANALYSIS OF COMPANY S OPERATING AGREEMENT Impact on DLOC Lack of Control Issues Decision making ability Ability to control cash flows Swing Vote Issues Impact on DLOM - Lack of Marketability Issues Ability to sell or transfer an interest Timing and process to sell or transfer Impact on Fair Market Value 7

8 BUY-SELL/RIGHT OF FIRST REFUSAL ISSUES Does the face value of insurance used in a buy-sell agreement suggest a value for the key person s interest? Use of Buy sell agreements to determine fair market value Relevance and/or legitimacy Impact on valuation analysis 8

9 STANDARD OF VALUE FAIR MARKET VALUE VS. INTRINSIC VALUE Willing buyer/willing seller vs. synergistic benefits Definition of Fair Market Value and Intrinsic Value Comparisons between the standard of values Impact on conclusion based upon standard of value used 9

10 STANDARD OF VALUE FAIR MARKET VALUE VS. INTRINSIC VALUE: EXAMPLE Fair Market Value Intrinsic Value Value of Equity on a Controlling, Marketable Basis $ 5,000,000 $ 5,000,000 Less: Discount for Lack of Control 20.0% (1,000,000) - Value of Equity on Noncontrolling, Marketable Basis 4,000,000 5,000,000 Less: Discount for Lack of Marketability 30.0% (1,200,000) - Value of Equity - FMV $ 2,800,000 Value of Equity - Intrinsic Value $ 5,000,000 10

11 ISSUING AN OPINION OF VALUE Issuing an opinion of value in a situation where you have been asked to critique an opposing expert s report, but have not done the work to meet the AICPA development standards What are the standards setting bodies (i.e. AICPA, ASA, etc ) What are the standards set forth by these governing bodies Impact on valuation analysis and opinion/estimate of value 11

12 VALUATION STANDARDS WHICH ONES APPLY USPAP 9 & 10 SSVS # 1 ASA NACVA 12

13 MARKET APPROACH: STANDALONE METHODOLOGY Comparability of transactions and public companies Usefulness of transactions and public companies Type of valuation analysis Answering the question: why no income approach? 13

14 OPTIMISTIC PROJECTIONS Optimistic projections supplied to the bank or bonding company Management s projections for bonding company vs. projections given during management interview Analysis of market and industry factors Key is to account for all variables through research, financial statement analysis and discussions with the owner during the management interview and due diligence process 14

15 PROCEEDING TO TRIAL: DANGERS OF CALCULATIONS Dangers of using calculations for cases that may proceed to trial. You can use a calculation for settlement purposes, but need to consider changing scope if moving to trial Valuation standards SSVS NO. 1 Definition of calculation engagement as defined by SSVS: An engagement to estimate value wherein the valuation analyst and the client agree on the specific valuation approaches and valuation methods that the valuation analyst will use and the extent of valuation procedures the valuation analyst will perform to estimate the value of a subject interest. A calculation engagement generally does not include all of the valuation procedures required for a valuation engagement. If a valuation engagement had been performed, the results might have been different. The valuation analyst expresses the results of the calculation engagement as a calculated value, which may be either a single amount or a range. 15

16 PROCEEDING TO TRIAL: DANGERS OF CALCULATIONS Definition of valuation engagement as defined by SSVS: An engagement to estimate value in which a valuation analyst determines an estimate of the value of a subject interest by performing appropriate valuation procedures, as outlined in the AICPA Statement on Standards for Valuation Services, and is free to apply the valuation approaches and methods he or she deems appropriate in the circumstances. The valuation analyst expresses the results of the valuation engagement as a conclusion of value, which may be either a single amount or a range. Differences in pricing Differences in valuation standards Recent court case accepted expert s testimony based on calculation of value Hipple v. SCIX, LLC, 2014 U.S. LEXIS (Aug. 13, 2014) Different level of due diligence and analysis in calculation vs. valuation engagement 16

17 SCOPE OF THE ASSIGNMENT Complexity of valuation Time to complete the valuation Costs associated with the valuation Moving parts during valuation more information provided requires change to the valuation report 17

18 TAX ISSUES: DIVORCE AND VALUATION Are distributions made to individual stockholders or members for tax purposes considered income available for support? How to deal with potential capital gains taxes on the value of the business 18

19 QUESTIONS? 19

20 KEY ISSUES IN BUSINESS VALUATIONS FOR DOMESTIC MATTERS A VALUATION EXPERT S PERSPECTIVE February 14 21, 2015 MSBA Punta Cana, Dominican Republic Presented by: R. Christopher Rosenthal, CPA / ABV, ASA, CFF, AEP Director, Ellin & Tucker, Chartered Assistance provided by Anton A. Ermolov Suite East Pratt Street Baltimore, MD Suite Fifteenth Street, NW Washington, DC crosenthal@ellinandtucker.com aermolov@ellinandtucker.com