1 BRAD DAVIDSON Brad Davidson is President of SPARDATA Business Valuation Experts of Elkridge Maryland and is a recognized expert in the valuations field. Organizations which have invited Davidson to lecture include the Internal Revenue Service, the Securities and Exchange Commission, the North American Securities Administrators Association, the Department of Labor, the Federal Financial Institution Examination Council, the Federal Reserve, the Michigan Bankers Association, the Virginia Bankers Association and the American Society of Pension Actuaries. SPARDATA has been cited on numerous occasions by the Wall Street Journal, the Washington Post and other publications. In 1980 Davidson began his career in the financial services industry when he became a financial advisor with Merrill Lynch, where he was a rookie of the year in 1981. In 1984 he joined Prudential-Bache Investments as a vice president, leaving in 1986 to run an investment fund that bought and sold real estate limited partnership interests in the secondary market. In 1990 he became president of SPARDATA, a firm with experience valuing over 27,000 privatelyheld businesses. The firm s clients include business owners; the advisors serving them (including financial advisors, trust officers, CPAs and attorneys) and government institutions. Financial service providers that have chosen SPARDATA to provide valuation services to their clients include New York Life, AXA Advisors, National City Bank, MassMutual, PNC Bank, Guardian and Morgan Stanley Trust. Beyond financial analysis, Davidson has had a diverse array of work experiences. From 1977-1979 in his first job after college, he worked on Capitol Hill as a legislative assistant to a Texas Congressman from a rural district. (To this day he will discuss the Federal Insecticide, Fungicide and Rodenticide Act with anyone willing to listen.) Working on the Hill infected him with the political bug so in 1979 Davidson enlisted in the Maryland Army National Guard and was ordered to Ft. Sill OK for basic training. (Later he attended Officer Candidate School, was commissioned an infantry officer and retired in the late 1980s having achieved the rank of Captain in the United States Army Reserve.) Two years later Davidson became the boy wonder of Annapolis politics by becoming the youngest person ever elected to the Annapolis City Council; he was reelected without opposition in 1985. In 1987 Governor William Donald Schaefer appointed him Chairman of the State Commission on the Capital City, a position he held until 1996. Today Davidson serves on the boards of St. John s College of Annapolis Maryland and Santa Fe New Mexico; the Historic Annapolis Foundation and the J. M. Kaplan fund in New York City. From 1984 until 2002 Mr. Davidson was a Director of Microsemi Corporation of Santa Ana, California, a publicly-held manufacturer of electronic products where he served on the audit and compensation committees. He lives in Annapolis Maryland with Lynne, his wife of 25 years. They have two children. I:\Knowledge Base\Presentations\CV-MACPA.doc
The SSVS 1 What It Means & How To Comply www.spardata.com 800 895 4100 1 Founded 1990 27,000 entities valued since 1990 Valuations only, no audit services Clients include IRS, SEC, DOL CPAs refer when they: don t do valuations do valuations but have a conflict etc. www.spardata.com 800 895 4100 2 www.spardata.com 1
1. What Is The Value? www.spardata.com 800 895 4100 3 Estate of Thompson v. Commissioner Valuation date: May 2, 1998 Thompson Publishing Company: 95 year old publisher of product information catalogs, buying guides, industry newsletters. Successful, profitable company had an effective monopoly on B2B industrial and manufacturing print publications. Internet: risks, competition, new opportunity? 6 th most trafficked B2B websites in early 1998. www.spardata.com 800 895 4100 4 www.spardata.com 2
Estate of Thompson v. Commissioner 1993 1998 Financial Results (note: dod 5/2/98) Fiscal Year 1993 Net Sales Revenue $168,059,000 Total Net Income $14,333,288 Total Liquid Investments $48,317,000 1994 179,287,018 12,804,431 57,691,114 1995 200,487,153 11,107,716 71,211,665 1996 216,924,156 13,171,695 72,901,317 1997 240,116,975 15,927,549 97,255,140 1998 256,806,493 28,370,056 98,675,893 www.spardata.com 800 895 4100 5 Estate of Thompson v. Commissioner 1993 1998 Internet Growth Fiscal Year Print Subscribers CD-ROM Subscribers Internet Subscribers 1993 73,500 1,000 N/A 1994 78,000 2,500 N/A 1995 81,000 5,000 40,000 1996 80,000 13,000 225,000 1997 67,500 25,000 550,000 1998 45,500 45,500 * www.spardata.com 800 895 4100 6 www.spardata.com 3
What Was Thompson Publishing Worth In 1998? Fiscal Year Net Sales Revenue Total Net Income Total Liquid Investments 1998 $256,806,493 $28,370,056 $98,675,893 How many say: A. $25,000,000? B. $100,000,000? C. $200,000,000? www.spardata.com 800 895 4100 7 Estate of Thompson v. Commissioner Tax Court s Description of Estate s Valuator #1 Hired George E. Goerig, an Alaskan lawyer to appraise and prepare a valuation report Goerig believed and apparently represented that he would be able to obtain for the estate a more favorable valuation of the estate s TPC stock. estate learned of Goerig from an attorney for decedent s family who had met Goerig on a fishing trip.... he appears to have attended limited appraisal courses, other than a few courses while working for (IRS) many years ago. www.spardata.com 800 895 4100 8 www.spardata.com 4
Estate of Thompson v. Commissioner Tax Court s Description of Estate s Valuator #2 (CPA) Wichorek provides accounting and tax preparation services...and undertakes occasional valuations for small businesses.... He belongs to no professional organizations or associations relating to his appraisal or valuation work.... Goerig and Wichorek were barely qualified to value a highly successful and well established New York City based company with annual income in the millions of dollars. www.spardata.com 800 895 4100 9 Estate of Thompson v. Commissioner The Tax Court s Opinion Of Value Fiscal Year Net Sales Revenue Total Net Income Total Liquid Investments 1998 $256,806,493 $28,370,056 $98,675,893 A. $25,784,000 (Estate) B. $225,000,000 (IRS) C: $110,508,000 (Tax Court) www.spardata.com 800 895 4100 10 www.spardata.com 5
1. What Is The Value? 2. Overview of SSVS 1 www.spardata.com 800 895 4100 11 Foreword... to improve the consistency and quality of practice among AICPA members performing business valuations.... AICPA members will be required to follow this standard when they perform engagements to estimate value.... www.spardata.com 800 895 4100 12 www.spardata.com 6
Scope, Exceptions Applies to engagement to estimate value (conclusion of value or calculated value) where analyst applies professional judgment. Does not apply when: part of attest engagement (i.e. as part of audit, compilation review) value provided by client internal use assignments by employee members not in public accounting. determining economic damages mechanical computations when use is not practical or reasonable. www.spardata.com 800 895 4100 13 Professional Competence... A valuation analyst should possess a level of knowledge of valuation principles and theory and a level of skill in the application of such principles...... An in depth discussion of valuation theory and principles, and how and when to apply them, is not within the scope of this Statement. www.spardata.com 800 895 4100 14 www.spardata.com 7
101: Credentialing Organizations American Society of Appraisers ASA (Accredited Senior Appraiser) Institute of Business Appraisers CBA (Certified Business Appraiser) Nat l Association of Certified Valuation Analysts CVA (Certified Valuation Analyst) American Institute of CPAs CPA/ABV (CPA Accredited in Business Valuation) www.spardata.com 800 895 4100 15 Objectivity, Conflicts Objectivity is a state of mind. If attest services client:...would a reasonable person aware of all the relevant facts conclude that there is an unacceptable threat to the memberʹs and the firm s independence... www.spardata.com 800 895 4100 16 www.spardata.com 8
101: Getting Ready Analyze financial statements Liquidity (current ratio, quick ratio etc.) Utilization of assets (turnover etc.) Profitability (margins etc.) Leverage Normalize financial statements non recurring items related party transactions salary adjustments etc. www.spardata.com 800 895 4100 17 Analyze the Interest Applicable standard of value Applicable premise of value Assumptions & limiting conditions Governmental rules, other professional standards Non financial information Ownership information Financial information www.spardata.com 800 895 4100 18 www.spardata.com 9
101: Standards of Value Fair Market Value: (Rev. Rul. 59 60) Fair Value. Varies by state very inconsistent. Used in dissenting stockholder litigation, etc. Investment Value. Value to a particular investor. Intrinsic Value. True value. www.spardata.com 800 895 4100 19 101: Premises of Value Business status under which transaction assumed to take place: Going concern value in continued use Assemblage of assets value in place, but not in current use or as a going concern Orderly disposition value in exchange on piecemeal basis given a normal time to sell Forced liquidation value in exchange on piecemeal basis given less than normal time to sell www.spardata.com 800 895 4100 20 www.spardata.com 10
Approaches & Methods Income Approach valuing the business based on some form of economic income stream. Discounted future benefits method Capitalization of benefits method Market Approach valuation by reference to other transactions. Guideline public company method Guideline company transaction method Asset Based Approach valuation on the basis of assets and liabilities Adjusted net asset value method Excess earnings method www.spardata.com 800 895 4100 21 Income Approach Examines benefits flowing from the asset; converts them into a present value. Commonly used for: Service businesses Professional practices Etc. www.spardata.com 800 895 4100 22 www.spardata.com 11
Capitalized Income Method Used to analyze income streams expected to grow at constant rate (or stay constant) over time. 1. Start with 5+ years of after tax adjusted earnings. Assumption: a. Amount of income capitalized will remain constant each year in perpetuity; or b. Amount of income being capitalized will either increase or decrease at some constant rate forever. 2. Determine capitalization rate a) Cap Rate = Discount Rate (aka fair return ) Growth Rate www.spardata.com 800 895 4100 23 Discounted Future Benefits Method Used to analyze income streams expected to fluctuate over time. 1. Projections DO NOT INCLUDE a constant growth rate of the income stream. Growth (if any) built into projections. 2. Discount rate = cost of capital = risk free rate + risk premiums. www.spardata.com 800 895 4100 24 www.spardata.com 12
Estate of Thompson v. Commissioner Discounted Future Benefits Method (IRS expert) Fiscal Year 1998 1999 2000 2001 2002 Subtotal Plus Liquidation* Value PV of Future Cash Flows PV of Estimated Cashflows $1,390,000 1,333,000 1,261,000 1,178,000 1,108,000 $6,260,000 152,567,000 $158,827,000 *Liquidation, not terminal www.spardata.com 800 895 4100 25 Asset Based Approach Assumes the value of a business is based on underlying value of its assets. 1. Per 59 60, suitable for: Real estate holding companies Investment companies Finance companies Mfg companies heavily invested in fixed assets Distressed; assets worth more than benefit stream 2. Assets and liabilities adjusted from book value to fair market value. 3. Problem: most business assets are a means to generate future income. www.spardata.com 800 895 4100 26 www.spardata.com 13
Adjusted Net Asset Method 1. Obtain or develop an accrual basis balance sheet 2. Determine which assets and liabilities on the balance sheet require valuation 3. Identify any off balance sheet assets or liabilities 4. Value the items identified in steps 2 and 3 5. Construct a market valuebased balance sheet using the adjusted values www.spardata.com 800 895 4100 27 Cost Method Used to value intangible assets: type of cost (i.e. reproduction or replacement) appropriate depreciation, obsolescence and remaining useful life. www.spardata.com 800 895 4100 28 www.spardata.com 14
Guideline Public Company Method Guideline Public Company Method share prices of similar, actively traded publicly owned companies are applied to the subject company through valuation multiples. Stock Price/Net Income Stock Price/Cash Flow Stock Price/Revenue Etc. Data Sources: SEC filings Public information database Other? www.spardata.com 800 895 4100 29 Guideline Transactions Method Transaction prices of similar, public or privately owned companies are applied to the subject company through valuation multiples. Data Sources: Sales of Public Companies Mergerstat /BVR Control Premium Study Public Stats Sales of Private Companies Pratt s Stats BIZCOMPS www.spardata.com 800 895 4100 30 www.spardata.com 15
Valuation Adjustments Step 1: estimate entity value (affects all shareholder) Step 2: analyze factors affecting subject interest (some shareholders, not all) Minority versus control ( LOC ) Lack of marketability ( LOM ) Blockage discount Key person discount Restrictive Agreement discount Investment company discount Lack of voting rights discount www.spardata.com 800 895 4100 31 101: Valuation Discounts and Premiums www.spardata.com 800 895 4100 32 www.spardata.com 16
Conclusion of Value Correlate and reconcile results obtained from different approaches and methods Assess the reliability of the different results Determine whether conclusion of value should reflect one or multiple approaches and methods. Weighting of valuation method results Final value estimate Review of appraisal process Did the analyst appraise the right thing? Did the analyst appraise the right thing in the right way? www.spardata.com 800 895 4100 33 Other Items 43 Subsequent events 44 45 Documentation 46 Calculation engagement 47 50 Valuation report 51 70 Detailed report 71 78 Other report types www.spardata.com 800 895 4100 34 www.spardata.com 17
1. What Is The Value? 2. Overview of SSVS 1 3. Using Valuations Proactively www.spardata.com 800 895 4100 35 Owners misjudge what their businesses are worth Owners think¹ business is worth $X; actually it is worth $2X, $½X etc. Owners don t know they don t know. Advisors tend not to raise the issue. ¹2005 SPARDATA study of owners www.spardata.com 800 895 4100 36 www.spardata.com 18
Why rules of thumb are wrong: they assume all companies are alike. Dry Cleaner #1 Dry Cleaner #2 Sales: $1,000,000 Value: $1,500,000 Sales: $1,000,000 Value: $750,000 www.spardata.com 800 895 4100 37 So What? 1. Botched succession (caused by value disconnect) 2. Botched sale (caused by value disconnect) 3. Fight with partner s spouse (caused by underfunded buy sell agreement) 4. Miserable retirement (caused by value disconnect) 5. Fire sale of business (to pay estate taxes) www.spardata.com 800 895 4100 38 www.spardata.com 19
Ask the valuation question Q: When was the last time you had your business professionally valued? A: Never. www.spardata.com 800 895 4100 39 The SSVS 1 What It Means & How To Comply www.spardata.com 800 895 4100 40 www.spardata.com 20