introduction to business valuation & understanding the engagement

BV Fundamentals for CPAs Part One June 2009

Business Valuation Fundamentals for CPAs –A Five-Part Webinar Series

Part One: Introduction to Business Valuation & Understanding the Engagement

Presenter

Jason Pierce CPA, CMA, CFM, CVA, CFFA


DISCLAIMERThe Information contained in this presentation is only intended for general purposes.

It is neither intended nor should it be construed as either legal, accounting, and/or tax advice nor as an opinion provided by the Consultants’ Training Institute (CTI), the National Association of Certified Valuation Analysts (NACVA), the presenter or the presenter’s firm.

The material may not be applicable or suitable for the reader’s specific needs or circumstances.

Readers/viewers may not use this information as a substitute for consultation with qualified professionals in the subject matter presented here.

Lastly, all rights are reserved. No part of this work covered by the copyrights herein may be reproduced or copied in any form or by any means without the express permission of the presenter(s), the CTI or NACVA.


Continuing Professional Education (CPE) Attestation for this WebinarProgram Level: Basic Delivery Method: Group-Internet-BasedPrerequisites: None CPE Credits: Two (2) hoursAdvanced Preparation: None Fields of Study: Specialized Knowledge & Applications

The presentation will include periodic online questions to assess continuous participation and to determine the program's effectiveness.

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Jason specializes in litigation and business valuation Jason specializes in litigation and business valuation work at an RSM McGladrey network firm. He is a work at an RSM McGladrey network firm. He is a graduate of the University of Tennessee (BS) and the graduate of the University of Tennessee (BS) and the University of Alaska Anchorage (MBA). Jason is an University of Alaska Anchorage (MBA). Jason is an adjunct professor for Alaska Pacific University and adjunct professor for Alaska Pacific University and Danube University in a variety of subjects. He is a Danube University in a variety of subjects. He is a frequent instructor and technical reviewer for NACVA as frequent instructor and technical reviewer for NACVA as well as Alaska’s NACVA State Chapter president. Jason well as Alaska’s NACVA State Chapter president. Jason also volunteers his time for a number of non-profit also volunteers his time for a number of non-profit organizations, including the AICPA’s Financial Literacy organizations, including the AICPA’s Financial Literacy campaign. Recently, he was recognized as one of campaign. Recently, he was recognized as one of NACVA’s outstanding members.NACVA’s outstanding members.

Jason Pierce, CPA, CMA, CFM, CVA, CFFAJason Pierce, CPA, CMA, CFM, CVA, CFFA


Evolution of Business ValuationEvolution of Business Valuation

How much is this business worth?How much is this business worth?

It all starts with Alcohol and MoneyIt all starts with Alcohol and Money


ARM 34ARM 34 Issued in 1920Issued in 1920 To determine the amount of “intangible value” To determine the amount of “intangible value”

lost by businesses previously involved in the lost by businesses previously involved in the alcoholic beverage industryalcoholic beverage industry

IntroducedIntroduced– GoodwillGoodwill– Capitalization of excess earningsCapitalization of excess earnings




It all It all endsends with Death and Taxes with Death and Taxes



IRS Revenue Ruling 59-60IRS Revenue Ruling 59-60

Issued in 1959Issued in 1959 Regarded as single most important piece of valuation Regarded as single most important piece of valuation

literatureliterature Related to Gift and Estate TaxesRelated to Gift and Estate Taxes Outlined methods and factors to be used in valuing Outlined methods and factors to be used in valuing

closely held businessesclosely held businesses


Rev. Rul. 59-60 Relevant FactorsRev. Rul. 59-60 Relevant Factors

1.1. The nature and history of the business.The nature and history of the business.2.2. The economic outlook in general and the condition and The economic outlook in general and the condition and

outlook of the specific industry in particular.outlook of the specific industry in particular.3.3. The book value of the stock and the financial condition of The book value of the stock and the financial condition of

the business.the business.4.4. The earnings capacity of the business.The earnings capacity of the business.5.5. The dividend-paying capacity of the business.The dividend-paying capacity of the business.6.6. Whether or not the business has goodwill or other Whether or not the business has goodwill or other

intangible value.intangible value.7.7. Sales of the stock and the size of the block of stock to be Sales of the stock and the size of the block of stock to be

valued.valued.8.8. The market price of stocks of corporations engaged in the The market price of stocks of corporations engaged in the

same or similar line of business having their stocks traded same or similar line of business having their stocks traded in a free and open market either on an exchanged or over-in a free and open market either on an exchanged or over-the-counter.the-counter.


Evolution of Business ValuationEvolution of Business ValuationHistory of Internal Revenue Service

Pronouncements

(Similar to FASB 123r)

ARM 34Goodwill

Excess Earnings

1920's 1950's 1960's 1970's 1980's 1990's

Revenue Ruling 81-253Revenue Ruling 68-609

Revenue Ruling 65-193Revenue Ruling 66-49

Excess Earnings or Treasury Method, introduced a "formula"

to determine value for intangibles.

Revenue Ruling 59-60

Regarded as single most important piece of valuation

literatureOutlined methods & factors


Amplified Rev. Rul. 59-60, recognized criteria for

determining discounts for lack of Marketability


Guidelines for valuing Preferred Stock



Methodology - Compensatory Stock

Options



Financial Accounting Standards Board (FASB)Financial Accounting Standards Board (FASB)

Issuance of Financial Accounting Statements No.:

1995 – 123 Stock-Based Compensation – Revised in 2004

2001 – 141 Business Combinations – Revised in 2007

– 142 Goodwill & Other Intangible Assets

– 144 Impairment or Disposal of Long-lived Assets


Professional & Regulatory BodiesProfessional & Regulatory Bodies

Internal Revenue Service (IRS)Internal Revenue Service (IRS)

Considered as a primary theoretician in the Considered as a primary theoretician in the field of valuation of closely held businesses.field of valuation of closely held businesses.

Note: Revenue Rulings Note: Revenue Rulings do notdo not have the force have the force of Law. of Law.


Financial Accounting Standards Board

Significant Pronouncements

Professional & Regulatory Bodies

FASB 141R – Requirements for valuing identifiable intangible assets acquired, in a business combination.

FASB 142 – Measures of impairment testing of intangible assets.

FASB 123R – FASB 123R – Accounting for Stock-Based Compensation.


The United States Department of Labor (DOL)The United States Department of Labor (DOL)

Issues regulations specifically pertaining to business valuations for Employee Stock Ownership Plans (ESOP’s)



National Association ofNational Association ofCertified Valuation Analysts (NACVA)Certified Valuation Analysts (NACVA)

Founded in 1990 Approximately 6,000 professionals Mission is to provide resources to members and enhance their

status, credentials, and esteem in the field of performing valuations and other advisory services.

NACVA is the premier organization of professionals representing the dominant force in business valuation, financial forensics and the industry’s hottest growth niches.



Professional & Regulatory BodiesProfessional & Regulatory BodiesNational Association ofNational Association of

Certified Valuation Analysts (NACVA)Certified Valuation Analysts (NACVA)

Pioneers in the industry providing the esteemed Certified Valuation Analyst (CVA), Accredited Valuation Analyst (AVA) and Certified Forensic Financial Analyst (CFFA) designations.CFFA Specialties include: Forensic Accounting Financial Litigation Business and Intellectual Property Damages Business Fraud Deterrence, Detection and Investigation Matrimonial Litigation Support

The industry’s foremost Continuing Professional Education organization through the Annual Consultants’ Conference, Consultants’ Training Institute, Online Learning Lecture Series and Tri-Annual State Chapter Meetings.


Other Professional OrganizationsOther Professional Organizations

American Institute of Certified Public Accountants American Institute of Certified Public Accountants ** SSVS #1 SSVS #1

Appraisal Foundation - USPAP Appraisal Foundation - USPAP American Society of Appraisers American Society of Appraisers Institute of Business Appraisers Institute of Business Appraisers Institute of Management Accountants – SMA on BVInstitute of Management Accountants – SMA on BV Canadian Institute of Chartered Business ValuatorsCanadian Institute of Chartered Business Valuators



Polling QuestionPolling QuestionPlease rate your experience in Please rate your experience in

the field of business the field of business valuation.valuation.

A. NoneA. None B. NominalB. Nominal C. ModestC. Modest D. SeasonedD. Seasoned E. ExtensiveE. Extensive


Purposes of Business ValuationPurposes of Business Valuation

LitigationLitigation

Partnership Disputes

Dissenting Shareholders

Divorce

Wrongful Death

Patent Infringement

Wrongful loss of Property



Gift and Estate Estate/Retirement Planning – Transferring shares of a

closely held business to children

What happens if owners of a closely held business die before transferring ownership?

Universal Standard of value for gifts and estate is “Fair Market Value”

Defined by Rev. Rul. 59-60


Financial ReportingFinancial Reporting

FASB: 141R, 142 FASB: 141R, 142 Value of Intangibles included in a Value of Intangibles included in a business combination/Impairmentbusiness combination/Impairment

123R 123R Valuation for Stock Options Valuation for Stock Options

Universal Standard of value for financial reporting is “Fair Value”

Defined by FASBS No. 157



Other Purposes of Business ValuationOther Purposes of Business Valuation

Tax PlanningTax Planning

Employee Stock Option Plans (ESOPS)Employee Stock Option Plans (ESOPS)

Comprehensive Financial AnalysisComprehensive Financial Analysis



Valuation ConceptsValuation Concepts

VALUATION VS. APPRAISAL



ADVOCATE VS. EXPERT



ART VS. SCIENCE


Value of a BusinessValue of a Business

The value of an interest in a closely held The value of an interest in a closely held business is typically considered to be equal to business is typically considered to be equal to the future benefits that will be received from the future benefits that will be received from the business, discounted to the present at an the business, discounted to the present at an appropriate discount rate.appropriate discount rate.

Expected Benefit

=Required Return

=Present Value

Expected Benefit

Return


This simple definition of value raises several problems:This simple definition of value raises several problems:

Whose definition of “benefits” applies?Whose definition of “benefits” applies? Future projections are extremely difficult to make Future projections are extremely difficult to make

and get two opposing parties to agree.and get two opposing parties to agree. What is the appropriate discount rate?What is the appropriate discount rate? How long of a benefit stream should be included in How long of a benefit stream should be included in

the determination of value?the determination of value?



2 Things to Remember:2 Things to Remember:

1.Almost everyone will have an opinion of value!!1.Almost everyone will have an opinion of value!!

2. The term “value” means different things to 2. The term “value” means different things to different people.different people.



Polling QuestionPolling Question

Polling QuestionPolling QuestionHow many others in your How many others in your

firm/company provide firm/company provide business valuation or business valuation or litigation services?litigation services?

A. 0 – 5A. 0 – 5 B. 6 – 10B. 6 – 10 C. 11 – 25C. 11 – 25 D. 25 or moreD. 25 or more


Overview of the Valuation ProcessOverview of the Valuation Process

Step 1: Understanding the Engagement (Session 1)Step 1: Understanding the Engagement (Session 1) Step 2: Financial/Economic/Industry Analysis Step 2: Financial/Economic/Industry Analysis

(Session 2)(Session 2) Step 3: Valuation Approaches (Sessions 3 and 4)Step 3: Valuation Approaches (Sessions 3 and 4) Step 4: Discounts & Premiums (Session 5)Step 4: Discounts & Premiums (Session 5) Step 5: Sanity Checks Step 5: Sanity Checks Step 6: Value & Delivery Step 6: Value & Delivery



DeterminePurpose & Client

Standard of Value

Interest to be Valued

Value & Delivery

Discounts & Premiums

Valuation Approaches

Financial, Economic &

Industry AnalysisUnderstanding the

Engagement

Sanity Checks

Weightings

Selecting Approach

esPurchase

Justification

Rules of Thumb

Minority/Control

Mergerstat

Big Tax

Income

Capitalization of Income/Cash Flow

Discounted Cash FlowWACC

Economic/Industry

Global/National/Local Analysis

Trade PublicationsInternet/Web Sites

Valuation Date

Premise of Value

Type of Report

Report

Calculation of ValueSummary Report

Oral Report

Other Approaches

Subsequent Events

Marketability

Restricted Stock Studies

Pre IPO StudiesAsset

Adjusted Net AssetsExcess Earnings

Market Completed Transactions

Public Guideline CompanyFinancial

Site Visit Reliability of InformationNormalizing Adjustments

Benefit Stream

AnalyzeLimiting Conditions

Experience & QualificationsLegal & Regulatory Requirements

Professional Standards

Building the Valuation Pyramid

Step 1: Covered Today (Lucky you!!)




Standard of Value


Value & Delivery





Engagement

Sanity Checks

Weightings

Selecting Approach

esPurchase

Justification

Rules of Thumb

Minority/Control

Mergerstat

Big Tax

Income



Economic/Industry



Valuation Date

Premise of Value

Type of Report

Report


Oral Report

Other Approaches

Subsequent Events

Marketability







Benefit Stream




STEP 2: Financial Economic & Industry Analysis

Covered in Session 2: (Stick around, this group is just getting started)




Standard of Value


Value & Delivery





Engagement

Sanity Checks

Weightings

Selecting Approach

esPurchase

Justification

Rules of Thumb

Minority/Control

Mergerstat

Big Tax

Income



Economic/Industry



Valuation Date

Premise of Value

Type of Report

Report


Oral Report

Other Approaches

Subsequent Events

Marketability







Benefit Stream




Step 3: Valuation Approaches

This is the nuts and bolts – Sessions 3 & 4




Standard of Value


Value & Delivery





Engagement

Sanity Checks

Weightings

Selecting Approach

esPurchase

Justification

Rules of Thumb

Minority/Control

Mergerstat

Big Tax

Income



Economic/Industry



Valuation Date

Premise of Value

Type of Report

Report


Oral Report

Other Approaches

Subsequent Events

Marketability







Benefit Stream




Step 4: Discounts and Premiums

Session 5: Don’t be Scared of heights, see you then!




Standard of Value


Value & Delivery





Engagement

Sanity Checks

Weightings

Selecting Approach

esPurchase

Justification

Rules of Thumb

Minority/Control

Mergerstat

Big Tax

Income



Economic/Industry



Valuation Date

Premise of Value

Type of Report

Report


Oral Report

Other Approaches

Subsequent Events

Marketability







Benefit Stream




Step 5: Sanity Checks

Making sure we have it together before we reach the top




Standard of Value


Value & Delivery





Engagement

Sanity Checks

Weightings

Selecting Approach

esPurchase

Justification

Rules of Thumb

Minority/Control

Mergerstat

Big Tax

Income



Economic/Industry



Valuation Date

Premise of Value

Type of Report

Report


Oral Report

Other Approaches

Subsequent Events

Marketability







Benefit Stream




Step 6: Now put it

all together

and ship it off !!


Understanding the EngagementUnderstanding the Engagement

Ready for our 1Ready for our 1stst Engagement? Engagement?

Valuation is a Valuation is a PICNIC PICNIC !!!!!!

PP Purpose of the ValuationPurpose of the Valuation

I I Identify the Client

CC Check for conflict of Interest

N N Need to deliver final product

II Interest to be valued

C C Confidence


Understanding the EngagementUnderstanding the Engagement

Business FairGift & Value

Estate

ConsultantIntrinsic (Seller) (Buyer) StrategicValue Value

Divorce FairValue

Fair MarketValue

Consultant

ValueFair Market

Combination

PurposeDefines Value



Polling QuestionPolling QuestionWhat is your favorite picnic What is your favorite picnic

food?food? A. HamburgersA. Hamburgers B. Hot DogsB. Hot Dogs C. BratwurstC. Bratwurst D. Fried ChickenD. Fried Chicken


Client & PurposeClient & Purpose

ADVOCATE VS. EXPERT


Standard of ValueStandard of Value

We will introduce three “standards of value”We will introduce three “standards of value”

Fair Market ValueFair Market Value

Fair ValueFair Value

Strategic/Investment ValueStrategic/Investment Value


Fair Market Value (FMV)Fair Market Value (FMV)

The IRS has defined FMV in Revenue Ruling The IRS has defined FMV in Revenue Ruling 59-60 as follows:59-60 as follows:

““The price at which the property The price at which the property would change hands between a willing buyer would change hands between a willing buyer and a willing seller, when the former is not and a willing seller, when the former is not under any compulsion to buy and the latter us under any compulsion to buy and the latter us not under any compulsion to sell, both parties not under any compulsion to sell, both parties having reasonable knowledge of the relevant having reasonable knowledge of the relevant facts.”facts.”


Fair Market ValueFair Market Value

The “Break Down”The “Break Down” The PriceThe Price – expressed in terms of cash equivalents – expressed in terms of cash equivalents Property Property – Business, tangible & intangible property– Business, tangible & intangible property Hypothetical buyer & hypothetical sellerHypothetical buyer & hypothetical seller – creates a market – creates a market

placeplace Arms length transaction in an open and unrestricted market – Arms length transaction in an open and unrestricted market –

no funny businessno funny business– No CompulsionsNo Compulsions– No forced saleNo forced sale

Having reasonable knowledge – Having reasonable knowledge – Understand industry, Understand industry, economics, and business.economics, and business.



Fair Value can have several meanings depending Fair Value can have several meanings depending on the purpose of the valuationon the purpose of the valuation



Statutory ValueStatutory Value

In most states, fair value, is the In most states, fair value, is the statutory standard of value statutory standard of value applicable in cases of dissenting applicable in cases of dissenting stockholders’ valuation rights.stockholders’ valuation rights.



In the states that have adopted the Uniform Business In the states that have adopted the Uniform Business Corporation Act, the definition of fair value is:Corporation Act, the definition of fair value is:

““Fair value,” with respect to a dissenter’s shares, means Fair value,” with respect to a dissenter’s shares, means the value of the shares immediately before the the value of the shares immediately before the effectuation of the corporate action to which the effectuation of the corporate action to which the dissenter objects, excluding any appreciation or dissenter objects, excluding any appreciation or depreciation in anticipation of the corporate action depreciation in anticipation of the corporate action unless exclusion would be inequitable.unless exclusion would be inequitable.



Fair value is also the standard of value used by Fair value is also the standard of value used by the Financial Accounting Standards Board the Financial Accounting Standards Board (FASB) in its pronouncements pertaining to (FASB) in its pronouncements pertaining to business valuation.business valuation.

There are two different definitions for standards There are two different definitions for standards of value under FASB:of value under FASB:


Fair Value – for Financial ReportingFair Value – for Financial Reporting

SFAS No. 157SFAS No. 157Fair Value: the price that would be received toFair Value: the price that would be received to sell sell an asset or an asset or paidpaid to transfer a liability in an orderly to transfer a liability in an orderly transaction between transaction between market participantsmarket participants at the at the measurement datemeasurement date

Sell or Paid = considered an exit price in the most Sell or Paid = considered an exit price in the most advantageous marketadvantageous market

Market Participants: Independent; Knowledgeable, Market Participants: Independent; Knowledgeable, Willing and AbleWilling and Able


We all know 157 = 123 and FASB agrees:We all know 157 = 123 and FASB agrees:

SFAS No. 157 says it does not apply to SFAS No. 157 says it does not apply to accounting for employee stock options and accounting for employee stock options and

other share bases payments (SFAS No 123R)other share bases payments (SFAS No 123R)



Fair value is defined in FASB Statement 123R, as:Fair value is defined in FASB Statement 123R, as:

““the amount at which an asset (or liability) could the amount at which an asset (or liability) could be bought (or incurred) or sold (or settled) in a be bought (or incurred) or sold (or settled) in a

current transaction between willing parties, that is, current transaction between willing parties, that is, other than a forced liquidation sale.”other than a forced liquidation sale.”



Fair Value – Marital Fair Value – Marital

Fair value may also relate to a value in divorce.Fair value may also relate to a value in divorce.

Many states have specific definitions of fair Many states have specific definitions of fair value with regard to marital dissolution.value with regard to marital dissolution.

Make sure you understand the case law for your Make sure you understand the case law for your state.state.


Strategic / Investment ValueStrategic / Investment Value

The value to a particular investor based on The value to a particular investor based on individual investment requirements and individual investment requirements and

expectations.expectations.

““Value to the Holder”Value to the Holder”


Standards of ValueStandards of Value

Valuation take away:Valuation take away:Based on the standards of value’s previously discussed there are Based on the standards of value’s previously discussed there are

numerous opportunities in valuation.numerous opportunities in valuation.

Gift and EstateGift and Estate Fair Market ValueFair Market Value

Intangible Assets in Business Intangible Assets in Business CombinationsCombinations


Stock OptionsStock Options Fair ValueFair Value

DivorceDivorce Fair Market Value / Fair ValueFair Market Value / Fair Value

Other Valuation Opportunities: M&A, Strategic Planning, ESOP’sOther Valuation Opportunities: M&A, Strategic Planning, ESOP’s



Polling QuestionPolling QuestionWhat percentage of your What percentage of your

firm/company’s business is firm/company’s business is derived from BV services derived from BV services (including litigation support (including litigation support related to the BV services?)related to the BV services?)

A. 0 – 10%A. 0 – 10% B. 11 – 24%B. 11 – 24% C. 25 – 50%C. 25 – 50% D. 51 – 74%D. 51 – 74% E. 75% or moreE. 75% or more


Premise of ValuePremise of Value

After a standard of value has been determined, After a standard of value has been determined, the valuator must determine the appropriate the valuator must determine the appropriate premise of value.premise of value.


Premise of ValuePremise of Value

Book ValueBook Value

Going Concern ValueGoing Concern Value

Liquidation ValueLiquidation Value


Premise of Value – Book ValuePremise of Value – Book Value

The difference between total assets and total The difference between total assets and total liabilities as they appear on the balance sheet. liabilities as they appear on the balance sheet. Also known as Shareholder’s Equity.Also known as Shareholder’s Equity.

Adjusted book value – would adjust assets & Adjusted book value – would adjust assets & liabilities recorded at cost to their current liabilities recorded at cost to their current market values.market values.


Premise of Value – Going ConcernPremise of Value – Going Concern

The value of a business enterprise that is The value of a business enterprise that is expected to continue to operate into the future.expected to continue to operate into the future.

The intangible elements of Going Concern Value The intangible elements of Going Concern Value result from factors such as having a trained result from factors such as having a trained work force, customer list, and systems and work force, customer list, and systems and procedures in place.procedures in place.


Premise of Value – Liquidation ValuePremise of Value – Liquidation Value

The net amount that would be realized if the The net amount that would be realized if the business is terminated and the assets are sold business is terminated and the assets are sold piecemealpiecemeal

A liquidation can be:A liquidation can be:

Orderly Orderly oror

ForcedForced


Limiting ConditionsLimiting Conditions

Designed to Protect the Valuation AnalystDesigned to Protect the Valuation AnalystExamples include:Examples include:1. We have relied up financial information & representations provided by 1. We have relied up financial information & representations provided by

managementmanagement2. Provision for subsequent event:2. Provision for subsequent event:

This valuation reflects facts and conditions existing at the date of This valuation reflects facts and conditions existing at the date of this this valuation. Subsequent events have not been considered, and we valuation. Subsequent events have not been considered, and we have have no obligation to update our report for such events and conditions.no obligation to update our report for such events and conditions.3. No financial interest in client3. No financial interest in client

See SSVS #1 for listing of recommended disclosuresSee SSVS #1 for listing of recommended disclosures



Polling QuestionPolling QuestionHave you taken any business Have you taken any business

valuation related training valuation related training prior to this webinar prior to this webinar series?series?

A. YesA. Yes B. NoB. No


Qualifications & ExperienceQualifications & Experience

Follow Professional StandardsFollow Professional Standards

Be aware of legal & regulatory requirementsBe aware of legal & regulatory requirements

Have confidenceHave confidence

Don’t be afraid to use a mentorDon’t be afraid to use a mentor


Questions to ask YourselfQuestions to ask Yourself

Am I qualified?Am I qualified? Do I have any conflicts of interest?Do I have any conflicts of interest? Do I understand the purpose and users of the Do I understand the purpose and users of the

valuation report?valuation report? Do I understand the industry?Do I understand the industry? Am I familiar with professional standards?Am I familiar with professional standards? Did I identify limiting conditions and/or scope Did I identify limiting conditions and/or scope

restrictions?restrictions?


Recommended Resources for Your Libraryavailable through NACVA at Discounted Prices…PPC’s Guide to Business Valuation

Valuation: Measuring and Managing the Value of Companies

Valuing a Business: The Analysis & Appraisal of Closely Held Companies

Valuing Small Businesses & Professional Practices

How to Value Over 100 Closely Held Businesses

Business Valuation and Taxes—Procedure Law & Prospective

The Market Approach to Valuing Businesses


Conclusion to Part 1Conclusion to Part 1

QUESTIONS?


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introduction to business valuation & understanding the engagement

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