understanding and using the goodwill valuation … and using the goodwill valuation report •...

Understanding and Using theGoodwill Valuation Report

IRWA Chapter 12012 Fall SeminarOctober 23, 2012

William W. Thomsen, ASA, CFA, MBAThomsen LLC

www.thomsenllc.com

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Understanding and Using the GoodwillValuation Report

• Agenda

– When a Goodwill Valuation May be Needed

– Elements of a Goodwill Loss Valuation

– How Goodwill Relates to Other Elements of Valueand Compensation

– Potential Areas of Controversy

– Considerations When Reviewing a Goodwill LossValuation Report

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When a Goodwill Valuation May beNeeded

• Pre-Condemnation Planning

• Agency Offer and Deposit

• Negotiations

• Trial/Litigation

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• Pre-Condemnation Planning– What site to acquire? Agency must identify and evaluate

sites before deciding

– Appraisers may assist in this process

– Preliminary analysis to test for potential goodwill exposure• Businesses on site?

• Shared facilities parking

• Impact of partial takings

• Inverse condemnation claim exposure

– Complications• Limited information may be available at this early stage

• Goodwill exposure may be only one factor of many to consider

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• Agency Offer and Deposit

– Before an Agency can condemn, it must make anoffer based on an appraisal

– The appraisal used to make offer may also be usedto support the pre-condemnation deposit

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• Negotiations

– An appraisal report (preliminary or formal) may beused for mediation or settlement purposes

– The appraisal expert may be brought in to explainfindings and opinions

– Appraisal experts from opposing sides may bebrought in to discuss differences andcommonalities – and to possibly arrive at amutually agreeable value range

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• Trial/Litigation

– The formal appraisal is performed in concert withexpert designation and exchange of reports

– The expert is typically deposed after appraisalexchange

– The expert may testify in court to explain/defendvaluation (goodwill loss) opinions and to rebutother expert opinions

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Elements of a Goodwill Loss Valuation

• How California Statute Defines Loss ofGoodwill and Compensation

• Calculating Loss of Goodwill

• Implications for Valuation and Compensation

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• How California Statute Defines Loss ofGoodwill and Compensation

– California Code of Civil Procedure Section1263.510 (b) defines goodwill as:

• the benefits that accrue to a business as a result of itslocation, reputation for dependability, skill or quality,and any other circumstances resulting in probableretention of old or acquisition of new patronage.

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• How California Statute Defines Loss of Goodwill andCompensation– Section 1263.510 (a) of the Code of Civil Procedure states:

• The owner of a business conducted on the property taken, or onthe remainder if the property is part of a larger parcel, shall becompensated for loss of goodwill if the owner proves all of thefollowing:

1) The loss is caused by the taking of the property or the injury to theremainder.

2) The loss cannot reasonably be prevented by a relocation of thebusiness or by taking steps and adopting procedures that a reasonablyprudent person would take and adopt in preserving the goodwill.

3) Compensation for the loss will not be included in payments underSection 7262 of the Government Code [No overlap with relocationbenefits].

4) Compensation for the loss will not be duplicated in the compensationotherwise awarded to the owner.

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– Goodwill Before – Goodwill After (Mitigated) =Goodwill Change (Loss), where:

• Goodwill Before measures goodwill in the absence ofeminent domain,

• Goodwill After (Mitigated) represents goodwill reducedby condemnation and the costs of mitigation, and

• Goodwill Change (Loss) is the difference in goodwillbetween the “before” and “after” measurements.

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– Causes of goodwill loss:

• Sales decline (lost patronage)

• Increased costs (occupancy/rent, operational/logistic)

• Lower growth

• Higher risk

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• Implications for Valuation and Compensation– The loss of goodwill is limited by the amount of goodwill

computed in the “before” condition. Need to establishexistence of goodwill (Sobke)

– Compensable goodwill loss must be attributable to the subjecteminent domain action

– In order to be compensated, the business owner mustdemonstrate that reasonable efforts were made to preservegoodwill (mitigation is an essential element of the analysis)

– Avoidable betterment not included in loss– Compensation for loss of goodwill must not be included in

relocation payments or elsewhere (ex: real property award)

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How Goodwill Relates to OtherElements of Value and Compensation

• Components of Business Value

• Goodwill Relationship to Other Componentsof Value

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Components of Business EnterpriseValue

Working Capital (Current Assetsless Current Liabilities)

Tangible Assets (Cars and Trucks,Machinery and Equipment,Leasehold Improvements) --Some Movable, Some Not

Other Identified IntangibleAssets (e.g., Liquor License)

Goodwill

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• FASB ASC Topic 805 identifies the following intangible assetcategories:– Technology-related (e.g., patents, software, databases, trade secrets);– Customer-related (e.g., customer lists and related relationships);– Marketing-related (e.g., trademarks and trade names);– Contract-related (e.g., licensing agreements, supply contracts); and– Artistic-related (e.g., pictures, photographs, literary works, a/v

material).– Assembled workforce– Goodwill

• “Goodwill” under the eminent domain statute actuallyconsists of various types of intangible assets– Understanding this asset composition can help understand how

condemnation may impact goodwill (facts and circumstances driven)

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• Components of Business Enterprise Value

– Business Enterprise Value = Working Capital + TangibleAssets + Identified Intangible Assets + Goodwill

– Goodwill = Business Enterprise Value less WorkingCapital, less Tangible Assets, Less Identified IntangibleAssets (Residual Approach)

– Goodwill = Capitalized “Excess Earnings” AboveRequired Returns on Working Capital, Tangible Assets,and Identified Intangible Assets (Excess EarningsApproach)

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• Goodwill Relationship to Other Components of Value– For a given business enterprise value, a higher value of

working capital, tangible assets, or other identifiedintangible assets would imply a lower goodwill value

– Stated otherwise, higher working capital, tangible assets orother identified intangibles would necessitate a higherlevel of “excess earnings” to justify the same level ofgoodwill

– Thus, there may be a tradeoff between goodwill and otherallocated components of value – and a possible tradeoffamong award categories. “Efficiency” in tangible assetutilization rewarded in higher goodwill/intangible value

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• Goodwill Relationship to Real Estate– Value of real estate is typically reflected in the fair market

rent computed for the subject business – separating thepotential award for real property value from goodwillvalue

– Other things equal, a higher fair market rent results in alower economic earnings for the business, and hencelower goodwill.

– In most cases, real estate value is positively correlated withfair market rent. So, a higher real estate appraisal mayimply a lower goodwill value

– However, all things not always equal. High fair market rentmay reflect a superior location that supports higher sales,profits and business goodwill

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Potential Areas of Controversy

• Use of Projections and “Hypothetical”Calculations

• Project Attribution

• Mitigation Assessment

• Accounting for Economic Trends/Cycle

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• Use of Projections and “Hypothetical” Calculations– Need to value the actual business conducted on site, not a

hypothetical operation (Mesdaq, Coyne, S&M)

– However, Aklilu decision seemed to turn “hypothetical vsactual” logic on its head (“cost to create” seemed topresume existence of goodwill without quantitative proof)

– Any business valuation is necessarily forward-looking, andmay not be reflective of past performance

– Key may be whether the analysis is sufficiently supported,or whether it would be considered “speculative”

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• Project Attribution

– How has/will the project impact the business?

– Other factors potentially contributing to companytrends – such as the economic climate,competition, changes in management andchanges in the marketplace – need to beseparated from project impacts

– Has the project affected the company indirectly byimpacting customers or suppliers?

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• Mitigation Assessment– Relocation site search and assessment: has an adequate

effort been made?

– Relocation assistance from the agency: how much benefit?A data dump from the MLS may be of limited assistance

– Have any betterments resulting from relocation beentaken into account?

– Soft costs of relocation and reconfiguration – such as timespent by management and potential impact on clients,suppliers and employees – should be considered

– Is it goodwill mitigation or “reestablishment cost?”

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• Accounting for Economic/Industry Trends– Decline in business performance – due to relocation or to

economic and industry trends?– Was business condemned at the trough of the economic

cycle? If so, has an anticipated recovery been adequatelyfactored into the valuation analysis? If, on the other hand,bad times were ahead at the value date, were thoseexpectations reasonably reflected in the analysis?

– Has economic or industry risk been accounted for in theanalysis to the extent considered appropriate?

– Do comparable company transactions used in the analysisreflect or have been adjusted to reflect currentexpectations?

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Considerations When Reviewing aGoodwill Loss Valuation Report

• General Considerations

• Specific Considerations

• Overall Considerations

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– Appraiser qualifications

• Credentials and experience)

– Identification of assignment

• Business to be valued, date of value, value definition

– Conformity to accepted professional standards

• USPAP, ASA

– Use of accepted valuation methodologies

• Explanation of why methods used or not used

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– Accuracy and adequate disclosure of relevant factsand assumptions

• Disclosure of hypothetical, critical or extraordinaryassumptions

– Adequate support for assumptions

– Appearance of objectivity/absence of obvious bias

– Demonstrated understanding of company,industry and economic factors

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• Specific Considerations

– Adjustments to historical earnings/results

• Normalization, officer compensation, fair market rent,project-specific

– Use of market data

• Selection of comparable companies, multiples, discount rate

– Mitigation considerations

– “After” condition and project attribution/causation

– “Temporary” vs. “permanent” impacts andcompensability considerations

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• Overall Considerations

– Does the appraisal accurately reflect the facts andcircumstances?

– Does the appraisal interpret relevant marketevidence and apply them to the facts usingreasonable appraisal techniques?

– Does the appraisal bring together the facts andanalysis to arrive at a credible conclusion?

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Questions?

William W. ThomsenThomsen LLC

www.thomsenllc.com

[email protected]

310-871-6904

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