Will appear on BV pages – RECENT VALUATION ARTICLES

Goodwill Part II: Goodwill vs. Goodwill Value

/in , , /by Bob Altieri

All businesses have goodwill; however, not all businesses have goodwill value!

Goodwill, which is usually the largest portion of the purchase price of a business, is the sum of intangibles such as having a good location and trade dress, a negotiated lease in place, trained employees, a website, customers, etc. Not all businesses have goodwill value, which is measured by the amount of earnings the business produces adjusted for the risk of earnings continuing to flow into the future, since all value is in anticipation of future economic benefit.

IRS Revenue Ruling 68-6091  defines this very well. The Ruling states that goodwill value is that component of the earnings stream that is in excess of a reasonable rate of return on the investment made in the Tangible Assets (furniture, fixtures, equipment and vehicles) that the business owns, AND after paying the owner a reasonable market wage for his/her services in the business. The latter is often referred to as a “return on labor,” which has nothing to do with the value of the business since a prospective buyer can get a management job in the same industry and obtain a market rate of compensation without investing a dime in a business opportunity. If there are earnings in excess of these two requirements it must be attributable to goodwill value.

[1] During prohibition, this was the formula designed by our government to fairly compensate owners of spirit, wine, or beer producers before closing them down. It might be the only good thing that came out of prohibition!

Personal versus Enterprise Goodwill in a Business Sale

/in , , /by Bob Altieri

Goodwill can exist in two different forms:

  1. Personal Goodwill, which is defined as an intangible asset that is attached to a person; and
  2. Enterprise Goodwill, also an intangible asset that is attached to a business enterprise.

If goodwill is attached to an individual, it is non-severable since the person to which it is attached is not being sold. This also implies that the asset is non-transferable. Of course we often establish contractual arrangements between the parties to lessen the non-transferable portion of personal goodwill to some degree. The ability to pull this off depends on the size and nature of the business being transferred. Smaller businesses tend to have more personal goodwill due to the owner’s personal contact with customers or channel partners, or unique skills (e.g. a chef in a restaurant operation, a surgeon, etc.).

With enterprise goodwill being attached to the enterprise, this asset is indeed transferable because it is a part of the business being sold. So it may be obvious that enterprise goodwill usually transfers to the buyer without special arrangements. Personal goodwill, on the other hand, requires much deeper analysis to determine how and how much of this intangible asset is reasonably transferrable to a willing buyer.

Enterprise goodwill has transferable value, whereas personal goodwill may or may not have transferable value.

Without proper analysis of goodwill value, whether or not it is related to an individual (usually the owner), and thoughtful strategies for the transfer of the personal goodwill component, the value of a business can be significantly distorted (diminished).

Independent Valuation Litigation Support

/in /by Bob Altieri

This week I was asked to value a medical practice, relating to a dispute between shareholders. Before I head off to my secret fishing spot for the weekend, I want to share these thoughts about how independent valuation experts assist in the litigation or dispute resolution process.

Business valuation and transaction professionals are frequently engaged as independent financial experts for purposes of assisting in dispute resolution, litigation, or potential litigation. Litigation support services include any professional assistance provided to a client in a matter involving pending or potential litigation or dispute resolution proceedings before a trier of fact.

In rendering litigation support services, the expert may be retained to provide an expert opinion on the financial effects of facts and assumptions. In addition to forming an expert opinion, the expert may value a business, project future financial results, analyze the performance of a business operation, interpret financial data, opine on an impaired streamof earnings, or render other similar types of professional services.

In providing litigation-support services, an independent financial expert may play a role as:

  1. Expert. One who is qualified by knowledge, skill, experience, training, or education in performing business valuation services and/or related financial analyses.
  2. Expert Witness. An expert who is engaged to explain technical, scientific, or specialized knowledge in order to assist the trier of fact in understanding evidence.
  3. Arbitrator. An expert who serves as a trier of fact in an alternative dispute resolution context.
  4. Court-Appointed Expert. An expert who is engaged by a court to assist the trier of fact.
  5. Consulting or Advisory Expert. An expert who is engaged to review another expert’s work product or who is engaged to advise the client, lawyer or another expert witness about technical matters relating to the subject litigation, but who will not be called to testify at trial, and may or may not be independent. Accordingly, this Procedural Guideline may not apply to such an expert.

Source: ASA Business Valuation Standards, ©2009 American Society of Appraisers

Expiration of $5.12 Million Gift Tax Exemption Presents Unique Gifting Opportunity

/in , /by Al Statz

As a result of the tax cuts enacted under former President George W. Bush and extended under President Barack Obama, the estate and gift tax currently is set at a maximum rate of 35% with a $5.12 million exemption amount.  But unless Congress takes action, the maximum estate and gift tax rate will revert to 55% and the exemption amount to $1 million, effective January 1, 2013.

It is uncertain what, if anything, Congress will do.  But given the impending “fiscal cliff” and substantial pressures to increase taxes, particularly on those with high net worth, there would appear to be a significant possibility that the estate and gift tax environment will become less favorable after the end of 2012.

As a result, there could be a one-time opportunity to make substantial gifts without incurring gift tax.  Since the gift and estate taxes are unified, an individual currently can make gifts up to $5.12 million (and a married couple up to $10.24 million) without incurring gift tax.  These amounts are set to reduce to $1 million for an individual and $2 million for a couple, effective January 1, 2013.

Exit Strategies appraises operating companies and asset holding companies for gifting, estate tax, and other purposes. You must establish fair market value of gifted assets as of the date of gift, and an independent valuation by a qualified business appraiser is often your best defense against an IRS challenge. For fractional interests, we quantify appropriate discounts for lack of control and marketability. Our quality valuation reports comply with USPAP and IRS business valuation standards, and we are prepared to defend our work in the unlikely event of an IRS audit.

If you think you might benefit from making sizeable gifts before year-end, contact your CPA and/or tax attorney right away, while there still is time to formulate and implement an appropriate strategy. Time is running out.

Business Valuation Rules of Thumb

/in /by Bob Altieri

A valuation “Rule of Thumb” is a mathematical relationship between price and one or more variables, based on experience, observation, hearsay, or a combination of these, applicable to businesses within a specific industry. The Business Reference Guide published by Business Brokerage Press is a common resource for people involved in valuing, buying or selling privately held businesses. The guide contains rule-of-thumb and pricing tips on hundreds of types of small businesses. Below are a few of the price/sales rules of thumb presented in the guide:

Industry Valuation Rule of Thumb
Accounting Firms 100–125% of annual revenues
Auto Dealers (New Cars) 0–10% of annual sales + inventory
Day Care Centers 45–50% of annual sales
Dental Practices 60–65% of annual revenues
Distribution / Wholesale in general 50% of annual sales + inventory
Engineering Services 40–45% of annual revenues
Grocery Stores (Supermarkets) 15% of annuals sales + inventory
Hardware Stores 45% of annual sales incl. inventory
Landscape Businesses 45% of annual sales
Machine Shops 55–65% of annual sales incl. inventory

Be aware that there are disadvantages to using rules of thumb, and they should never be relied upon by themselves to appraise a business or price a business for sale.  For example, applying one of the above rules of thumb to your company would assume that its cost structure, risks and growth prospects are identical to the industry average company. This is almost never the case! We use rules of thumb, when available, as a sanity check on values produced by accepted business valuation methods, and the Business Reference Guide is often the first place we look.

Valuations for SBA Business Acquisition Loans

/in /by Al Statz

Determining the value of a business is a key aspect of an SBA lender’s underwriting process for loan applications involving a business acquisition (change of ownership).

According to SBA Standard Oprating Procedure 50-10-5(c), paragragh (i), page 179, for all business acquisition loans over $350,000, or whenever a buyer and seller have a close relationship, the lender must obtain an independent business valuation from a qualified source.  Examples of “close relationships” include transactions between: Employer-Employee; Family members; Co-Owners; and any parties that have an existing, non-arms-length relationship. A “qualified source” is an individual who regularly receives compensation for business valuations and is accredited by a recognized organization.

As Certified Business Appraiser’s (CBA’s) accredited through the Institute of Business Appraisers, Exit Strategies Group, Inc., is a qualified source for business appraisals for SBA loans.

Exit Strategies provides quality, SBA- and USPAP-compliant valuation reports within 2 weeks, at a competitive cost.

Lenders may call Bob Altieri, CBA, at 530-478-9790 to request a quote or receive a sample SBA loan valuation report.

Exit Strategies Joins National Business Valuation Group

/in , /by Al Statz

Exit Strategies has joined forces with National Business Valuation Group, LLC, a consortium of independent business valuation and litigation support firms that have affiliated in order to provide clients with highest quality  professional expertise.  The relationship between offices allows each firm to provide its clients with technical, database, industry, geographic and consulting expertise that would not be available from typical business valuation firms.  Offices regularly communicate with each other regarding specific cases and valuation issues in order to ensure the highest quality work for clients.

Each office in the group is required to have senior level business appraisers with either Certified Business Appraiser (CBA) or Accredited Senior Appraiser (ASA) professional designations, the most coveted and difficult professional designations to obtain.

Does Size Matter in Business Valuation?

/in /by Al Statz

As a business broker I hear lots of interesting comments and questions about the value of businesses. Recently a business owner said to me, “Peet’s Coffee, (Nasdaq:PEET) trades for 20 times earnings, so should I be able to sell my Mike’s Coffee Company for that?” It’s a great question. Besides brand recognition and the liquidity of public vs. private company shares, size is the obvious difference between Peet’s and Mike’s. So how much does the size of a company and its earnings affect valuation multiples? Quite a lot as it turns out.  Smaller companies tend to sell at lower multiples of most financial measures than larger companies in the same industry.

Companies under $50 million typically sell for considerably lower price-to-earnings multiples than companies from $50 to $500 million, and companies over $500 million typically sell for higher multiples than those from $50 to $500 million. According to business valuation expert Shannon Pratt, who has authored many seminal works and is widely recognized as the “father” of privately held business valuation, “Larger companies are less risky, and therefore, are priced in the market reflecting lower discount rates and higher market multiples.” Conversely, the smaller the company, the lower the average market valuation multiple.

This relationship between price multiples and company size holds true for smaller businesses as well. Middle Market companies with $1 to 5 million of EBITDA (normalized annual earnings before interest, taxes, depreciation and amortization) are easier to sell and command higher pricing multiples on average than companies with less than $1 million EBITDA.  In my experience with private businesses at the low end of the Middle Market, those with higher revenue and earnings are clearly more marketable, command higher price multiples, involve less risk, and are more readily financed.

The following table illustrates the relationship between two price multiples and company revenues, using data from a study of thousands of sales of small and very small businesses across all industries:

Size of Company Sale Price / Revenue Sale Price / Discretionary Earnings*
Up to $1 million revenue 0.51 2.2
$1 to 5 million revenue 0.62 2.9

* Discretionary Earnings is defined as EBITDA plus market compensation to a general manager (usually the business owner). It is interesting to note that in many of these very small transactions EBITDA (Discretionary Earnings less a reasonable GM salary) is actually zero or negative, and EBITDA shouldn’t be used as a basis of comparison. The purchaser essentially buys a job.

Business valuation theory is consistent with the data. In his book, The Market Approach to Valuing Businesses, Shannon Pratt says “This conclusion (that smaller companies sell for lower multiples), reached from analysis of market data, is consistent with income approach (cost of capital) research, which shows that smaller companies have higher costs of capital (higher discount rates) than larger companies. Higher discount rates in the income approach should mean lower multiples in the market approach, and this relationship does, indeed, hold true.”

Since size does affect business value, using prior transaction data or indirect industry rules of thumb derived from companies that are much larger or smaller than your company can result in incorrect conclusions about business value. Any market data used to estimate the value of your company should be limited to an appropriate size range.

So what’s at stake?

Errors in business valuation can lead to poor decisions about buying, selling, merging, gifting, tax planning, investing in or loaning money to a business. If you’re selling for example, you risk undervaluing your business and leaving hard-earned money on the table, or you risk overpricing it and wasting precious time and resources and experiencing undue market exposure and potential loss of confidentiality. For the small business owner, when making important decisions involving your life’s work and perhaps your most valuable asset, it makes sense to value it right the first time.

Al Statz, CBA/CBI, is President of Exit Strategies Group, Inc., a business brokerage, mergers, acquisitions and valuation firm serving closely-held businesses in Northern California. He can be reached confidentially at 707-778-2040 or alstatz@exitstrategiesgroup.com. – See more at: https://exitstrategiesgroup.com/blog.html?bpid=2183#sthash.gD1ch5ie.dpuf