Welcome to Shannon Pratt Business Valuations
- Our Mission
- What We Do
- Business Valuation Services
- Valuing Your Business
- Reasons to Value a Business
- Approaches to Value
- Discounts and Premiums
As a recognized profession leader, Shannon Pratt Business Valuations aims to use its members' substantial valuation experience to support our clients with the highest quality, independent business valuation services available.
WHAT WE DO
Business Valuation Services
Shannon Pratt Business Valuations performs various business valuation services including comprehensive business valuation reports, valuation report review, business valuation expert testimony, fairness opinions and solvency opinions, and arbitration. Business valuation services are needed for a variety of purposes, including estate and gift taxes, marital dissolutions, mergers and acquisitions, shareholder and partner disputes and appraisal actions, bankruptcy, damages and lost profits actions, and ESOPs. We are also accredited to perform multi-disciplinary valuation reviews required for banks and other lending institutions to comply with international and domestic credit risk regulations.
Valuing Your Business
Every business owner should have his or her business valued by a qualified professional business appraiser at least once every five years and when business circumstances change significantly. This will provide the business owner with a greater understanding of the company's value over time as well as considerably aid the company during critical times, such as the death of an owner, litigation, merger or acquisition, etc.
REASONS TO VALUE A BUSINESS
Merger & Acquisition
The owner may want to sell the business. Having an idea of what the business is worth may influence the decision as to whether or when to sell. A side benefit of a professional appraisal is obtaining advice on what to do to make it easier to sell and to maximize the sale price.
When contemplating selling a business, an appraisal should be done as early as possible, preferably three years or more before the contemplated sale time. This will be helpful in planning the timing of the sale as well as in identifying strengths and weaknesses and capitalizing on the strengths and curing the weaknesses.
To maximize the sale price, it is desirable to forecast revenues and expenses out at least a year and have a record of how accurate the forecasts were. Buyers like dependability. It is desirable to have the books and records in tip-top shape. Buyers like transparency.
It is important to minimize the personal expenses going through the company's books. Take retired Grandma off the payroll. Sell any assets that could be considered nonoperating or excessive (e.g., the company airplane, a hunting retreat, etc.).
Hire the best possible business broker and follow his advice. A good business broker has the wisdom born of experience to work the market to your best advantage
While it is generally good if the broker can find a buyer that has synergies with your company, don't expect the buyer to pay the full value of the synergies. A synergistic buyer will probably pay a little more than a strictly financial buyer, but usually less than half of the value of the synergies.
A buyer buys a business or an interest in a business for what is expected of that business in the future. Recent performance history is often useful as a guide to what to expect in the future. The buyer will largely discount the business's potential unless the business has a proven track record.
Gift and Estate Taxes
The owner may die some day. The heirs probably would benefit by having a credible idea of what the business is worth. If the business is substantial, there may be estate taxes. Knowing what the business is worth can assist the owner in arranging adequate liquidity (usually through life insurance) to cover the estate taxes. The owner may want to minimize or avoid the estate taxes through a program of gifting shares of stock to eventual heirs.
For an estate or gift tax return, the business value or the ownership interest value should be supported by a qualified business appraiser, and the appraisal report should be a complete report that complies with the Uniform Standards of Professional Appraisal Practice (USPAP). The standard of value for estate and gift taxes is always fair market value, as defined in the Internal Revenue Service Regulations.
If one wishes to pass the company to heirs while minimizing estate and gift taxes, one should do so by means of a series of gifts of minority interests. Minority interests under the standard of fair market value are valued at a substantial discount from a proportionate share of the business as a whole. Every gift is valued on its own, without regard to the holdings of the donor or donee. If a donor has three heirs to whom he wishes to pass the company, he could even give them 33 1/3% interests all at the same time, and each would be valued as a minority interest.
Employee Stock Ownership Plans (ESOPs)
The owner may wish to sell minority interests to employees or outside investors. An ESOP is a tax-advantaged vehicle for employees to own shares of the company. The ESOP may own anywhere from less than 1% to 100% of the company. If the ESOP owns a minority interest, the shares must be valued as minority shares. However, the discount from a proportional share of the enterprise value is usually only 10% to 15%, because it is offset by a mandatory "put" option by which the employees have the option to sell the shares at fair market value on termination of employment.
The ESOP may acquire the shares either from an existing stockholder or by the company issuing new shares to the ESOP. If the company issues new shares to the ESOP, it can take a deduction from its taxable income for the fair market value of the shares issued. The ESOP must have a qualified appraisal of the shares at least once a year.
Many companies with two or more owners enter into buy-sell agreements. The buy-sell agreements give the company or other stockholders the option or obligation to purchase the interests of other owners under some specified circumstances such as termination of employment, retirement, or death.
All such agreements should contain a valuation provision that either sets a price or provides a mechanism for setting a price, as well as terms of payment when the triggering event occurs. We highly recommend hiring a valuation professional for a couple of hours' consultation when drafting the buy-sell provision and to explain the ramifications of the provision when the parties sign the agreement, because much misunderstanding and ill will can arise when the triggering event occurs and one party to the agreement has an understanding that differs from that of another party as to what the price will be or how it will be determined.
For example, many buy-sell agreements state that the price will be "the fair market value of the shares" as determined by a qualified business appraiser. Fair market value usually implies a sometimes large discount from a pro rata share of the value of the company as a whole for a minority interest holder. Many minority owners do not understand this, and are shocked to learn it too late when a price that is less than what was expected is binding on them.
The valuation provision might call for a proportionate share of the fair market value of the company, or a proportionate share of the fair market value of the company less some specified percentage, perhaps 20%. The provision may be different pursuant to different triggering events.
Even when the standard of value is specified, there frequently can be disagreement over the amount, so the valuation provision should specify a means of resolving the price. Our CEO, Dr. Shannon Pratt, has served as an arbitrator or expert witness in many such disagreements. The valuation agreement should specify a means of selecting an arbitrator or arbitrators in case of disagreement. In order to assure fairness to all parties, the provision should specify that the arbitrator or arbitrators be qualified business appraisers.
Unfortunately, statistics show that about 50% of marriages end in divorce. The owner of a business might like to have an idea of what it would cost to get divorced.
The statutes governing valuing businesses for marital dissolution vary from state to state. Unfortunately, they tend to be vague regarding criteria for valuation, so the business appraiser must look to the case law that establishes relevant precedent for standards and criteria for valuing a business for marital dissolution in that particular jurisdiction.
It is common for the nonoperating spouse to think that the business is worth more than the operating spouse thinks it is. Sometimes the ratio exceeds ten to one. Unfortunately, most family law judges have little expertise or experience in business valuation, so when there is a dispute over the value of the business in a divorce, it pays to retain the best possible business appraiser who can convincingly educate the judge.
Most states these days distinguish between enterprise goodwill (that which arises form the business itself and thus is transferable in a sale) and personal goodwill (that which arises from the operating spouse's talents and efforts). In a divorce, in most states, the portion of value attributed to enterprise goodwill is part of the marital estate and the portion attributed to personal goodwill is excluded from the marital estate. The separation of enterprise and personal goodwill can significantly affect the value of the business for marital dissolution.
Corporate and Partnership Dissolutions
When the eventual end of a corporation or partnership is triggered, whether by agreement or disagreement by the parties involved, it is advantageous and often required by state statues to have a business valuation conducted. In circumstances when the parties involved are in disagreement, arbitration is often recommended and can lead to resolution prior to trial. Having an accredited independent business valuation expert may assist in resolving issues of contention.
When a business determines it has been damaged by an illegal action, the value of the damages must be determined. There are three types of claims: those in which the business suffered losses but continues to operate; those in which the losses of income caused the business to cease; and those where the losses caused the business to never exist. Damage actions are unique in business valuation in that they often can incorporate subsequent information to determine the proper amount of damages. Often in damage actions there is a greater risk for juries and courts to be swayed by sentiment toward the parties involved.
Minority Oppression and Dissent Actions
The incidence of adjudicated actions brought by minority stockholders has increased dramatically over the last decade. Under state statutes, a minority stockholder is typically provided the opportunity to dissent and be paid the fair value of his or her shares when a company effects an extraordinary corporate action. In dissenting stockholder disputes, fair value is often interpreted as a measure of that which has been taken from the shareholder.
Minority interest dissolution actions arise when a minority shareholder can demonstrate minority oppression or a deadlock on decision making. This type of action is governed in many states by judicial dissolution statutes that often allow the controlling owner to avoid dissolution by paying the oppressed minority holder the fair value of his or her shares.
Under both types of actions, the respective states' court case precedents interpret the standard for fair value. In states where no precedent exists, case precedents from other states tend to be considered. It is important that the business appraiser be aware of any case precedents in a minority oppression or dissent action.
Multi-Disciplinary Valuation Reviews
We also provide independent appraisal reviews for credit risk assessment. These reviews are required for compliance with Federal Reserve, FDIC, Office of Thrift Supervision, and Internal Revenue Service lending standards and to comply with international Basel II credit risk requirements.
APPROACHES TO VALUE
The appraisal profession has recognized three broad approaches to valuing a business:
1. The income approach
2. The market approach
3. The asset approach
Any single business valuation approach or a combination of two or all three approaches may be appropriate for valuing a particular business depending on the facts and circumstances.
The Income Approach
The income approach to business valuation values a company by estimating some measure of its earning power in the future and converting that measure to a present value based on an investor's required rate of return on the investment considering the risk of the investment.
The measure of earning power most frequently used is "net cash flow", which represents the amount that an owner could take out of the business over time without jeopardizing it as a going concern. For a business with no long-term debt, net cash flow is calculated as:
Plus noncash charges (depreciation, amortization, etc.)
Minus capital expenditures
Minus additions to working capital.
The Market Approach
The market approach to business valuation involves valuing a company by reference to what other similar companies or interests in companies have sold for relative to some fundamental variable in the subject company, such as sales, net income, EBITDA (earnings before interest, taxes, depreciation and amortization), EBIT (earnings before interest and taxes), etc.
Several transaction databases are available that provide details of sales of private companies (e.g., Pratt's Stats, BIZCOMPS, Done Deals). Using the databases, "pricing multiples" such as price/sales or price/net income, are developed and applied to the subject company's comparable fundamental to arrive at a range of potential values.
Such pricing multiples may also be developed from the market prices of public companies when appropriate. Under this approach, publicly available data concerning the public companies market value of equity and/or debt is used in developing the pricing multiples.
The Asset Approach
The asset approach to business valuation values a company by adjusting its assets and liabilities to fair market value and the difference represents the "net asset value" of the company. The procedure is to adjust each asset and liability item on the balance sheet to its fair market value. Any assets or liabilities not on the balance sheet should also be valued and brought onto the balance sheet. This approach is usually not applicable to a profitable going concern because in that case the value lies largely in the earning power of the business. This approach is also usually not used when valuing a minority interest because the minority owner does not have the ability to liquidate the assets of the business.
DISCOUNTS AND PREMIUMS
Discounts and premiums hold a high degree of significance in a business valuation. They often greatly affect the ultimate value of a business interest in a specific valuation assignment. Frequently, discounts and premiums turn out to be the most debated topic in a litigation setting. Due to the amount of money at stake in determining what discounts or premiums are applicable in an assignment, it is important to have a qualified appraiser who thoroughly understands and can effortlessly explain any discount or premium taken in a business valuation assignment.
Entity-Level versus Shareholder-Level Discounts
There are two broad categories of discounts and premiums: entity-level and shareholder-level. Entity-level discounts apply to the business as a whole regardless of the individual shareholder's characteristics. Examples of these types of discounts include a key person discount, discounts for known or potential environmental liability, and discounts for pending litigation. Entity-level discounts are applied before shareholder-level discounts.
Shareholder-level discounts are related to characteristics of ownership. The degree of control and the degree of marketability are the two main shareholder-level discounts. In business valuation, the degree of control is considered before the degree of marketability. The most common shareholder-level discount is the discount for lack of marketability.
Minority and Marketability Discounts
The fair market value of a minority interest in a business usually is somewhat less than a proportionate share of the business as a whole. This is because the minority owner does not have control over important business decisions like dividends, compensation, policies, and even selling out or liquidating. Consequently, when valuing a minority interest, there is usually a discount for lack of control from the enterprise value. Minority interests are hard to sell. Consequently, there usually is another discount for lack of marketability. These discounts often total to 50% or more from a proportionate share of the value of the business as a whole.
There are many reasons to have a business valued by a qualified professional business appraiser. Professional accreditations in business appraisal are conferred by the American Society of Appraisers, the AICPA (most CPAs are not qualified business appraisers but the AICPA does offer the designation CPA/ABV, accredited in business valuation), the Institute of Business Appraisers, and the National Association of Certified Valuation Analysts.
When the owner has the business valued for any litigation purpose, it is wise to have the opposition's business valuation report as well as the owner's expert business valuation report reviewed by an independent qualified appraiser.