Business Valuation Part 1: Levels of Value

Business Valuation Part 1: Levels of Value

Introduction This is Part 1 of a four part series that will serve as a valuation primer. The purpose of Part 1 is to give an overview of common terms and methods used to value an equity interest in a company. The issue we are trying to resolve when valuing a business is the price that two independent parties would pay for or be willing to receive for the interest they hold. The value of a business interest depends on the future benefits that will accrue to it.  The financial benefits from ownership must come from one of the following sources: distribution of earnings, from the sale of the interest, or distribution from the liquidation of assets.  In determining the value of a business interest, one should focus on the benefits the shareholder(s)/member(s) may receive from long-term ownership in the securities. In appraisal terminology, these three sources of return correspond to the income, market, and adjusted net asset value approaches, respectively. When using each of the three approaches, the valuation analyst must also keep in mind the size of the interest being valued and the underlying financial information used to determine the value. This series of four valuation primers will cover the levels of valuation and the approaches to value. Minority Interests and Controlling Interests The value of a shareholder’s interest in the stock of a company is influenced by the shareholder’s access to and ability to distribute cash. In general, an ownership interest greater than 50% is considered a controlling interest and an ownership interest less than 50% is considered a minority interest.  The type of interest being...
What is a Business Valuation?

What is a Business Valuation?

A business valuation, or also sometimes referred to as a business appraisal, is a formal process to inform a business owner or a shareholder of the value of their interest in the company. A company can take many different forms and hold a variety of assets or perform a variety of services but a business valuation can use the information provided by a company to give an opinion of the value of that business. The most common request from a client is to determine what is called the fair market value of an equity interest. Fair market value is defined by the IRS as “… the price at which the property would change hands between a willing buyer and a willing seller, neither being under any compulsion to buy or to sell and both having reasonable knowledge of relevant facts.” The conclusion of value can be presented in a few different formats. A calculation of value is a valuation performed using previously agreed upon procedures between the valuation firm and the client. Typically a calculation of value relies on limited information from the company and the result is for informational purposes only. The results of a calculation of value are presented in a short letter with accompanying schedules. A conclusion of value can be presented in a summary report or a full formal report. A conclusion of value takes into account all available information on a company’s operations. The difference between a full formal report and a summary report is a summary report omits certain information that is not pertinent to the end user. For example, if the end...
Jason Bolt, CFA, ASA Joins Jones & Roth Business Valuation Team

Jason Bolt, CFA, ASA Joins Jones & Roth Business Valuation Team

Jones & Roth CPAs and Business Advisors are excited to announce that Jason Bolt, CFA, ASA has joined the Firm’s Business Valuation Team. Mr. Bolt holds expert knowledge in all areas of business valuation. His experience includes valuations of businesses in numerous industries (e.g. software, medical devices, convenience stores, forest products, manufacturing, professional services, retail/wholesale, agriculture, and restaurants). Mr. Bolt’s professional experience stems from his time providing valuation services since 2005 and his experience in corporate finance and his education at Cornell University where he studied corporate finance, investments, portfolio theory, and economics. His appraisal experience includes individual Client case management and all aspects of appraisal engagements including Client Company due diligence and valuation approaches and methodologies. His valuation experience includes appraisal engagements for a variety of purposes including M&A transactions, gift and estate tax, 409A valuation, and ESOP purposes. Mr. Bolt attends annual business valuation conferences which include annual Advanced Business Valuation Conferences offered by the American Society of Appraisers and Portland chapter meetings of the American Society of Appraisers. Mr. Bolt has qualified and testified as an expert witness in Oregon. Jason is active as a writer and presenter on business valuation education and thought leading...
Big Changes in Estate Taxes and Planning Opportunities

Big Changes in Estate Taxes and Planning Opportunities

by William V. Mason, ASA, CPA/ABV, CFF, Partner & Shareholder, Jones & Roth Aren’t estate taxes and estate planning based on the “fair market” value of assets at the date of death or the date of the gift? You only thought so! Fair Market Value is defined as “…the price at which property would change hands between a willing buyer and a willing seller when the former is under no compulsion to buy and the latter is under no compulsion to sell, both parties having reasonable knowledge of all relevant facts.” It is being proposed by the Treasury Department that this will not be the standard of value used when valuing minority interests in family-controlled entities On August 2, 2016, The US Treasury Department released proposed regulations under Internal Revenue Code Section 2704. The proposed regulations change significantly the manner in which minority/non-controlling interests in family controlled entities are valued for estate, gift, and generation skipping transfer tax purposes. The proposed valuation regulations impact these interests in family limited partnerships, family owned C and S corporations, family owned LLCs, and family owned joint ventures. In addition, “family controlled” is the governing wording. The entity need not be owned 100 percent by the family, it need only be controlled by the family. The Treasury Department is proposing to eliminate the application of the lack of control discount. As appraisers, we access data bases which provide objective observations of the existence and magnitude this discount for lack of control (DLOC). The Treasury Department is, with these regulations, re-defining “fair market value” as it pertains to these types of non-controlling interests. Objective observations...
Confusion Between Income Approaches

Confusion Between Income Approaches

by: William V. Mason II, ASA, CPA/ABV, CFF Christopher Hays, ASA, CPA/ABV, CVA, CFE Tiffany Mellow, CPA/ABV   Let’s clear up some confusion between two income approaches — Capitalization of Earnings vs Discounted Cash Flow. Which calculation relies on greater speculation?  Does the court need some education?  Is your appraiser not properly incorporating available financial information, or has the appraiser not asked all the pertinent questions? These methods are not different methods, they are the same method. The “Capitalization of Earnings” method (more appropriately called “capitalization of cash flow”) is the Discounted Cash Flow (DCF) method collapsed (using simplifying assumptions) to a single future year projection with a constant growth rate. The “Capitalization” method relies on a projection of the cash flow one period into the future, then it assumes this projected cash flow will grow at a constant periodic rate.  To arrive at the value estimate, the projected cash flow for the first year into the future is divided by the “capitalization rate.”  The capitalization rate is the discount rate (the rate of return an investor requires for investing in a business as risky as the business being valued) adjusted for the expected constant growth rate.  The formal name of this is the “Gordon Growth” Model. The Gordon Growth Model states the present value of a perpetual annual stream of cash growing at a constant rate is: V  =  D/(r – g) where: V = present value of stream of cash flows D = next period projected cash flow r = investor (buyer’s) required rate of return, also called “discount rate” g = annual growth rate in cash flow The common...
Personal Goodwill, Enterprise Goodwill and Enterprise Value

Personal Goodwill, Enterprise Goodwill and Enterprise Value

By Bill Mason, ASA, CPA/ABV, CFF Chris Hays, ASA, CPA/ABV, CVA, CFE Tiffany Mellow, CPA/ABV   Has your business appraiser appropriately valued the enterprise, or enterprise interest, or has the business appraiser included goodwill assets which are not “owned” by the enterprise? Is your client buying all of the assets which generate the revenues or are you missing some? Who owns the goodwill? Goodwill is defined as the intangible asset that arises as a result of name, reputation, customer loyalty, location, products and other similar factors. It does not include identifiable intangible assets such as copyrights, trademarks, patents, licenses/licensing agreements, etc. In general, the concept of goodwill, at its most basic, is the propensity of a customer or client to return to, or the propensity of a new client or customer to visit, a particular business or individual associated with the business. Goodwill creates additional cash flow/value from this propensity to return/visit by generating a return in excess of a reasonable return on tangible and identifiable intangible assets. Goodwill can be personal (assignable to an individual’s actions/relationships), or enterprise goodwill (assignable to the enterprise/business and its reputation, location, etc.). Whether the valuation is performed for transactional planning purposes, marital or partnership dissolution, or estate and gift tax purposes, the existence of personal goodwill can be a material issue in a company’s valuation. Personal goodwill can be associated with key employees and/or owners. The impact on Company value for any of the purposes noted will vary depending upon whether the person to whom the goodwill is attached is subject to an employment agreement, a non-compete agreement or neither. If a business is being sold, and personal goodwill can...