Business Valuations (28 QUESTIONS) Flashcards
What are standards v the approaches and methods?
The approaches and methods are used to establish [fair market value], and the term [FMV] is a standard under which various approaches and methods are employed.
What are the 4 standards of value?
- FMV
- Fair Value
- Investment Value
- Intrinsic Value
What is the Fair Market Value standard?
FMV is the price, expressed in terms of cash equivalence, at which property exchanges hands between a hypothetical willing and able buyer and seller, acting in an arm’s length in an open and unrestricted market where neither is under compulsion to buy or sell and when both have reasonable knowledge of the relevant facts
What is the fair value standard of value?
Fair Value is often used in dissenting minority interest shareholder suits, which has been either statutorily or judicially defined.
What is the difference between Fair Value and FMV
The difference between Fair Value and FMV is you ignore discounts. The discounts only apply to FMV really.
What is the Investment Value of standard value?
Typically this is the value to a specific buyer requiring consideration of buyer specific attributes of the buyer. The value to a specific buyer is opposite to that of the hypothetical buyer assumed in the FMV standard. For example, this may be from an investment point of view and return point of view, the buyer want “X.”
GOOGLE:
The valuation assumes that the business will be sold to a SPECIFIC BUYER who has unique synergies with the business.
What is the intrinsic value
Value in the hands of the present owner without the sale. This is referred to as “holder value” or as investment value to the business owner. This typically recognizes the business owner will not be selling the business and there is no hypothetical transaction (as there is in the FMV appraisal), and the owner will continue to receive the value of the business into the future
What is value in the hands of the present owner without the sale also known as?
Holder value AKA INTRINSIC VALUE
Which standard value is the most wildly used method
FMV
What does FMV assume?
A hypothetical sale
What is not included FMV analysis?
It means that any broker’s fees or other sales commissions that would be required to sell the asset is therefore hypothetical and speculative, and should NOT be subtracted from the value. For the same reason, capital gains taxes which would be due from a hypothetical sale should not be subtracted from the value.
Should capital gains taxes be included under the FMV standard?
NO - because it is a hypothetical sale and therefore speculative
What are different types of discounts in business valuations?
- Discount of Lack of Marketability (DLOM)
- Discount for Lack of Control (DLOC)–
- Key Person Discount
What are Discounts of Lack of Marketability (DLOM)?
Some close corporations are difficult to sell on the open market.
This discount reflects the disadvantages of interests that are difficult to market other than minority status.
You should not apply a marketability discount if the comparables selected are of businesses that are likewise difficult to market.
Most of the reported discounts are in the 20%-30% range. A lack of marketability discount cannot reduce the value of a business to less than the total net value of its tangible assets
When should you apply marketability discounts?
When there are other similarly situated businesses you can use as a comparable
When should you NOT apply a marketability discount
If the comparables selected are of businesses that are likewise difficult to market.
What is the typical range of most discounts for lack of marketability
Most of the reported discounts are in the 20%-30% range.
Can a lack of marketability discount reduce the value of a business to less than the total net value of its tangible assets?
No - a lack of marketability discount cannot reduce the value of a business to less than the total net value of its tangible assets
What is a Discount for Lack of Control (DLOC)?
the lack of control in the company.
What would be an example of when to use a discount for lack of control
If you are purchasing 50% of the ownership or less, there may be a discount for lack of control because you don’t have control
What is the position on minority control discounts in states that apply a FMV standard
A minority discount is generally permitted but it is never automatic
When would you NOT apply a minority discount?
(a) if you are looking at comparable sales of other minority interests;
(b) where spouses together own a majority, no discount should be applied even where one spouse owns minority because the court is valuing the marital estate’s interest in the business;
(c) the minority owner had effective de facto control of the company. This is usually in the range of 25%-35%.
What can a minority control discount not do?
A minority discount cannot reduce the value of a business to less than the total net value of its tangible assets
What is the key person discount?
There is authority for discounting the business that is unduly dependent upon the services of one particular person if that person is not contractually obligated to remain with a company for a substantial period of time.
What happens if an expert considers the presence of a key person in setting a capitalization rate under the capitalization of earnings or excess earnings method?
It’s a double dip to include this discount
Who is subject to paying a premium?
A buyer in a purchase and sale is going to pay more. For example, you could pay a premium if you have majority ownership
What is a buy sell agreement?
This is the contract between the owners that provide for the sale of an owner’s interest in the business to their owners.
What is a common triggering event that prompts a buy sell agreement?
Common triggering events include death, disability, retirement and divorce.
What is the sale price based on in a buy sell agreement
The sales price is determined by a valuation method specified in the agreement.
What are common valuation approaches for buy sell agreements?
Common valuation methods included a fixed price, and independent appraisal or a formula approach
What is personal good will?
Personal goodwill is the goodwill that adheres to an individual.
It consists of personal attributes to an individual including personal relationships, skill, personal reputation, and various other factors
How do states who recognize value to the holder address personal goodwill?
Personal good will is usually not transferable and so states with the “value to the holder” (intrinsic value which is value to the present owner without sale bc it recognizes that the owner will not be selling the business and there is no hypothetical transaction) premise usually do not require it to be distinguished from enterprise goodwill
What are factors that indicate personal goodwill?
- Age and Health of the professional;
- Professional’s Demonstrated Earning Power;
- Professional’s Reputation in the community for Judgment, Skill and Knowledge
- Professional’s Comparative Professional Success; and
- The nature and duration of the professional practice, whether as a sole practitioner or contributing member of a partnership or corporation.
What is enterprise goodwill?
Enterprise goodwill is favorable consideration shown by the purchasing public to the goods or services known to emanate from a particular source.
Customers return to an enterprise based upon its location, staff, telephone number, facilities and the reputation of the overall entity.
It is the goodwill adhering to an entity regardless of the input of any specific individual
Is enterprise goodwill transferable?
Upon selling the business, one has the ability to transfer enterprise goodwill to the buyer.
What are factors to identify enterprise goodwill?
a) appropriate compensation package for the replacement of the spouse;
(b) which customers would follow spouse if departed;
(c) look at competitors and would pricing strategy need to change upon departure of spouse;
(d) who would spouse leaving effect the operating efficiency;
(e) qualifications of remaining personnel;
(f) tangible evidence of entity goodwill (i.e. databases, intellectual property, trade secrets);
(h) would departure of spouse change the operating risk of the business; and
(i) any employment contracts between the professional spouse and business that would spouse from competing
What is the assumption for sale when there is enterprise goodwill?
That upon selling the business, one has the ability to transfer the enterprise goodwill to the buyer..
Is going concern value the same as goodwill?
No – going concern value is not the same as goodwill.
What is going concern value?
Going concern value is the intangible value attached to the assemblage of assets of the business, including the business’s fixtures, equipment and its assembled workforce.
GOOGLE:
It is value that assumes the company will remain in business indefinitely and continue to be profitable
What is business goodwill not concerned with?
Business goodwill is not concerned with physical assets; instead, it can be viewed as the excess earnings a business produces due to its reputation and skill, among other things.
What is personal goodwill concerned with?
Personal goodwill concerns the excess earnings reliant on the practitioner’s personal attributes.
What is fair value?
Fair value can entail an exchange, but not necessarily from a willing seller. Fair value may also assert that a lack of intention to sell the business prevents its valuation as a value in exchange.
In general, when do we consider a valuation to be fair value?
Generally, if a valuation takes a pro rata portion of the enterprise value without shareholder-level discounts, we considered it to be fair value
What may courts do to compensate the non-title spouse
The courts may look to compensate the non-titled spouse for the value generated during the marriage but realized after the divorce.
How do SOME courts view discounts ?
A court evaluating discounts may see the application of discounts as an unfair advantage to the party that will continue to enjoy the benefits of the asset.
Why are there no discounts applied in Fair Value jurisdictions?
If you think of a shareholder entering into a partnership, the shareholder has the expectation of the sharing in the benefits of the business over the course of his or her life or the life of the contract. Should those expectations be breached, the court looks to fairly compensate the individual. Marriage is viewed as an economic partnership where each party has an expectation of sharing the economic benefits generated during the marriage. Therefore, the court may view discounts as unfairly benefiting the owner spouse at the expense of the non-owner spouse.
What happened in Bobrow v. Bobrow?
The husband had a partnership interest in Earnst & Young and his partnership agreement limited the owner’s interest to the value of the capital account, thereby excluding goodwill. The agreement applied only to a transaction of his partnership interest such as resignation, retirement or death. The court recognized that the assets of E&Y belonged to the institution of which each partner had a share. These institutional assets included intangible assets such as E&Y’s trade name, reputation, etc. All of these assets were transferable to an outside purchaser. The court included the value of the enterprise goodwill in valuing E&Y and awarded the wife the share of the value of the husband’s partnership interest in E&Y based on his pro rata share of the enterprise. Because of its conclusion of value as the prorate share of the enterprise value, this case may be construed as a fair value case under value in exchange premise. While the husband had a buy-sell agreement that limited the value to the capital account, the court valued the husband’s ownership interest similar to the way it would be treated under a fair value standard in a dissenting or oppressed shareholder’s case.
GOOGLE:
Fair value is defined as the pro rata business enterprise value - a total equity value that is not discounted for lack of marketability or lack of control. The fair value is equivalent to the corporations por rata value immediately prior to the corporate action to which shareholders are dissenting
What happened in Howell v. Howell?
The husband had a partnership interest in a law firm. Virginia case law provides that while enterprise goodwill that is transferable is marital, personal reputation and future earning capacity are not. The husband’s contract with the law firm provided that when a partner withdraws from the firm, he may receive the balance of his capital account with his share of the firm’s net income through the date of withdrawal. The court looked at whether any goodwill should be included in distributable assets and if so, how to calculate it. The court held that while the restrictive agreement exists, it should not control the value. The court found the DLOC was not an issue worth discounting because no one partner had a controlling interest in the firm. The court similarly found DLOM was inappropriate, as the highest and best use for the husband’s share was to remain with the corporation. Accordingly, the court used the concept that the highest and best use, reasoning the highest value that would be realized was that which would be achieved through the owner’s continued presence, not upon sale, and therefore discounts shouldn’t be applied. This case appears to have elements of FMV (distinguishing between enterprise and personal goodwill, implying a titled spouse’s departure) and investment value (the court considered the highest and best use was the title holder’s continued presence). Thus, the article categorizes it as fair value because it calculates the value as a prorate share of the enterprise value.
What is investment value?
Assumes the business will not be sold and the owner will continue to receive benefits from the business or business interest (unless a sale really is occurring).
What standard does the investment value fall under?
This standard falls under the Value of the Holder premise.
What does the investment value contemplate?
This standard contemplates value not to a hypothetical buyer but to a “particular buyer” which in the context of a divorce, is the current owner (hence, value to the holder). It will apply a going concern value to the current owner.
What is often not at issue in an investment value?
The transferability (and therefore, marketability) of personal goodwill is often not at issue because there is likely no intention to sell.
What does the use of the investment value standard suggest?
The use of the investment value standard suggests the court is attempting to compensate the nontitled spouse for the economic benefits the titled spouse will receive in the future, regardless of whether that spouse can sell those benefits.
What is the intrinsic value
Valuation standard applied to assets that cannot be sold. It is normally determined by measuring the future benefits of ownership and reducing those benefits to present value. Intrinsic value can also properly based upon the present income capacity, as opposed to the actual future earnings of a business.
