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Creative Exit Strategies
Valuing the Company
Presented by:
Clark Schaefer Hackett
&
Taft Stettinius & Hollister, LLP
Defining a Closely-Held Corporation
• Closely‐Held Corporations
– Shares of which are owned by a relatively limited number of stockholders
– Little, if any, trading
– No established market for the stock
– Lack marketability
– Have concentration of management in a family group
– Influence shareholder’s personal circumstances on dividend policy
– Lack access to public markets for capital funds
– Have greater possibility of asset realization through a merger, sale, or liquidation of the company
Situations that call for Valuations
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Gift and Estate Taxes
Fair and Enforceable Buy‐Sell Agreements
Buying and Selling Shares in the Company
Employee Stock Ownership Plans (ESOP’s)
Corporate Dissolution
Divorces
Mergers and Acquisitions
Compensatory Damage Cases
Defining the Appraisal Assignment
• Requirements of the Appraiser
– Do not use financial statements or perform an audit
– Minimum education requirement (CPA)
– Experience in subject matter
– Regular basis
– Receives compensation for work
– Not prohibited from practice in front of IRS
Defining the Appraisal Assignment
• Requirements of the Appraisal
– Written
– Signed and Dated
– Small Business Administration (SBA) requires valuation if the business is sold to a family member, regardless of the size of loan
– SBA requires non‐family transactions with loan value above $250,000 to have a certified valuation
– Do not use financial recast, financial statements or perform an audit
Definition of Value: Projected Earnings
vs. Historical Data
• Appraiser may use either past projections for determining future earnings or rely on historical data for determining the value of a company. • “Fair Market Value (FMV).” FMV is defined as the price at which a business “would change hands between a willing buyer and a willing seller, neither being under a compulsion to buy or sell and both having reasonable knowledge of relevant facts.
Basic Factors Affecting Value
Earnings
Cash Flows
Assets
Gross Revenues
Dividends
Marketability/Liquidity
Entity Type (next slide)
C Corporation
– Two layers of Tax
– No preferential Capital Gains Rate
– Classification of Personal Goodwill
• S Corporation
• Partnership
• Limited Liability Company
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Revenue Rulings
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Revenue Ruling 59‐60 – 8 factors
Revenue Ruling 65‐193
Revenue Ruling 68‐609 ‐ Goodwill
Revenue Ruling 77‐287
Revenue Ruling 83‐120
Revenue Ruling 93‐12
Retained Interests and Buy-Sell Agreements
• A bona fide business purpose is a legitimate business purpose. The courts have acknowledged that the desire to maintain family control through a buy‐sell agreement.
– binding during life and death
– obligates the sale of the interest
– the price is fixed or determinable
Employee Stock Ownership Plans
• Employee Stock Ownership Plans (ESOPs) provide an excellent opportunity for employers, employees, banks, and insurance companies
• ESOPs are a valuable tool for business succession plans
Financial Analysis
• Provide key benchmarking ratios for the use of comparable companies
• Ratios aid the appraiser in adjusting for the expenses or the income generating potential of the company being appraised
• Recasting financial statements
Recasting Income Statement
• Profit and Loss Statement
• Presents the results of the operating activities over a period of time, generally one year
• Net Income or Loss – the difference between revenues and expenses
• Adjustments:
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Salaries and Perks of Owners
Nonrecurring expenses and income
Investments and non‐operating expenses
Interest payments
Depreciation expense
Rent Expense to fair value
Discretionary expenses
Pensions
Recasting Balance Sheet
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Presents a snapshot of investing and financing activities (including property, assets, investing)
Assets (monetary and non‐monetary)
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Cash
Inventory
Property
Equipment
Accounts Receivable
Liabilities
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Accounts Payable
Loans
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Owner’s Equity
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Adjustments:
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Assets on books
Obsolete inventory
Uncollectible accounts receivable
Loans to owners
Value assets at fair value
Cash
Goodwill
Recasting Statement of Cash Flows
• In recent times the cash flow statement has been perceived as more important than the income statement
• Shows inflows and outflows
– Operating
– Investing
– Financing
Weighting the Results
• The weights must total 100% but cannot be randomly assigned
• The weighting scale must be justified by the appraiser
• The weights assessed by the appraiser should be based on the factors of each individual case
Discounts and Premiums
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Marketability Discount
ESOP Discount
Minority Discount
Key Employee Discount or Personal Goodwill
Nonvoting Discount and Premium
Control Premiums – IRS allows 35%
Valuation Methods
Comparables Price
Capitalization of Earnings
Adjusted Book Value (Net Tangible Assets)
Excess Earnings Capacity (Goodwill) – delete all expenses
• Present Value of Future Income Stream (Leverage Cash Flow Debt Method)
• Use more than one method •
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Background on Valuations
• Consider three approaches to value:
– Asset approach
– Market approach
– Income approach
Background on Valuations
• Three types of reports:
– Calculation report
• Can be used as planning tool
– Summary report
• Another planning tool; more information than the calculation
– For items going to IRS
• Detailed report is necessary to address items required
Business Valuations
• Difference between valuing 100% and partial interest in business
• Under fair market value we make normalizing adjustments for unusual or non‐recurring items
• If we use investment value, we can make assumptions based on who buyer is
Valuations for 100% Interest
• Have control of business decisions
• Would use maximum capital structure based on industry data
• If valuing 100% in mergers & acquisitions, can do projections to estimate changes expected
– Higher margins on costs savings or change in workforce
Non-controlling Interests
• Cannot force a sale or liquidations
• Would use current capital structure, which may be very different than maximum available
• Example – Business with no debt would have much lower multiple
Application of Discounts
• Discount for lack of control when valuing a non‐controlling interest
• Discount for lack of marketability
• Lack of marketability is applicable for both controlling interest and non‐controlling interest
Type of Sale
• Asset sale vs. stock sale
• Difference in market data used based on type of sale
• If asset sale, what assets will be transferred?
• Entity type may impact type of sale
Conclusion
• Many reasons exist to have a business valued
• Valuation must be done by a competent professional
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