You should always consult a professional appraiser for a business valuation when you are selling your company, but that’s not the only time you should have your business appraised, according to Michael Gould, director of Litigation Support and Valuation Services at RotenbergMeril. Mr. Gould discusses some of the other common reasons you should seek the services of a valuation consultant, some of which you may have never considered. Failure to do so could mean reduced value for your business and leaving a lot of your hard-earned money on the table. This is another don’t-miss “Deal Talk” episode!
A lot of business owners are very good at what they do but they don't necessarily understand what drives the value to a buyer.
- Michael Gould
Jeff: To start with, I'd be interested in knowing, of the valuations that you and your firm perform, Michael, what percentage are transactional versus those that are non-transactional?
Michael: Well, most of the transactions are non-transactional though we do a lot of fair value accounting and purchase price allocation type work for our clients who have done acquisitions and they need an allocation of those purchase prices for financial statement reporting purposes. But most valuations we do are either for state gift tax purposes or for litigation matters.
Jeff: Okay, very good. What we're really finding out here, we’re kind of setting this up all from the beginning Michael, and thanks very much for bearing with me. I know that that question is probably somewhat elementary. But really, we're trying to kind of understand why valuations are an important part of doing business, not just for the purpose of getting a better idea of how much our business could possibly be worth at some point on the open market. But really to find out that valuations are really kind of necessary for other purposes. There are many small business owners out there, particularly those owners of smaller businesses that may be somewhere in the ball park of a million dollars annual revenue, maybe even less than that, that are concerned about the short run cost of a comprehensive valuation of their business. But I'm kind of wondering, if it could be advantageous to business owners to spend the money and use the information that valuation will uncover to his company's benefit down the line. We're talking about really valuation, taking and spending that money upfront is really something that could be of great importance later on, could it not, and in more ways than one?
Michael: Sure, absolutely. The truth is a full valuation or what we call a comprehensive business valuation really provides small business owners with a lot of information about his company. And a small business owner would want a business valuation for any number of reasons. Whether they're talking about succession planning and gifting that company down to the next generation, or he wants to set up his company for a potential sale. And a full comprehensive business valuation really delves into how the company has operated over the past, what the projections are for the future, how that company stacks up against the industry. And it would include an analysis of the industry, analysis of the economics, the economic environment that that company actually functions in, whether it's global or local. The business valuator would examine that and see how that market is doing. And so from that full valuation report the business owner could see where the weaknesses are in his company which he may not regularly see on an ongoing basis if he's just looking at financial statements. As a matter of fact he's making money and everything's fine and dandy when there's plenty of cash around. It tends to cover up a lot of errors. So a full business valuation could really help in that regard.
The truth is a full valuation or what we call a comprehensive business valuation really provides small business owners with a lot of information about his company.
Jeff: Interesting points, Michael, and we know that there are some companies out there like you said that are making money. They have cash flow and everything seems to be operating as normal or as well as could probably be expected. But sometimes as well as canbe expected is not always optimal, and particularly when you know that the business might be stagnant when the economy is thriving. A full valuation would allow a business owner and his team to be able to see where their certain weaknesses are that they could shore up. And actually, really at the end of the day and after some hard work maybe at the front end, really allow them to realize real improvements in their company's value over the long run. Is that not right?
Michael: Sure. A full valuation would really point out to the business owner where the value drivers are so he can maximize the value of his business. Most small business owners, most of them that worth is tied up in their business. So that's their retirement. So the sale of that business sometimes is really what they expect to retire on. So that's an asset you want to maximize the value. So you really need to understand what the value drivers are in the business. And a lot of business owners are very good at what they do but they don't necessarily understand what drives the value to a buyer.
Jeff: Today's expert is Michael Gould, CPA, Certified Valuation Analyst, and Director of Litigation Support and Valuation services at RotenbergMeril. You're listening to Deal Talk. My name is Jeff Allen. Full and low cost valuation options, you kind of touched on this just a little bit. When are these two options best used for the small business owner today? When would you go in and say, provide a low cost option as opposed to the full enchilada?
Michael: A business owner might be thinking of selling and maybe several years, few, five years down the road, or he may be considering gifting the business down to his heirs. And he may want to get some idea of what value of the business would be without spending a lot of money on a full comprehensive valuation or report. So we have another process that we go through and we call it a calculation engagement. And that engagement does not include a lot of the bells and whistles that a full company business valuation would entail, and therefore be less time consuming and less costly to the owner. And it essentially is what we call an agreed upon procedure. So we agree upon with the client, "This is what we're going to do. We're going to run a couple of income approaches.” We may agree to do a little market research in terms of comparable transactions or guideline companies. We will agree on a limited number of procedures we're going to go through to give us some indication of what a range of value would be for the business. And this is probably less than half the cost of a full valuation and to give that owner kind of an idea of what he's looking at.
So you really need to understand what the value drivers are in the business.
Jeff: Would you use that same kind of approach for the other non-transactional types of valuations that you do as well, Michael, or are these typically reserved for just kind of the periodic checks that an owner wants to kind of make just to make sure that he's on the right track?
Michael: That's actually an interesting question and it's kind of subject to some debate in the valuation community. We as a firm have a policy. We will not testify when it comes to a calculation engagement because in our mind and if you read our business valuation standard and reporting standards, the calculation engagement is not an opinion of value, it's a calculation or indication of value. So that we do not use calculation engagements if we're going to have to testify to an opinion as to what the value is because it's not an opinion of value. But it is used in a non-transactional litigation matters or... matters where the parties are working towards settling the matter in non-litigated areas. So they want to get some idea of what the value and if they can agree to it. We may use a calculation engagement for those purposes, and often do knowing that this is not going to trial and I do not have to testify to it, but we want to get some idea of what the value is.
Jeff: A calculation engagement is really kind of another way of saying it's a smart estimate that is close but it's not anything that you can really go ahead and hold someone to for the purpose of, like you said, testifying in court or litigation proceedings.
Michael: Right, because if you go to court you want to be able to say that you have a professional opinion as to what the value of a business is. And a calculation engagement, the procedures that are involved in a calculation engagement don't allow you to give that opinion. And under our business valuation reporting standards that we have to adhere to as credential business valuators.
The calculation engagement is not an opinion of value, it's a calculation or indication of value. So that we do not use calculation engagements if we're going to have to testify to an opinion as to what the value is because it's not an opinion of value.
Jeff: Correct. So the need to be accurate and as close as precise as you possibly can comes with more of a full-scale valuation procedure, and that's something that your company does an awful lot of. Transactional and non-transactional valuations, when do you need the latter? I'm Jeff Allen talking with Michael Gould, Director of Litigation Support and Valuation Services for RotenbergMeril. We'll be back with more on Deal Talk right after this.
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Jeff: Welcome back to Deal Talk, Jeff Allen here with my guest Michael Gould, Director of Litigation Support and Valuation Services for RotenbergMeril. And Michael Gould is a CPA, also has a designation of a CVA, Certified Valuation Analyst. Michael, we appreciate you're being on our program today. Let's talk about the main differences between transactional and non transactional valuations. We could go over in terms of time spent, any other details the way that they're calculated and the way that these things are processed, and all the information that they require. But maybe you can kind of give us some insight on that?
Michael: Well, there are some differences between a valuation for divorce purposes versus a valuation for tax purposes, or transaction for a potential sale of a business. In a divorce situation ... Let me back up a second. A lot of the information that you need to perform all of these valuations is a lot of the same information. Assuming historical information, you need projections if you can get them, etc. However, in a divorce valuation for instance, it really depends on what state you're in or what jurisdiction you're in because in certain states the premise of value will be different. In New Jersey for instance, there's been some precedent cases, the most notable being Brown vs. Brown in New Jersey where they basically say the premise of value is value to the holder, but that's the way everyone is interpreting the Brown vs. Brown case in New Jersey. That means that the values to the holder there's no valuation discounts applied in a valuation for matrimonial purposes in New Jersey. However in New York it doesn't hold that way. There are certain valuation discounts that are applied in New York valuations.
Jeff: I was going to say, if you don't mind, before we kind of go on just a second, Michael, valuation discounts, exactly what are those?
Michael: Valuation discounts would be for instance if you're valuating less than 50 percent it could be a lack of control or minority interest discount. It could be if you're valuing a closely-held business where there's a restriction on the transferability of the interest. It could be a lack of marketability or lack of liquidity discounts. It could be key man discounts, those types of things. The main ones are lack of control and lack of marketability.
Jeff: Okay, very good. I hope I didn't steer you too far off the track there when I jumped in with that question. You can continue your explanation.
Michael: Excellent. And then versus the valuation for tax purposes, you're pretty much guided by the business valuation standards and regulations that you'll find in the internal revenue code and the regulations thereof where it is a what they call fair market standard of value for tax purposes. However, as you may know right now and this is in October 2006 we expect some regulations to come down from the IRS probably early next year. The kind of thinking is which is going to address some of the restrictions probably, and some of these family limited partnerships and family LLCs which restrict transferability, or the right to withdraw. And if they come down with these regulations then what we expect to happen is that the IRS is going to say that valuing some of these entities, the valuations ignore these restrictions in their valuation. So if you have to ignore these restrictions in your valuation that's going to limit the discounts for lack of marketability for instance, in a tax valuation. Mainly we think now and those entities that hold only marketable securities. We believe that for tax purposes, the valuations of operating companies, operating businesses and rental real estate entities are probably going to escape these regulations. But quite frankly until they come out it's all speculation at this point.
So if you have to ignore these restrictions in your valuation that's going to limit the discounts for lack of marketability for instance, in a tax valuation. Mainly we think now and those entities that hold only marketable securities.
Jeff: So to take advantage of those valuation discounts you need to be able to take advantage of them before the end of 2015, is that correct?
Michael: I would say if you’ve got a family LLC in your plan, or sitting there and you want to start making gifts you should do it before these regulations come out. Most likely these regulations are not going to be retroactive, they will be prospective. So if you want to get the maximum valuation discounts allowable under the rules now you should do it now, absolutely.
Jeff: My goodness. There we go. Make sure that's food for thought and everybody listening is hopefully going to take what you say very seriously and take advantage of that. It's rather short porch. So if you're considering valuation right now and taking advantage of discounts such as what we just discussed with Michael Gould that you do so now. Let's talk now about non-transactional valuations where you are going in, let's say, and divorces come and it's unfortunate. But the fact of the matter is it happens and it's probably something you get a lot of calls maybe at your office about this type of thing, Michael. I can't pretend to know for sure but I can imagine that it is probably important for something like that to require a neutral party or a neutral business valuation in particular. Let's talk about that. What exactly that means and how you go about ensuring that you're getting a neutral business valuation for something like this, like divorce for example?
Michael: Yeah. Actually, I just gave a speech, a national conference last week about hiring a neutral financial expert as opposed to each party retaining their own and what are the main benefits to having a neutral expert. What normally happens, each party to a manner will hire their own experts. Those experts, their opinions lined up worlds apart, so then what happens? The judge, if it goes to litigation, is going to hire a third expert. Or the judge just decides he's going to split the baby which generally is not the right answer. So hiring one neutral expert that instead of ending up with three is clearly less expensive. The other main issue is a neutral expert doesn't owe any allegiance to either party. He or she is only an advocate for his own opinion. So his mindset is he wants to come to the most equitable and the most correct answer that he can. And that's a benefit to both parties. And then the other issue that happens when you end up each party with their own expert with kind of built-in biases because they feel they owe an allegiance to the people paying their fees is sometimes one of the parties hires what we'll call a hired gun. When a hired gun doesn't control the expectations of the client they end up putting totally distorted figures into the mindset of the party. And when that happens it becomes very difficult to actually settle the matter because they get into the matter, this unreasonable expert is, "We're going to get you a gazillion dollars." And when they find out that they're going to get half a gazillion dollars, you can't settle the matter. So it's always better to start out with a neutral expert.
So hiring one neutral expert that instead of ending up with three is clearly less expensive.
Jeff: The question is, how does one go about defining one as neutral and how do they actually come to the agreement that they use this particular appraiser or valuation expert as opposed to this one? How is a neutral expert chosen?
Michael: There are a few ways a neutral expert gets retained in a manner. In a mediation a lot of times we brought in a lot of very ... mediators. And a mediator in a manner who may not be a financial person, might be an attorney, might tell the employees there are complicated financial issues here and maybe valuations that need to be done. And he or she needs a financial expert. They may give the parties a couple of names that he or she knows of and work with. And say, “Here, interview them, pick one,” or they may say, "Look, this is the person I work with. This is the person I'm most familiar with, I have confidence in, and we've had good results with." That's in a mediated matter. There's another divorce process which is gaining favor these days and that's collaborative divorces. In a collaborative matter there's a team. And on a team there's usually one neutral financial expert on that team. So when you get into a collaborative divorce there is an already chosen neutral financial expert that the parties will retain. And then in a litigated matter, and this happens quite often, either the parties themselves will agree on a neutral expert to be brought in for the financial matters, or the judge can appoint a neutral financial person and very often we become court appointed. That's sort of the way it happens.
Jeff: Is there anything that is not included in the valuation when your team goes out and whether you've been appointed by the court or otherwise. You start to put this together for whether it be a dissolution, divorce, or what have you. Anything at all that isn't included or may in fact be included where you typically might not include in an appraisal, and all that you can talk to us about?
Michael: I'm not sure exactly how to answer that except to say that if we're doing a minority interest valuation for tax purposes we may or may not be hired to do a lot of forensic accounting. Whereas in a divorce situation you have to do a valuation sometimes and then close the old business. There may be some personal prerequisites that are running through the business which many not be what we'll call an ordinary necessary business expenses. So we may have to go in and determine what kind of adjustments we have to make for the historical income statements to normalize them so that we have a correct historical cash flow from which to develop a value for that business. So there may be some differences in what we do, but usually that gets defined early on in the process so they know whether how much time they're going to be spending doing that kind of work.
So we may have to go in and determine what kind of adjustments we have to make for the historical income statements to normalize them so that we have a correct historical cash flow from which to develop a value for that business.
Jeff: What is maybe an example from the work that you've done in the past of some things that you've uncovered? And obviously you're not going to mention any companies here but I mean what have you seen that you've gone through and you're going through the investigative process to put together these numbers and some stuff that you've uncovered where the books are just completely upside down or just a complete mess. Or maybe even we can talk about some common areas where you've seen some major accounting weaknesses that weren't anything that were deliberate but it caused your process of preparing your valuation it created a greater period of time, more work for you, in order to get where you wanted to be and have those final figures already for your client.
Michael: Yeah. There's not enough time in this program to give you all the war stories. But what'll happen, and it does happen more often than you would like is that you'll take a look at tax returns in a matter for a company, small business. And then you look at the books and records and they look like they're two different companies. You're trying to figure out, you can't trace the books and records for the company to what's been reported to the IRS. That becomes quite a bit of a nightmare and results in a lot of forensic work and analysis to try to figure out what's the true, which set of books are we supposed to be using. And then you get to the cash-based businesses like restaurants, salons, and whatnot that 50 percent of the income is actually being reported and we've had a recent case where we went to a restaurant and we had to make a couple of site visits, not that they knew who we were. We had some staff people going there and eat. We had to count tables, and heads. And because the income, I think they showed ... So we walked in and counted 20 employees and there were two on the books, that type of thing. So we had to totally reconstruct the operations of the business in order to develop some indication, what the value of that business was and that wasn't even for a divorce, that was a shareholder dispute.
Jeff: Oh my gosh, no kidding? What about for lawsuits, are you contacted by a client, a business owner when they know that maybe they're being sued, or there's litigation coming their way, and they need to reach out to you to come out and kind of analyze things before the proceedings?
Michael: Yeah, sometimes what will happen is there's a suspected theft for instance inside a company, and the company ends up actually going out of business. The damages could be either the amount that was stolen or the actual value of the business that was destroyed. Sometimes we'll get involved in shareholder disputes where one equity owner thinks he's the operator and another one's a passive investor, and they think the operating person is stealing from them, or was not reporting everything they should be. Often, rather than jump to a legal complaint and start the legal process running they'll come to us and say, "This is what's going on. What we want to do is without the judge getting involved. What's the value of this thing? Let's see if we can come to an agreement and want to buy out the other and move on without spending hundreds of thousands of dollars in litigation costs."
Jeff: Any final thoughts, Michael, as we're running out of time here that you have for business owners who may be in need of valuation, and it could be for any purpose. Maybe they're planning on selling their business soon. They're looking for kind of a midterm type of calculation just to make sure they're on the right track, or anything at all that you could leave with us, any key take aways from your perspective and experience?
Michael: I would say that it's always a good idea to periodically have the business appraised by a qualified business appraiser, and that's people who have experienced in the field, who have credentials, like having a CVA like ... and also an ASA, Accredited Senior Appraiser. There are number of credentials out there. It's always a good idea to have an idea. The truth is if they've got a buy-sell agreement in place, if they have partners, if they are doing some esstate planning and passing it along to their heirs they really need to know what the value of that business is. That's really something that should be done on a periodic basis.
It's always a good idea to have an idea. The truth is if they've got a buy-sell agreement in place, if they have partners, if they are doing some esstate planning and passing it along to their heirs they really need to know what the value of that business is.
Jeff: If somebody would like to get in touch with you, Michael Gould, at your office there at RotenbergMeril, how can they do that?
Michael: Well, they can certainly call me. My direct telephone line is 201-490-2077. Our New Jersey office is in Saddle Brook, south of New Jersey, and we have a Manhattan Office at 40th and Lex. You can always reach me through my direct line. My email address is email@example.com which is the initial of the firm.
Jeff: Very good. Michael Gould, it's been a pleasure sir. Thank you so much for giving us a slice of your time today in discussing these very important points. We are out of time. We'll have to leave it there. Michael Gould, thank you.
Michael: Thank you. Thanks for having me.
Jeff: Michael Gould, director of Director of Litigation Support and Valuation Services at RotenbergMeril.
Deal Talk has been presented by Morgan & Westfield, a nationwide leader in business sales and appraisals. If you're thinking about selling a business or buying one you can call Morgan & Westfield at 888-693-7834 or visit morganandwestfield.com. And for more valuable information and insight from our growing list of small business experts like Michael Gould from RotenbergMeril make sure to join us again here on Deal Talk. I'm Jeff Allen, thanks again for listening. We'll talk again soon.