In many instances, economic damages may be alternatively calculated as future lost profit or lost business value. Lost business value may seem to the jury to be less speculative than projected future profits, and the tax treatment of any award may be more favorable. Calculating the value of a business in accordance with professional standards requires specialized expertise, experience and credential. Thomas Neches is a credentialed and experienced business valuation expert: he has performed numerous business valuations in a litigation context, and he is a Certified Valuation Analyst and is accredited in Business Valuation.
Here is a seminal quotation that captures a fundamental issue in business valuation:
“In many cases valuation amounts to little more than a guess, though a guess by informed persons.” (U.S. Supreme Court, [U.S. v. Miller, 317 U.S. 369 (1943)])
The reason behind this quotation is that, fundamentally, the value of a business is the value of the money the owner of the business owner expects to earn from the business in the future. Hence, no matter the approach(es) used to calculate business value, every business valuation amounts to a projection of future earnings, which can never be certain and precise.
Reasons to Value a Business
Reasons to value a business include the following:
- Buy/sell agreements
- Capital infusions
- Charitable contributions
- Collateral valuations
- Bankruptcy liquidation value
- Eminent domain proceedings
- Employee benefit plans
- Employee Stock Ownership Plans
- Estate planning and taxation
- Expert testimony/litigation support
- Fairness opinions
- GAAP valuations (FAS 141, FAS
- Gift taxes
- Insolvency opinions
- Loan applications
- Marital dissolution
- Mergers and acquisitions
- Purchase price allocations
- S Corporation Elections
- Sales and divestitures
- Shareholder transactions
- Solvency opinions
Standards of Value
Standards of value of a business include this following:
Fair Market Value
“The price at which the property would change hands between a [hypothetical] willing buyer and a [hypothetical] willing seller when the former is not under any compulsion to buy and the latter is not under any compulsion to sell, both parties having reasonable knowledge of relevant facts.”
Fair Market Value in Continued Use
Fair Market Value plus freight, tax and installation (used in equipment purchase valuations).
Value to a specific strategic buyer.
An analytical judgment of value (e.g., an analyst says, “this stock is overpriced”).
Legal standard, which varies from state to state and often is left to the discretion of the judge. Fair value is used in:
- Dissenting shareholders’ cases
- Minority oppression cases
- Fraudulent conveyance cases
- Fair value is also used in FASB 820 financial reporting per GAAP.
Fair Market Value assuming a reasonable length of time in the open market (used in real estate appraisals). Market value also assumes “Highest and Best Use,” defined as The reasonably probable and legal use of vacant land or an improved property, which is physically possible, appropriately supported, financially feasible, and that results in the highest value.”
Premises of Value
Premises of value include the following:
- Going Concern
Categories of Value
Categories of value include the following:
- Asset or Security
- Minority or Control Interest
- Marketable or Non-Marketable Interest
- Equity or Capital
- Direct Equity (value of the company “as is”)
- Invested Capital (value of the company as restructured after
Approaches to value a business include the following:
- Industry Approach (“Rules of Thumb”) Provides a sanity check but should not be relied on alone.
- Market Approach Compares the business to sales or prices of similar businesses.
- Cost Approach (also called “Asset Approach”) Determines construction or replacement cost.
- Income Approach Determines the present value of projected future cash flows or
The steps involved in applying the market approach include the following:
- Obtain the financial statements of the subject company.
- Select comparable (“guideline”) companies.
- Obtain the financial statements of the guideline companies.
- Analyze the differences between the subject company and the guideline companies.
- Adjust the financial statements of the subject company and the guideline companies as appropriate.
- Calculate valuation multiples for the guideline companies (e.g., price/sales or price/earnings). Apply the valuation multiples to the subject company.
- Apply discounts or premiums.
The cost approach generally produces a control, marketable indication of value. The steps involved in applying the cost approach include the following:
- Prepare appraisals of tangible property.
- Reproduction cost new – current cost of reproducing an exact replica.
- Replacement cost new – current cost of similar new item with same functionality.
- Fundamental assumption: Value = Assets – Liabilities.
- Supported by economic principle of substitution. “A prudent buyer will pay no more for an object than the cost of producing an equally desirable substitute with comparable utility.”
The steps involved in applying the income approach include the following:
- Obtain and adjust the financial statements of the subject company.
- Project future income or cash flows.
- Apply discount rates to projected future earnings.
- Apply discounts or premiums.
Financial Statement Adjustments
Both the market approach and the income approach require analysis of the financial statements of the subject company. These financial statements may need to be adjusted to accounting for differences between “real world” and reported values for:
- Officers’ compensation
- Timing differences
- Non-conformance with GAAP
- Accounting changes
- Related-party transactions
- Obsolete equipment
- Unusual or non-recurring items
- LIFO to FIFO inventory
- Non-performing employees.
Discounts and Premiums
Both the market approach and the income approach require analysis of premiums and discounts that may be applied to the indications of value of obtained. These premiums and discounts include:
- Minority/Controlling interest
- Small company risks
- Specific company risks
- Key person
- Restrictive agreements
- Information access and reliability
- Non-homogeneous assets
- Lack of diversification
- Liquidation costs
- Trapped capital gains
- Voting rights
Use an Experienced Business Valuation Expert
Business valuations can be complex to perform and challenging to explain. You need an experienced business valuation expert to provide the services. For your next business valuation, consider using Thomas Neches, who is a Certified Valuation Analyst (CVA – National Association of Business Valuators and Analysts) and is Accredited in Business Valuation (ABV – American Society of Certified Public Accountants).
Trial Testimony: Business Valuation
Thomas M. Neches, CPA/ABV, CVA, CFF
Representative Business Valuation Engagements
|Industry||Entity Valued||Interest Valued|
|Retail||Car dealership||100% ownership|
|Mining||Rock milling company||100% ownership|
|Real Estate||Real estate holding company||Minority interest|
|Fast Food||Yogurt shop||100% ownership|
|Real Estate||Condominium project||100% ownership|
|Entertainment||Rock group||Partnership share|
|Retail||Photo processing center||100% ownership|
|Insurance||Insurance company||100% ownership|
|Manufacturing||Plastic wrap manufacturer||Minority interest|
|Public Relations||Marketing company||Minority interest|
|Entertainment/Retail||Virtual reality store chain||Minority interest|
|Garment||Dress design/manufacturer||100% ownership|
|Manufacturing||Thermoformed plastic manufacturer||100% ownership|
|Retail||Liquor store||100% ownership|
|Entertainment||Graphics design||100% ownership|
|Health Care||Medical practice||100% ownership|
|Legal Services||Law firm||Partnership share|
|Advertising||Coupon sales company||100% ownership|
|Legal Services||Jury consulting and graphics firm||Minority interest|
|Health Care/Finance||Medical receivables finance firm||Minority interest|
|Entertainment||Rock group||Partnership share|
|Consulting Services||Software research firm||49% ownership|
|Automobile||Automobile repair shop||100% ownership|
|Entertainment||Music royalties||100% ownership|
|Banking||Mortgage loan brokerage||40% ownership|
|Wholesale||Garment wholesaler/distributor||50% ownership|
|Real Estate||Real estate development company||Minority interest|
|Retail/Wholesale||Automobile dealership||60% ownership|
|Retail||Automobile repair shop||100% ownership|
|Health Care||Hospice owner/operator||100% ownership|
|Entertainment||Record label||100% ownership|
|Computer Services||Radiology management software||Controlling interest|
|Medical Insurance||Claims processing company||100% ownership|
|Entertainment||Cover band||20% ownership|
|Health Care||Radiology laboratory||30% ownership|
|Wholesale||Food distribution company||100% ownership|
|Manufacturing||Truck body manufacturer||100% ownership|
|Finance||Investment analysis company||2.75% ownership|
|Education||Private primary school||100% ownership|
|Computer Services||Tier III+ colocation company||33.3% ownership|
|Repair Services||Appliance repair company||50% ownership|
|Surveying Services||Drone images services company||Minority interest|
IF YOU HAVE ANY QUESTIONS, PLEASE CALL THOMAS NECHES DIRECTLY AT 213.624.8150.CONTACT US