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).

 

Investment Value

Value to a specific strategic buyer.

 

Intrinsic Value

An analytical judgment of value (e.g., an analyst says, “this stock is overpriced”).

 

Fair Value

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.

 

Market Value

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
  • Liquidation
    • Orderly
    • Forced

 

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
      purchase)

 

Valuation Methods

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
    income.

 

Market Approach

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.

 

Cost Approach

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.”

 

Income Approach

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
  • Depreciation
  • Timing differences
  • Non-conformance with GAAP
  • Accounting changes
  • Related-party transactions
  • Non-operating:
    • Assets
    • Liabilities
    • Income
    • Expenses
  • 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
  • Marketability
  • Small company risks
  • Specific company risks
  • Key person
  • Blockage
  • 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

IndustryEntity ValuedInterest Valued
RetailCar dealership100% ownership
MiningRock milling company100% ownership
Real EstateReal estate holding companyMinority interest
Fast FoodYogurt shop100% ownership
Real EstateCondominium project100% ownership
EntertainmentRock groupPartnership share
RetailPhoto processing center100% ownership
InsuranceInsurance company100% ownership
ManufacturingPlastic wrap manufacturerMinority interest
Public RelationsMarketing companyMinority interest
Entertainment/RetailVirtual reality store chainMinority interest
GarmentDress design/manufacturer100% ownership
ManufacturingThermoformed plastic manufacturer100% ownership
RetailLiquor store100% ownership
EntertainmentGraphics design100% ownership
Health CareMedical practice100% ownership
Legal ServicesLaw firmPartnership share
AdvertisingCoupon sales company100% ownership
Legal ServicesJury consulting and graphics firmMinority interest
Health Care/FinanceMedical receivables finance firmMinority interest
EntertainmentRock groupPartnership share
Consulting ServicesSoftware research firm49% ownership
AutomobileAutomobile repair shop100% ownership
EntertainmentMusic royalties100% ownership
BankingMortgage loan brokerage40% ownership
WholesaleGarment wholesaler/distributor50% ownership
Real EstateReal estate development companyMinority interest
Retail/WholesaleAutomobile dealership60% ownership
RetailAutomobile repair shop100% ownership
Health CareHospice owner/operator100% ownership
EntertainmentRecord label100% ownership
Computer ServicesRadiology management softwareControlling interest
RetailRestaurant100% ownership
Medical InsuranceClaims processing company100% ownership
EntertainmentCover band20% ownership
Health CareRadiology laboratory30% ownership
WholesaleFood distribution company100% ownership
ManufacturingTruck body manufacturer100% ownership
FinanceInvestment analysis company2.75% ownership
EducationPrivate primary school100% ownership

IF YOU HAVE ANY QUESTIONS, PLEASE CALL THOMAS NECHES DIRECTLY AT 213.624.8150.

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