Examples of How We Helped Clients
Second Opinions and Deal Due Diligence Pays
The critique of valuation and calculation reports represents our top growth service. The critical analysis resembles the best of a detective novel, and a favorite part of my professional work.
A recent evaluation of a report for an internal transition stated "10% of the largest clients control 40% of the revenue. The Practice exhibits concentration risk, Slight Increase - Impact on Risk Profile”
The problem is that they did not know the industry or their limits on the risk. For the firm, 40% of revenues are over the maximum acceptable amount of risk for the subject's industry peers.
The risk eliminates the value of any sellable goodwill. BAD surprise for the seller! But, it's very good news for the prospective buyer that dodged the high risk to the deal and his investment money.
A large regional CPA firm who just dabbles in valuation wrote the report. This is why they missed two more deal killers, and miss used or relied too much on the valuation software to do the job.
The Wrong Way to Exit
Owner exit planning is a big challenge today. The odds of selling your company are 4 to 1 against you. In addition, less than 6% sell their company and are happy with the results.
By the early 1990's I had 15 years of experience helping people plan for retirement, and value and sell their businesses.
Emily, a tax client, called to tell me that Susan wanted to buy her well-established operations. I outlined the process and how I worked to maximize the price, expedite the transition, and prevent problems. The fee back then was a flat $3,500 for the $300,000 firm.
She decided to have Jonathan Snail, her attorney, handle it all. I cautioned Emily because I had dealings with Jonathan and Susan before. About three months later Emily called in tears asking for help on a deal gone horribly wrong. Susan hadn't paid and had possession of the location and operating assets.
After getting copies of the paperwork I spoke with my attorney. The civil suit fee could run tens of thousands of dollars with the chance of coming to 60-70% of the asset values. After spending a little over $10,000 Emily gave up and got a job rather than retiring.
Family Business Owner Discussion Starters
How is your family business handling the following challenges?
Selling Price Growth. How are you allocating time to work "on” your business while you are busy working "in” your business? Building the company's selling price takes deliberate planning.
Estate Planning.Treating family members fairly does not always mean equally. Have you set a plan for ownership transition and estate equalization, and have you had this discussion with those inside and outside the business? In addition, finding out what the company is worth allows setting tax and transfer strategies.
Succession and Exit Planning. Exiting your business happily on your terms requires wise planning. What planning have you done to target a buyer, curb business risks, assure continuity of operations growth and profitability, increase the company's value, find out what the company is worth, and protect your personal assets?
Communication. Family meeting priorities: promote good communications of business and personal goals, desires, and written policies to support the decided expectations. Dealing with family dynamics takes time and patience.
I heard you say X and I understand that to mean Y. Did I get it right? These are the best two questions I have heard used that help control conflicts for family members and financial advisers.
Governance. Corporate governance is the system of rules, practices and processes by which a company is directed and controlled. Corporate governance essentially involves balancing the interests of a company's many stakeholders, such as shareholders, management, customers, suppliers, financiers, government and the community.
Since corporate governance also provides the framework for attaining a company's objectives, it encompasses practically every sphere of management, from action plans and internal controls to performance measurement and corporate disclosure. http://www.investopedia.com/terms/c/corporategovernance.asp
Buy-Sell Agreement, Not a Set It and Forget It Planning Tool
Many are familiar with the four points of IRC 2703 for buy-sell agreements. Few seem to be aware of the importance of the need to document the annual reviews, changes in the price and the valuation formula appropriateness, and keeping records of when the agreement is used.
My story is about a dispute concerning two brothers who started a small concrete construction business in the 1990's. They incorporated and the attorney included a buy-sell agreement using a set price.
The brothers worked very hard. The business expanded so much they built their own production plant. They made a lot of money by being in the right place at the right time for a construction boom.
The unfairness that can result from not maintaining the agreement and tracking the history became very apparent when the 1991 valuation price of $200,000 from life insurance was used to pay the widow of the surviving brother in 2002. The angry widow filed suit against the origin attorney, the company's current attorney, the company's accountant, the selling insurance agent, the agent's manager, the agent's company, and of course the brother. She knew she was in the right. The company's tangible assets in real estate exceeded $750,000, the concrete plant cost $3 million to build with less than a $1 million still owed, and the two acres of trucks and other heavy equipment were debt free.
The result after over 2 years of litigation, the widow did not get any more than the $200,000 set in the contract. And she no longer had the $200,000 because that and more was spent trying to prove she was right and deserved more.
Moral of the Story. Had there been annual reviews with a valuator there should not have been the tragedy of the surviving spouse. Even with family when it comes to money you'd better have it in writing and know what the writing says.
The Questions Unasked, and The Rest of the Story
A SW Ohio business owner recently asked for the "multiple" for his business. He stated that someone had recently told him that "3 times earnings" was a "good" number. And that "it would probably be less since he was the company`s #1 Key Employee."
After asking him several questions over a couple of hours, it became very clear that this business owner was not as "key" as he thought. He had actually made three very smart management moves to reduce the reliance of the company on his presence and make the company very marketable.
The result of the analysis showed a more appropriate valuation multiple of "5 times earnings" if the company would be marketed to general industry buyers, an increase of 67%.
The good news didn't stop there. The business has several attractive characteristics of a large regional company which the owner was not aware of. A casual comment by the owner provided a clue, that when later researched, showed significant national and even international possibilities. These factors could boost the multiple up to a range of "seven to nine." The bad news is that I see owners making this same mistake of using general industry data all too frequently.
The moral of the story is don`t rely on "rule of thumb" or "industry" methods that can miss the mark by thousands of dollars, that do not consider the characteristics of the subject company, and will do little to convince a buyer, banker, or judge of your company`s value. Do your homework and get some experienced help.
What's wrong with this valuation report?
The attorney's request to review an opposing divorce report came with four good questions. Three were easy to answer. The forth could take days. The report was over 175 pages of disjointed commentary, self-promotion (a nationally known author), and missing common data lists.
I have an aversion to my mistakes being pointed out in front of others. This started with Mrs. Puterbaugh my second grade teacher, and magnified by Mr. Davis in the sixth grade. So, I used a proprietary report review process. An analysis regularly improved for over 30 years to control report quality.
The process took just 3 hours. A basic principle violation was uncovered. Best of all, the mistake confirmed facts supporting my selected method and value.
Come out, Come out, Where ever you are!
One-third of my work is on estate tax planning and another one-third is on transaction related personal and business tax planning. Business owners are becoming very sophisticated. Hiding income and assets is now the standard rather than the exception. The planning tactics are uncomplicated and legal (when the formalities are followed). The owner's financial benefits come from protecting assets from creditors and income from the IRS.
When an Ohio divorce or partner dispute valuation arises, my work experience makes reverse-engineering to find the assets and income fairly easy. A recent hidden income case showed a lease expense was on the books for nearly $500,000. My firm's proprietary appraisal library showed that the Fair Market Value of the lease should have been only $300,000.
Where was the $200,000 excess expense going? The money was going through a planning strategy and straight into the owner's pocket. Adjusting the company's earnings up by the $200,000 and considering the median valuation multiple was 2.5; the company's value jumped $500,000.
Get More Later - Knowing When to Hold'em and When to Fold'em
The owner of an internet business was being sued for divorce in Ohio. The internet bubble had just burst. The attorney's client was the non-owner spouse. The referring attorney recognized the goodwill value problem and asked for an opinion. The business was in the early stages of development.
They had shown little profit, but critical milestones had been reached to establish and build a foundation for future goodwill. The investigation showed very little current goodwill value, but a large potential for goodwill value in just a few years.
The recommendation was to take the stock division that was offered by the owner-spouse under specific terms and safe guards we outlined. In less than 4 years the company was "the company" in its niche and was acquired by a public company at a multiple in the "OMGG" range, O My Goodness Goodwill- and the client owned half.
Sell and Get Paid
Referred to us by their CPA, two long time owners of a pool construction company wanted to sell the business to a younger enthusiastic long-time employee. The owners understood that financing of the goodwill would be over time.
They also wanted to be assured that the business would succeed so they would get paid. The plan we outlined kept the control in the old owner's hands while motivating the young employee in a smooth ownership transition.
Knowing the Right Questions to Ask
A divorce has been described as two good people on their worst behavior. One spouse says the business is worth very little. The other spouse says there has to be substantial furniture, fixtures, equipment and especially goodwill value. You might think that there's a common ground in the middle value range - often there is not.
In one 2004 case, there was substantial documented evidence that the sole family practitioner's practice was worth more than either spouse imagined. The non-physician spouse (the firm's client) had the potential to get a larger share of the practice's value because of special circumstances and intangible assets we uncovered in the valuation process.
In another 2004 case, the opposing attorney fought providing the requested family practice data. The attorney that retained the firm's services authorized a call to the doctor over the opposing attorney's objections.
The very first question provided the compelling evidence needed to show the practice was worth only the doctor's proportional value of tangible assets with no goodwill. And the information showed that there was no goodwill when 88% of the family practices in the market transaction data sample did have goodwill, value above the tangible asset's value. The call saved the client a substantial amount of time and fees.
Expanding the Market for Proprietary Internet Technology
A five year old digital video company on the northeast coast was pioneering new internet technology, an intangible asset that's different than goodwill. Sales were growing at over 25% per year. The owner wanted to sell part of the company to finance expansion from a local to a regional business down the coast to Florida.
The ultimate goal was to sell the business to a public company. The owner wanted to document the proprietary intangible value secured in the early years that could be sold. He also wanted to build a presentation that would persuade prospective buyer(s) with clear and compelling evidence of value. The valuation service was provided entirely over the internet.
The first presentation brought an offer of 1.75 times expectations. The second presentation drew an offer over 1.45 times expectations. The final deal closed at a full two times.
Getting More Today from Unique Tangible and Intangible Assets
Intellectual property (IP) represents a large pool of unidentified business assets with unrealized value that have not been monetized. Building market sales, preparing to sell the firm or specific IP Assets are three reasons to identify and value IP. Our IP research shows that 60% to 80% of a profitable and marketable entity's value is intellectual property, IP.
The owner of a regional Ohio, Indiana, and Kentucky specialty chemical cleaning product line with a large secure customer base was approached for a synergistic merger. The level of customer loyalty was unusually high - only three lower quality customers had been lost in the last 3 years. (An interesting profit building indicator.) I provided the seller with information to negotiate a sale at several times the going valuation multiple. The higher price was achieved by knowing and then leveraging what the buyer was really after - and it wasn't just the great product line or customer lists, or profit potential.
Uncover the Rest of the Story
A prospective buyer of a Cincinnati, Ohio retail company offered by a large well known Midwest broker called us for due diligence on a deal. The offering information was highly polished and seemed to be well supported in every detail. Observations at a negotiating meeting of what was not covered at the usual level suggested skeletons in the closet.
After a brief private discussion with the client, we asked some targeted questions. Two substantial contingent liability risks were uncovered. Of course the broker denied any knowledge, but that didn't do anything to help his already damaged credibility.
The risks were from the undisclosed future costs of the location's real estate and critical supplier problems. Either risk was more than enough to kill the deal. Most importantly the discovery saved the client from substantial financial risk.
Avoiding Mismatched Planning Tactic
In this case a family limited partnership was recommended by the family's financial advisers to three siblings whose father owned a large piece of real estate straight in the path of development. The valuation project was to complete the valuation of the partnership for gifting purposes.
The problem was the discovery of a mismatch of the partnership planning tool with the client's financial sophistication and their ability to follow through on the required management actions. We also found no feasible support for valuation discounts which were needed to make the family limited partnership plan work.
Other tactics were investigated to "uglify" the assets (our process of making an asset less attractive and therefore worth less for gifting and estate planning purposes).
Finding Hidden Assets - Skimming Income - Inappropriate Business Deductions
The Motion to Compel generated a sketchy page and a half letter from the opposing attorney in response to the document and data request for this Ohio divorce case. The tax return papers were missing detail worksheets. The letter included a list of "all assets" owned by the subject business with a "value" estimate.
The data from the letter, tax returns, and other documents provided by the client's attorney were put into the firm's proprietary forensic investigation system for a cross-match analysis.
Ten major pieces of operating equipment, three vehicles, two computer systems, office furniture (desks, filing cabinets, fax, etc.), a bank account, unlisted inventory, prepaid deposits, and a truck load of tools were the hidden assets discovered for additional analysis.
The costs for the disclosed equipment were researched to compare to the provided "value" estimate by the business owner's equipment dealer, a questionable source. When analyzed, one example was a 2 year old machine valued at less than 3% of the purchase cost. An equipment appraisal suggested a value at 60% of the purchase cost. The huge difference shows obvious bias. The rest of the list had similar discrepancies.
When other documents were finally provided, $100,000 in unclaimed income was uncovered and several thousands of dollars of inappropriate deductions had been taken. This information painted a very different picture of profits and the owner's financial benefits. One deduction was for the owner's home mortgage.
The analysis of income and expenses showed the second year back had unusually heavy subcontractor costs. Further analysis showed that only one contractor's costs had jumped over 20% of sales giving the company a loss for the year. The contractor company was investigated and we were not surprised to find it was owned by a related party of the subject business owner. Curiosity unveiled that was the year a divorce settlement was thought to be likely - not surprising either.
Impeaching the Opposition's Valuation
Forensic business valuation has a great deal to do with looking for what's not there. The equitable distribution in divorce report was prepared by a national firm specializing in funeral homes, and not located in Ohio. No Ohio site visit was made and the data for the analysis was provided by their client, the owner. Both are red flags.
The client's attorney sent the initial copy of what was represented as the "complete" report for critique. Systematic review found the report wasn't complete. All of the calculation exhibit references were buried in the fine print, but the worksheets were deleted from the furnished report.
When the entire report was delivered the first obvious problem was the report did not answer the court's question of value. The owner had bought into the business before the marriage. The question of value was to determine the amount of growth in the business value during the marriage excluding the real estate to be valued separately.
The next problem was the real estate appraisal used as a major component for the valuation calculation. The wrong real estate location was appraised. As of the valuation date, the real estate appraised was the new easy to access expanded facilities at the outskirts of town worth about $600,000 rather than the old location with limited parking in the congested down town area worth about $400,000.
Funeral home valuation methods combine the real estate value with the business operations value as a single dollar amount. If the real estate is worth more, then the business operations slice of the value pie is worth less. Therefore, a motivation for valuing the new property and not the old could have been to show a smaller growth in the business operation's value for the marital division. A simple mistake, maybe. But a mistake that seems all to convenient.
No Goodwill, but don't forget that spousal support is based on income.
Some businesses cannot show evidence for goodwill; the intangible value above the value of tangible assets. Many artfully use tax planning to reduce their taxable income. Small businesses often have poorly kept financial records. Only a few create financial statements. And a few get 'creative' in their accounting. It's for these reasons that a valuator will often use the entity's tax returns for a valuation. However, there can be a very big difference between what an owner gets to spend and what the IRS sees on the return.
While there may be no goodwill included in a business valuation conclusion, there may be a substantial restatement of the owner's income for expenses that a fair market value "willing buyer" would not have or pay. Some legal and many gray area deductions should be income adjustments. They are adjustments to the interest's income whether or not goodwill is present in the valuation process.
Because the owner's business financial benefit is used to calculate spousal support, the non-owner spouse's attorney and other advisers should have an accurate figure to argue the case.
Using the wrong owner's financial benefit figure to calculate spousal support can warp the result by hundreds, thousands and even tens of thousands of dollars over the support period. The old adage "a dollar here, a dollar there, and pretty soon you're talking real money" is very true here.
My recommendation is to know what the owner's financial benefit is not just what they made in income on the tax return.