Articles

Prep Your Business Before You List It

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Make your business sparkle – and tidy up the books, too – to help ensure a successful sale. Photo by Verne Ho on Unsplash

The COVID-19 pandemic has put unprecedented stress on private business owners. Some are now considering selling their businesses before Congress has a chance to increase the rates on long-term capital gains. Before putting your business on the market, it’s important to prepare it for sale. Here are six steps to consider.

1. Clean Up the Financials

Buyers are most interested in an acquisition target’s core competencies, and they usually prefer a clean, simple transaction. Consider buying out minority investors who could object to a deal and removing nonessential items from your balance sheet. Items that could complicate a sale include underperforming segments,nonoperating assets, andshareholder loans.

Sales are often based on multiples of earnings or earnings before interest, taxes, depreciation and amortization (EBITDA). Do what you can to maximize your bottom line. That includes cutting extraneous expenses and operating as lean as possible.

Buyers also want an income statement that requires minimal adjustments. For example, they tend to be leery of businesses that count as expenses personal items (such as country club dues or vacations) or engage in above-or below-market related party transactions (such as leases with family members and relatives on the payroll).

2. Highlight Strengths and Opportunities

Private business owners nearing retirement may lose the drive to grow the business and, instead, operate the company like a “cash cow.” But buyers are interested in a company’s potential. Achieving top dollar requires a tack-sharp sales team, a pipeline of research and development projects and well-maintained equipment. It’s also helpful to have a marketing department that’s strategically positioning the company to take advantage of market changes and opportunities, particularly in today’s volatile market conditions.

3. Downplay (or Eliminate) Risks

It’s no surprise that businesses with higher risks tend to sell for lower prices. No company is perfect, but industry leaders identify internal weaknesses (such as gaps in managerial expertise and internal control deficiencies) and external threats (such as increased government regulation and pending lawsuits). Honestly disclose shortcomings to potential buyers and then discuss steps you have taken to mitigate risks. Proactive businesses are worth more than reactive ones.

4. Prepare a Comprehensive Offer Package

Potential buyers will want more than just financial statements and tax returns to conduct their due diligence. Depending on the industry and level of sophistication, they may ask for such items as:

  • Marketing collateral,
  • Business plans and financial projections,
  • Fixed asset registers and inventory listings,
  • Lease documents,
  • Insurance policies,
  • Franchise contracts,
  • Employee noncompete agreements, and
  • Loan documents.

Before you give out any information or allow potential buyers to tour your facilities, enter into a confidentiality agreement to protect your proprietary information from being leaked to a competitor.

5. Review Deal Terms

Evaluate different ways to structure your sale to minimize taxes and maximize selling price. For example, one popular element is an earnout, where part of the selling price is contingent on the business achieving agreed-upon financial benchmarks over a specified time. Earnouts allow buyers to mitigate performance risks and give sellers an incentive to provide post-sale assistance.

Some buyers also may ask owners to stay on the payroll for a period of time to help smooth the transition. Seller financing and installment sales also are commonly used.

6. Hire a Valuator

A fundamental question buyers and sellers both ask is what the company is worth in the current market. To find the answer, business valuation professionals look beyond net book value and industry rules of thumb.

For instance, a business valuation professional can access private transaction databases that provide details on thousands of comparable business sales. These “comparables” can be filtered and analyzed to develop pricing multiples to value your business.

Alternatively, a valuation expert might project the company’s future earnings and then calculate their net present value using discounted cash flow analyses. These calculations help buyers set asking prices that are based on real market data, rather than gut instinct. However, final sale prices are influenced by many factors and can be higher or lower than a company’s appraised value.

They can also estimate the value of buyer-specific synergies that result from cost-saving or revenue-boosting opportunities created by a deal. Synergistic expectations entice buyers to pay a premium above fair market value.

Planning for a Sale

Operating in a sale-ready condition is prudent, even if you’re not planning on selling your business anytime soon. Our experiences in 2020 have taught us to expect the unexpected: You never know when you’ll receive a purchase offer, and some transfers are involuntary.

The professionals at Advent can help you prepare for a sale whether in 2021 or beyond.

© 2021, Powered by Thomson Reuters Checkpoint 

How Much is that Donated Stock Worth?

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A valuation may be necessary if you’ve donated stock in a private company. Photo by Sarah Pflug from Burst

Philanthropic business owners may have made last-minute gifts of stock to charities at the end of 2020. Others plan to make donations in 2021. How much is that stock worth? Donations of publicly traded stocks are relatively easy to value, but private equity interests are typically more complicated to value.  

Deduction Requirements

Qualified charitable donations can help lower your taxable income as well as support worthwhile causes. However, not all donations are tax deductible. Individuals can deduct them only if they itemize.

In addition, charitable contributions must be made to qualified organizations. You can determine whether an organization is qualified by going to the IRS Tax Exempt Organization Search (formerly Select Check).

Depending on the amount of the donation, to claim the tax break you’ll have to:

  • File Form 8283 Section B for a donation valued at more than $5,000,
  • Obtain an independent appraisal within 60 days of the date of the gift (before or after) if the stock is valued at more than $10,000, and
  • Attach the appraisal to your tax return if the shares are deemed to be worth more than $500,000.

Fair market value (FMV) is the appropriate standard of valuation for these donations. Under IRS Revenue Ruling 59-60, FMV represents “The amount at which the property would change hands between a willing buyer and 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.”

If you put a restriction on the use of the property you donate, the FMV must reflect that restriction.

Business Valuation Report

Appraisals for donations valued at more than $10,000 must be written. Abbreviated calculations or letter formats may cost less, but they may also raise a red flag with the IRS. Moreover, valuators’ reports typically serve as their direct testimony if a return ends up in U.S. Tax Court.

According to IRS Publication 561, Determining the Value of Donated Property, qualified appraisals must include the following items:

  • Detailed descriptions of the donation, including dates of the contribution and valuation as well as terms of any agreements relating to the use, sale or other disposition of the property,
  • Statements that the appraisals were prepared for income tax purposes,
  • FMV on the date of contribution,
  • The methods used to value the business interest, such as the cost, market or income approach, and
  • Any specific data the appraiser used to determine FMV, such as comparable sales transactions.

Business valuation reports should identify the appraisers’ firms and list their qualifications, including background, experience, education and memberships in professional appraisal associations.

Always use an appraiser who has earned an appraisal designation from a recognized professional organization and who meets IRS requirements for education and experience. The IRS specifically prohibits do-it-yourself valuations by the donor, recipient or related parties.

It is important to note that you are not permitted to take a charitable deduction for business valuation or appraisal fees. In previous years, those fees may have qualified as miscellaneous deductions, subject to the 2 percent-of-adjusted-gross-income limit. However, starting in 2018, that tax break has been temporarily suspended through 2025 under the Tax Cuts and Jobs Act.

Forewarned Is Fair Warned

The IRS has cracked down on charitable contributions in recent years. The bigger your deductions, the more stringent the substantiation rules are — and the more likely the IRS is to audit them. Hire an experienced business valuation professional to help ensure your deduction survives IRS scrutiny.

Please contact the professionals at Advent Valuation Advisors if you have any questions regarding the valuation of a stock donation or other business valuation matters.

© 2021, Powered by Thomson Reuters Checkpoint 

The Difference Between Price and Value

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Photo by Mackenzie Marco on Unsplash

When a business is sold, it often sells for more (or less) than the appraised value. This may come as a surprise to laypeople, but valuators understand that there are many valid reasons that “price” and “value” may differ. Businesses that understand this subtlety are better positioned to make informed decisions.

Price is specific to an individual buyer and seller. It’s the amount of cash (or its equivalent) for which anything is bought, sold or offered for sale. It requires an offer to sell, an acceptance of that offer and an exchange of money (or other property). Some strategic or financial buyers may be willing to pay more than others because they can benefit from economies of scale or synergies that aren’t available to all potential buyers.

The term “value” often refers to “fair market value” in a business valuation context. The International Glossary of Business Valuation Terms defines fair market value as:

The price, expressed in terms of cash equivalents, at which property would change hands between a hypothetical willing and able buyer and a hypothetical willing and able seller, acting at arms-length in an open and unrestricted market, when neither is under compulsion to buy or sell and when both have reasonable knowledge of the relevant facts.

Fair market value is essentially a consensus of what the universe of potential buyers would agree to pay for a business, a business interest or an asset. In the real world, sales may occur for more (or less) than fair market value, because the individual parties have their own perceptions of the investment’s risk and return, are under duress to buy (or sell), or lack relevant knowledge about the transaction or the subject company.

Another reason that value and price frequently differ is timing. In many cases, a valuator’s work is done months or years before the company is sold. Differences in market conditions or the company’s financial performance between the two dates could cause the company’s selling price to vary from its appraised value.

Real World Example

To illustrate how price and value may differ, consider the sale of a medical practice. There are primarily three potential buying groups for medical practices:

  • Another physician,
  • A physician group, or
  • A hospital.

To determine fair market value, a valuator would consider potential transactions to purchase the practice by all three of these groups, under the cost, market and income approaches. But in the real world, only one specific buyer would make an offer. So, for example, the analyses involving a physician or physician group wouldn’t be relevant if a hospital is buying the practice.

Price and Value Aren’t Synonymous

It’s critical for buyers and sellers to understand that the appraised value of a business interest may not reflect its future selling price. Value can vary substantially, depending on the effective date and the purpose(s) specified in the appraiser’s report.

When the purpose of a valuation is to establish an asking (or offer) price, valuators may provide a range of values that considers various buyers and transaction scenarios. This range can help a buyer and seller arrive at a reasonable selling price that’s based on the individual parties’ expectations of risk and return.

If you’re planning to buy or sell a business interest, the professionals at Advent Valuation Advisors are here to help.

© 2020, Powered by Thomson Reuters Checkpoint

Understanding the Terms of Engagement

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When you need to know how much your business is worth, one of the first questions to ask is, how much work – and how much expense – will it take to get the job done?

In many circumstances, a comprehensive valuation is required or preferred. Sometimes, however, a relatively straightforward, and less costly, calculation of value may be sufficient. The purpose of the valuation will often dictate the scope of work that is appropriate.

Both the American Society of Appraisers (ASA) and the American Institute of Certified Public Accountants (AICPA) have defined the scope of various assignments used to value a business, business ownership interest, security or intangible asset. In its Business Valuation Standards, The American Society of Appraisers (ASA) defines three types of engagements:

  • An appraisal engagement is the most comprehensive. It considers all relevant information as of the appraisal date and results in the expression of an unambiguous opinion of value, which is supported by all procedures the appraiser deems relevant.
  • A limited appraisal engagement is based on consideration of limited relevant information and limited procedures deemed necessary by the appraiser. It results in an estimate of value.
  • In a calculation engagement, the appraiser and the client may agree on the procedure or procedures to be performed. The appraiser collects limited information, performs limited procedures and provides an approximate indication of value.

The American Institute of Certified Public Accountants defines two types of engagements:

  • In a valuation engagement, the valuation analyst applies the approaches he or she deems appropriate. The result is a conclusion of value.
  • In a calculation engagement, the analyst and the client agree ahead of time on the procedures the analyst will perform, and these procedures are generally more limited than in a valuation engagement. The result is a calculation of value.

A full appraisal or valuation engagement will generally result in the production of a comprehensive report that describes in detail the procedures performed, while a calculation may result in an estimate, with limited additional information provided to the client. In any of the engagements described above, the resulting value may be a single amount or a range.

So, how does a business owner determine which type of engagement is appropriate?

The right tool for the job

There are times when a calculation may be sufficient. For instance, a small business owner who receives an offer to sell his or her business may simply want to gauge the fairness of that offer. According to the AICPA’s Statements on Standards, a calculation engagement also may be acceptable when acting as a neutral party in a dispute. For a matter involving the IRS or the Tax Court, a full valuation resulting in an opinion/conclusion of value is generally preferred.

The use of calculations in court matters has become a contentious matter. In a piece in the November 2019 issue of Business Valuation Update, Michael Paschall, an accredited senior appraiser and attorney, criticizes a phenomenon he terms “calculation creep,” the increased use of calculation engagements in litigation settings.

He claims the “incomplete and potentially biased aspects of calculation engagements represent a dumbing down of the valuation process and profession,” and calls on the governing bodies in business valuation to bar calculations for litigation, ESOPs, IRS purposes “or any other context where a reliable opinion of value is needed or third-party reliance is present.”

In Hanley v. Hanley, a case decided in June 2019 in New York State Supreme Court in Albany, the court rejected a value calculation produced by an accountant retained by one of the parties. The decision cites several concerns, including questions about the independence of the valuation professional and the lack of documentation in the valuation report, which did not describe the limited procedures or approaches used in the calculation.

At the end of the day, any valuation is only as credible as the professional who renders it. The judgment of the valuation professional is a key ingredient in every phase of the assignment, from determining the appropriate scope to selecting the best methods, reconciling the results of different procedures and, ultimately, deriving the indicated value.

Advent’s valuation professionals can walk you through the process and help you determine what type of engagement will best meet your goals.