Selected Business Valuation Topics for Attorneys 4-22-14

Business Valuation Brown Bag

Presented by:

Ethan Lee, CPA / ABV / CFF

April 22, 2014

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Ethan has specialized in Business Valuation & Litigation Support since 2006

He is a CPA and holds the Accredited in Business Valuation (ABV) and Certified in Financial Forensics (CFF) credentials through the American Institute of CPAs

He performs business valuations for litigation, tax, and business planning purposes

Industries served include professional services, retail, agriculture, construction, healthcare, manufacturing, import/export, hospitality & tourism, and others

Ethan is currently the ABV Champion for Hawaii as well as an active member of the Hawaii Society of CPAs and the Hawaii Estate Planning Council

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“And what… is the food of the soul? Surely, I said, knowledge is the food of

the soul.”

Plato

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What’s for Lunch?

• Considerations in selecting a business valuation (BV) expert

• How to fully utilize a BV expert

• Substantive factors in BV

• Tips for reviewing a BV report

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Considerations in Selecting a BV Expert

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• Credentials are good indicators of knowledge, skill, experience, training, and education

• CPA – Certified Public Accountant• ABV – Accredited in Business Valuation, American Institute of CPAs• CFF – Certified in Financial Forensics, American Institute of CPAs• CVA – Certified Valuation Analyst, National Association of Certified Valuators & Analysts• ASA – Accredited Senior Appraiser, American Society of Appraisers• CBA – Certified Business Appraiser, Institute of Business Appraisers

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• Most BV credentials require the following:

• Have a college degree or CPA license

• Pass exam(s)

• Hours/years of experience

• Submit a BV report

• Continuing education

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• Excellent written and oral communication skills are critical

• If called upon to testify, it is the BV expert’s task to help the trier of fact understand the BV issues at hand so that an informed decision can be made

• BV experts should be advocates for their opinions, not for their clients

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• No restrictions to practice BV in State of Hawaii and most states, so it’s “Buyer Beware”

• There are many professionals who market BV services, but only a few BV professionals

• Of the credentialed BV professionals in Hawaii, there are only a handful who practice full-time AND provide expert witness services

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How to Fully Utilize a BV Expert

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• Litigation matters that might require a BV expert include:

• Partnership/shareholder disputes

• Dissenting shareholder and shareholder oppression actions

• Bankruptcy

• Divorce

• Gift/estate tax litigation

• Buy-Sell Agreement disputes

• Business damages (e.g. lost profits or diminution of value)

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• Retain as consulting or testifying expert?

• Prior to amended Rule 26 of FRCP, attorneys were inclined to retain two BV experts – one as consulting expert and another as testifying expert – to avoid discovery of draft work product

• Now, with amended Rule 26, attorneys are retaining one BV expert to fill both roles (i.e. consulting and testifying expert)

• This has made the process more efficient and cost-effective for clients

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• Retain BV expert early on!• Assist with discovery

• Reduce deadline continuations

• If contacted late in the process, some experts may decline an engagement if deadline is unreasonable given their workload

• Review opposing expert’s report

• Assist in the preparation of opposing expert deposition and/or trial questions

• Assist in preparation of direct examination questions

• Prepare trial exhibits

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Substantive Factors in BV

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• What business valuation IS

• BV is the process of estimating the value of a business or ownership interest

• Obtain an understanding of the business and business ownership interest

• Perform a thorough financial and qualitative analysis

• Consider all three (3) valuation approaches: Asset-based, Market, and Income

• Consider valuation adjustments (e.g. discounts or premiums)

• Reconcile indicated values to arrive at a conclusion of value

• Present findings in a report

• BV is forward looking – the present value of future benefits to an investor

• Dividends – cash flow from operations

• Capital appreciation – cash flow recognized upon the future sale of assets

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• What business valuation IS NOT

• BV is not a rule of thumb exercise

• Aren’t all law firms worth 90-100% of Annual Fee Revenue?

• Rules of thumb should be used only as sanity checks

• BV does not always determine fair market value

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• Standards of value• Fair market value

• Amount, in cash, at which property would change hands

• Hypothetical willing and able buyer/seller

• Neither under compulsion to act

• Both having reasonable knowledge of relevant facts

• Fair value (state rights)• In dissenting shareholder actions in Hawaii, fair value is defined in HRS Sect. 414-341

• “…the value of the [dissenter’s] shares immediately before the effectuation of the corporate action to which the shareholder objects, excluding any appreciation or depreciation in anticipation of the corporate action unless exclusion would be inequitable.”

• Fair value (financial reporting)

• Investment or strategic value

• Intrinsic value

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• Date of valuation

• Specific date at which the value of an ownership interest is being estimated

• In divorce matters, there can be two valuation dates if the business was owned prior to marriage (date of marriage and date of separation)

• Only information that is known or knowable at the Date of Valuation may be considered by the BV expert

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• Valuation Considerations (Required by most BV standards)

• Company-specific factors

• Nature and history of the business

• Earnings capacity

• Financial condition

• Intangible assets/goodwill

• Dividend paying capacity

• External factors

• Economic and industry outlook

• Market price of similar businesses

• Sales of company stock and size of block being valued

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• Subject interest

• Is the interest being valued a controlling (>50%), non-controlling (50%), or a minority interest (<50%)?

• What rights and restrictions are associated with the subject interest?

• Will valuation adjustments be applicable?

• Discount for lack of control

• Discount for lack of marketability

• Embedded capital gains discount

• Nonvoting stock discount

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Tips for Reviewing a BV Report

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• BV reports should be in compliance with applicable professional standards

• Development standards

• Reporting standards

• Most BV standards require a full/detailed report or a summary report for valuation engagements

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• Some BV standards provide a litigation exemption for reporting

• HOWEVER, development standards must still be followed

• In practice, detailed reports are commonly used in litigation matters

• Detailed reports *should* allow readers to replicate the BV expert’s work and understand the reasoning for the expert’s conclusion of value.

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• Utilize your BV expert to review the opposing expert’s report

• If you choose to review a BV report, look for the following:

• Inaccurate, insufficient, or unreliable data

• Biased tone

• Inappropriate reliance on rules of thumb

• Computational and mathematical errors

• Failure to correctly apply the selected valuation approach and methodology

• Failure to use the appropriate standard of value

• Inappropriate discounts or premiums

• Unreasonable assumptions

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• Also consider the following:

• How much time did the BV expert devote to the valuation engagement?

• Is it really the BV expert’s conclusion of value?

• Can they explain all of the analyses and supporting exhibits?

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Conclusion

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• Considerations in selecting a business valuation (BV) expert• BV credentials?• Full-time or “dabbler”?• Communication skills

• How to fully utilize a BV expert • Retain early• Utilize for discovery, case planning/strategy, reviewing BV reports, trial prep

• Substantive factors in BV• Standard of value – Should it be fair market value or fair value or other? • Date of valuation – As of what date?• Valuation considerations – Company-specific and external factors• Subject interest – Controlling or non-controlling? Rights and restrictions?

• Tips for reviewing a BV report• Is it in compliance with standards?• Utilize BV expert to review opposing expert’s report• Watch for quality of data, biased tone, errors, unreasonable assumptions, etc.

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Summary

Mahalo!

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Law

Selected Business Valuation Topics for Attorneys 4-22-14