Understanding Business Valuation: A Practical Guide to Valuing Small to Medium Sized Businesses - Third Edition

• Introduction
• Steps of an Appraisal
• Notation System Used in This Book
• Chapter 1 - Overview of Business Evaluation
  • Chapter Goals
  • Introduction
  • A Brief Walk Down Memory Lane
  • Why Are Businesses Appraised?
    • Mergers, Acquisitions, Reorganizations, Spin-offs, Liquidations, and Bankruptcy
    • Allocation of Purchase Price (Tax or Financial Reporting)
    • Estate, Gift, and Income Taxes
    • Marital Dissolution
    • Employee Stock Ownership Plans
    • Buy-Sell Agreements
    • Stockholder Disputes
    • Financing
    • Ad Valorem Taxes
    • Incentive Stock Option Considerations
    • Initial Public Offerings
    • Damages Litigation
    • Insurance Claims
    • Charitable Contributions
    • Eminent Domain Actions
    • Fairness Opinions
  • Who Values Businesses?
    • Business Valuation Analysts
    • Accountants (CPAs)
    • Business Brokers
    • College Professors
    • Commercial Real Estate Appraisers
    • Investment Bankers
    • The Internet
  • Professional Appraisal Organizations
    • The American Institute of Certified Public
    • Accountants (AICPA)
    • The American Society of Appraisers (ASA)
    • The Institute of Business Appraisers, Inc. (IBA)
    • The National Association of Certified Valuation
    • Analysts (NACVA)
    • The CFA Institute
    • The Appraisal Foundation
  • Conclusion
• Chapter 2 - Business Valuation Standards.
  • Chapter Goals
  • Introduction
  • AICPA Statement on Standards for Valuation Services No. 1
  • Foreword
    • Why Issued
  • Valuation of a Business, Business Ownership Interest, Security, or Intangible Asset
    • Introduction and Scope
    • Overall Engagement Considerations
    • Development
    • The Valuation Report
    • Effective Date
  • Interpretation No. 1-01, “Scope of Applicable Services” of Statement on Standards for Valuation Services No.1, Valuation of a Business, Business Ownership Interest, Security, or Intangible Asset
    • Background
    • General Interpretation
    • Specific Illustrations
    • Illustrations Relating to Litigation Engagements and Certain Controversy Proceedings
    • Illustrations Relating to Tax Engagements
    • Illustrations Relating to Other Engagements
    • Illustrations for PFP-Specific Engagements
  • AICPA Statement on Standards for Consulting Services No. 1
    • AICPA Code of Professional Conduct — Rule 102
    • Professional Competence
    • Due Professional Care
    • Planning and Supervision
    • Sufficient Relevant Data
    • Client Interest
    • Understanding With the Client
    • Communication With the Client
  • IBA Standards
  • ASA Standards
  • Uniform Standards of Professional Appraisal Practice
  • NACVA Standards
  • Conclusion
• Chapter 3 - Getting Started
  • Chapter Goals
  • Introduction
  • Learning About the Engagement
  • Deciding Whether to Accept the Engagement
    • Conflicts of Interest
    • Purpose and Function of the Engagement
    • Amount of Time Required To Do the Job
    • The Scope of the Assignment
    • The Type of Report To Be Issued
  • Engagement Letters
    • Description of the Scope of the Assignment
    • Detailed Description of the Appraisal Subject
    • Standard of Value That Will Be Used, Including the Definition of That Standard
    • Effective Date(s) of the Valuation
    • Type of Report That Will Be Issued To Communicate the Value Estimate
    • Client Responsibilities
    • Method of Determining Fees and the Terms of Payment
  • Five Steps of an Appraisal Assignment
    • Engagement Letter Considerations for Litigation Reports
  • The Initial Document Request
    • Using a Standard Checklist
    • Setting Up Multiple Checklists
  • Conclusion
• Chapter 4 - Appraisal Principles and Theory
  • Chapter Goals
  • Principles of Appraisal
  • Standards of Value
  • How the Purpose of the Valuation Influences the Standard of Value
  • IRS Influence on Appraisals
  • Conclusion
• Chapter 5 - Data Gathering
  • Chapter Goals
  • Introduction
  • What Items Affect Value?
  • Internal Information
  • External Information
  • The On Site Interview
  • Conclusion
• Chapter 6 - Data Analysis
  • Chapter Goals
  • Introduction
  • Economic Analysis
  • Industry Analysis
  • Subject Company Analysis
  • Financial Analysis
  • Financial Statement Adjustments
  • Nonoperating and Non-Recurring Adjustments
    
  • Minority Interest Valuations
  • Conclusion
• Chapter 7 - The Market Approach--Part II
  • Chapter Goals
  • Overview
  • Guideline Public Company Method
  • Using Valuation Multiples
  • Valuing Invested Capital Instead of Equity
  • Advantages of Using the Guideline Public Company Method
  • Disadvantages of Using the Guideline Public Company Method
  • Conclusion
• Chapter 8 - The Market Approach — Part II
  • Chapter Goals
  • Introduction
  • Merger and Acquisition (Transaction) Method
  • Let’s Get Back to Theory
  • Internal Transactions
  • Industry Method
  • Conclusion
• Chapter 9 - The Asset Based Approach
  • Chapter Goals
  • Introduction
  • Common Applications of the Asset Based Approach
  • Advantages and Disadvantages of the Asset Based Approach
  • Valuation Methods
  • Working With Other Appraisers
  • How To Locate and Recognize Specialists
  • Conclusion
• Chapter 10 - The Income Approach
  • Chapter Goals
  • Introduction
  • Value Is From an Investor’s Viewpoint
  • The Income Approach
  • Selecting Benefit Streams
  • Using Pretax or After Tax Information
  • Valuing Invested Capital Instead of Equity
  • Using Cash Flow Instead of Earnings
  • Defining Cash Flow
  • Projecting Future Benefit Streams
  • The Acceptance of Forecasts and Projections
  • Income Approach Methods
  • And Finally —What To Do About S Corps and Flow Through Entities
  • Conclusion
• Chapter 11 - Discount and Capitalization Rates
  • Chapter Goals
  • Introduction
  • Discount Rates
  • Capitalization Rates
  • Deriving Discount and Capitalization Rates Applicable to Net Income Directly From the Market
  • Back to the Real World
  • Conclusion
• Chapter 12 - Premiums and Discounts
  • Chapter Goals
  • Introduction
  • Control Premium
  • More Control Premium Issues
  • Lack of Control (Minority) Discounts
  • Discount for Lack of Marketability (Illiquidity)
  • Small Company Discount
  • Discount From Net Asset Value
  • Key Person Discount
  • Blockage Discount
  • Nonvoting Stock Discount
  • Application of Discounts and Premiums
  • Other Premiums and Discounts
  • Conclusion
• Chapter 13 Revenue Ruling 59-60.
  • Chapter Goals
  • Introduction
  • Revenue Ruling 59-60
  • Conclusion
• Chapter 14 - The Valuation Report
  • Chapter Goals
  • Introduction
  • Components of a Valuation Report
  • Types of Valuation Reports
  • Preparing the Business Valuation Report
  • Defending the Business Valuation Report
  • Common Errors in Business Valuation Reports
  • The Reconciliation Process
  • Conclusion
• Chapter 15 - Valuing Intangible Assets: An Overview
  • Chapter Goals
  • Introduction
  • What is Intellectual Property?
  • Conducting a Valuation of Intangible Assets
  • What Is a Remaining Useful Life Analysis?
  • What Is a Reasonable Royalty Rate and Where Do I Get This Stuff?
  • Importance of Fair Value Measurements
  • What Is an “Amortization Benefit”?
  • How About Some More Examples!
  • Conclusion
• Chapter 16 - Estate and Gift Valuations
  • Chapter Goals
  • Overview
  • Penalties for Undervaluation on Estate and Gift Tax Returns
  • Penalties Against Appraisers
  • Revenue Ruling 59-60
  • Chapter 14 Guidelines
  • Case Law
  • The Valuation Report
  • The Family Limited Partnership Report
  • As Valuation Analysts, Do We Go for the Big Discounts?
  • Conclusion
• Chapter 17 - Divorce Valuations
  • Chapter Goals
  • Introduction
  • The Role of the Valuation Analyst
  • Definition of Value
  • Valuation Dates
  • Valuation Methods
  • Valuation as of a Specific Date
  • Data Gathering and Analysis
  • The Valuation Process
  • Normalizing the Financial Statements
  • Explaining the Valuation
  • Reaching a Conclusion of Value
  • Divorce Valuations of Professional Practices
  • Noncompete Agreements
  • Valuation of Other Marital Assets
  • Conclusion
• Chapter 18 - Professional Practice Valuations
  • Chapter Goals
  • Overview
  • Why Are Professional Practices Valued?
  • Characteristics of the Professional Practice
  • Professional Practice Versus Other Business
  • The Valuation Process
  • Valuation Calculations — Unique Aspects of the Calculations
  • Conclusion
• Chapter 19 - Shareholder Disputes
  • Chapter Goals
  • Introduction
  • Dissenting Shareholder Matters
  • Oppressed Shareholder Matters
  • Fair Value
  • The Valuation Date
  • Fair Value Methodology
  • Conclusion
• Chapter 20 - My Favorite Court Cases
  • Chapter Goals
  • Introduction
  • Estate of Joyce C. Hall v. Commissioner
  • Estate of Samuel I. Newhouse v. Commissioner
  • Charles S. Foltz v. U.S. News & World Report, Inc
  • Bernard Mandelbaum, et al. v. IRS Commissioner
  • Mad Auto Wrecking Inc. v. Commissioner
  • Delaware Open MRI Radiology Associates P.A. v. Howard B. Kessler, et al.
  • Conclusion
• Chapter 21 - Economic Damages
  • Chapter Goals
  • Introduction
  • Lost Profits
  • The Lost Profits Analysis
  • Don’t Forget To Check the Lost Profits Computation for Reasonableness
  • Conclusion
• Appendix 1 - AICPA Statement on Consulting Services Standards I
• Appendix 2 - IBA Standards
• Appendix 3 - ASA Standards
• Appendix 4 - NACVA Professional Standards
• Appendix 5 - International Glossary of Business Valuation Terms
• Appendix 6 - SSVS 1 Appendix C
• Appendix 7 - Revenue Ruling 59-60
• Appendix 8 - Revenue Ruling 65-192
• Appendix 9 - Revenue Ruling 65-193
• Appendix 10 - Revenue Procedure 66-49
• Appendix 11 - Revenue Ruling 68-609
• Appendix 12 - Revenue Procedure 77-12
• Appendix 13 - Revenue Ruling 77-287
• Appendix 14 - Revenue Ruling 83-120
• Appendix 15 - Revenue Ruling 85-75
• Appendix 16 - Revenue Ruling 93-12
• Appendix 17 - Technical Advice Memorandum 94-36005
• Appendix 18 - Private Letter Rulling 91-50001
• Appendix 19 - Business Valuation Resources
• Index

056604

Here we go again.This time it’s the third edition. I really have to get a life. Oh, I forgot, business valuation is my life. Do you feel sorry for me yet? Well, since you don’t, and you probably bought this book, keep reading.

I said it the last two times, and I will say it again: This is just what we need, another book on business valuation. Years ago, there were only a limited number of books on this topic—mostly finance texts. Today, you cannot read everything that is being published unless you have no life. Oh gee, that’s me. Anyway, for those of you with a limited life, there are definitely some books on this topic that are worth reading. I can no longer list only two or three books that are my favorites because so many good books on this topic have been published over the last several years that the list has grown too much. I have included many references to these books throughout this edition, so you should have no problem figuring out which ones I like.

Okay, so why did I do this again, and what is new in this edition? I did it again because I find that there is still a need for this stuff to be explained in plain, uncomplicated English, in a manner that helps apply appraisal theory to real world practice. Please don’t get me wrong! I am not claiming to know everything. In fact, I am afraid of what I don’t know. But I also finally realize that there are things in this world we may never understand. As to the new stuff in this edition, I will tell you about it soon.

The purpose of this book is to provide some guidance on the theory, as well as on how to apply it in a meaningful fashion.Whether or not I’m successful is up to you. First, some basic ground rules:

1. To get the most out of this book, you must read it, not only in its entirety but also in the sequence in which it is written. Don’t go to the chapter on capitalization rates without reading the earlier sections of the book. Otherwise, you may not understand what you are capitalizing and why. It is also important to make sure that you read the exhibits and the appendixes at the time they are referenced. The exhibits have been included as an integral part of this book. If you skip over them, or if you go back to them later, you may miss a valuable point that I am trying to make.
2. In general, I do not think in terms of complex mathematical formulas. I do not like equations with lots of parentheses, nor do I like formulas that have Greek letters in them. Therefore, if you really get off on mathematical equations, this book is not for you. Believe it or not, I want readers to understand this stuff! In certain sections of this book, you will see some mathematical formulas. You will even see some Greek letters. The notation may be different from that found in other books. Concentrate on the concepts and not on the letters and symbols used.
3. I am a firm believer of the KISS theory (keep it simple, stupid). This does not mean, however, that business valuations are simple. Quite the contrary! If you are at all like me, after reading this book you will never feel comfortable doing a business valuation again. This can be an extremely subjective process. For the accountants out there, this is not at all like accounting, where the debits have to equal the credits.What you will learn is that there is no black and white answer. There are a million shades of gray. To quote a good friend of mine, the answer to most questions is, “It depends.”
4. The concepts discussed in this book cannot be read and applied as if they were in a vacuum. Many of the items discussed will — directly or indirectly — affect other parts of the valuation process. You must be a big picture type of person.
5. In some of the exhibits, I cheated. They were so good in the last edition that I decided to merely update the dates to freshen them up. If I messed up because the interest rates are not from that exact period, please forgive me. I am much more concerned with the concepts than the dates. In some instances, where I felt the exhibit was date sensitive, I did not change the dates. In some cases, I also changed the location of the business to protect the confidentiality of the client, so here, too, if it is a little inconsistent, please forgive me.
6. This book is not intended to present every alternative to every situation. Just because I have included something in this book, please do not rely solely on my writings. There may be facts and circumstances that could negate my opinion. You will find that there is no substitute for common sense in this process.
7. In some instances, I will be illustrating points from the negative. Several of the exhibits contain sections of actual reports critiquing someone else’s work. Learn from what they may have done wrong.
8. Please don’t shoot the messenger! Throughout this book, several topics will be discussed that are controversial. Some may not even have a definitive answer. But you must think about these issues when you do a business valuation.
9. While reading this book, you are going to be exposed to my own form of humor. This is not intended to insult anyone but, rather, to add a little levity to what can be a very dry and technical topic. Although business valuation tends to be extremely complex, let’s have some fun while we learn. You just can’t take this stuff too seriously.
10. And finally, in much of what I am trying to teach, I have made many of the mistakes that I am trying to prevent you from making. Someone once told me that I will learn from my mistakes. By now, I am a genius!

With that stuff out of the way, please enjoy my attempt to explain what little I know about business valuation.

056604