Valuing Small Businesses and Professional Practices

by Pratt, Shannon P.; Schweihs, Robert P.; Reilly, Robert F.

• ISBN13: 9780786311866
• ISBN10: 078631186X
• Edition: 3rd
• Format: Hardcover
• Copyright: 1998-05-01
• Publisher: McGraw-Hill

Summary

The classic bestseller on estimating the value of small businesses and professional practices is fully updated and enhanced. While continuing to take readers step-by-step through the valuation process, it now features timely new or significantly revised chapters on valuation for estate plans, employee stock ownership plans, and corporate partnership dissolutions/buyouts. Along with case studies, it also offers greatly expanded coverage of data sources and their availability to small businesses.

Author Biography

Dr. Shannon P. Pratt is a managing director and one of the founders of Willamette Management Associates. Founded in the 1960s, Willamette is one of the oldest and largest independent valuation consulting, economic analysis, and financial advisory firms in the country. It has regional offices in Atlanta, Georgia; McLean, Virginia; Chicago, Illinois; San Francisco, California; and Portland, Oregon. In addition to this book, Dr. Pratt is the author of Valuing a Business, third edition, with Robert Reilly and Robert Schweihs, and co-author of Guide to Business Valuation, seventh edition. Dr. Pratt holds a doctorate in finance from Indiana University. He is a chartered financial analyst and a fellow of the American Society of Appraisers (the highest designation awarded by that society). Dr. Pratt is also editor-in-chief of Shannon PrattÕs Business Valuation Update, a monthly newsletter. Robert F. Reilly is a managing director of Willamette Management Associates. He holds a master of business administration degree in finance from the Columbia University Graduate School of Business and a bachelor of arts degree in economics from Columbia College. He is an accredited senior appraiser (certified in business valuation), a chartered financial analyst, a certified public accountant, a certified management accountant, and a state- certified affiliate of the Appraisal Institute. Mr. Reilly serves in an editorial capacity for, and is a regular contributor to, such professional journals as The American Bankruptcy Institute Journal and The Journal of Property Tax Administration. As an appraiser and economist, he has testified both in domestic and international courts on well over 100 occasions regarding the valuation of assets, properties, and business interests, and regarding various economic damage issues. Robert P. Schweihs is a managing director of Willamette Management Associates. He holds a master of business administration degree in economics and finance from the University of Chicago and a bachelor of science degree in mechanical engineering from the University of Notre Dame. He is an accredited senior appraiser of the American Society of Appraisers (certified in business valuation). Mr. Schweihs is a frequent speaker to professional societies and an author of articles on various aspects of business valuation. He is often called upon to testify in court on contested business valuation matters.

Table of Contents

PART I Introduction: Understanding the Valuation Process	1	(92)
1. Business Valuation Standards and Professional Associations	3	(16)
Introduction: Professionalization of Business Valuation.
Uniform Standards of Professional Appraisal Practice.
American Society of Appraisers.
Institute of Business Appraisers.
National Association of Certified Valuation Analysts.
American Institute of Certified Public Accountants.
Canadian Institute of Chartered Business Valuators.
Internal Revenue Service.
Department of Labor.
Summary.
Bibliography and Resource List.
2. Defining the Valuation Assignment	19	(18)
Accepting and Defining the Engagement.
Obtain a Clear Mutual Understanding.
Conflict of Interest Check.
Basic Elements of the Valuation Assignment.
Definition (Standard) of Value.
Identification of the Property to Be Valued.
Identification of the Entity.
Specification of the Ownership Interest to Be Valued.
Equity versus Invested Capital.
Effective Valuation Date.
Choosing an Applicable Valuation Date.
Valuation Dates Determined by Law.
Relevant Ownership Characteristics.
Control versus Noncontrol.
Degree of Marketability.
Going-Concern or Liquidation Premise of Value.
Intended Use or Uses of the Appraisal.
Scope of the Written and/or Oral Report.
Written Valuation Reports.
Oral Reports and Testimony.
Access to Information Sources and Any Known Limiting Conditions.
Special Instructions from the Client or Attorney.
Contractual Relationship with the Client.
Work Product Timing.
Fee Arrangements.
Summary.
3. Defining Value	37	(14)
Standards of Value.
Fair Market Value.
Investment Value.
Intrinsic or Fundamental Value.
Fair Value.
Ownership Characteristics.
Alternative Premises of Value.
Sources of Guidance about Applicable Standards and Premises of Value.
Effect of Terms on Value.
Summary.
4. How Valuations Differ for Different Purposes	51	(14)
Typical Buy and Sell Transactions.
Buying or Selling a Business or Practice.
Buying or Selling a Partial Ownership Interest.
Leveraged Buyouts.
Mergers.
Obtaining or Providing Financing.
Going Public.
Transactions Governed by Federal Tax Laws.
Estate, Gift, Inheritance, and Income Taxes.
Charitable Contributions.
Employee Stock Ownership Plans.
Buy-Sell Agreements.
Determining Life Insurance Needs.
Valuations for Litigation and Dispute Resolution.
Property Settlements in Divorces.
Damage Cases.
Squeeze-out Mergers and Dissenting Stockholder Actions.
Minority Stockholder Oppression Actions.
Ad Valorem Taxes.
Valuations for Multiple Purposes.
Considering Alternatives: Estate Planning and Other Types of Choices.
Summary.
5. Differences between the Valuation of Large and Small Businesses	65	(18)
Introduction.
Definitions and Distinctions.
Operational Differences.
Transactional Differences.
Market Dynamics Differences.
Summary.
6. Comparison between Business Appraisal Practices and Real Estate Appraisal Practices	83	(10)
Nature of the Property Rights Subject to Appraisal.
Relative Development of the Discipline.
Language Similarities and Differences.
Differences in Appraisal Approaches.
Real Estate Appraisal Approaches.
Business Appraisal Approaches.
Differences in Estimating Capitalization Rates.
Availability of Comparative Transactional Data.
Summary.
PART II Analyzing the Company	93	(98)
7. Adjusting the Balance Sheet	95	(22)
Accounts Receivable.
Inventory.
FIFO versus LIFO.
Write-Down and Write-Off Policies.
Income Tax Effect.
Prepaid Expenses.
Other Current Assets.
Real Estate.
The Real Estate Appraisal Process.
Approximations of Real Estate Values.
Income Tax Effect.
Tangible Personal Property.
Depreciated Replacement Cost.
Liquidation Value.
Approximations of Personal Property Values.
Intangible Assets.
Liabilities.
Interest-Bearing Debt.
Deferred Taxes.
Contingent or Off-Balance-Sheet Assets and Liabilities.
Product Liability.
Lawsuits.
Regulatory Compliance.
Past Service Liability.
Employment Agreements.
Unrecorded Obligations.
Liens.
Examples of Adjusted Balance Sheets.
Sole Proprietorship Example.
Corporation Example.
Summary.
8. Adjusting the Income Statement	117	(16)
Compensation to Owners.
Analyzing the Components of Compensation.
Sources of Comparative Compensation Data.
Depreciation.
Cost of Goods Sold.
Adjustment for Companies Using LIFO Accounting.
Unconventional but Not Uncommon Practices.
Occupancy Costs.
Rented or Leased Premises.
Owner-Occupied Premises.
Nonrecurring Items.
Business Interruptions.
Insurance Proceeds.
Lawsuit Settlements.
Gains or Losses on Disposal of Assets.
Discontinued Operations.
Payments on Employment Contracts and Covenants Not to Compete.
Abnormal Market Conditions.
Accrued Expenses.
Bad Debts.
Insurable Liabilities.
Nonoperating Income and Expenses.
Adjusting for Taxes, if Necessary.
Samples of Adjusted Income Statements.
Sole Proprietorship Example.
Corporation Example.
Summary.
9. Comparisons with Industry Averages	133	(16)
Advantages of Comparative Analysis.
Identifying Errors.
Identifying Strengths and Weaknesses.
Identifying Opportunities.
Sources of Comparative Industry Data.
General Sources.
Specialized Sources.
Interpretation of Financial Statement Ratios.
Short-Term Liquidity Measures.
Balance Sheet Leverage Ratios.
Activity Ratios.
Profitability Ratios.
Examples of Comparative Industry Analysis.
Sole Proprietorship Example.
Corporation Example.
Summary.
10. Analyzing Qualitative Factors	149	(28)
Relevant Economic Data.
National Economic Data.
Regional and Local Economic Data.
Industry Factors.
Markets.
Channels of Distribution.
Technology.
Sources of Industry Information.
Competition.
Existing Competition.
Potential Competition.
Regulation.
Present Regulations.
Potential Changes in Regulatory Environment.
Product or Service Line.
Existing Lines.
Opportunities for Related Lines.
Patents, Copyrights, Trademarks.
Relative Profitability of Lines.
Service or Warranty Obligations.
Supplier Relationships.
Continuity.
Degree of Exclusivity.
Contractual Relationships.
Market Position.
Reputation.
Geographic Scope.
Method of Marketing and Distribution.
Pricing Policies.
Customer Base.
Customer Relationships.
Market Continuity, Growth Opportunities, and Weaknesses.
Management and Employees.
Size and Composition of Workforce.
Key Employees.
Other Employees.
Compensation.
Personnel Policies, Satisfaction, Conflict, and Turnover.
Adequacy of Physical Facility.
Condition.
Heat, Light, Plumbing, and Other Systems.
Size.
Continuity of Occupancy.
Operating Efficiencies and Inefficiencies.
Physical Plant.
Accounting and Other Controls.
Reason for Sale.
Summary.
Bibliography.
11. The Buyer's Perspective-Pro Forma Statements	177	(14)
Analysis of Working Capital Requirements.
Steps in Analyzing Working Capital.
An Example of Working Capital Analysis.
Analysis of Fixed Assets.
Deferred Maintenance and Replacement Requirements.
Compliance Requirements.
Other Asset Inadequacies.
Excess Assets.
Contingent Liabilities.
Structure of Long-Term Liabilities.
The Buyer's Income Statement.
Changes in Existing Operations.
New Business Directions.
Synergies and Efficiencies.
Samples of Buyer's ProForma Statements.
Purchase of a Sole Proprietorship.
Purchase of Corporate Stock.
Summary.
PART III Reaching the Value Conclusion	191	(366)
12. Value Drivers	193	(8)
Buyer/Seller Motivations.
Elements That Influence Value Drivers.
Size.
Persistence of Customer, Supplier, and Employee Base.
Ease of Entry.
Licenses, Franchise Agreements, or Permits.
Competition.
Classification of Valuation Methods.
Summary.
13. Understanding Discount and Capitalization Rates	201	(34)
"Discounting" versus "Capitalizing."
Discounting.
Capitalizing.
Components of a Discount Rate.
Risk-Free Rate of Return.
Premium for Risk.
Premium for Size.
Premium for Illiquidity.
Premium for Administrative Costs.
Relationship between Discount Rates and Direct Capitalization Rates.
Reflecting Growth or Decline in Expected Returns.
Return on Investment versus Return on and of Investment.
Distinguishing between Return on Equity (ROE) and Return on Invested Capital (ROI).
Return on Equity.
Return on Invested Capital.
Implication for Discount and Capitalization Rates.
Relating Discount or Capitalization Rate to Economic Income Flow.
Developing a Discount Rate.
Discount Rates for Debt.
Discount Rate for Net Cash Flow to Equity.
Premium for Risk.
Weighted Average Cost of Capital (WACC).
Discount Rate for Other Return Variables.
Developing a Direct Capitalization Rate.
Direct Market Comparison Method.
Converting a Discount Rate to a Direct Capitalization Rate.
Warning! Historical Industry Returns Not Reliable for Discount and Capitalization Rates.
Relationship between Payback Period and the Direct Capitalization Rate.
Different Rates for Different Buyers.
Summary.
Bibliography.
14. The Discounted Economic Income Method	235	(18)
The Essentials of the Discounted Economic Income Method.
The Discounted Economic Income Formula.
Valuing Equity versus Invested Capital.
Selecting the Measure of "Economic Income."
Projecting Prospective Economic Income.
Period of the Projection.
Constant Real Dollars or Nominal Dollars?
Who Prepares the Projections?
Selecting the Present Value Discount Rate.
Cash Flows plus a Terminal Value.
An Example.
The "Midyear Discounting Convention."
Does the Discounted Economic Income Model Produce a Control Value or a Minority Value?
What Standard of Value Does a Discounted Economic Income Model Produce?
Growing Acceptance of the Discounted Economic Income Method.
Marital Dissolution.
Damage Cases.
Legal Malpractice.
Gift and Estate Taxes.
Dissenting Stockholder Actions.
Summary.
Bibliography.
15. The Capitalized Economic Income Method	253	(16)
The Essentials of the Capitalized Economic Income Method.
The Capitalized Economic Income Formula.
Essential Difference between the Discounting Model and the Capitalization Model.
Valuing Equity versus Invested Capital.
Selecting the Appropriate Measure of Economic Income.
Projecting the Basic Economic Income Level and the Growth Rate.
Start with Normalized Expected Economic Income.
The Projected Long-Term Growth Rate.
The Gordon Growth Model.
Modification of the Capitalized Economic Income Method to Reflect the Midyear Discounting Convention.
Using the Capitalized Economic Income Method to Develop a Terminal Value for the Discounted Economic Income Method.
Why the Capitalized Economic Income Method Is Preferable.
Implementation of the Capitalized Income Method to Estimate the Terminal Value.
Does the Capitalized Economic Income Method Produce a Control Value or a Minority Value?
What Standard of Value Does the Capitalized Economic Income Model Produce?
Summary.
Bibliography.
16. The Guideline Publicly Traded Company Method	269	(28)
Introduction to the Guideline Publicly Traded Company Method.
When Is the Guideline Publicly Traded Company Method Most Useful?
Standard of Value.
Levels of Value.
Quantity and Quality of Available Data.
Criteria for Guideline Publicly Traded Company Selection.
How Many Guideline Publicly Traded Companies?
Time Period for Analysis.
Compiling Guideline Publicly Traded Company Tables.
Developing a List of Guideline Publicly Traded Companies.
Financial Statement Adjustments to Guideline Publicly Traded Companies.
Comparative Ratio Analysis.
Obtaining the Guideline Publicly Traded Company Market Pricing Data.
Presenting Guideline Publicly Traded Company Tables.
Selecting and Weighting Pricing Multiples Based on Guideline Publicly Traded Companies.
Impact of Guideline Publicly Traded Company Data Evaluation.
Multiples of Earnings or Cash Flow.
Capitalization of Dividends or Dividend-Paying Capacity.
Multiples of Revenue.
Multiples of Stock Value to Asset Value.
Typical Adjustments to Reach a Value Conclusion.
Disadvantages of the Guideline Publicly Traded Company Method.
Common Errors.
Failure to Conduct and Adequate Search for Guideline Transaction Data.
Failure to Make Appropriate Financial Statement Adjustments to Guideline Companies.
Multiples That Mismatch Numerator and Denominator.
Naive Reliance on Average of Guideline Publicly Traded Company Multiples without Comparative Analysis.
Summary.
Bibliography.
17. Public Company Data: What's Available and How to Get It Easily and Inexpensively	297	(12)
EDGAR.
Additional Sources of Financial Data.
Disclosure Incorporated.
Moody's Investors Service.
Standard & Poor's Corporation.
Other Sources of Data.
Summary.
Bibliography.
Resource List: Publicly Traded Company Financial Data.
Major Sources.
Additional Sources.
On-line Service Providers.
18. The Comparative Transaction Method	309	(18)
Overview of the Comparative Transaction Method.
General Framework of the Comparative Transaction Method.
When Is the Comparative Transaction Method Most Useful?
Standard of Value.
Characteristics of Value.
Premise of Value.
Prior Subject Company Transactions.
Prior Subject Company Transfers.
Subject Company Prior Changes of Control.
Prior Acquisitions by the Subject Company.
Elements of Comparison.
Formulas or Rules of Thumb.
Adjustments to Comparative Transactions.
Adjust for the Terms and Conditions of the Comparative Transactions.
Time Value of Money Considerations.
Owners' Compensation and Related Benefits.
Facilities Ownership versus Facilities Lease.
Comparative Ratio Analysis.
Time Period to Consider.
Treating Nonoperating Assets, Excess Assets, and Asset Deficiencies.
Nonoperating Assets.
Marginal Operating Real Estate.
Excess Assets or Asset Deficiencies.
Typical Adjustments to Reach a Value Conclusion.
Selecting and Weighting Multiples for the Subject Company Based on Comparative Transactions.
Impact of Comparative Transactional Data Evaluation.
Multiple of Stock Value to Asset Value.
Reaching the Value Indication.
Summary.
Bibliography.
19. The Multiple of Discretionary Earnings (Seller's Discretionary Cash) Method	327	(12)
Defining Discretionary Earnings.
Selecting the Appropriate Multiple.
Pricing Multiples from Empirical Evidence.
Analytical Development of a Pricing Multiple.
What Is Being Valued?
Multiple of Discretionary Earnings Method Produces a Control Value.
What Standard of Value Does the Multiple of Discretionary Earnings Method Produce?
Summary.
Bibliography.
Books and Articles.
Sources of Current Price/Discretionary Earnings Ratios.
20. The Gross Revenue Multiples Method	339	(10)
The Basic Concept of This Method.
When Gross Revenue Multiples May Be Useful.
When Gross Sales Are the Only Reliable Income Data Available.
For Companies with Losses or Erratic Earnings.
For Highly Homogeneous Industries and Professions.
Estimating Value of Intangible and/or Other Assets.
Where There Is a High Industry Correlation between Price and Return on Sales.
Gross Revenue Multiples Generally Indicate Debt-Free Value.
Problems in the Application of Gross Revenue Multiples.
Ambiguity about Exactly What Was Sold.
Ambiguity about the Terms of the Transaction.
A Profit Factor Usually Comes into Play.
Differences in Persistence of Revenues.
Uniqueness of Each Entity.
Multiples Change Considerably over Time.
Even Gross Revenue Data May Not Be Reliable.
Multiples of Some Measure of Physical Volume.
Using Industry Earnings Data to Check Gross Revenue Multiples.
Summary.
21. Comparative Transaction Databases	349	(16)
The IBA Market Database.
Bizcomps.
Done Deals Data.
Pratt's Stats.
How Does Business Value Vary with Time?
How Is Price Affected by Terms?
Using the Databases in the Market Approach.
Summary.
22. The Asset Accumulation Method	365	(36)
Fundamentals of the Asset-Based Approach.
Asset-Based Approach versus Book Value.
Asset-Based Approach Valuation Methods.
Collective Revaluation of Assets and Liabilities.
Discrete (Individual) Revaluation of Assets and Liabilities.
Partial Revaluation of Individual Assets and Liabilities.
Steps in the Application of the Asset Accumulation Method.
Obtain or Develop a GAAP-Basis Balance Sheet.
Identify Recorded Assets and Liabilities to Be Revalued.
Identify Off-Balance-Sheet Assets That Should Be Recognized.
Identify Off-Balance-Sheet and Contingent Liabilities That Should Be Recognized.
Value the Items Identified Above.
Construct a Valuation-Basis Balance Sheet.
Valuation Premises for Individual Assets.
Value in Continued Use, as Part of a Going Concern.
Value in Place, as Part of a Mass Assemblage of Assets.
Value in Exchange, in an Orderly Disposition.
Value in Exchange, in a Forced Liquidation.
Selecting the Appropriate Premise of Value.
Individual Asset Valuation Approaches, Methods, and Procedures.
Financial Assets.
Real Estate.
Tangible Personal Property.
Intangible Real Property.
Intangible Personal Property.
Example.
Advantages of the Asset Accumulation Method.
Disadvantages of the Asset Accumulation Method.
Summary.
Bibliography.
23. The Capitalized Excess Earnings Method	401	(24)
History of the Capitalized Excess Earnings Method.
How This Valuation Method Works.
Application of This Method.
The Apparent Simplicity of This Method.
An Illustration.
A Popular Version.
Analysis of the Capitalized Excess Earnings Method.
Estimating the "Net Tangible Asset Value."
Estimating a "Normalized Level of Earnings."
Appropriate Rate of Return on Tangible Assets.
Appropriate Capitalization Rate for Excess Earnings.
Comprehensive Example.
The Treatment of Negative Goodwill.
Common Errors in Applying the Capitalized Excess Earnings Method.
Failure to Allow for Owner's Salary.
Failure to Use Realistic Normalized Earnings.
Errors in Selecting Appropriate Rates.
Summary.
Bibliography.
24. Discount for Lack of Control	425	(20)
Elements of Ownership Control.
Degree of Ownership Control.
Effect of State Statutes.
Effect of Articles of Incorporation and Bylaws.
Effect of Distribution of Equity Ownership.
Distinction between Discount for Lack of Control and Discount for Lack of Marketability.
How the Applicable Standard of Value Affects Minority Ownership Interests.
Fair Market Value.
Investment Value.
Intrinsic Value.
Fair Value.
Approaches to the Valuation of Minority Ownership Interests.
Proportion of the Overall Enterprise Value less a Discount.
Valuation by Comparison with Other Minority Ownership Interests.
"Bottom Up" Approach.
Errors to Avoid.
The Public Offering Myth.
Irrelevant Financial Statement Adjustments.
Comparison with Real Estate Minority Discounts.
Data on Sales of Minority Ownership Interests.
Trust and Estate Sales.
Public Stock Market Data.
Other Influences Related to a Minority Ownership Interest Discount.
Highly Regulated Industries.
Buy-Sell and Other Shareholder Agreements.
Fiduciary Duties.
Private Company with Public Securities.
Private Company That Operates Like a Public Company.
Control Has Already Been Dissipated.
Summary.
Bibliography.
25. Discount for Lack of Marketability	445	(32)
Concept and Importance of Marketability.
Adjustment for Lack of Marketability for Minority Ownership Interests.
Evidence for the Quantification of Discount for Lack of Marketability.
Marketability Discounts Extracted from Prices of Restricted Stocks.
SEC Institutional Investor Study.
Gelman Study.
Trout Study.
Moroney Study.
Maher Study.
Standard Research Consultants Study.
Willamette Management Associates Study.
Silber Study.
FMV Opinions, Inc., Study.
Management Planning, Inc., Study.
Summary of Empirical Studies on Restricted Stock Transactions.
Studies of Private Transactions before Initial Public Offerings.
Robert W. Baird & Company Studies.
Willamette Management Associates Studies.
Summary of Conclusions from Private Transaction Studies.
Other Analysis of Discounts for Lack of Marketability for Minority Interests.
Discounts for Lack of Marketability for Controlling Ownership Interests.
Illiquidity Factors Affecting Controlling Ownership Interests.
Benchmark for the Discount for Lack of Marketability for Controlling Ownership Interests.
Differences between Private and Public Company Acquisition Price/Earnings Multiples.
Factors That Affect the Discount for Lack of Marketability.
"Put" Rights.
Dividend Payments.
Potential Buyers.
Size of Interest.
Prospect of Public Offering or Sale of the Business.
Information Access and Reliability.
Restrictive Transfer Provisions.
Court Decisions on Discounts for Lack of Marketability.
Summary.
Bibliography.
26. Valuation Synthesis and Conclusion	477	(12)
The Reconciliation Process.
Criteria for the Selection of Valuation Approaches and Methods.
Quantity and Quality of Available Data.
Access to Available Data.
Supply of Industry Transaction Data.
Type of Business, Nature of the Subject Business Assets, and Type of Industry Subject to Appraisal.
Statutory, Judicial, and Administrative Considerations.
Informational Needs of the Particular Appraisal Audience.
Purpose and Objective of the Appraisal.
Compliance with Promulgated Professional Standards.
Professional Judgment and Technical Expertise of the Analyst.
Criteria for the Synthesis of Multiple Valuation Indications.
Income Approach Methods.
Asset-Based Approach Methods.
Market Approach Methods.
Reconciling an Inconsistency of Results among Valuation Approaches and Methods.
Summary.
27. Tradeoff between Cash and Terms	489	(14)
Converting a Price on Terms to a Cash Equivalent Value.
A Typical Example.
Some Variations.
Estimating the Applicable Market Interest Rate.
Data on Market Interest Rates.
Using Professional Judgment.
Converting a Cash Value to a Price on Terms.
Contingent Payments.
Summary.
28. Making a Reality Check: Is the Value Estimate Reasonable?	503	(8)
Cash Available for Debt Service.
Amount of Debt Service Coverage Needed.
Possible Adjustments to the Purchase Contract.
Protective Covenants in the Purchase Contract.
Example.
Summary.
29. Common Errors	511	(22)
Failure to Clearly Identify and/or Adhere to the Applicable Standard of Value.
Rigid Categorization of Business Valuation Methods.
Reliance on Real Estate Appraisal Methods.
Reliance on Rules of Thumb.
The "Assets plus. . ." Method.
Indiscriminate Use of Price/Earnings Multiples.
Failure to Identify What the Buyer Gets for the Price.
Applying Price/Earnings Multiples to Earnings That Are Not Comparable.
Applying Price/Earnings Multiples When Time Periods Are Not Comparable.
Using the Reciprocal of the Price/Earnings Multiple as the Required Rate of Return.
Failure to Make Appropriate Adjustments.
Other Errors in Deriving Capitalization Rates.
Using Rates from an Earlier Time Period.
Applying Rates on "Safe" Investments to Small Business Investments.
Failure to Match the Capitalization Rate with the Earnings Base.
Mistaking Historical Results for Required Rates of Return.
Failure to Estimate a Realistic Normalized Earnings Base.
Reliance on Past Results without Judgment.
Failure to Recognize Any Depreciation.
Not Allowing Compensation to Owner/Operator.
Failure to Consider the Full Cost of the Purchase.
Working Capital Requirements.
Deferred Maintenance.
Other Investment Needed.
Failure to Understand What the Indicated Value Represents.
What Assets and/or Liabilities Are Included?
Asset versus Stock Valuation.
Ownership Characteristics.
Assuming That the Buyer Will Pay for the Now and the Hereafter.
Emphasis on Items Not in Proportion to Their Relative Importance.
Inadequate Documentation.
Failure to Conduct a Site Visit and/or Management Interviews.
Errors Articulated by Tax Court Judges.
Common Mistakes Made by CPAs.
Summary.
30. Sample Case	533	(10)
Background of Rusty Metals, Inc.
Economic Outlook.
Industry Outlook.
Operations.
Competition.
Management and Employees.
Customers.
Financial Statements.
31. Solution to the Sample Case	543	(14)
Financial Statement Adjustments
Financial Statement Analysis.
Balance Sheets.
Statements of Operations.
Financial and Operating Ratios
Guideline Publicly Traded Company Analysis.
Valuation Approaches.
The Market Approach.
The Guideline Publicly Traded Company Method.
Invested Capital Valuation Methods.
Value Indication.
Ownership Control Premium Analysis.
Value Indication.
The Income Approach.
Valuation Theory and Methodology.
Valuation Calculations.
Value Indication.
Summary of Value Indications.
Valuation Synthesis and Conclusion.
PART IV Valuing Professional Practices	557	(114)
32. Introduction to Professional Practice Valuation	559	(10)
Reasons to Value a Professional Practice.
Characteristics of a Professional Practice.
Service Business Characteristics.
Client Trust and Respect.
Dependence on Referral Sources.
Education.
Licensing and Certification.
Distinctions between Professional Practice Valuations and Other Business Valuations.
Type of Assets.
Dependence on the Professional.
Professional Licenses.
Cash-Basis Accounting.
Limited Life of the Practice.
Value Drivers for Professional Practices.
Summary.
33. Adjusting the Professional Practice Balance Sheet	569	(14)
Assets.
Cash.
Accounts Receivable.
Work-in-Process Inventory.
Inventory of Supplies.
Prepaid Expenses.
Equipment.
Leasehold Improvements.
Intangible Assets.
Liabilities.
Accounts Payable.
Accrued Liabilities.
Deferred Liabilities.
Long-Term Debt.
Lease Obligations.
Contingent Liabilities.
Summary.
34. Elements That Create Professional and Practice Goodwill	583	(12)
Distinction between Practice Goodwill and Professional Goodwill.
Practice Goodwill.
Professional Goodwill.
Buying and Selling a Practice-Elements of Goodwill.
Expected Future Earnings.
Level of Competition.
Referral Base.
Types of Patients and Clients.
Work Habits of the Practitioner.
Fee Schedules.
Practice Location.
Employees of the Practice.
Marketability of the Practice.
Valuation for Marital Dissolution Purposes-Elements of Goodwill.
Practitioner's Age and Health.
Demonstrated Past Earning Power.
Reputation for Judgment, Skill and Knowledge.
Comparative Professional Success.
Nature and Duration of Practice.
Summary.
35. Estimating the Value of the Professional Practice	595	(18)
Methods of Professional Practice Valuation.
Discounted Economic Income.
Capitalization of Economic Income.
Multiple of Revenues.
Comparative Transactions and Buy-Ins (Market Data Comparison).
Punitive and Retirement Formulas.
Capitalized Excess Earnings.
Asset Accumulation.
Depreciating Goodwill.
Rule-of-Thumb Methods for Various Types of Professional Practices.
Accounting Practices.
Dental Practices.
Engineering/Architecture Practices.
Law Practices.
Medical Practices.
Optometric Practices.
Medical Laboratories.
Veterinary Practices.
Summary.
Bibliography.
36. Sample Professional Practice Valuation Report	613	(36)
Introduction.
Description of the Assignment.
Summary Description of Gateway Pediatrics.
Sources of Information.
Summary and Conclusion.
Regional Economic Outlook.
Overview.
Oregon.
Benton County.
Health Care Industry.
Overview.
Physician Characteristics and Distribution in the United States.
Recent Industry Issues and Trends.
History and Description of the Practice.
Practice Development and Overview.
Facilities.
Office Hours.
Staff.
Patients.
Financial Analysis of Gateway Pediatrics.
Overview.
Summary.
Medical Practice Valuation Analysis.
Overview.
The Asset Accumulation Method.
The Discounted Cash Flow Method.
The Comparative Transaction Method.
Valuation Synthesis and Conclusion.
Appraisal Certification.
Statement of Contingent and Limiting Conditions.
Professional Qualifications of the Principal Analyst.
37. Examples of Professional Practice Valuation Methods	649	(22)
Example of an Accounting Practice Valuation.
Example Fact Set.
Discounted Economic Income Method.
Asset Accumulation Method.
Guideline Market Transactions Method.
Valuation Synthesis and Conclusion.
Example of a Veterinary Practice Valuation.
Example Fact Set.
Capitalized Excess Earnings Method.
Capitalization of Economic Income Method.
Guideline Market Transactions Method.
Valuation Synthesis and Conclusion.
PART V Valuations for Specific Purposes	671	(64)
38. Buy-Sell Agreements and Estate Planning	673	(26)
Buy-Sell Agreements.
Types of Agreements.
Provisions for Valuation.
Beware the Fair Market Value Standard in Buy-Sell Agreements.
Role of the Business Appraiser in Buy-Sell Agreements.
Gift and Estate Taxes.
Transfer Tax Rates and Exemptions.
Penalties for Undervaluation.
Rules for Valuation-Standard and Special.
Judicial Precedent.
Methods Used to Minimize Gift and Estate Taxes.
Appraisals for Charitable Contributions.
Summary.
Bibliography.
39. Employee Stock Ownership Plans in Small Companies	699	(14)
What Is an ESOP?
Leveraged ESOPs.
The Leveraged Buyout.
The ESOP as a Financing Vehicle.
Advantages of ESOPs.
Tax-Free Rollover of Sale Proceeds.
Tax-Deductibility of ESOP Dividends.
Improve Employee Morale and Productivity.
Achieve Other Corporate Objectives.
When Does an ESOP Make Sense?
Value of the Company.
Corporate Form.
Adequacy of Payroll.
Cash Flow.
Dependence on the Primary Shareholder(s).
Corporate Culture.
Issues in the Valuation of ESOP Stock.
Government Regulation.
Requirements for Valuation Analyses.
Qualified and Independent Financial Advisor.
Common Problems in ESOP Valuation.
Summary.
Bibliography.
40. Corporate and Partnership Buyouts and Dissolutions	713	(8)
Buyouts.
Dissolutions.
Deprivation.
Dissenting Shareholder Actions.
Bankruptcy.
Standard of Value.
Fair Market Value.
Fair Value.
Premise of Value.
Summary.
41. Marital Dissolutions	721	(14)
Standard of Value.
Valuation Date.
Discovery.
Valuation Methods.
Income Approach.
Market Approach.
Asset-Based Approach.
Goodwill.
Compensation.
Noncompete Covenants.
Valuation Discounts and Premiums.
Capital Gains Tax.
The Role of the Analyst.
Summary.
Bibliography.
PART VI Topics Related to Valuation	735	(70)
42. Valuing Intangible Assets	737	(22)
Fundamentals of the Appraisal.
Identification of Intangible Assets.
Categorization of Intangible Assets.
Listing of Intangible Assets.
Valuation of Intangible Assets.
Market Approach.
Income Approach.
Cost Approach.
Replacement Cost New.
Curable versus Incurable Obsolescence.
Reproduction Cost.
Replacement Cost.
Remaining Useful Life Analysis of Intangible Assets.
Covenants Not to Compete.
Summary.
Bibliography.
43. Buying or Selling a Business or Practice	759	(16)
To Sell or Not to Sell.
Timing of the Sell Decision.
Preparing the Business for Sale.
Have Excellent Records.
Clean Up the Financial Statements.
Have a Good Profit Record.
Have the Business in Good General Condition.
Have Adequate Personnel.
Have the Business Appraised.
Deciding What to Buy.
Preparing to Make an Offer.
Differing Perceptions and Circumstances of Sellers and Buyers.
Assessment of Future Profits and Risk.
Opportunity.
Personal Rewards.
Buying a Job.
Synergy.
Compulsion.
Structuring a Deal.
Stock Sale versus Asset Sale.
Selling on an Installment Contract.
Selling for Stock of the Buying Company.
Leveraged Buyouts.
Earn-Outs.
Contingencies.
Covenants Not to Compete.
Employment Contracts.
Allocating the Purchase Price.
Summary.
Bibliography.
44. Working with a Business Appraiser	775	(18)
Services Typically Offered by Business Appraisers.
Finding and Engaging an Appraiser.
Selecting the Appraiser.
Qualifications of Business Appraisers.
Fees and Scheduling.
Professional Services Agreement.
Contingent and Limiting Conditions.
Information to Provide to the Appraiser.
Financial Statements.
Other Financial Data.
Company Documents.
Other Information.
Field Visit.
Preparation.
Mission.
Confidentiality.
Adversarial Proceedings.
The Appraisal Report.
Independence of the Appraiser.
Summary.
45. Working with a Business Broker	793	(12)
Services Offered by a Business Broker.
Criteria for Selecting a Broker.
Types of Businesses.
Size of Businesses.
Geographical Scope.
General Competence.
Success Ratio.
Willingness of a Broker to Spend Money on Advertising a Business for Sale.
Locating the Broker.
Pricing and Listing a Business or Practice for Sale.
Typical Fees.
Working with the Broker.
The Seller's Role.
The Buyer's Role.
Closing the Deal.
Summary.
PART VII Litigation and Dispute Resolution	805	(56)
46. Litigation	807	(18)
The Legal Context.
Statutory Law.
Administrative Rulings and Regulations.
Judicial Precedent.
Court Directives and Preferences.
Types of Litigation.
Dissenting Shareholder Disputes.
Corporate and Partnership Dissolutions.
Marital Dissolutions.
Estate, Gift, and Income Tax.
Bankruptcy, Insolvency, and Reorganization Situations.
State and Local Property Taxes.
Intellectual Property Rights Infringement.
Litigation Support Services.
Assessing the Case.
Discovery.
Critique of the Opposition.
Expert Testimony.
Rebuttal.
Summary.
Bibliography.
47. Damages	825	(20)
The Causation of Damages versus the Amount of Damages.
Establishing the Causation of Damages.
Proximate Cause.
Reasonable Certainty.
Foreseeability.
Calculating the Amount of Damages.
The Before-and-After Method.
The Yardstick (Comparable) Method.
Sales Projections (But-For) Method.
Some Comments on Projections.
Prejudgment Interest and Discounting Anticipated Returns.
Common Damage Cases.
Breach of Contract.
Condemnation.
Lost Business Opportunity.
Antitrust Actions.
Personal Injury.
Insurance Casualty Claims.
Mitigation.
Selected Damage Cases.
American Federal Group.
Cooper Distributing Co.
Cambridge Plating Co.
Summary.
Bibliography.
48. Arbitrating or Mediating Disputed Valuations	845	(16)
Advantages of Arbitration versus Litigation.
Independent Role of Arbitrators.
Situations Giving Rise to Arbitration.
Marital Dissolution.
Corporate and Partnership Dissolutions.
Dissenting Stockholder Actions.
Damage Cases.
Selection of Arbitrators.
Criteria for Selection.
Procedure for Selection.
American Arbitration Association Procedure.
Engagement and Compensation of Arbitrators.
Establishing the Ground Rules for Arbitration.
Factors Specified in the Arbitration Agreement.
Factors Left to the Arbitrators' Discretion.
The Arbitration Process.
Review of Arbitration Document.
Initial Communication among Arbitrators.
Field Visit.
Hearings.
The Valuation Meeting
Reporting the Results of the Arbitration.
Mediation.
Summary.
Bibliography
Appendix A General Resource List	861	(4)
Appendix B Revenue Ruling 59-60	865	(6)
Index	871