Category: Valuation & Litigation

Get Your Creative Juices Flowing

By Christopher Sargent, CPA
Senior Analyst, Valuation & Litigation Services
[email protected]

If something’s not broken, you shouldn’t fix it, right? If you’re talking about your business, the answer is wrong! Even if it seems like your business is doing just fine, you won’t continue to grow if you don’t challenge the status quo! You must instill a creative entrepreneurial spirit within your team.

First, don’t be afraid to identify weaknesses or shortcomings in your processes and procedures. Putting them under the microscope will shed light on what’s actually working versus what has simply and arbitrarily become protocol — or maybe outdated!

Create a culture of constant improvement. Perhaps you could dedicate monthly meetings to discussing areas in which you can implement changes that will make a positive impact. Be deliberate by putting someone in charge of affecting change. Appoint a Chief Innovation Officer (CIO) to develop ideas and long-term strategies for implementing them. This person could also help you identify these three important aspects of your business: what you should stop doing, what you should start doing and what you should continue.

Look at what happened when Amazon stopped solely selling books and started shipping CDs, DVDs, video games, groceries and more. Remember when Netflix was simply a DVD rental and sales company? Now it dominates the entertainment industry, producing original films and series that have won numerous Oscars and Emmys. Imagine where our culture would be if these businesses stuck to their initial services and never branched out beyond them.

On a local level, look at a business like Ash & Elm Cider Co. Initially conceived as a craft beer brewery, the business pivoted toward hard cider when the craft beer industry started crowding the market in Indy. In the business world, you can either adapt or close your doors. There’s always hope for successful adaptation.

In your own time of reinvention, you should turn to your customers. When was the last time you sat down with them and asked what they honestly think of your products and services? If they find them merely adequate, statistics show that you risk losing those customers to a competitor. Consider feedback from vendors as well. Outsider perspectives are crucial to helping you revitalize your business.

Don’t be afraid of change — embrace it! What you should fear is the idea of sticking to the status quo. So get back to the drawing board and start throwing bold, brave ideas at the wall. You’ll be surprised by which ones stick. All stakeholders will benefit, and your company or organization will shine bright with a new vitality.

If we can assist you further with achieving success in your business or personal affairs, please contact Christopher Sargent at (317) 613-7851 or email [email protected].

Reporting the Red Flags of Fraud

By Jason Thompson, CPA/ABV, ASA, CFE, CFF
Partner and Director of Valuation and Litigation Services
[email protected]

Occupational fraud continues to be an all-too-common threat across a wide spectrum of industries. Perpetrators range from entry-level employees to C-suite executives. Small businesses with under 100 employees are particularly vulnerable to fraud, experiencing a median loss of $200,000.

Among other things, this report identifies the employees and departments that pose the greatest threat to organizations when it comes to occupational fraud.

According to this study, fraud is most often committed by perpetrators who fall within the following demographics. Keep in mind that these demographics are not indicative of employees who will definitely commit occupational fraud; they are merely common demographics among occupational fraud perpetrators.

• Gender — In the United States, men accounted for 58% of all occupational fraud cases. Even when taking authority level into consideration, men still tend to cause larger losses than women in managerial and owner/executive positions.

• Age — According to the study, the largest median losses were caused by fraudsters aged 56 and older.

• Education — Approximately 60% of perpetrators have a college degree or higher.

• Position of perpetrator — Occupational fraud is committed most frequently by low-level personnel, but fraud committed by managers/executives results in much higher median losses.
o Employee — 44% of cases; median loss of $50,000
o Manager — 34% of cases; median loss of $150,000
o Owner/Executive — 19% of cases; median loss of $850,000
o Other — 3% of cases; median loss of $189,000

• Perpetrator’s tenure with the business — Fraud losses significantly increase based on how long the fraudster worked for the company.
o Less than 1 year — 9% of cases; median loss of $40,000
o 1-5 years — 44% of cases; median loss of $100,000
o 6-10 years — 23% of cases; median loss of $173,000
o More than 10 years — 24% of cases; median loss of $241,000

• Department within organization — Employees in the accounting department generated the highest number of occupational fraud cases, followed closely by operations and executive/upper management.

• Prior criminal background or negative employment history — Most occupational fraudsters are first-time offenders.

Fraud losses tend to be much lower in organizations with telephone hotlines or some other kind of anonymous reporting mechanism. Random audits and forensic data monitoring also rank among the most effective tools for detecting occupational fraud.

If you are concerned about occupational fraud in your organization, please call Jason Thompson at (317) 608-6693 or email [email protected].

Valuation Analyst Credentials

Amber HooverBy Amber Hoover, CPA/ABV
Senior Analyst, Valuation and Litigation Services 

When you need a valuation of a business, the first step is also the most important: hiring an expert.

Using an in-house accountant or relying on the do-it-yourself method can often make an uncertain situation into an even worse one. It’s important to find someone who has experience and knowledge in valuation so you can arrive at a result that is not only fair, but legally justified.

The Internal Revenue Service (IRS) and the U.S. legal system both have guidelines for what constitutes a “qualified” valuation expert. These guidelines describe the experience, training and continuing education necessary to earn this designation.

There are a number of credentials available that denote valuation expertise, which have undergone some changes in recent years. These include:

Organization Certification Membership
 
American Institute of Certified Public Accountants (AICPA) Accredited in Business Valuation (ABV) Certified Public Accountants (CPA)s
 
American Society of Appraisers (ASA) Accredited Senior Appraiser (ASA)

Accredited Member (AM)

 CPAs and Non-CPAs
 
National Association of Certified Valuators and Analysts (NACVA) Certified Valuation Analyst (CVA)

Accredited in Business Appraisal Review (ABAR)

 CPAs and Other Credential Holders
 
Institute of Business Appraisers (IBA) Certified Business Appraiser (CBA)

Master Certified Business Appraiser (MCBA)

 *

*Credential holders must comply with the same recertification requirements as NACVA’s credential holders.

In 2008 the NACVA acquired the assets of the Institute of Business Appraisers, but that organization was subsequently dissolved. The CBA and MCBA credentials are no longer available to obtain, but current holders of these credentials must still comply with NACVA’s recertification requirements.

Valuation analysists who have been credentialed through these organizations have been through training that provides the knowledge and skills needed for valuing a business and the required standards to follow. Continuing education requirements allow members to keep current on trends and issues in the valuation world.

When you’re considering an engagement with a valuation analyst, don’t be afraid to inquire about their credentials and experience with various types of businesses. An analyst who has expertise in one particular type of valuation may not necessarily be the person best suited for your needs.

If you are unsure what type of valuation expertise you require, please call Amber Hoover at (317) 613-7844 or email [email protected].

What Factors Should Valuation Analysts Consider When Valuing A Business?

Jason ThompsonBy Jason Thompson, CPA/ABV, ASA, CFE, CFF
Partner and Director of Valuation and Litigation Services

When performing a business valuation, a valuation analyst reviews numerous factors that may impact the resulting value. While the specific factors considered may vary from business valuation to business valuation, Internal Revenue Service (IRS) Revenue Ruling 59-60 identifies certain factors the IRS considers fundamental to analyze when valuing a closely held corporation’s stock.

IRS Revenue Ruling 59-60 was developed to provide guidance for valuing a closely held corporation’s stock, when market quotations are not available, for estate and gift tax purposes. Because this guidance comes from the IRS, it is considered by most valuation analysts as a relevant guidance when performing any valuation engagement.

The following is a discussion of the “Factors to Consider” identified in IRS Revenue Ruling 59-60:

  • The nature of the business and the history of the enterprise from its inception – This factor deals with issues like stability or instability, growth or lack of growth, the diversity or lack of diversity of operations, and other facts needed to form an opinion of the degree of risk involved inside the business.
  • The economic outlook in general and the condition and outlook of the specific industry in particular – This factor considers the current and prospective economic conditions as of the date of the valuation, both in the national economy and in the industry or industries the business operates within. These factors are issues outside the business that impact risk.
  • The book value of the stock and the financial condition of the business – This factor addresses issues like liquidity, reported values of assets, liabilities, working capital and debt, capital structure and net worth. These factors are helpful in identifying financial risk for the business.
  • The earning capacity of the company – This factor deals with financial performance and the use of trends in financial performance as predictors for future financial performance. This is another mechanism for identifying the financial risks of the business.
  • The dividend-paying capacity – This factor, which differs from the previous factor, addresses the amount of funds flowing through the business to owners and the amount of funds that could reasonably flow through to owners without jeopardizing the financial stability of the business.
  • Whether or not the enterprise has goodwill or other intangible value – This factor deals with whether the business has value beyond that of its tangible assets. In many cases, the existence of “excess” net earnings over and above a fair return on the business’ tangible assets is an indication of goodwill or intangible value. In certain situations, the identification of goodwill or intangible value is needed as part of the business valuation.
  • Sales of stock and the size of the block of stock to be valued – This factor and the next both address the consideration of known transaction data. In this case, the transaction data is other sales of the subject closely held corporation’s stock. While this information may exist, careful consideration of the terms and the block/position previously transacted is necessary before applying this data in a current business valuation.
  • The market price of stocks of corporations engaged in the same or a similar line of business having their stocks actively traded in a free and open market, either on an exchange or over-the-counter – This factor directs a valuation analyst to consider published transaction data for other companies when valuing a closely held corporation. We refer to this as a Market Approach. The market approach is based on the theory of substitution, meaning that the known value of a business’ stock can serve as a benchmark indicator of value for the subject closely held corporation’s stock.

At Sponsel CPA Group, our team of valuation experts is well versed in not only the factors to consider from IRS Revenue Ruling 59-60, but also many of the other factors that influence the value of a business.

If you have questions about the value of a business or the valuation process, please call Jason Thompson at (317) 608-6694 or email [email protected].

Treasury Pulling Back from Limiting Valuation Discounts

Jason ThompsonBy Jason Thompson, CPA/ABV, ASA, CFE, CFF
Partner, Director of Valuation and Litigation Services
[email protected]

Earlier this month the U.S. Treasury announced its plans to withdraw its newly proposed regulations under Section 2704 related to limiting valuation discounts. The move came after intense pushback from valuation experts, the estate planning community and family business owners.

The move is good news for owners of closely held businesses who plan to eventually pass the company on to the next generation.

Commenters on the proposed regulation claimed Section 2704 would have hurt family-owned and operated businesses by making it difficult and costly to transfer companies to the next generation. Critics also claimed the valuation requirements of the proposed regulations were unclear and could not be meaningfully applied.

Treasury Secretary Steven T. Mnuchin made the announcement as part of the Trump administration’s ongoing effort to reduce the burden of tax regulations. Its comprehensive review has already identified over 200 regulations that Treasury believes should be repealed, which will begin in the fourth quarter of 2017, according to a statement from the Treasury.

“This is only the beginning of our efforts to reduce the burden of tax regulations,” Mnuchin said. “Our tax code has been broken for too long, and this retrospective review, along with our efforts on tax reform, will ensure that we have a tax system that fosters economic growth.”

If you have questions about transitioning your closely held business to the next generation, please contact Jason Thompson at (317) 608-6694 or email [email protected].

Employee spotlight: Amber Hoover

Amber HooverAmber Hoover is another one of the firm’s “first day” employees, joining the company upon its founding in 2009. She graduated from Indiana University Kelley School of Business in Indianapolis, and soon found her calling in financial analysis and valuation. She is both a CPA and holder of an Accredited in Business Valuation (ABV) certification.

Now a Senior Valuation Analyst in the Valuation and Litigation Services department, Amber performs many different varieties of valuations, focusing mostly on privately held businesses, and also specializes in fraud investigation, lost profit analysis, forensic accounting and economic damage analysis.

Amber has been married to Andy Hoover for six years, and they have an energetic 1-year-old boy, Miles, who will be joined by a baby sister in the very near future. Amber also volunteers with Food Rescue, a charitable group that distributes food to those in need, serving as their treasurer and member of the board of directors.

Where Is the Employment Market Headed?

Amber HooverBy Amber Hoover, CPA/ABV
Senior Analyst, Valuation and Litigation Services

Want to know where the employment market is heading? Know a new or upcoming college graduate and want to give them some useful career advice for now and down the road?

IBISWorld, a global business intelligence leader specializing in industry market research and procurement and purchasing research reports, has assembled a list of industries showing strong employment growth in 2017. And they also have put together a rundown of the top five distressed industries.

Below are the industries that IBIS has identified with the greatest capacity to hire the largest share of new college graduates:

Industry 2017 Employment Growth Rate 2017

Wage growth rate

 College Majors 2017 average industry wage
 
Internet Publishing & Broadcasting 10.3% 10.9% Computer Engineering, Computer Science, Communications $82,069
Geophysical Services 7.7% 9.4% Geology, Environmental Engineering $58,569
Elderly & Disabled Services 7.3% 5.9% Nursing, Hospitality $19,338
Financial Planning & Advice 6.0% 6.9% Accounting, Financial Mathematics, Economics $82,180
Language Instruction 6.0% 6.7% Humanities, Communications, Education $18,804

IBISWorld has listed the following industries as distressed, measured by the quickest expected industry value added (IVA),which measures the industry’s contribution to the U.S. economy, curated using IBISWorld’s proprietary database, declines between 2012 and 2017.

DVD, Game and Video Rental

  • Projected annualized IVA decline: (15.8%)
  • Attributing factor: increase reliance on digital outlets such as Netflix, Hulu, Amazon and Comcast.

Gold & Silver Ore Mining

  • Projected annualized IVA decline: (16.5%)
  • Attributing factor: financial markets have rebounded over the past five years; therefore, investors have decreased their need to buy assets such as gold and silver.

Cotton Farming

  • Projected annualized IVA decline: (12.5%)
  • Attributing factors: unfavorable exchange rates and overseas competition.

Camera Stores

  • Projected annualized IVA decline: (7.9%)
  • Attributing factor: competition from online retailers, department stores and consumer electronic stores.

Database & Directory Publishing

  • Projected annualized IVA decline: (10%)
  • Attributing factor: competition from online search engines such as Google.

If you have any questions, please call Amber Hoover at (317) 613-7844 or email [email protected].

New Insights on Occupational Fraud

Amber HooverBy Amber Hoover, CPA/ABV
Senior Valuation Analyst

Occupational fraud continues to be a serious problem for many businesses across a wide range of industries. Asset misappropriation is a common type, often involving cash schemes — skimming, larceny and fraudulent disbursements.

The Association of Certified Fraud Examiners submitted their most recent findings in their 2016 Global Fraud Study. It includes many insights on who, when and how occupational fraud is most likely to occur.

Small organizations (under 100 employees) were the most common victims in this study, at approximately 30 percent. The median loss for all cases was $150,000, according to the study.

The best way to deal with occupational fraud is to avoid it. While no system is perfect, taking preventative steps with a robust set of oversight measures is the best defense.

It’s also prudent to conduct periodic audits and other types of in-depth financial analysis to detect when fraud has occurred.

Based on this new data, occupational fraud is most often committed by perpetrators with the following demographics:

  • Gender — Males account for 55.7% of total cases of occupational fraud cases that occurred in the United States.
  • Age — According to the study, approximately 55% of perpetrators were between the ages of 31 and 45.
  • Education — Approximately 60 percent of perpetrators have a college degree or higher.
  • Position of Perpetrator (cases that occurred in the United States) — Occupational fraud is committed most frequently by the rank-and-file employees of a company, but losses by managers/executives result in much higher median losses.
    • Employee — 45.3% of cases; median loss of $54,000
    • Manager — 31.1% of cases; median loss of $150,000
    • Owner/Executive — 19.9% of cases; median loss of $500,000
  • Perpetrator’s tenure with the business — The longer an employee works for a company, the more trust they can build with their supervisors and co-workers.
    • Less than 1 year — 8.2% of cases; median loss of $49,000
    • 1-5 years — 42.4% of cases; median loss of $100,000
    • 6-10 years — 26.5% of cases; median loss of $210,000
    • More than 10 years — 22.9% of cases; median loss of $250,000
  • Department within organization — Employees in the accounting department generated the highest number of occupational fraud cases according to the study, followed closely by operations and sales, respectively.
  • Prior criminal background or negative employment history — Approximately 88 percent of the cases with prior criminal background information available indicated that the perpetrator had not been previously convicted of a fraud-related offense. Of the cases with employment history available, approximately 83 percent indicated that the perpetrator had no prior termination or punishment for an occupational fraud.

Please keep in mind these demographics are not indicative of an employee who will commit occupational fraud, but are merely common demographics among occupational fraud perpetrators.

If you are concerned about occupational fraud in your organization, please call Amber Hoover at (317) 613-7844 or email [email protected].

Are All Values Created the Same?

Amber HooverBy Amber Hoover, CPA/ABV
Senior Analyst, Valuation and Litigation Services

When valuing a business or partial equity interest in one, the valuation analyst relies on a “standard of value” as the definition of the value being determined. The standard of value is typically dependent upon the intended purpose of the valuation, and thus different standards of value may result in different values.

The following is a discussion of the more frequently utilized standards of value and an example of their respective application. This highlights that not “one size fits all” when valuing a business. So careful application of the appropriate standard of value is a critical step in valuation process.

The term Standard of Value is defined by the International Glossary of Business Valuation Terms (the “Glossary”) as: the identification of the type of value being utilized in a specific engagement.

The most popular Standard of Value is Fair Market Value.

Fair Market Value (FMV)

IRS Revenue Ruling 59-60 defines FMV as: The price at which the property would change hands between a willing buyer and a 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.

This definition of FMV is most often utilized in valuations for reporting to the Internal Revenue Service (IRS). This definition is also frequently utilized in many other valuation contexts, because of its recognition and acceptance by the IRS as the FMV, Standard of value.

Court decisions on the use of this definition state the hypothetical buyer and seller are assumed to be able, as well as willing, to trade and be well informed about the property and its marketability.

The Glossary defines FMV 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 arm’s 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.

This definition has been accepted and endorsed in the standards of the following organizations that train and educate valuation analysts: the American Institute of Certified Public Accountants (AICPA), American Society of Appraisers (ASA), National Association of Certified Valuation Analysts (NACVA) and Institute of Business Appraisers (IBA).

Because of the endorsement by these organizations, this definition has become the one frequently applied when valuing a business (or partial ownership) outside of an IRS reporting situation, e.g., a dispute, marital dissolution, merger, acquisition or sale, buy/sell value, etc.

Fair Value (FV)

Fair value differs from FMV and is another frequently utilized standard of value. Fair value is typically defined in the particular context it is being utilized/required. For instance, many states have a statutory definition for Fair Value that is required to be utilized in certain litigation.

Indiana State Statute defines FV with respect to a shareholder dissenter’s shares as: The value of the shares immediately before the effectuation of the corporate action to which the dissenter objects, excluding any appreciation or depreciation in anticipation of the corporate action unless exclusion would be inequitable.

Thus in Indiana, in the context of a dissenting shareholder litigation proceeding, FV would be the standard of value that should be utilized.

Another popular venue for FV is in the context of financial reporting. Generally Accepted Accounting Principles (GAAP) require certain assets and liabilities of a business be reported at their fair value.

GAAP defines FV as: The price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. Source: Financial Accounting Standards Board Accounting Standards Codification glossary.

This Standard of Value is used for financial reporting purposes, i.e. the determination of the value of goodwill for impairment analysis.

Investment Value

Investment value is defined by the Glossary as: The value to a particular investor based on individual investment requirements and expectation.

This standard of value is best utilized in a sale, merger or acquisition transaction where a known buyer or seller wants to identify/justify a specific value using a specific set of criteria.

As you can see, these three standards of value have very different definitions. Thus, applying the different definitions should lead to dissimilar results. Knowing which standard applies in a particular situation is critical to obtaining a value for a business or partial ownership interest that is relevant and reliable for the circumstances.

Make sure you utilize a knowledgeable and qualified valuation analyst when you need to value a business. They can help you choose the right standard of value, and thus obtain a value that meets the needs of your situation.

If you have any questions about standards of value, please contact Amber Hoover at (317) 613-7844 or [email protected].

What Is Your Continuous Improvement Plan?

Jason ThompsonMany occupations start out with initial requirements for training or certification. For instance, a Certified Public Accountant (CPAs) needs a master’s degree in accounting, then must study for, take and pass an exam to get a CPA license. An electrician begins as an apprentice, then progresses to a journeyman before becoming a master electrician. For many, education and training are something you do at the start of your career, rather than a life-long endeavor toward self-improvement regardless of where you are in your career.

Whether you own the business, are managing it or a new staffer, consider developing your own Continuous Improvement Plan (CIP). Your CIP can be as simple as a list of goals, prioritized with a plan of action and timetable. If you’re in a position of influence in your organization, encourage other team members to each write their own CIP.

Start with what makes sense for your chosen occupation. For example, in addition to being CPA, I have obtained an Accreditation in Business Valuation (ABV), and am also an Accredited Senior Appraiser (ASA), a Certified Fraud Examiner (CFE) and Certified in Financial Forensics (CFF).

From there, think about the knowledge and talents necessary to help you become a more valuable member of your company’s team. This knowledge and experience will not only help you rise within the ranks of your organization, it can also focus your interests and assist you in planning your career goals for the next five, 10 or 20 years.

Some companies have a formal process for CIPs, including assigning each employee a coach to help them develop their skills and expand their base of knowledge. The goal of this process should be to have each employee develop into a well-rounded person as they move up the chain of responsibility. Too often, newly promoted employees are found to be lacking skills their new position requires.

For example, many if not all Millennials joining the job market today are more technologically savvy than any generation before them. They’re digital natives who grew up with the Internet and mobile devices. Many however, tend to be weaker on the “soft” skills necessary to advance into senior leadership roles: writing, speaking and communicating objectives.

Companies with a formal CIP process may need to allocate time and money for their employees’ improvement plans, and even provide a curriculum.

Some mutual benefits of a corporate CIP process are; team members realize they are valued by their organization, climb to higher positions with increased responsibilities, and realize their personal goals. The employer gains a stronger and more valuable workforce with more diversified capabilities, which in turn can translate to greater employee morale and loyalty.

As you and your team develop CIPs, don’t forget to talk to customers about the products and services they desire to assist them in their operations. Use their input to tailor the improvement plans, balancing individual preferences with the skills needed to deliver on what your clients want.

Your company may already be great at what it does. To continue or even prolong its greatness consider encouraging employees to hunger for improvement of themselves and their capabilities. This can lead to growth and evolution from new opportunities.

If you have questions or comments, contact Jason Thompson at (317) 608-6694 or [email protected].

Employee Spotlight: Jason Thompson

Jason ThompsonAs one of the founding Partners of Sponsel CPA Group, Jason Thompson has led the firm’s Valuation and Litigation Services department since inception, helping clients find innovative solutions to challenging financial and legal issues. He provides executive-level counsel to business owners and investors across a broad range of industries, specializing in the valuation of privately held businesses, ownership interests and intangible assets.

A graduate of Indiana University with a bachelor’s degree in accounting, Jason places a strong emphasis on continuing education and expanding his areas of expertise. In addition to being a CPA for over two decades, he holds certifications as an Accredited Senior Appraiser (ASA), Certified Fraud Examiner (CFE), Financial Forensics (CFF) and Accredited in Business Valuation (ABV). Jason routinely provides consultation related to business valuation in mergers and acquisitions, in estate and gift tax compliance and planning and for an array of litigation related reasons. In addition to his skills as a valuation professional, he also performs the firm’s fraud and forensic accounting investigations and serves as an expert witness from time to time in accounting and financial related matters.

In 2008 he was named a Super CPA award by Indiana Business magazine. Active in the community, Jason volunteers his time as a board member for Noble of Indiana, a not-for-profit organization serving people with disabilities and their families.

What makes you different from your best competitor?

Jason ThompsonBy Jason S. Thompson, CPA/ABV, ASA, CFE, CFF
Partner, Director of Valuation and Litigation Services

I have often heard that it’s difficult to see your own weaknesses – especially in an organization of like-minded people. When everyone is committed to a common set of goals, there’s a tendency to overestimate strengths and downplay – or even ignore – weaknesses.

If you want your company to improve in what it’s doing, take a look at the blind spots. One mechanism to do this is to ask yourself what makes your organization different from your closest competitor.

As a business owner, you may constantly compare your business to other organizations in the marketplace, though usually from the perspective of: who’s landing the top clients, who attracts the top talent or who’s got the most revenue, etc.

Drilling down on this comparison a little deeper may shed some light on what makes your company different.  As a business owner, it shouldn’t be difficult to identify your biggest rival (closest competitor).  Next, make a list of the differences between your company and theirs. Ask questions like:

  • What do they do better than us?
  • What do we do better than them?
  • Why/how are they adding customers?
  • Why/how do their costs compare to ours?
  • Do they have a market niche we don’t?

This exercise can be humbling if your competitor is a larger entity with access to a broader range of resources. If this is the case, you are the small fish and they are the big fish, asking these sorts of comparative questions can help you identify opportunities you might not have previously explored. Keep in mind, a smaller enterprise is often more nimble, entrepreneurial and closer to customer relationships than large companies.

As you identify your differences, don’t be afraid to emulate the things your competitor does well. In areas they are weak, consider ways to develop your team’s expertise and offerings and fill that gap or be the “better” option!

Ego can sometimes get in the way of an exercise like this.  It’s healthy to take pride in your business’s capabilities and accomplishments. Just don’t let ego get in the way of improvement.

Challenge everyone in your office, especially younger team members.  Make sure their 30 -second elevator speech emphasizes how your company stands out in the crowd.  Simple things like a consistent message go a long way toward building perception.

Weaknesses within your business may be difficult to see, but if you ask the right kinds of questions and make the difficult comparisons, you’ll soon recognize weaknesses as opportunities to improve. Then maybe one day in the future, your company is the standard others compare themselves to.

It is OK to be a “secret admirer” of your competition.  Use that admiration to make your company BETTER!!!

If you have questions or comments, contact Jason Thompson at (317) 608-6694 or [email protected].

 

IRS Regulations to Limit Gift and Estate Tax Valuation Discounts

Jason ThompsonBy Jason S. Thompson, CPA/ABV, ASA, CFE, CFF
Partner, Director of Valuation and Litigation Services
[email protected]

In August 2016, the Internal Revenue Service (IRS) followed through with its threats to impose new regulations affecting the valuation of closely-held business interests for gift and estate tax purposes. The net effect of these changes is to limit valuation discounts in the case of the transfer of family-owned businesses and assets.

Such discounts reduce the amount of the estate tax exemption applied in a transfer of an ownership interest, such as commonly made to children, grandchildren or other family members.

There has been a flurry of activity in the business valuation and estate and gift tax communities since the issuance of these proposed regulations. Much of it has been focused on understanding the impact of the proposed regulations and organizing the fight to prevent the proposed regulations from becoming final.

The American Society of Appraisers has recently issued talking points for use in expressing opposition to the proposed regulations. These serve to highlight the controversy the proposed regulations have sparked among the business valuation community, estate and gift tax advisors and family business owners.

The following is a listing of the ASA’s talking points:

  • The Proposed Regulations Unfairly Increase the Values of Fractional Interests in Family Controlled Businesses and Holding Companies for Estate and Gift Tax Purposes.

The result is a “stealth” tax increase of 25 to 50 percent (or more) in taxes. The root cause of the tax increase is the IRS’ institution of the discredited notion of “family attribution.”

  • IRS Replaces Fair Market Value with a New and Unknown Definition of Value – Counter to Its Own Standard.

Revenue Rulings 59-60 has long been clear on the issue of what standard of value is to be applied: The price at which a hypothetical willing buyer and seller at arm’s length would agree to buy/sell an interest for. Based upon the realities of the marketplace, the fair market value of a minority interest is not worth as much as that interest’s pro-rata share of the whole entity. This is because such interests do not enjoy control or marketability. These required valuation adjustments are referred to as “discounts.” The IRS now proposes the use of a new valuation theory for taxing intra-family estate and gift transfers, with the seller and buyer allowed to be known parties. Because of the lack of clarity in the proposed regulations, valuation discounts will either be reduced substantially or disregarded altogether. This renders useless all accumulated prior knowledge built up by decades of Tax Court precedent, appraisal education and experience and academic research.

  • The IRS’s Return of “Family Attribution” Has Been Rejected by the Supreme Court and the IRS Itself.

In Estate of Bright v. United States, the Supreme Court dismissed the IRS’s position that families will always work in concert and always agree on business and financial matters. A subsequent Revenue Ruling, 93-12, makes clear that discounts for lack of control cannot be denied simply because the interests are passed from one family member to another.

  • The Rule Treats Intra-Family Transfers Differently Than Those Involving Non-Family Third Parties.

The proposed rule applies only to transfers from one family member to another; meanwhile, non-family third parties can still claim the same discounts on similar estate or gift transfers. The IRS does not provide any reasoning as to why this disparate treatment exists.

  • The Proposal Would Override Limitations Placed on Interests in the Business – Including Those Imposed by State Law.

The IRS proposes – by regulatory fiat – to overturn both existing private party contractual agreements and various state laws by ignoring the marketability restrictions placed on interests when valuing them for taxation purposes.

  • The Impacts to Family-Owned Businesses Will Be Significant.

At a minimum, these businesses will delay capital investments or hiring as the available cash will go toward paying an increased tax bill. Worse, these businesses may take on more debt simply to pay the IRS. Finally, business owners may decide to sell or liquidate the business rather than continue on as a family-owned going concern. The last outcome is highly destructive, especially for small businesses.

  • Support the Protect Family Farms and Business Act!

The House bill proposed by Rep. Warren Davidson (R-Ohio) is H.R. 6100. The Senate bill proposed by Sen. Marco Rubio (R-Florida) is S-3436.

These talking points illustrate what is at stake for the family business should these proposed regulations become final.

If you have any questions about how the new regulations on estate and gift tax valuations could affect your business succession plans, please call Jason Thompson at (317) 608-6694 or email [email protected].

Are You a Thought Leader in Your Organization?

Jason ThompsonBy Jason S. Thompson, CPA/ABV, ASA, CFE, CFF
Partner, Director of Valuation and Litigation Services

Do you know what it means to be a “thought leader” within your business or organization? It’s not just someone who acts smart and offers lots of pushy ideas!

A thought leader is a person who shares their knowledge with other members of the team in order to enhance the capabilities of the entire organization. It’s someone who sees learning as an ongoing endeavor rather than something you do when you’re young to land your first job.

When someone behaves in this manner on a consistent basis over a long time, eventually others will seek them out for their knowledge and advice. So if you’re a manger or executive in your organization – or seek to become one – you should strive to be in a position where people recognize you as a thought leader.

Everyone who’s been around awhile gains knowledge, even if it’s just a basic sense of do’s and don’ts. But a thought leader seeks out information. They read about current events and devour industry-related publications and websites – such as Financial News, Wall Street Journal, Fortune magazine, etc. They read business related literature on a regular basis as they can provide informed discussions on new trends in business and government policies.

Thought leaders grasp that learning is not just about going to training: it’s also the things you do on your own to expand your base of knowledge and improve your power of positive thinking. Doing this also allows you to be a better performer in whatever path you choose in life.

For example, as a CPA I am often asked about the current state of the financial markets or who would be the best political candidate for local, state or federal office, and why. Instead of just giving a reflexive opinion, this is an opportunity to educate the questioner using the perspective you’ve gained over the years related to critical economic success factors – local, state, and national.

Thought leaders can be both young and old – certainly when it comes to emerging technology and digital communication, the novice can educate the old-timer these days!

But as a general rule of thumb, thought leaders tend to be people who’ve plied their trade for 10, 20 years or more. Experience breeds valuable insights as to what long-term success looks like. Sometimes the wise person will forego short-term success for the benefit of a long term permanent solution. In this age of instant gratification, this may appear to be a novel strategy.

Because they’ve been around the block a few times, their knowledge goes beyond theory to real-life successes and failures. Veterans know what works and what doesn’t. When it comes to becoming a thought leader, there really is no replacement for experience.

Sometimes people gain a great deal of information and experience during their tenure within an organization, but keep it to themselves. Often they think they are guarding their own position, or improving their chances at promotion by keeping a few “aces up their sleeves.”

While it’s possible hoarding knowledge can help an individual’s prospects in the short run, over the long term this type of practice is harmful to the health of the entire organization. Executives would be wise to instead promote a culture that rewards sharing and support between colleagues.

Thought leaders thrive in an environment where nurturing other people is standard practice. Servant leadership is the overriding principle. If you create dialogues with other people and freely offer them the benefit of your counsel and experience, soon people will seek out your knowledge.

You should seek to be an inspirational leader who drives others to thirst for the knowledge of experience and desire to learn more. This will lead to a stronger, more informed organization that operates in a productive manner to achieve success.

Seek out knowledge, and share it, and you will have enhanced your own professional status as well as your company’s future prospects.

If you have questions or comments, contact Jason Thompson at (317) 608-6694 or [email protected].

Types of Valuation Engagements

Amber HooverBy Amber Hoover, CPA/ABV
Senior Analyst, Valuation and Litigation Services
[email protected]

One of the issues we commonly address as we begin the valuation process is: What kind of valuation is needed? Does the situation require a definitive value of the company or asset, or will a less detailed analysis suffice?

These two different choices line up nicely with the American Institute of Certified Public Accountants (AICPA) Statement on Standards for Valuation Services (SSVS) guidance on the types of services a Certified Public Accountant (CPA) with an Accredited Business in Valuation (ABV) can offer.  A CPA/ABV can perform either a Valuation Engagement (Comprehensive) or a Calculation Engagement (Limited). The following is a rundown of the differences between the two to assist you in making the right decision for your valuation situation.

The result of a valuation engagement can be expressed as a single amount or a range of value, using one or more of several appropriate valuation approaches and methods.  Using the selected approach(es) and method(s), the valuation analyst prepares the appropriate documentation to support their conclusion, and submits a report. The report can be an oral report, a summary or a detailed report.

A valuation engagement is more thorough than a calculation engagement and therefore requires more time which equates to a higher cost than a calculation engagement.  Valuation engagements are best suited for litigation, such as shareholder or marital dissolutions and regulatory reporting like estate and or gift reporting to the Internal Revenue Service etc.

A calculation engagement is a limited-scope engagement in which the valuation analyst and client agree on the valuation approaches and methods that will be utilized.  The result of a calculation engagement is expressed as a “calculated value”, which again can be a single amount or a range.

In many cases a calculation engagement will exclude certain procedures required to be performed in a valuation engagement.  Excluding these procedures often leads to a calculation engagement having a lower cost than a valuation engagement.  Because of the lower costs, a calculation engagement is often chosen as the valuation service.  Keep in mind that while the results of a calculation engagement are typically a reliable value, because limited work is performed, there must be disclosure in the calculation report that the value could be different had more work been done.  This disclosure requirement of the SSVS often limits the use of a calculation engagement in an adversarial situation.

Here at Sponsel CPA Group we offer a preliminary overview of your client’s financial data before recommending whether a calculation or valuation engagement is warranted.  We offer this in order to prevent the users of our work product from paying for a service that may not be necessary.  And we offer the overview free of charge.

We understand the desire to control professional fees. We want our clients to have confidence in the valuation service we provide and feel comfortable with Sponsel CPA Group as their valuation analysts.

If you have any further questions about the types of valuation reporting available, please contact Amber Hoover at (317) 613-7844 or [email protected].

Non-operating Assets in Business Valuation

Amber HooverBy Amber Hoover, CPA/ABV
Senior Analyst, Valuation and Litigation Services

What are non-operating assets? In the context of a business valuation, the Statement on Standards for Valuation Services (SSVS) defines a non-operating asset as one not necessary to ongoing operations of the business. Thus the business entity could continue to operate without the non-operating asset (or liability).

Non-operating assets and liabilities can be especially prevalent in privately held businesses. Some examples of non-operating assets would be items owned by a business with little business purpose; for example, a condo in Florida, a boat, a recreational vehicle, etc.

These assets, while potentially permissible as a business asset in many cases, serve no essential operating purpose for the business entity from the perspective of a potential buyer. Instead they are perks for the existing business owner.

Another form of non-operating assets (or liabilities) are shareholder receivables or loans. For many small businesses capital is difficult to come by. So the business owner often funds operations from their “take” of the businesses’ profits. Managing the flow of funds in and out of a company with the tax regulations that currently exist often result in shareholder receivables and loans.

While these items may be popular in small businesses, they are typically viewed as “equity” transactions from a valuation perspective and thus excluded from the operating value of a business.

A final form of non-operating asset is the existence of “Excess” assets. Excess assets can be identified as a result of comparisons of the subject company being valued to other companies in the same industry or line of business. In situations where there is a substantial upside difference in asset category between the subject and the subject’s peers, it is arguable that the business’s performance is superior and thus has accumulated an “excess” that other businesses have not.

The excess (i.e. cash, marketable securities, etc.) is thus treated as a non-operating item because the peer group operates effectively and efficiently without such excess, and so should the subject business. The excess may also represent an accumulation of working capital far beyond what is necessary for ordinary business operations.

The business valuation process necessitates identification of non-operating assets (and liabilities). Once identified, what do you do with these items? Because these non-operating items are “owned” by the business they should be included in the value of the overall business.

However, because these items are not essential to operations they need to be isolated and removed (and any income or expense associated with them removed) from the determination of the operational value of a business. Typically, non-operating assets are an add-back to the valuation methodologies after determining the operating value of the business.

For divorce purposes, non-operating assets and liabilities related to the business owner may also be a corresponding personal asset or liability on a marital balance sheet. In many cases, the value of a non-operating item, if personal to the business owner, has an offsetting impact to the business owner’s marital estate.

For example, a company that has a shareholder receivable (company’s non-operating asset) would have as part of its overall value this shareholder receivable. For this shareholder receivable to have value, there would be an expectation of repayment by the shareholder of this personal debt. Thus the shareholder has a personal liability for the same value as the shareholder receivable (or company’s non-operating asset).

Accordingly, the proper identification and classification of non-operating assets is a critical step in the analysis of the equity value of a business. As stated above, in the case of a marital divorce, non-operating assets may add to the complexity in properly determining the value of a marital estate.

If you have any questions about non-operating assets or liabilities, please contact Amber Hoover at (317) 613-7844 or [email protected].

How Marketability Affects Valuation

Amber HooverBy Amber Hoover, CPA/ABV
Senior Analyst, Valuation and Litigation Services
[email protected]

What is a Discount for Lack of Marketability (DLOM)?

According to the International Glossary of Business Valuation Terms, Marketability is the ability to quickly convert property to cash at minimal cost. If an ownership interest lacks that ability, a DLOM is the amount or percentage deducted from the value to reflect the relative absence of marketability.

Depending on what valuation method is used, a DLOM can be critical to assigning a value to a company or asset.

In valuing a privately held ownership interest (either partial equity interest or 100% equity interest) the adjustment to the value of the private enterprise to reflect its estimated marketability must consider many factors and there are no “rules of thumb.” It takes the experience of the valuation analyst, along with supporting specific analysis of the pertinent data, to apply professional judgement in estimating the appropriate marketability of the subject interest valued.

The Internal Revenue Service (IRS) uses a Job Aid in applying DLOM to valuation analysis. Given two identical business interests, an investor will pay a higher price for a business that could be converted to cash quicker. Alternately, that investor will pay a lower price for a business that cannot be converted to cash quickly without the risk of loss in value.

How can DLOM be determined?

Using the IRS Job Aid as a guide, the following factors influence a property’s marketability:

  • Value of subject corporation’s privately traded securities vs. its publicly traded securities
  • Dividend-paying (or distribution) ability and history
  • Dividend yield
  • Attractiveness of subject business
  • Attractiveness of subject industry
  • Prospects for a sale or public offering of the company
  • Number of identifiable buyers
  • Attributes of controlling shareholder, if any
  • Availability of access to information or reliability of that information
  • Management
  • Earnings levels
  • Revenue levels
  • Book to market value ratios
  • Information requirements
  • Ownership concentration effects
  • Financial condition
  • Percent of shares held by insiders
  • Percent of shares held by institutions
  • Percent of independent directors
  • Listing on a major exchange
  • Active vs. passive investors
  • Registration costs
  • Availability of hedging opportunities
  • Market capitalization rank
  • Business risk
  • Subject Interest Factors
  • Restrictive transfer provisions
  • Length of the restriction period
  • Length of expected holding period
  • Offering size as a percentage of total shares outstanding
  • Registered vs. unregistered
  • General economic conditions
  • Prevailing stock market conditions
  • Volatility of stock

There are studies and methods that have been developed to help valuation analysts determine DLOM. These include the Benchmark Method, the Quantitative Marketability Discount Model, The Pre-IPO Approach, Hedging Models, Comparative Analysis with Restricted Stock Approach, the Bajaj Method, the Burns Method and the FMV Method.

Ultimately, after assessing the marketability factors and whatever valuation method the analyst employs, determining DLOM can still be a judgment call that requires the keen eye of an expert. Calculating DLOM incorrectly can lead to great variations in the potential sale price of a business or other property.

If you have further questions about DLOM or any other valuation issue, please contact Amber Hoover at (317) 613-7844 or [email protected].

Employee spotlight: Amber Hoover

Amber HooverAs a Valuation Analyst in the Valuation and Litigation department, Amber Hoover has been with Sponsel CPA Group since its founding. Her primary duties involve the valuation of privately held businesses, including partial ownership and intangible assets. She also specializes in forensic accounting and fraud investigations, economic damage analysis and lost profit analysis.

A CPA and ABV (Accredited in Business Valuation), Amber is a member of the American Institute of Certified Public Accountants (AICPA) and the Indiana CPA Society (INCPAS).

Amber graduated from the Indiana University Kelley School of Business in Indianapolis. She grew up in Pendleton, Ind., and married Andy Hoover in October 2011. The couple enjoys traveling as much as their busy careers allow.

Amber also spends her spare time volunteering for Food Rescue, a not-for-profit organization that gathers useable leftover food from local restaurants and distributing it to those in need through partnerships with local food pantries. Amber serves on the board of directors and as the group’s treasurer.

What Were the Craziest Business Expenses of 2015?

Jason ThompsonEver wonder what employees are trying to pass off as legitimate business expenses through the expense reimbursement process? Certify, Inc., a travel and expense software reporting company, has a list of their Top 10 most outlandish things people tried pass off in 2015.

These make for great stories. What’s really amazing is that some of these came not from the financial officer responsible for reviewing the expense report, but were actually sent in by the people who submitted the expense!

I particularly liked the $18,000 night in Las Vegas. That took a lot of guts to put on an expense report. I wonder if that included gambling losses?

Among the others:

  • $400 for a shotgun given to a customer as a gift
  • $85 for a separate hotel room for garlic samples, because the sales person couldn’t stand the smell
  • $1,000 for “adult entertainment”

Head over to the Certify website to read the rest.

All joking aside, occupational fraud is a serious problem, and expense reimbursement fraud is one of the sub-schemes within the asset misappropriation category. According to the Association of Certified Fraud Examiner (ACFE) 2014 Report to the Nations on Occupational Fraud and Abuse, expense reimbursement fraud made up about 14 percent of all asset misappropriation cases, ranking fourth in overall frequency.

Another interesting stat from this survey is that about 50 percent of companies utilize a spreadsheet as the system for the expense reimbursement process. While that stat appears to be in line with what we see across our own client base, there are a number of issues to consider when using this basic system for expense reimbursements.

Generally speaking, a spreadsheet system for expense reimbursements should include/address the following:

  • Communication of the acceptable guidelines for when employees may utilize their own funds to pay for a business related expense. This should be done frequently – definitely more than once after an employee’s initial hire. Ideally, business-related expenses should be paid with business funds whenever possible.
  • A template spreadsheet for reporting the common types of expenditures acceptable for reimbursement.
  • A time limit for submitting an expense for reimbursement.
  • A requirement that expenses submitted for reimbursement be substantiated with an original receipt or appropriate documentation.
  • Independent approval of expenses submitted for reimbursement. This tends to be a critical factor in preventing fraud.
  • Comparison of expenses submitted for reimbursement to a budget or expectation for the expense.
  • Review of trends and ratios for expense categories that are typically reimbursed.
  • Surprise audits of employee’s expense reimbursement submissions and communication to the employee group that these audits occur.

Preventing occupational fraud is an ongoing process. In many instances, oversight or the fear of oversight is an important deterrent. Something as simple as another employee, supervisor or even business owner reviewing an expense report for approval can be enough of a deterrent to prevent fraud in the expense reimbursement process at your company.

If you want to learn more about occupational fraud deterrents, we would be happy to discuss how we can assist you. Please call Jason Thompson at (317) 608-6694 or email [email protected].

Get Out of the Weeds: THINK Strategically!

Jason Thompson thumb“In the Weeds” is a saying commonly used to describe being immersed or entangled in details. For many business owners, managing the day-to-day details (the weeds) of the business is a constant task. Thus being stuck in the weeds leaves a business owner with little, if any, time and energy to think strategically.

In managing time and energy, it’s important to distinguish between tactical and strategic matters. Tactics cover the day-to-day details necessary to keep a business running smoothly, such as maintaining customer relationships or making sure deadlines are met. Strategy is long-term. It is the planning that incorporates broader goals for continued and future success.

Are you driven by tactics or strategy? Knowing which one drives you is vital if you are going to successfully allot time for strategic thinking.

Some business owners are driven by tactics, so dealing with day-to-day details is rewarding to them. If you like spending time in the weeds, then you will probably need a push from someone outside your company to get you to do strategic thinking.

For other owners, the weeds are the last place they want to be. Unfortunately, many of these owners get pulled into the weeds regularly because they are the owner. Having the right people doing the right things is a must for these individuals if they are going to get out of the weeds and think strategically.

Regardless of which camp you are in, strategy is important. Formulating your strategy can be as simple as having a vision and a direction for the future. Where do you want to go? What benchmarks would you like to achieve? Once you’ve identified these goals, then you’ll need a map for how to achieve them.

The map tends to surface as “action steps” or initiatives that move the company toward the vision. Monitoring of the action steps with the existing daily tactical activities is a good way to assess whether or not the company is moving in the direction you want to go. If there isn’t much movement, then it may be time to revise the action steps.

A key to making a strategic initiative successful is making sure everyone in the business, from the old timers to the latest hire, understands the initiative and steps for getting there. Encourage your workforce by illustrating to them how their role fits within the overall strategic blueprint.

Communication of the plan to your key personnel is especially important. Not only should they be taking time — whether it’s daily, weekly or monthly — to think strategically, they should also be a messenger to the entire workforce about the plan and how employees can help.

Strategic goals can be addictive, meaning once you begin the process of setting goals you want to tackle everything at once. Keep in mind, strategic movement is a continuous process. Thus, two or three goals a year are usually all most businesses and employees can accomplish. Prioritizing and focusing on the most critical initiatives increases the chance of effectively addressing them — and thereby creating opportunity to move on to other issues.

Making time for strategic planning isn’t easy; if it were, everyone would do it regularly. The weeds are going to get in the way, but keep in mind the benefits of regular strategic planning tend to be exponentially more valuable to the vitality of your enterprise than any short-term hiccup in day-to-day operations.

The age old adage is true: owners that work on their business see more success than those who choose to work in their business.

If you would like to talk about assessing your enterprise from a strategic standpoint, or have questions or comments, contact Jason Thompson at (317) 608-6694 or [email protected].

Why Does Business Value Change?

Amber HooverOne interesting question that comes up during a valuation engagement is if the value of a company can change on a day-to-day basis.

While this may be true for publicly-owned companies, since stocks change price every day, it is not something that is generally experienced in privately held businesses. For these businesses, the value shift occurs over time.

Here are some examples of reasons for a change in business value:

  • Addition or loss of a significant customer
  • Introduction of a new product or service
  • Change in management/depth of management team
  • Expansion of services into new locations

While all of these events would impact the cash flow of a business, resulting in an increase or decrease in the company’s value, none of these happen overnight. Even a change in key personnel tends to take a period of time to impact a Company’s value.

Owners always strive to avoid a decrease in the value of their business. Even when significant events occur, there may be ways to mitigate the situation or plan in advance to cope with the changes. Good backstops include having a working capital reserve, a solid budget in place, formulating an action plan to grow the business and a succession plan for management.

There are obviously many risks associated with running a business:

External risks – events or trends the owner can’t control

  • Economy – national, regional and local
  • Industry changes – broad changes in the industry such as technology shifts
  • Geographic events – e.g., recently problems at an Indiana oil refinery boosted gas prices and transportation costs for the entire region

Internal risks – risks the business owner has control over

  • Financial risks – cash flow problems, defaulting on a loan, etc.
  • Operating risks – problems associated with the day-to-day running of the company
  • Are your workforce skillsets diversified? Can a job be easily transitioned to another person?
  • Not enough cash flow to pay for operations of the business or finance the growth of the business
  • Is there sufficient workforce in place to meet demands?

As you can see, there are many factors that can affect the value of a privately held business over time, and many opportunities to ensure it doesn’t taper off.

The important recognition for the business owner is to focus on the factors that drive value into the business and create wealth. Very few companies are successful without proper planning. The owners must be deliberate in their actions and demonstrate prudent leadership to create and enhance the wealth creating factor for that enterprise.

If you would like to talk about planning within your business or have further questions or comments, please contact Amber Hoover at (317) 613-7844 or [email protected].

Hit the Beach, Root Out Fraud

Jason Thompson thumbIt’s June and summer is in full swing: the weather is hot, kids are out of school and the pool is open. Summertime for many also means vacation, so where are your employees going this year? Did you know the answer to that simple question could be an indicator of whether there is fraud in your business?

Sound crazy? Let’s take a look at the “fraud triangle” to find out how.

The fraud triangle is in essence an explanation of why fraud occurs. The triangle has three elements: Opportunity, Pressure and Rationalization.

Opportunity tends to manifest itself when an employee has access to a business asset and also controls the reporting of that business asset. Pressure is a motivation or incentive to do something, while rationalization is the mental justification for doing it.

When all three elements exist, an employee is more likely to commit fraud.

Opportunity is the element employers have the greatest ability to control. Eliminating opportunities for employees to commit fraud lowers the risk of it actually happening. One way to limit opportunity is through the cross training of employees to do the work of another employee when they are away from the office.

This tends to happen when people take vacation or are out sick. Thus a rotation of duties is helpful in preventing fraud in a business.

Going back to the vacation question, what does the answer tell us about an employee? In most cases the answer is not something to be concerned with, because in general people are good and behave accordingly.

However, an employee who doesn’t take vacations may be someone worth looking into. If you have an employee like this who is also very protective of their work and activities, refusing to share or let other employees help, this should be a red flag they may have something to hide.

At the other end of the spectrum, an employee going on an extravagant vacation given their level of compensation may also be something to watch for. While this may not be an issue in the particular situation, a common characteristic of fraudsters is spending beyond their means.

Do you know where your employees are going on vacation — or not going — this summer? Maybe you should.

If you would like to talk about a potential fraud situation in your business, or have questions or comments, contact Jason Thompson at (317) 608-6694 or [email protected].

How do you use a financial expert?

Amber HooverWhen should I hire a financial expert? How much will an analysis cost? What will the work product look like?

These are common questions we get asked before being engaged as financial experts. Because of the wide variety of situations that necessitate the use of a financial expert, there is no one-size-fits-all answer for these important questions.

Timing

There are different strategies in play with many of the projects we are asked to assist with. Some may be legal strategies, some are geared at gaining negotiating power, and others simply may be a matter of getting educated about a particular issue.

In any of these situations, early involvement of an expert is often better than waiting until the last minute. The earlier an expert is on board, the more opportunity they will have to provide input based on their knowledge and expertise. In many cases, this specific knowledge and expertise can be very beneficial to the overall process and for arriving at a favorable result.

Costs

Financial experts are professionals; professionals sell their time and expertise. Therefore, their cost is a function of use, so the more you use the expert the higher the cost. Determining the right amount of involvement (use) or the right level of service needed from the expert is therefore critical to identifying a potential cost.

Financial experts understand the client doesn’t have an open checkbook to fund their engagement. So asking for a range of fees, or even a fixed fee agreement, is something experts have learned to expect for common services or projects. Agreeing to a fee up front is beneficial to both parties, and it sets the parameters for the work that will be performed on both sides of the table.

Scope of work

What is the right level of service or work product for my situation? This is a key question to answer in effectively and efficiently utilizing a financial expert. In some situations, the answer may be obvious; in others, it may evolve as the situation progresses. This is again where communication with an expert early on is beneficial.

There are some situations where a limited amount of work may be sufficient to achieve the results needed. Communicating this to the expert early on allows them to know what is needed and adjust accordingly. If that work product doesn’t remedy the situation, then the expert may be able to layer on additional analysis to arrive at a more complete or defendable answer and thus bolster the chance of arriving at a favorable result.

If you need a financial expert, would like to talk about a particular situation or have further questions or comments, please contact Amber Hoover at (317) 613-7844 or [email protected].

Thompson publishes succession article

Jason Thompson thumbJason Thompson, Partner and Director of Valuation and Litigation Services, recently wrote an article that was published by Inside Indiana Business.

The piece, titled, “Succession Planning: A Guide For Business Owners,” is a distillation of a six-part series that appeared in this newsletter over the last few months. It offers advice on every aspect of selling a business, from initial planning to investing the proceeds and finding a contented retirement.

Click here to read it.

What Can the Market Tell Us About Valuation?

Amber HooverWhen it’s time to place a value on your company, there are three valuation approaches that are generally accepted for determining the value of a privately held business. For this discussion, let’s focus on the Market approach.

Simply put, the market approach is based on the theory of substitution. That means comparing the value of an asset, business or ownership interest in a company to the value of a similar asset, business or ownership interest. When using this method, the valuation analyst identifies “Guidelines” from which metrics can be developed for valuing the ownership – whether it’s the entire company or a smaller piece.

Sponsel CPA Group subscribes to resources containing transactional information, from which we can identify these guidelines. These resources publish summaries of the data they collect on transactions. This data can be extremely helpful in understanding general market indications. But they must be considered cautiously when applying them to the valuation of a specific business.

According to 4Q 2014 Pratt’s Stats Private Deal Update (a quarterly publication analyzing private company acquisitions by private buyers), the number of reported transactions increased by approximately 90 from 2013 to 2014. The median reported multiple of Market Value of Invested Capital (MVIC) to Earnings Before Interest, Taxes, Depreciation and Amortization (EBITDA) for transactions across all industries reported for year to date 2014 was approximately 2.3 – a decrease of .77 from 2013.

Another source, the PitchBook’s 4Q 2014 U.S. Private Equity Breakdown report, stated 2,097 deals were completed by the end the third quarter. Deal volume increased compared to the third quarter 2013’s 1,364 deals completed. This is an increase of approximately 700 deals between 2013 and 2014. The median exit EBITDA multiple decreased from 10.7x in 2013 to 9.7x in 2014. According to PitchBook, the decline of the EBITDA multiple is mostly due to smaller equity commitments versus acquiring debt to close a deal.

The trend data for the number of transactions in each of the publications indicates an increase in deals. However, there is a wide disparity in the valuation multiples reported. This difference is probably due to the size and sophistication of the companies analyzed in each publication.

Pratt’s Stats is for smaller privately held businesses, while the private equity investments in PitchBook are for larger companies with potentially complex capital structures. In other words, each publication is only representative of the population of data represented.

This is an important concept to grasp when relying on the market to derive a value for a privately held business. Generalized information, while easy to obtain and understand, may not be representative of the subject asset, business or ownership interest in the business being valued. Issues such as size, growth, customers, competition, liquidity, profitability, management, location, etc., are all factors that should be taken into consideration when arriving at a valuation under the market approach.

If you ignore these differences, or assume they are somehow eliminated by using an average of the entire population of data, you could get an incorrect indication of value.

If Sponsel CPA Group can be of assistance in helping you with a valuation or litigation need, please feel free to contact Amber Hoover at (317) 613-7844 or [email protected].

Most family-owned businesses lack a succession plan

Jason Thompson thumbA new survey by PricewaterhouseCoopers LLP shows that the majority of family-owned businesses in the U.S. lack a succession plan — and that’s not good news for the next generation that will eventually take over the company.

According to an article in CFO.com:

“PwC surveyed 154 owners, leaders and top executives of U.S. family businesses and found that 73% of respondents admitted they do not have a documented and robust succession plan in place for senior roles. Moreover, two-in-five respondents say it would be difficult to hand over complete control to their successors, and 56% would remain involved in management longer than optimum to ensure a smooth transition.

This does not bode well for survey respondents who are “next-generation” family members, as 47% say the delay in handing over the reigns was creating an age gap that was making succession more difficult.”

Alfred Peguero of PwC labeled this “Sticky Baton Syndrome,” in which the older generation of management hands over control of the firm in theory, but remains in charge of what really matters. As a result, transitions take longer and potential successors don’t gain the experience they need to run the company.

Here at Sponsel CPA Group, we advise business owners to start planning 5 to 10 years out for succession — though it’s never really too late to get started. If you would like to learn more, read our ongoing series on succession planning, or contact me at (317) 608-6694 or email [email protected].

 

Thinking about retirement? Know the value of your business

Jason Thompson thumbAt Sponsel CPA Group we often encounter business owners who haven’t given enough serious thought to their exit strategy, whether it’s retirement or a new venture. In these cases, they often haven’t done very much to determine the value of their company — even though it’s usually the chief source of liquidity after a sale.

Over at The Exit Planning Review, T. Ray Phillips has an excellent new article up that addresses this subject, “Knowing Business Value is a Very Good Place to Start.”

You can read the entire article by clicking here.

He writes:

“Knowing the value of your business today is critical whether you plan to leave your business tomorrow, or in five years because:

  1. An estimate of value establishes your starting line and distance to the finish. An estimate of value tells you where your unique race to your exit begins. Your job, whether your company is worth $500,000 or $50M, is to fill the gap between today’s value (the starting line) and the value you need when you exit (the finish line). Based on today’s value, your race to the finish may be shorter, longer, or perhaps much longer, than you expect. Once you know how far you and your business need to travel, you can begin to create timelines and implement actions to foster growth in business value.
  2. An estimate of value tests your exit objectives. An estimate of value helps you to determine if your exit objectives are achievable. Let’s assume that you decide that your finish line (financial objective) is to receive $7,000,000 (after taxes) from the transfer of your business interest. You also want to complete your race in three years (timing objective). An estimate of value will tell you if the distance between today’s value and the finish line is too great to reach in three years. If a growth rate is unrealistic for your business, you must either extend your time line or lower your financial expectations.
  3. An estimate of value provides important tax information. First, an estimate of value gives you a basis for analyzing the tax consequences of Exit Path alternatives. Once you choose your path, the value estimate provides a basis for your tax-minimization efforts. Taxes can take a significant chunk out of a business sale price so the value of your company (what a buyer pays for it) must usually exceed the amount of money you need to fund your post-exit life. The size of that excess depends on how you and your advisors design your exit, and exit design in turn begins with knowing starting value and the distance to your finish line.
  4. An estimate of value gives owners a litmus test. When owners know how much value they need to create to meet their objectives, it helps them determine where they need to concentrate their time and effort. Instead of growing value for the heck of it, dedication to a goal may enable owners to exit sooner with the same amount of after-tax cash than owners who do little or no planning. Pursuing exit plan success all begins with a starting value.
  5. An estimate of value provides an objective basis for incentive plans. As you design incentive plans for key employees (such as Stock Purchase, Stock Bonus and Non-Qualified Deferred Compensation Plans) to motivate them to increase the value of your company (so you can successfully exit) you must base these plans on an objective estimate of value. You and your employees need a current value (or starting line) that you all can confidently rely on.”

Please read the entire article for more of Phillips’ analysis and information. And contact me at (317) 608-6694 or email [email protected] if you need to jump-start your own exit planning.

 

Budgeting: Key to Your Success in 2015

Jason Thompson thumbAs a new year begins, so do many of us undertake resolutions and goals for 2015, whether it’s to spend more time with our children or drop a few pounds. And just like people, businesses need a plan in order to improve and reach those goals. For a business this plan usually takes the form of a budget.

For some business owners, setting a budget is not always a top priority. Often this is because they have no mechanism for guessing what will happen with their company in the coming year. So creating a scenario that takes a stab at predicting the year’s outcome is not seen as very important.

As financial advisors, we here at Sponsel CPA Group disagree with this mindset.

A budget can take many forms, from something basic that serves as a measure for whether the business is performing as expected to a more exact estimate of performance used in setting key metrics for incentives and performance bonuses. A budget can also encompass both an estimate of financial performance (an income statement) and financial position (a balance sheet).

At its most basic level, a budget is a simple comparison of the upcoming year to the prior year. If everything goes as planned, then the results should be much the same. If you begin with the prior year as the starting point, you can then modify its actual results for things you know will change in the coming year.

For instance, let’s say the business has won over a new client and that account should generate an additional $50,000 in revenues for 2015. The simple modification to the 2014 revenue amount would be an increase of $50,000, assuming everything else is expected to remain status quo.

With the additional revenues, you can then begin to estimate the additional costs that will be incurred to generate these additional revenues. Product costs, salaries and other overhead items can easily be projected from other customer relationships and then used with this new customer revenue to arrive at the expected profitability associated with the new account.

This basic example can be leveraged across different lines of revenue and expenses to generate a new expectation for the coming year’s profit.

An additional benefit of budgeting is the potential to predict cash flow patterns for the coming year. By building a balance sheet with a budgeted income statement, a business owner can visualize how cash may be generated and used over the course of the year. This exercise can be very helpful in planning for capital expenditure needs and debt service obligations that should be part of the budget but do not manifest themselves in an income statement.

If you are interested in the budgeting process or want to learn how a budget can help your business, we would be happy to discuss how we can assist you. Please call Jason Thompson at (317) 608-6694 or email [email protected].

How to Value a Business: The Asset Approach

(Part 4 of 4)

Jason Thompson thumbIn part three of our series on the valuation process, we discussed the market approach, one of three approaches available to a valuation analyst as they determine the value of a company or partial interest in the company. Our final communication in this series addresses the third valuation approach, the asset approach, and the specific methodologies within it.

The asset approach is defined by the International Glossary of Business Valuation Terms (“Glossary”) as a general way of determining a value indication of a business, business ownership interest or security using one or more methods based on the value of assets minus liabilities. Under this approach, the valuation analyst adjusts the value of the assets and liabilities (both reported and not reported) of the business from their stated values to the chosen standard of value for the engagement, i.e. fair market value.

In applying an asset approach, the valuation analyst must make an assumption about the operational premise of value for the business. The operational premise of value is an assumption regarding the most likely set of transactional circumstances that are applicable to the business being valued. Two of the general premises utilized are going concern, meaning the business is expected to operate indefinitely into the future, and liquidation, meaning the business should be shut down and the assets disposed of in either an orderly or forced manner.

This approach is typically used in connection with a business that has a heavy concentration of assets, e.g. real estate or investment holding companies. In addition, this approach is often utilized in situations where the earnings of a business are insufficient and do not provide a reasonable return on assets.

One of the more popular methods within this approach is the adjusted net asset method. This method is defined by the Glossary as a method whereby all assets and liabilities — including off-balance sheet, intangible and contingent — are adjusted to their fair market values. Under this method, all assets and liabilities of the subject company are identified and adjusted from their stated values to their fair market values. The adjustments considered are dependent on the “premise of value” chosen for the valuation.

One challenge that often accompanies the application of an asset approach is the identification of off-balance sheet assets and liabilities/contingencies. Under Generally Accepted Accounting Principles and the various U.S. Treasury regulations that guide income tax reporting, there are varying definitions for what is and what is not reported on a balance sheet.

For instance, neither set of these “accounting rules” requires a business to record their own internally generated goodwill, an intangible asset of the business. Thus a subject company’s balance sheet will not include any amount for internally generated goodwill, only goodwill purchased from a third party. In order to appropriately apply an asset approach, this goodwill would need to be valued and included with the other reported assets. This same issue exists for unreported liabilities or contingencies, e.g. a long-term operating lease obligation.

Use of the asset approach often requires the assistance of other appraisers. Real estate, machinery and equipment appraisers can be very helpful in determining the specific fair market value of assets held by the subject business. In addition, it often requires the use of other valuation methodologies and therefore can be a more cumbersome valuation approach if you are already applying an income and/or market approach.

For more questions about how to determine the value of your business, call Jason Thompson at (317) 608-6694 or email [email protected].

Succession Planning: Avoiding the Post-Exit Blues

(Part 4 of 6)

Jason Thompson thumbIn our previous segments of this series, we have discussed the sequence of events leading up to the exciting big event that the business owner has worked toward: when you “cash out” and head towards your “second career” in retirement.

We find that many owners who go through this process do not always prepare themselves for the post-exit transition period. This can be a very challenging existence for a number of reasons.

Many sale agreements require that you remain with the company for a transitional period — usually 6 months to two years. During this time you may find that no longer being “in charge” is not only foreign to you, but a situation that you find incredibly frustrating. You may find that the new owner is making changes to your “beloved operations” that are very different from your philosophy and inconsistent with the way you ran the business for 20, 30, or 40 years!

You may also find that your former employees are not being treated in the manner that was at the core values of the company when you owned it. You may also find that after the initial transition period, you are still being paid and have an employee agreement, but there is very little for you to do but answer questions. You may even come to question in your own mind what your value is to this endeavor.

Our experience is that in about 40%-50% of these cases, the former owner terminates the transitional employment agreement before its term is complete. The former owner will be challenged by his or her own relevancy to the company they used to preside over, as the “troops” are now seeking direction from the management team installed by the new owner.

So as an owner contemplating a sale of your company, how do you avoid these pitfalls? To a certain degree, you can’t, as they come about as a result of a natural human reaction to life’s events. But you can help yourself as follows:

  • Psychologically prepare yourself for this change. Many owners have sought counseling, or at least conferred with other business owners who have experienced a similar transition.
  • Talk very candidly with the buyer and clearly define your terms, conditions and responsibilities during the transition period.
  • We would recommend agreeing to a short transition period as practical, with options to extend upon mutual agreement, rather than a longer period.
  • In the sale or exit event, if there are people or conditions you want to see maintained, negotiate for those in the sale agreement. Because after this transaction, you are no longer the owner, president or CEO – you gave up that authority upon the sale, and hopefully have a much larger bank account to show for it!

The key to a personally successful exit from your company and avoiding any second-guessing after the transaction includes:

  • Honest self-reflection on your personal motivation for exiting, and acceptance that your professional life will change!
  • Proper planning in all phases and negotiations of the transaction.
  • If you have any “sacred cows” of any sort, cover these in the legal agreements related to the sale.
  • Discuss any apprehensions with your spouse or significant other, as you will need their listening ear and support.
  • Make it a fun event!

We as a firm have done a multitude of exit transitions on a number of different scales and structures. If we can help, please give us a call Jason Thompson at (317) 608-6694 or email [email protected].

Collaborative Law: An Alternative Approach to Divorce

Tom_SponselDivorce can obviously be a very painful transition in anyone’s life — not only from an emotional and family perspective but also logistically, legally and fiscally. It is not unusual for some contentious divorces to take three to five years to complete, mentally and financially draining the estranged spouses, and dragging out the process when what they most desire is to get on with their lives.

Fortunately, a new area of practice has emerged that aims to make divorce more amicable, quicker and less costly. Collaborative Law combines the skills of trained attorneys, financial and mental health professionals who come together with the stated goal of rendering the legal separation — including property settlement, child custody and support needs — as painless as possible.

In some cases, divorces governed by collaborative law are completed with just a handful of meetings after only a few months.

In collaborative law, both parties enter an agreement stating that they do not want to go to court. The spouses declare their desire to maintain mutual respect for one another. Obviously, there must be a high level of trust between the separating spouses — including truth about the marital assets — in order for this process to work.

Each spouse retains their own attorney trained in collaborative law, and financial and mental health professionals are selected from an agreed-upon list of qualified individuals. If the collaborative law engagement fails, it is stipulated in the contract that the couple has to start the legal process over with a completely new set of professionals, in order to avoid conflicts of interest.

From an accounting perspective, our role in a collaborative law divorce includes tasks like valuing business interests, preparing the marital balance sheet, determining the potential incomes of the parents and calculating child support payments. (The attorneys are there to advocate on behalf of their respective clients’ needs and desires, and mental health professionals help them traverse the mental and emotionally minefield involved with children, mothers and fathers.)

The benefits for the separating couple are obvious — a less contentious divorce that generally costs far less and happens much quicker than a judicial proceeding. And they get to be directly involved in every step of the process, splitting the marital assets and any support payments by mutual agreement rather than having a judge make that determination for them.

Aside from the reduced costs and time involved, getting to make your own decisions is perhaps the most attractive feature for couples going through this very difficult task. A court divorce can leave both people feeling stripped and laid bare, while a collaborative law process allows them to feel safe, dignified and respected by their former spouses. It is important for the children to observe their divorced parents demonstrating mutual respect and civility for the long-term emotional welfare of those children.

If you are interested in consulting about a collaborative law engagement, please contact Tom Sponsel at (317) 608-6691 or [email protected].

Succession Planning: The Exit Transaction

(Part 3 of 6)

Jason Thompson thumbIn last month’s article on succession planning, we talked about selecting the right leadership team for a business ownership transition. Now it’s time to discuss the actual sale transaction: determining the liquidity the owner can expect to receive and what form it might take.

The first thing to determine is what type of sale it will be: a total outright transaction for the entire enterprise or a portion of the equity. Typically an outright sale occurs when the owner(s) is looking to retire or start an entirely new venture. If they want to stay involved, but move out of the hot seat of leadership, they might choose to sell only a part of their equity.

The next question is to whom the business will be sold. While sale to an outside party is common, other possibilities include a buyout by the current management, merger with another company, acquisition by an Employee Stock Ownership Plan (ESOP) or a similar vehicle in which the employees become the owners.

In my experience with many business exits, I find that the objectives of the selling shareholder — i.e., what they would like to see happen to the business after their departure — will define what type of transaction the “sale” evolves into. Many business owners who worked hard to build their enterprises feel a responsibility to the company’s legacy and to their employees, and that weighs heavily into their exiting objectives.

Part of any successful exit plan it to gather a team of advisors who will help the seller facilitate the transaction in a way that meshes with their objectives. This team can include legal counsel, accountants, a business broker who finds a buyer, insurance professionals and others necessary to properly effect the transition in an efficient manner and manage the risk involved.

Part of the advisors’ job is to manage the expectations of the seller, to help develop terms and conditions for the transaction and then be flexible in negotiating a transaction favorable to the seller. The most important things are getting a fair price for the value of the company and formulating a plan for the sale proceeds that meets the seller’s requirements.

As a rule, 100 percent cash sales are very rare. So that means the seller is probably going to carry some paper on the transaction. It’s important to establish terms of payment, time frame — it’s better to keep it short — and the interest rate. The seller also needs to consult with a tax advisor to understand the tax consequences of a sale to one’s personal financial situation.

Also, a seller should be aware that it is common for a buyer to insist upon a non-compete clause, so the seller can’t operate in the same market and/or industry for a specified term. After all, from the buyer’s position it makes little sense to pay a fair price for a company if the seller takes their expertise and business relationships to set up a new competing shop across the street!

Gathering the correct documents and executing them can be a time-consuming process that can even put the transaction at risk. Once the Letter Of Intent is signed, the seller should establish a tight timeline for consummation of the sale so distractions and delays don’t endanger the deal.

Finally, in my experience the most successful transactions are those in which the seller and buyer personally like each other. When they can communicate well and have a shared base of trust and mutual respect, differences and misunderstandings can often be worked out without sinking the sale. In one case that I was a party to, the lawyers reached a stalemate over terms, and the CEOs of the buying and selling companies resolved the matter with a simple phone call.

In next month’s succession article, we’ll talk about avoiding the Post-Sale Blues.

If we can assist you with any succession planning and business exit planning issues, please call Jason Thompson at (317) 608-6694 or email [email protected].

Succession Planning: Selecting the Right Leadership

(Part 2 of 6)

Jason Thompson thumbIn our last article on succession planning, we gave an overview of how to begin the discussion of an exit strategy for the business owner or owners. Now it’s time to look at selecting the right leadership team to ensure a smooth transition, as well as maximize the value of the company in preparation of a sale – whether to a third party or a family member.

One of the keys to making a business more valuable is to have the right human assets, talent and skillset already in the company at the management level. Depending on the role of the business, one of the best ways to provide for the perpetuation of the company’s success is to ensure you have outstanding management in place in all vital areas of the operation.

Think about it from a seller’s perspective. If you knew most of the key managers who helped build and run the business would leave after the transaction, or if the current leadership seems inept without daily guidance from the current owner, it will seem like much more of a challenge to take on. As a result, they won’t want to pay as much.

On the other hand, the more the managers already in place can operate in an autonomous way without requiring direction from the current owner/leader, the more valuable the company can be.

The first priority should be in the “C-suites,” the highest-level executives: the CEO, COO, CFO, CIO and so on. It’s obviously critical to have the “right people on the bus” — those who have the proper expertise for their role and share a common vision for the company’s goals.

But don’t ignore the lower levels of management. It’s smart to take a really hard look at the organization chart in a strategic manner, and think about who might be ready to retire or move on – and who their replacement might be.

In contemplating a succession, you should perform an exercise where you evaluate every key position you have, whether the current person is performing up to task, and if you have somebody identified who would be the logical choice to step in and take over.

At Sponsel CPA Group, we advise most owner/managers to start thinking about succession five to 10 years out – though it’s never too late to start planning. During this phase it’s important to recruit, train and promote from within the business so your bullpen is always strong.

This can be a challenge for some strong-willed CEOs, who think everything revolves around them and the business would come crashing down without their daily oversight. This may be true, and even gratifying to some extent, but it diminishes the potential value of the company if the people around you aren’t trained to operate in your absence.

We recommend that business owners meet from time to time with managers in vital positions to assess their place within the organization. Talk frankly about what’s expected of them today, and also how you envision their role changing in the next three to five years. If you spot a hole in the skillset they’ll need to advance to the position you both desire, develop a plan to fill it.

It can even be helpful to have a written plan of how to groom someone for their move up the company ladder. For example, in year one they will take on certain new responsibilities; in year two they will gain oversight of this particular department, and so on.

If you feel like your current team of managers isn’t up to snuff, start making moves now so in a few years they’ll be fully trained and ready to go when you’re heading out the door. This will not only help the company you created or grew, but enhance your own financial position when the business gains in value.

If you have any questions about the succession planning process, please call Jason Thompson at (317) 608-6694 or email [email protected].

Building Business Value In The Exit Planning Context

Jason Thompson thumbRecently the Exit Planning Review distributed an excellent article from T. Ray Phillips titled, “Building Business Value In The Exit Planning Context.”

In it, he talks about building value in a business in anticipation of the owner exiting the company with the right amount of cash they desire for retirement or their next venture.

He says:

We look at building value a little differently because in exit planning, we take a longer view and help business owners prepare to exit their companies when they choose, and for the amount of cash they desire.

So building value is not exit planning, but building value is a necessary and principal part of every owner’s Exit Plan. In turn, Exit Planning provides the context for building value. In other words, building value serves many masters—one (and I’d argue the primary one) is to enable owners to reach their ultimate goal of converting their lives’ work into the post-business lives they desire.

When we talk about building value in the context of Exit Planning we ask:

  1. What is the company’s current value?

  2. What value must the company achieve to enable its owner to reach his/her lifetime income and other exit objectives?

  3. What tactics will you employ to close any gap between today’s business value and the value you need upon exit?

  4. How can you transfer business value most efficiently (tax and otherwise)?

He goes on to offer some case studies of different clients’ situation, and how they used exit planning to enhance their position.

To read the entire article, click here.

How to Value a Business: The Market Approach

(Part 3 of 4)

 

Amber HooverIn our last article on the valuation process, we discussed the income approach, one of three valuation methods available to a valuation analyst as they determine the value of a company (or partial ownership of the company). This article talks about another approach, the market approach, and the specific methodologies within it.

The International Glossary of Business Valuation Terms defines the market approach as a general way of determining the value indication of a business, business ownership interest, security or intangible asset by using one or more methods that compare the subject of the valuation to similar businesses, business ownership interests, securities or intangible assets that have been sold.

In general, this approach is based on the theory of substitution, meaning that a known value can serve as a benchmark indicator of the value for a particular subject. In order to apply the market approach, the valuation analyst must identify and establish a relationship between the known values of another business (or business ownership interest) and the valuation subject.

Within the market approach, two of the more popular methodologies are the Guideline Public Company method and the Guideline Private Company Transaction method. As indicated by the names, the source of the known values used as guidelines is either public company values or private company values.

There are numerous sources for information on public companies, leading one to think this methodology would be most commonly utilized. While there is an abundance of data available for use in this method, the key to utilizing the method is establishing a “substitute” or “comparable” for the particular subject business or ownership interest.

When it comes to publicly traded companies, many are gigantic in revenue size and have diversified revenue streams, global operations, skilled and highly knowledgeable management, ready access to capital markets, complex capital structures and a wealth of other characteristics that simply don’t exist for a privately held business, or exist only in a limited fashion. These differences, if not properly adjusted for, can make use of this method quite challenging.

The private company transaction method is a second source for guideline information. In most instances private companies do not publicly disseminate the details of a sale. However, in some cases these transactions involve brokers or other professionals who may retain that information. With proper permission, they can submit it to various databases that collect and analyze transactions.

Valuation analysts subscribe to databases such as Prats’ Stats, BizComps, DoneDeals and the Institute of Business Appraisers (IBA) Market Database to gather information for use with the guideline private company transaction method.

Like the public company method, analysis of the information related to the transaction is key to identifying whether a particular transaction or a group of several transactions are a good substitute/comparable for use in valuing the subject business or ownership stake.

A third methodology often utilized within the market approach is the Prior Transaction method. This methodology uses prior transactions of the subject company as an indicator of current value. In applying this method, it is important to assess the circumstances surrounding the prior transaction in order to verify it is an arm’s length transaction and is representative of current market expectations.

In the final article of our series, we’ll analyze the asset approach to valuation.

For more questions about how to determine the value of your business, please contact Amber Hoover at (317) 613-7844 or [email protected].

Succession Planning: Starting the Discussion

(Part 1 of 6)

Amber HooverOne of the unfortunate consequences of the Great Recession is that so many business owners were focused on the immediate survival of their company, they put off long-term planning for the future – including an exit plan for when they want to retire or sell their business.

This month we are beginning a new six-part series that will walk you through the succession process, starting with an overview of how to begin the discussion. Subsequent articles will focus on specific topics like positioning the company for a sale, getting a new management team in place, finding the right advisors, and so on.

In our collective years of experience, the team at Sponsel CPA Group has often encountered owners of very successful ventures who haven’t adequately saved for retirement on a personal basis. Most of their personal wealth is tied up in the business, and they thought that was enough to fund their golden years.

One of the first things you must do is define financial freedom for yourself. What sort of lifestyle do you expect to maintain in retirement? How much money will you need? How can you best extract that value from the business and turn it into personal income-producing assets during your retirement years?

It’s vital to keep in mind that succession planning isn’t an overnight process. We advise most clients to start thinking about it five to 10 years in advance. If you want to retire young enough to enjoy the fruits of your labors, that can mean starting the planning process while you’re still in your prime. But it is never too late, if your timeline is shorter.

This can be a challenge in of itself. If you are a 55-year-old Baby Boomer who feels like you’re at the top of your game, it’s natural to resist contemplating the finale. So ask yourself: are you really ready to give up control?

If yours is a family business with multiple generations of ownership, there can be an additional sense of responsibility to those who came before and after. In this case, it’s vital to communicate with the next generation as early as possible to explore if they’re interested in acquiring the business.

Too often, this sort of serious discussion never takes place, which can result in all sorts of undesirable confusion and enmity. The legacy of the business operations may not survive.

For example, we once advised a client with two children: a son deeply involved in the day-to-day running of the business, and a daughter who was completely uninvolved and disinterested. The owner’s initial plan was to transfer ownership of the company to the son, but give the real estate to the daughter. The son objected, arguing that he would be doing all the work (50-70 hours a week) while his sister would sit back and collect rent checks, with no effort!

In another scenario, a father (a second generation owner) sold the company to a third party, only to learn after the letter of intent was signed that his daughter had hoped to one day take over the reins, even though she was not working for the business at the time of the sale. She was never asked by her father if she had an interest in the business.

These examples go to show that it is not always clear-cut in terms of what the family will think is fair. If that next generation is married, this adds another component as their spouse may want to have a say and/or participate in the business.

Finally, as you begin the discussion for succession, consider the potential value of the company and what terms of the transaction will be acceptable to you.

In our experience, a very small percentage of business owners walk away with a single check for a lump sum. In most cases, it’s actually less than 5 percent of the purchase price. So start thinking about the payment terms and financial structure you will need in retirement, or for your next venture.

In next month’s installment, we’ll talk about selecting the right leadership team to ensure a smooth transition.

If you have any questions about the succession planning process, please contact Amber Hoover at (317) 613-7844 or [email protected].

How to Value a Business: Determining the Value (Part 2 of 4)

Jason Thompson thumbIn our last discussion we provided a broad overview of the valuation process. One of the crucial steps in this process is “determining the value” of a company (or a partial interest in the company). In order to determine a value, valuation analysts have three valuation approaches and several valuation methodologies available to them. This article addresses one of those valuation approaches: the income approach, plus the specific methodologies within that approach.

This is one of the more commonly used approaches in valuation. The International Glossary of Business Valuation Terms defines the income approach as a general way of determining a value indication of a business, business ownership interest, security or intangible asset using one or more methods that convert anticipated economic benefits into a single amount.

There are two primary methodologies within the income approach: the capitalization of earnings method (COE) and the discounted cash flow method (DCF). In general, the COE method utilizes historical information to determine a value, while the DCF method employs forecasted or projected future cash flow expectations to determine a value.

The COE method is defined by the Glossary as a method within the income approach whereby economic benefits for a representative single period are converted to a value through division by a capitalization rate. Thus the COE method requires the development of a single period economic benefit and a capitalization rate. This method is often utilized in situations where earnings are stable and are expected to grow at a steady rate into the future.

In the DCF method, the present value of future expected net cash flows is calculated using a discount rate. Thus a DCF requires the development of projected expected net cash flows and a discount rate. This method is somewhat the opposite of the COE method in that it utilizes several periods of fluctuating earnings before a stabilized period, instead of just a single earnings period.

Both of these income approach methods require the determination of an earnings measure, either for a single period or for several future periods. The earnings measure selected by the valuation analyst can be any number of earnings measures. In many cases cash flow is considered the preferred earnings measure for the application of an income approach methodology. This is because cash flow is the best representation of the return an equity holder or invested capital holder (debt or equity) can expect from their investment in the business.

Equity cash flows differ slightly from invested capital cash flows. The difference is the treatment of cash flows to fund debt service. Equity cash flows are calculated after debt service payments (principal and interest) and/or inflows (borrowings). This is because, in most cases, debt holders have a preferred claim to cash flow over equity holders.

In addition to identifying an earnings stream for either a single period or for several periods into the future, both of the income approaches require identification of the risk associated with obtaining the earnings stream. This measure of risk is referred to as either a capitalization rate or a discount rate. These rates convert the earnings into values. Capitalization rates are used in conjunction with a single period earnings measure to determine value, while discount rates are used to present value future expected net cash flows back to a single present value.

While the income approach is the most common method used in valuing a business, it is not the only method to consider. In our next communication, we will look at the market approach and the various methodologies associated with it.

For more questions about the valuation process or how to determine the value of your business, call Jason Thompson at (317) 608-6694 or email [email protected].

Fraud 301: Why do perpetrators commit occupational fraud?

 (Final in a 3-part series)

Jason Thompson thumbIn the first part of our series, we dealt with popular occupational fraud schemes. In Fraud 201 we discussed who commits occupational fraud. This article delves into why employees may commit fraud and offers some suggestions on what you can do to keep it from happening.

Dr. Donald R. Cressey, a criminologist whose research focused on embezzlers, developed the following hypothesis:

“Trusted persons become trust violators when they conceive of themselves as having a financial problem which is non-sharable, are aware this problem can be secretly resolved by violation of the position of financial trust, and are able to apply their own conduct in that situation, verbalizations which enable them to adjust their conceptions of themselves as trusted persons with their conceptions of themselves as users of the entrusted funds or property.”

This hypothesis is the foundation for Cressey’s “Fraud Triangle,” a model for explaining the factors that cause someone to commit occupational fraud. The factors are Pressure, Opportunity and Rationalization. The existence of these three factors together can lead to fraudulent behavior.

Pressure is an incentive or reason for doing something. Pressure can be internal or external to the company. Internal pressures include perceived lack of appreciation, the perception of being under-compensated, being mistreated by a supervisor/boss/owner, etc. External pressures include addictions, unexpected financial difficulty, health concerns, family financial pressures, etc. In the context of occupational fraud, the pressure ultimately causes a financial problem for the employee. Thus they are forced to look for ways to solve their personal financial issue.

Identifying pressures is often a difficult task and one that may not provide a benefit in excess of the cost when trying to deter fraud. Keep in mind, however, that many convicted perpetrators were living beyond their means. So having knowledge about your employees’ activities outside of you business can prove to be a valuable fraud prevention technique.

Opportunity is any chance for advancement. Opportunities exist for employees when they have both access to an asset and access to the company records regarding that asset. For instance, when an employee has both the ability to authorize and record a cash disbursement.

Opportunities can be minimized with well-designed internal controls. Therefore, a review of your company’s processes, combined with periodic oversight and inquiry, will help in identifying opportunities and ways to eliminate them. Segregation of duties and authorization, along with avoiding conflicts of interest, are also strong preventive tools.

Rationalization is often considered the trigger for fraud to occur. Rationalization is the justification of the fraud as the solution to the pressure. In general, most people are good and want to do good things. Therefore rationalization is necessary in order for the good person to allow the pressure to coerce them into doing a bad thing.

The existence of all three fraud triangle factors in a particular instance causes the chances of fraud to skyrocket. Don’t get caught holding the triangle — know your critical employees, design and implement effective internal controls and watch for changes in employees attitudes, habits and activities.

If you are concerned about occupational fraud in your organization, call Jason Thompson at (317) 608-6694 or email [email protected] we would be happy to discuss how we could be of assistance and ideas for prevention that you can take advantage of.

Fraud 201: Who Commits Occupational Fraud?

(Second in a 3-part series)

By Jason S. Thompson, CPA/ABV, ASA, CFE, CFF
Partner, Director of Valuation and Litigation Services

Jason Thompson thumbOur Fraud 101 article last month dealt with common occupational fraud schemes that occur in privately held businesses. This knowledge can be helpful in designing internal controls to reduce the opportunity for fraud in your business. It’s also helpful to understand exactly who commits occupational fraud.

The Association of Certified Fraud Examiners (ACFE) 2012 Report to the Nations is their most recent study published on occupational fraud and abuse. This report includes demographic information about fraud perpetrators. Based on this data, occupational fraud is most often committed by perpetrators with the following characteristics:

Gender – Males account for approximately two-thirds of occupational fraud cases.

Age – According to the study, approximately 54 percent of the perpetrators were between the ages of 31 and 45.

Education – Approximately 54 percent of perpetrators have a college degree or above.

Position (level of authority) within the Company – Occupational fraud is committed most frequently by the rank and file employees of a company. While this level of authority constitutes the most frequent level of perpetrator, fraud at the owner/executive level of authority is approximately six times more costly than those of other employees.

Tenure with the Company – The longer an employee works for a company, the more trust they can build with supervisors and co-workers. They also have more experience and a better understanding of the company and its transactions. These factors contribute to employees with tenure of between one and five years being the most frequent perpetrators of occupational fraud.

Department at the Company – Employees in the accounting department generated the highest number of occupational fraud cases, according to the study. It was followed closely in second and third place by operations and sales, respectively.

Prior Criminal Background/Employment History – Approximately 87 percent of cases in which information about prior criminal background was available indicated the perpetrator had not been previously convicted of a fraud-related offense. Of the cases with employment history available, 84 percent showed the perpetrator had no prior termination or punishment for occupational fraud.

Keep in mind that just because an employee falls into one or more of these demographic patterns doesn’t mean they will commit occupational fraud; these are merely the common traits found among occupational fraud perpetrators.

Next month’s article will delve into “Why” a person may commit occupational fraud.

If you are concerned about occupational fraud in your organization, please call Jason Thompson at (317) 608-6694 or email [email protected] to discuss how we could be of assistance in finding or preventing fraud.

Next>IN Gearing Up for 2014

By Amber Cash-Hoover, CPA/ABV
Analyst, Valuation and Litigation Services

next-in_logoNext>IN is gearing up for an exciting slate of 2014 events! Created in 2011 with Sponsel CPA Group as its sponsor, Next>IN is dedicated to fostering the next generation of Central Indiana business leaders.

By bringing together young professionals for special events, the group seeks to educate and enlighten them about what it takes to transform themselves and our city for the better. If you’re looking to move up in your organization, Next>IN is a great venue to hear interesting speakers, engage with others in roundtable events on topical subjects and network with like-minded individuals.

We have four lunch events scheduled for 2014, with 30 minutes each set aside for meal, presentation and Q&A. The lineup is focused on professionals primed to take over a business:

  • June 18th – Succession Planning: An Introduction
  • July 23rd – Leadership Development: Becoming an Owner/Manager
  • August 20th – Basic Financial Introduction: Key Performance Indicators
  • September 24th – The Future: Mentoring Others and Setting Goals

If you are interested in participating in Next>IN, please contact Amber Cash-Hoover at (317) 613-7844 or [email protected].

Cash-Hoover earns ABV credential

Amber HooverAmber Cash-Hoover, a CPA and Analyst in the Valuation and Litigation Services department, has officially earned her ABV credential, designating her as Accredited in Business Valuation.

According to the American Institute of Certified Public Accountants (AICPA), which awards the credential, an ABV recognizes “premier business valuation service providers who differentiate themselves by going beyond the core service of reaching a conclusion of value and creating value for clients through the strategic application of this analysis.”

How to Value a Business: The Process

(Part 1 of 4)

Amber HooverOver the course of our next several communications, our team will address some of the basic but common questions we encounter as valuation analysts. Our aim is to provide useful information and allow you to become more comfortable with the entire valuation.

One of the most common questions we get when meeting with someone in need of a business valuation is, “What is the valuation process?” In general, it is straightforward and can be broken down into five steps: defining the engagement, gathering information, analyzing the information, determining the value and writing the report.

1. Defining the engagement

This step identifies the key ingredients for the valuation: who, what, when and why. The client is the user of the valuation results, and thus is the who. Valuation analysts can value all of a company’s equity, a portion of the equity (e.g., 10 percent), a specific asset or a group of assets, therefore establishing what is to be valued — the what. The valuation date establishes the cutoff for information to consider in determining the value: the when. Finally, the reason for the valuation often directs the standard of value applied in the engagement. Therefore the purpose of the valuation is the why.

Defining the engagement is typically a short conversation between the client (or their representative) and the valuation analyst. Defining the engagement is vital in order to produce results that are useful in the particular situation.

2. Gathering Information

Information gathering can be an easy process for those that are organized and difficult for those who are not. It typically starts with a formal questionnaire from the valuation analyst, which covers a number of general topics and includes requests for documents necessary for the financial analysis, operational assessment and governance review necessary in the valuation of a business.

In addition to a questionnaire, most valuation analysts also perform a management interview and/or site visit. This meeting is a more focused attempt at gathering information. Many of the questions and issues discussed at this interview stem from initial answers or documents obtained through the questionnaire.

In many cases, the information gathering process begins early in the valuation process but continues in varying degrees as the engagement progresses.

3. Analyzing the Information

Step three in the process is where the valuation analyst spends a majority of their time. Using the information provided, the valuation analyst constructs financial models to help identify and break down risks and value drivers in the particular circumstance.

The analysis process involves both financial and non-financial matters. Financial analysis tools like trend (horizontal), common-sizing (vertical) and ratio analysis are reviewed in order to better understand the financial workings of the company. Non-financial items like customer concentration, strength of management, market share, state of the industry and other factors are also reviewed to identify non-financial risks surrounding the company and their potential impact.

4. Determining the value

Determining the value is where the art of valuation meets the science. It is at this step that the valuation analyst couples financial models and non-financial risk assessments to arrive at a conclusion.

This step often involves a review of the available valuation approaches and their specific methodologies. The generally accepted valuation approaches are the income, market and asset approaches. Within each of these approaches are numerous valuation methodologies that can be utilized to derive the value of the company.

It is also during this step that valuation discounts or premiums are evaluated. A discount for lack of control (minority discount) may be necessary when valuing a partial ownership interest that doesn’t control the company. A discount for lack of marketability is usually warranted when valuing a privately held business, to quantify the lack of liquidity associated with the ownership interest.

5. Writing the report

The last step is communication of the value and the analysis that was performed to the client. For many valuation analysts, writing the report starts long before a value has been determined; keeping notes along the way is often easier than drafting something from scratch at the end.

A report may come in a number of different forms, but is almost always a written communication. This is because of the need for detailed explanations of the assumptions and assessments that went into determining value.

Knowing these five steps should be helpful when you need a valuation. If we can be of any assistance with a valuation need or in understanding the general valuation process, please contact Amber Hoover at (317) 613-7844 or [email protected].

Sponsel CPA Group named INSIDE Public Accounting All-Star Firm

IPA_logo

Sponsel CPA Group has been named a 2013 All-Star Firm, according to INSIDE Public Accounting (IPA), a national publication serving the accounting profession.

These firms, selected solely on their performance in specific areas, are compared with more than 500 participating firms in the IPA Annual Survey and Analysis of Firms.

“We explore profitability from several perspectives to provide a view of how firms at the top of the profession are performing,” says Kelly Platt, principal of the Platt Group and managing editor of INSIDE Public Accounting. “The IPA All-Star Firms are the best at what they do, be it health care consulting, litigation support, employee benefits or another specialty niche.”

The Indianapolis-based firm was ranked as the Top (#1) Business Valuation firm in growth among firms with gross revenue under $5 million. IPA also ranked Sponsel CPA Group #2 nationally as the Fastest Growing Firm in the same class.

“Our entire team is humbled by this tremendous honor. We work to serve our clients and that will always be our main focus. But being recognized within the accounting profession is validation of how much our labors are benefitting our clients,” Managing Partner Tom Sponsel said.

The following 2013 IPA All-Star Firms are named in the October issue of IPA:

  • Top 10 Fastest-Growing Overall
  • Top 5 Fastest-Growing By Region
  • Top Audit & Accounting Firms
  • Top Tax Firms
  • Top Business Valuation Firms
  • Top Computer Consulting Firms
  • Top Employee Benefit Firms
  • Top Fee-Based Financial Services Firms
  • Top Commission-Based Financial Services Firms
  • Top Health Care Consulting Firms
  • Top Human Resource Consulting Firms
  • Top Litigation Support Firms
  • Top Merger & Acquisition Firms
  • Top 10 Training Firms
  • Most Admired Peers
  • Top 10 Most Recommended Consultants

Making Your Family Business Your Legacy

By Jason Thompson, Partner and Director of Valuation and Litigation Services

Like any successful entrepreneur, most business owners look upon their company as not just their livelihood, but as part of their identity. As they approach retirement, it’s a natural instinct to want to protect that legacy and pass it on to worthy successors. This desire can be complicated when the business in question is family-owned.

The thought of relinquishing control to the next generation of the family may seem reasonable when you’re looking far down the road. But when the day actually arrives, control is often the last “asset” owners are willing to part with.

Sponsel CPA Group has extensive experience with assisting the successful transition of family-owned businesses. Many of these clients are first-generation owners, but we also have some that are in the fourth generation of ownership succession.

The statistics can be alarming: most family businesses do not survive through the third generation of owners.

The initial generation of owners are often the most “transition” challenged, as they have no experience “passing the baton.” Subsequent generations tend to better understand the challenge of ownership transition because they have personally lived through that experience. They know what a successful transition looks like, and what pitfalls to avoid.

The challenge of successful family business ownership compounds when there are multiple generations and multiple lines of family descendants.

A succession strategy must address numerous areas, including management transition, financial transactions related to ownership transfers, and the ultimate question: when will control actually transfer?

In some cases, companies are transferred via “gifting” of shares of ownership from one generation to another. Right now is an excellent time to take advantage of the historically high limit of the Lifetime Gift Tax Exemption, currently at $5,120,000. Given the political turmoil in Washington, the future of this exemption amount is highly uncertain.

In addition to gifting, there are other strategies that can be utilized to transfer wealth while retaining control of the business. These options can be beneficial because value is transferred out of the owner’s estate, but he/she maintains control of the asset transferred – in this case, the family business.

If you are family-owned company and desire to perpetuate the enterprise, Sponsel CPA Group recommends the following steps:

  1. Communicate your exact desires directly with the future generation of owners, often and openly.
  2. Seek their feedback and reaction to your family succession plan for the business.
  3. Start the process early – at least 10 years before the elder generation wants to retire.
  4. Be open-minded about the direction the company may take after transition. The next generation could have more energy and inclination for implementing major changes to the business model.
  5. Provide the future business operators the benefit of your experience, but allow them to make their own mistakes – so long as they’re not fatal!
  6. Use professional advisors to assist in counseling sessions designed to discuss difficult issues and the financial aspects of the business, both in good times and economically challenging ones.
  7. Develop a plan to address family members who are not involved in the business.
  8. Actively engage in the process – before, during and after transition.

Often we encounter older business owners who do not have a succession plan in place because of a misguided desire to avoid family conflict. In fact, the opposite is true: dealing with the issue of transition while you are still among the living is more beneficial to familial harmony than leaving yours heirs to speculate what you wanted after you are gone.

Unfortunately, we have seen many families permanently and tragically divided over the settlement of estate and business ownership issues.

Become proactive in working with your trusted advisor (CPA, attorney, etc.) to develop a succession plan. Conduct family meetings to explain and implement a plan that is best for your family-owned company’s situation. And take the necessary steps to ensure your business becomes your lasting legacy.

If we can be of any assistance in helping your business with succession issues, please call Jason Thompson in our Valuation and Litigation Services department at (317) 608-6694 or email [email protected].

What can the Market tell us about Valuation?

By Jason Thompson, Partner and Director of Valuation and Litigation Services

When it’s time to put a price tag on your company, there are three valuation approaches that are generally accepted for determining the value of a privately held business. For this discussion, let’s focus on the Market approach.

Simply put, the market approach is based on the theory of substitution. That means comparing the value of an asset, business or ownership interest in a company to the value of a similar asset, business or ownership interest. When using this method, the veteran valuation analysts at Sponsel CPA Group identifies “Guidelines” from which metrics can be developed for valuing of the ownership – whether it’s the entire company or just a slice of the pie.

Sponsel CPA Group subscribes to myriad resources containing transactional information, from which we can identify these guidelines. These resources, which have begun publishing summaries of the data they collect on transactions, can be extremely helpful in understanding general market indications. But they must be considered cautiously when trying to apply them to the valuation of a specific business.

According to Pratt’s Stats Private Deal Update, a quarterly publication analyzing private company acquisitions by private buyers, the number of reported transactions decreased by almost 200 from 2010 to 2011. The median reported Market Value of Invested Capital (MVIC) to Earnings Before Interest, Taxes, Depreciation and Amortization (EBITDA) multiple for transactions across all industries reported for 2011 was approximately 2.5 – virtually the same as the 2010 median multiple.

Another source, the PitchBook & Grant Thornton Private Equity Exits Report, 2012 Annual Edition, reports that exits by private equity firms in 2011 were down slightly compared to 2010 (420 total versus 434). This source, however, indicates a much larger median exit EBITDA multiple: 8.6 times for 2011, up from 8 times in 2010.

As you can see, while the trend data for number of transactions is similar in each of the publications, there is a wide disparity in the valuation multiples reported. This difference is probably due to the size and sophistication of the companies analyzed in each publication.

Pratt’s Stats is for smaller privately held businesses, while the private equity investments in PitchBook Grant Thornton are for larger companies with potentially complex capital structures. In other words, each publication is only representative of the population of data represented.

This is an important concept to grasp when relying on the market to derive a value for a privately held business. Generalized information, while easy to obtain and understand, may not be representative of the subject asset, business or ownership interest in the business being valued.

Issues such as size, growth, customers, competition, liquidity, profitability, management, location, etc., all factor in significantly when arriving at a valuation under the market approach.

If you ignore these differences, or assume they are somehow eliminated by using an average of the entire population of data, you could get two distinctly different indications of value – both of which may be incorrect!

That’s why you need a valuation analyst who can utilize these resources for a market-based valuation, while grasping their inherent limitations when applying them to a specific business.

If Sponsel CPA Group can be of assistance in helping you with a valuation or litigation need, please feel free to contact Jason Thompson at (317) 608-6694 or [email protected].

 

Inside Indiana Business Reports On Better Ways to Provide Accounting Services

As some of you may have seen over the weekend, I was a guest on Gerry Dick’s Inside Indiana Business TV show. First of all, let me say “thank you” to Gerry and his team for inviting me to be a guest.

Gerry asked me why I am not focused on retirement, why after over three decades in the business did I choose to launch a new company.  The answer was quite simple – I knew there was a better and different way to provide accounting services.   Please view the entire video and my interview with Gerry Dick.

Sponsel CPA Group, located in downtown Indianapolis, is one of the region’s most experienced full service accounting firms. Providing much more than traditional accounting services, Sponsel CPA Group specializes in Entrepreneurial Services, Auditing and Assurance, Valuation and Litigation, Mergers and Acquisitions, Tax Services, Financial Planning/Wealth Management , Employee Benefit Plan Administration and Technology Services.

Our Valuation And Litigation Services Are Designed To Provide Credible Answers To Difficult Financial Problems

In my role as a partner and director of valuation and litigation services for Sponsel CPA Group, I provide strategic counsel to business owners, buyers, sellers and other third parties primarily in the manufacturing and distribution, construction, professional service and retail industries. The entire team, including Jason Gritton and Amber Cash, specializes in the valuation of privately held businesses, partial ownership interests in privately held businesses and intangible assets.  When requested, I also serve as an expert witness in valuation and an array of other financial matters including, economic damage analysis, lost profit/lost business value analysis, and fraud or forensic accounting investigations.

To learn more about what the valuation and litigation team can do to help you, schedule a consultation today.