Viewpoint on Value
M&A deal skyrocket: Ways
to operate sale-ready
Mapping out standards of value
can go in 4 directions
5 questions to gauge
Minority shareholder disputes
Don’t always count on stock-
M&A deal skyrocket:
Ways to operate sale-ready
here has been a surge of mergers and acquisi-
tions in 2014 — up 75% globally in the first
half of the year to its highest level since 2007,
according to Reuters. The outlook remains strong for
public and private companies into 2015. This is good
news for business owners, especially baby boomers
You never know when a strategic buyer might make
an offer that’s too good to refuse. Here are some
recent M&A trends and ways for businesses to oper-
ate sale-ready to fetch top dollar in the marketplace.
Understanding M&A trends
Hot sectors for business combinations include
telecommunications, health care and life sciences,
Managers and investors are increasingly confident
energy, gas and oil, and consumer product manufac-
in the general economic outlook.
turers. In addition, a significant portion of this year’s
M&A activity has involved so-called megadeals,
Many of today’s buyers are strategic players — such
involving public companies like Time Warner Cable
as competitors or suppliers — who understand the
seller’s industry and may be willing to pay a pre-
mium, because they can achieve synergistic benefits
The transaction frenzy has trickled down to small
that the average “hypothetical” buyer cannot.
and middle market private companies as well. Last
year, private deal volume was up 49% and continues
In fact, buyers paid on average 13 times earnings
to rise. Deal activity among U.S. small businesses
before interest, taxes, depreciation and amortization
was up 11% in the first half of 2014, compared to the
(EBITDA) in the first half of 2014. That’s the high-
same period last year, according to BizBuySell Insight
est average EBITDA multiple since 2008, accord-
Report. That’s the highest deal volume since the sec-
ing to Reuters data. The average price-to-EBITDA
ond quarter of 2008.
multiple in the first half of 2013 was only 11.8 times.
Pricing multiples vary significantly from company to
Market conditions are ripe for continued deal-making
company and industry to industry, however.
Operating sale-ready in a hot market
Financing is relatively inexpensive (and available).
Beware that financial buyers are still trolling for
Corporations have excess cash on their balance
bargain-priced businesses to turn around and “flip.”
sheets to invest in M&A.
So, business owners shouldn’t take the first offer
they receive without consulting with valuation pro-
Business performance has generally improved.
fessionals. A business may be more valuable than its
owners anticipate in today’s market. A valuator can
The supply of for-sale businesses has increased.
help explain how potential buyers might perceive the
company and identify possible strategic buyers who’d
included implementing noncompete agreements with
be willing to pay top dollar.
developers and entering into long-term contracts
with key customers — as well as finalizing an impor-
Planning is essential to maximize the selling price.
tant pending patent. Bob also lowered his salary to
The first step is finding a valuator to help manage-
market rates and stopped running personal expenses
ment identify key value drivers in the company’s
through the business. And he divested an unrelated
industry. Potential buyers are attracted to busi-
side business that he wanted to pursue after closing.
nesses with high expected cash flows and low risks.
Valuators can recommend ways to improve both sides
Before soliciting offers, Barb helped Bob create an
of the valuation equation — by improving weak-
offering package that included audited financial state-
nesses, mitigating risks, and playing up core strengths
ments and positioned the company as a “nimble inno-
and emerging opportunities.
vator in cybercrime prevention.” She also identified
two large technology companies with complementary
offerings that were in acquisition mode. Bob’s com-
pany was sold to a prospective buyer in early 2014 for
A valuator can help explain
a 25% premium above fair market value.
how potential buyers might
Putting people before money
perceive the company and
Experienced M&A advisors understand that the deci-
sion to sell a private business is a personal one for
identify possible strategic
owners. A strategic buyer might offer the highest
buyers who’d be willing to
price — but might not be the best option for loyal
employees or the owner’s family members.
pay top dollar.
Valuators can brainstorm options that balance the
owner’s financial goals with his or her personal
prerogatives. In some cases, a management buyout,
For example, the owner of a high-tech company
gifts to family members or charities, or an employee
(Bob) contacted a local business appraiser (Barb) in
stock ownership plan (ESOP) is an owner’s preferred
2013 about selling. She suggested that he wait a year
choice. Valuators can help handle the administrative
to get his house in order. Her recommendations
aspects of these exit strategies, too. l
Strategic acquisitions offer growth opportunities
As the supply of for-sale companies mounts, it may be time to consider buying a competitor, supplier
or customer. Sometimes it’s easier to grow through a merger or an acquisition, rather than building up
in-house capabilities — especially if the buyer’s weaknesses are the seller’s core strength.
For example, a manufacturer was known for innovative, high quality products, but its sales department
struggled with underperformers and high turnover. So, it
merged with a competitor that had a highly motivated and
experienced sales team. The combination helped both
companies overcome their weaknesses — and it dramatically
lowered overhead costs for the combined entity.
But the buy-side isn’t without risks. A valuation professional
can objectively evaluate whether management’s expectations
regarding cost-reduction and revenue-building synergies appear
realistic. He or she can also recommend creative deal terms to
lower the buyer’s risks.
Mapping out standards of value
Business valuations can go in 4 directions
alue means different things to different people.
to the coin: a willing buyer and a willing seller. Fair
So, before starting any appraisal assignment,
market value is essentially a compromise between
it’s imperative to map out the appropriate
the “universe” of hypothetical bid prices (the buyer’s
“standard of value” to ensure that everyone arrives at
position) and ask prices (the seller’s position).
the same point. If not, the parties are likely to end up
off course — or in need of backtracking.
2. Strategic value
Strategic (or investment) value — the value unique to
A well-written appraisal report clearly defines which
one party — is the preferred standard in business com-
of the following four standards of value is right for
binations. Investment value considers a specific inves-
your current appraisal needs.
tor’s expectations, risks, tax situation and synergies.
1. Fair market value
When quantifying investment value, appraisers fre-
This is the most common standard of value, espe-
quently focus on the discounted cash flow method over
cially for gift and estate tax purposes and shareholder
other valuation techniques. Key inputs include manage-
buyouts. IRS Revenue Ruling 59-60 defines fair mar-
ment’s projected cash flows, expected growth rates and
ket value as “the price at which the property would
the combined entity’s expected cost of capital.
change hands between a willing buyer and a willing
seller when the former is not under any compulsion
In successful business combinations, the value of the
to buy and the latter is not under any compulsion to
combined entity usually exceeds the sum of the parts
sell, both parties having reasonable knowledge of rel-
operating independently. This incremental value
commonly is referred to as “synergy.”
When estimating the fair market value of a business,
Fair market value is a logical starting point for valuing
it’s important to remember that there are two sides
synergy, but rarely an ending point. Instead, sellers
hold out for strategic buyers, who often are willing to
pay a premium for control attributes and synergy.
3. Fair value — financial reporting
In many ways, fair value for financial reporting pur-
poses is similar to fair market value as defined in the
Treasury Department regulations. Both standards of
value assume an exchange price that involves hypo-
thetical buyers and sellers with both parties knowl-
edgeable, unrelated, and able and willing to transact.
In addition, buyer-specific synergies are excluded
from the company’s fair value.
There are some subtle differences between the two
terms. Fair value may contain some elements of
investment value. For instance, in September 2006,
Financial Accounting Standards Board (FASB)
Statement of Financial Accounting Standards No. 157,
Fair Value Measurements (SFAS 157), introduced the
For example, courts deciding marital dissolutions
concept of “market participants,” which refers to buy-
or shareholder oppression cases may seek the fair
ers and sellers in the principal (or most advantageous)
value of a business interest in the hands of the
market for the asset or liability.
controlling shareholder, rather than to a hypotheti-
cal shareholder. That’s because the application of
Thus, the pool of market participants in a hypotheti-
discounts for lack of control or marketability may
cal fair value transaction may be smaller than the
provide controlling shareholders with a windfall
entire universe of potential buyers and sellers consid-
when divvying up marital assets or buying out
ered when estimating fair market value. The principal
minority shareholders. In essence, the transaction is
market is also entity-specific and may vary from com-
frequently between a willing buyer and an unwill-
pany to company.
ing seller. In addition, fair value may exclude all (or
part) of the company’s goodwill in marital dissolu-
4. Fair value — litigation
tions in some jurisdictions.
The term “fair value” may also be statutorily
defined. Legal statutes and precedent use this term
Get it right
so they’re unencumbered by IRS and U.S. Tax
Measuring the wrong standard of value may cause an
Court interpretations of “fair market value.” Fair
expert’s conclusion to be excluded from evidence — or
value in a legal context is often guided by an under-
lead to misinformed business decisions. A little extra
lying principle of equity.
attention to standard of value on the front end can
eliminate big problems on the back end. l
5 questions to gauge
ll experts aren’t created equal. If you hire
draw upon. In order to keep up to speed on the lat-
someone to appraise a private business, he or
est developments, financial professionals need to
she should specialize in the business valuation
receive ongoing training and maintain credentials
discipline. This requires years of training and experi-
from one of the following recognized U.S. valuation
ence. Generalists who merely dabble in business valu-
ations are unlikely to withstand IRS scrutiny or cross-
examination by opposing counsel if the appraisal
The American Institute of Certified Public
winds up in court.
Here are five simple questions to help you differenti-
The American Society of Appraisers (ASA), or
ate specialists from generalists in the business valua-
The National Association of Certified Valuation
1. What are your credentials?
In the early 1990s, the business valuation discipline
In 2012, the Institute of Business Appraisers (IBA)
was relatively uncharted territory. Today there’s
merged with NACVA. Each of these organiza-
a significant body of knowledge that experts can
tions imposes specific coursework, experience,
4. What are the three
Valuators use the cost (or asset-based),
market and income approaches to value
businesses. Various valuation methods
fall under these broad approaches. For
example, the capitalization of earnings
and discounted cash flow methods are
classified under the broader income
Although valuators consider all three
approaches in every appraisal, they may
use only one approach (or combine
the results of a couple of approaches)
to arrive at their final conclusions. An
expert should be able to explain these
approaches using terms that laypeople
peer review and continuing professional education
can understand — and explain which are most rel-
requirements on its members. Double check that
evant to the case at hand.
the expert you’re hiring (or cross-examining) has
successfully completed all of these requirements.
In order to keep up to speed
2. What’s your track record?
on the latest developments,
Ask if an expert specializes in a particular type of
financial professionals need
case. For example, divorce attorneys typically want
experts who take on an equal number of husbands
to receive ongoing training
and wives as clients. Someone who’s always trying to
and maintain credentials
get the lowest possible value for monied (or control-
ling shareholder) spouses might also be perceived as a
from a recognized valuation
“hired gun” in the eyes of the judge or jury.
You also want an expert who’s an asset in court, not
a liability. Use seasoned experts over novices, and
5. Can you explain the DLOM?
review previous court transcripts to see whether an
The discount for lack of marketability (DLOM)
expert made mistakes or became flustered on the
doesn’t apply in every case. But it’s one of the more
stand. Previous court testimony might even contra-
technical aspects of valuation science. An expert who
dict something a valuator says in deposition or during
can easily explain this concept — including sources
of empirical data, the method used to quantify the
DLOM and whether it applies to the case at hand —
3. Can you define “fair market
demonstrates that he or she is more than a novice in
the business valuation discipline. It can also show the
This is a basic question that every valuation expert
expert has strong verbal communication skills.
should be able to answer off the cuff. An expert’s
response should include three elements — a cash-
There are thousands of questions you might ask to
equivalent price, willing and informed buyers and
gauge a valuator’s qualifications and the reliability of
sellers, and no compulsion to transact — under IRS
his or her conclusions. We’ve provided a few basic
Revenue Ruling 59-60 and the International Glossary
ones to serve as a simple “smell” test. If an expert
of Business Valuation Terms, a publication of all the
passes this initial screening, you’ll know you’re on the
appraisal organizations listed on page 5.
right track. l
Minority shareholder disputes
Don’t always count on
usiness owners enter into stock-purchase agree-
expert valued it at $1.296 million, also using the mar-
ments to facilitate buyouts upon certain trig-
gering events, such as a shareholder’s death or
divorce. But sometimes courts disregard these agree-
The district court decided that the stock-purchase
ments, leaving shareholders vulnerable to paying (or
agreement didn’t apply because the parties didn’t
receiving) an amount mandated by a judge, who may
anticipate a court-ordered buyout as one of its trig-
not be familiar with the parties’ preferences or finan-
gering events — and they never obtained updated
appraisals in accordance with the stock-purchase
agreement. After considering the conclusions of both
Case in point
expert witnesses, the district court valued the minor-
ity interest at $1.621 million, due immediately as a
In a recent Minnesota Court of Appeals case (Piche v.
Braaten), a minority shareholder had entered into a
stock-purchase agreement with three majority share-
The appellate court upheld the lower court’s valuation
holders in 2006. Four years later, his employment
of the minority interest. But it ruled that the district
was terminated and the majority shareholders froze
court should have allowed for monthly installment
him out of the corporation due to “hostile and offen-
payments over 15 years, in accordance with the stock-
sive misconduct in the workplace.”
purchase agreement. During trial, the majority share-
holders testified that monthly installment payments
The stock-purchase agreement originally called for
were intended to preserve the company’s solvency.
the minority shareholder to receive monthly install-
ments of $8,333 over 15 years — a total of roughly
$1.5 million — upon his death, divorce or bank-
ruptcy. It also required the shareholders to revise the
Stock-purchase agreements can’t premeditate every
purchase price annually.
buyout scenario, especially court-ordered buyouts
due to acrimonious shareholder or part-
A Minnesota district court ordered
ner relations. These agreements are
a buyout of the minority share-
even less likely to be upheld when
holder’s interest as of December
they’ve sat on a shelf for years,
31, 2010. At the time of the
without being reviewed. Rather
court-ordered buyout, the
than rely on a value or buyout
minority shareholder had
terms stipulated in a stock-
accrued a 22% interest in
purchase agreement, protect
yourself with a valuation
professional. He or she can
Both sides hired valuation
help ascertain whether the
experts. The plaintiff’s expert
valuation provisions of a
valued the minority interest at
$2.176 million using the mar-
remain relevant in today’s
ket approach. The defendants’
marketplace and periodically
provide updated appraisals. l
This publication is distributed with the understanding that the author, publisher and distributor are not rendering legal, accounting or other
professional advice or opinions on specific facts or matters, and, accordingly, assume no liability whatsoever in connection with its use. In
addition, any discounts are used for illustrative purposes and do not purport to be specific recommendations. ©2014 VVnd14
John M. Leask II CPA, LLC.
Business Valuation Services
PERMIT NO. 57
765 Post Road, Fairfield, Connecticut 06824
John M. Leask II (Mac), CPA/ABV, CVA, values 25 to 50 businesses annually. Often, Mac’s valuations,
oral or written, are compiled in conjunction with the purchase or sale of a business, to assist shareholders
prepare buy/sell agreements, or to set values when shareholders purchase the interest of a retiring share-
holder. Here are examples:
• Due Diligence & Assist with Purchase of a Business. Mac has assisted purchasers of businesses
by determining or reviewing the offer. He helps negotiate the price, perform due diligence prior to
closing and/or helps structure and secure financing. Services have included, but are not limited to,
verifying liabilities and assets, reviewing sales and expense records, and identifying critical issues
relating to future success, and helping management plan future operations.
• Family Limited Liability Partnerships, Companies & Closely Held Businesses. Mac regularly values
various sized business interests for estate and gift tax purposes. He provides assistance to estate and trust
experts during audits of reports prepared by other valuators.
Mac also helps business owners and their CPAs and/or lawyers in the following ways:
• Planning — prior to buying or selling the business
• Prepare valuation reports in conjunction with filing estate and gift tax returns
• Plan buy/sell agreements and suggest financing arrangements
• Expert witness in divorce & shareholder disputes
John M. Leask II CPA, LLC.
• Support charitable contributions
Business Valuation Services
• Document value prior to sale of charitable entities
• Assist during IRS audits involving other valuators’ reports
• Succession planning
• Prepare valuation reports in conjunction with pre-nuptial agreements
• Understanding firm operations & improving firm profitability
More information about the firm’s valuation services (including case studies) may be found at www.LeaskBV.com.
To schedule an individual consultation or to discuss any other points of interest, Mac may be reached at 203 – 255 – 3805.
The fax is 203 – 380 – 1289, and e-mail is Mac@LeaskBV.Com.
If you have a business valuation problem, Mac is always available to discuss your options — at no charge.