The economic recovery has created a surge in sales of small businesses. The number of deals tracked by online marketplace BizBuySell.com rose more than 40 percent in the third quarter. Behind the trend: Baby boomers want to retire, businesses are healthier after the recession and buyers are finding it is easier to finance deals.

At the low point of the recession – the second quarter of 2009 – BizBuySell logged just 1,040 closings. In the third quarter of this year 1,685 sales closed.

Expect sales to continue at their current hectic pace, says Curtis Kroeker, a general manager at BizBuySell.com.  “Next year could be a year of extreme growth, given the trend we’ve seen this year,” Kroeker says.

Many owners had hoped to get prerecession prices but lowered them after finding few takers. But don’t worry about sellers. They’re still doing fine, Kroeker said. The average selling price for a small business is up 3.4 percent from a year ago, and more people have the financial ability to buy a company since the recession.

In this Arkansas Court case, the various attempts to determine values for two related family-owned businesses led to widely divergent results.  Even from the same valuation analyst.

Farrell v. Farrell, 2013 Ark. App. LEXIS 33 (Jan. 23, 2013)
The wife appealed the trial court’s decision to assign all interest in the family businesses to the husband, which, she claimed, left her with a shortfall of $4.4 million.
The husband owned a 19.4% interest in two sets of closely held family businesses. The first entity included mining and land companies; the second was called the “Texas ventures.” At trial, the husband requested that the wife receive one-half of all business interests. However, she asked the court to value the companies and award money instead. Both parties presented experts to provide valuations.

As to the first entity, the wife’s expert stated that the value of a coal mine lay in its reserves—the coal in the ground—and that the value of the particular company was $13.2 million. He did not value the Texas ventures, but the wife’s CPA determined they were worth $3.2 million.

The husband provided several valuations for the first business, including one from the company’s controller that stated book value (not specified). One of the experts cautioned that any valuation had to account for the costs of extracting the coal as well as bonding and permitting. (Further details not provided.)

The husband’s CPA initially stated the Texas entities were worth $1.6 million but revised his opinion after talking with the wife’s CPA. Subsequently, he assigned a negative value of $536,000.

The trial court initially issued a letter opinion stating it had considered the various valuations but noted some had deficiencies and limitations “too numerous for a lengthy discussion.” The statute referred to “fair market value,” the court said. But this standard was of no consequence, since the business was a closely held family corporation and the shares were not for sale. The issue was the value long term to the owners or to someone who would buy the entire operation. As to the mining business, the court credited the wife’s expert’s valuation but applied a 25% discount “for mining costs and contingencies.” It determined a total value of $10.2 million. Adding this amount to the remainder of the valued estate, it found the total marital assets were worth $11.2 million and each party’s share was $5.6 million.

Among the court’s reasons for not making the wife a minority shareholder was its concern that she or her representative would impede business operations. Therefore, it awarded all the shares to the husband, along with the accompanying corporate debt, and the rest of the marital estate, valued at $979,000, to the wife. Because the court recognized that this resulted in an “uneven division” of assets in the husband’s favor, it also ordered the husband to pay the wife $10,000 per month for life in alimony. These payments would make the division equal.

The trial court did not incorporate its letter opinion in its subsequent divorce decree. Although it agreed with the wife that there had to be valuations for all assets, it did not expressly value the Texas ventures. In assessing the mining business, it again adopted the valuation of the wife’s expert. However, it lowered the value to $9.9 million, noting it had considered the business-related debt. At the same time, it reduced the wife’s share of the marital estate to $964,000.

The wife asked the court to reconsider its unequal division. She requested that it place a value on the Texas businesses. She also stated that, even if their value were zero, the marital estate would still be worth about $11 million. As it stood, her award was only 9.7% of the assets. To remedy the shortfall, the court should increase the monthly alimony payments to $33,000 or order the husband to pay a $4.4 million lump sum.

After the trial court denied the motion, she appealed, making ostensibly the same arguments. The husband contended that the trial court in fact had valued the Texas entity. It had lumped all the values into its calculation and incorrectly attributed the supporting evidence to the wife’s expert, whose $13.2 million valuation referred only to the mining business.

The Court of Appeals agreed with the wife that the lower court’s decision was problematic. The opinion left it unclear whether the trial court meant to include the Texas entities in the valuation it adopted. Although the court’s value for the first business was within the range of expert testimony, the law required it to state expressly the value of the property. And although the court explained its decision to award all business interests to the husband in its letter opinion, it failed to incorporate the latter in the official divorce decree. This failure was in violation of the statute. On remand, the lower court also might reconsider its alimony award, the appellate court noted.

The selection of a business valuation expert becomes critical if you or your clients have a need to “know” the value of a business. There are several considerations that must be made before selecting an expert. These qualifications and characteristics apply in any engagement:

• Is the analyst certified by a recognized national credentialing organization and subject to standards of work and ethics by that organization?
• Are they current in their education and knowledge?
• Do they have deep and varied experience in valuing businesses (not just the type of business you want to be valued)?
• Do they have a depth of business knowledge outside of just valuing businesses?
• Do they have a reputation for being independent, objective, and reliable?
• Are they clear in their description of the work that is to be done, the information they will need to do the work, the time it will take, and the cost of the valuation engagement?

These unique considerations depend on the context of some of the most common uses of a business valuation.

Estate/Gift
The Internal Revenue Service (IRS) is a highly experienced player on the other team when it comes to the valuation of business interests for estate and gift tax purposes. The valuation expert should have an excellent understanding of the reporting requirements imposed by the IRS, as well as a current and working knowledge of relevant court cases and IRS regulations. A valuation expert engaged early in a planning setting is invaluable to preventing problems “down the road.” Strong knowledge and experience in this type of engagement are essential.

If a family limited partnership (FLP), or similar entity, is being contemplated by the taxpayer, a skilled valuation expert can help design the entity to avoid later issues. The valuation expert can be critical in defending the entity before the IRS.

Employee Stock Ownership Plans
The Department of Labor (“DOL”) is the user of note in these engagements.  Their purpose is to (rightfully) ensure a fair valuation for the ESOP participants.  As such, it is often best to err on the side of caution when determining a value.  This can include some non-standard adjustments such as for compensation and rent paid to related parties.  Typically, a valuation analyst only considers those two adjustments if a control position is being valued.  We believe that officer/owner compensation and rent paid to related parties should always be considered, if not always adjusted.

In recent months. the DOL has challenged some initial transaction valuations based on too little compensation being paid to the selling officer/owner.  The result remains undetermined, but it appears the DOL believes the valuation is too high, resulting in too much consideration paid by the ESOP for the shares. The next logical step is for the DOL to look at all officer/owner compensation in all subsequent valuations, even for minority positions.  In our view, being “fair” to employees requires examining these components even in a minority situation.
We’re being proactive on our stance and examining it now.

Where Do I Find Such an Expert?
Call us about your valuation needs. We have the business valuation knowledge and skills to handle most tasks. Or, we can help you locate an experienced professional for your specific
situation.

Business valuations are prepared for many purposes, including litigation, estate and gift tax, and the purchase or sale of a business. To properly understand and utilize a valuation, the reader should critically review the report to determine its accuracy and reasonableness.In reviewing a business valuation report, the reader should determine if the report is prepared by a qualified appraiser, includes detailed planning, identifies the critical factors, and documents and analyzes specific information.

While reviewing the report, it should be evident that the appraiser has an understanding of the company’s unique characteristics including the history, ownership, management, products, services, customers, suppliers, facilities, and personnel. It should be apparent that the valuation analyst has analyzed and understands the risks involved with ownership, the stability or irregularity of the earnings as well as any other relevant factors that affect the company being valued. In the report, the appraiser should consider external factors that may affect the company as of the valuation date including the national and local economic conditions, relevant governmental regulations, and demographic trends.

Ask the following questions:

• Does the appraiser possess the proper education or experience to perform the valuation?
• Is the report mathematically accurate?
• Does the appraiser properly apply case law and statutes?
• Has a site visit been performed? By performing a site visit the appraiser is better able to understand the business’s products, assets, liabilities, and the competence of employees. We’re among the old school firms that require a site visit.
• Has the appraiser properly identified and valued the interest? For instance, is the interest a minority interest or controlling interest?
• Has the appraiser properly analyzed the books and records of the company and made appropriate adjustments?
• Was an analysis made to find material personal expenditures? It is important to understand the accounting methods being utilized by the company and to determine if they were being applied   consistently. Our firm consists solely of CPA’s, skilled in analyzing financial statements
• Has compensation been properly adjusted, if appropriate? Failure to properly adjust compensation could have a material impact on the valuation.
• Has there been a thorough and thoughtful analysis of the factors affecting risk?
• Has the appraiser addressed the discounts that were applied, how the specific discounts were computed and discussed empirical evidence and the company’s unique characteristics?

After analyzing the valuation report, the reviewer should consider whether the conclusion of value determined by the valuation analyst makes economic sense for the purpose that the valuation was prepared for. Would the reader buy (sell) the business for the value stated?