Posts Tagged ‘Business Valuation’

Buyers for your company: How to build a great list?

by Steve Popell on June 14, 2010

In a previous post, we discussed the fact that becoming an attractive strategic acquisition candidate should begin with learning precisely what prospective buyers think that means, and how to elicit that information in a series of telephone interviews.  But, an equally important element is determining whom to interview.  This post will address that question.

The first, and most obvious, step in compiling a list of prospective buyers in your industry is simply to brainstorm with anyone who fits the following profile.

  1. Has a valid input on this topic
  2. Can be relied upon to keep totally confidential even the fact that there has been such a conversation.  The notion that your company is (or will soon be) for sale can be very destructive in the marketplace.

As long as you have complete confidence in the discretion of each individual, the more contributors the better.

The next step is to consult as many merger & acquisition databases as you can identify.  Database research can help in two distinct ways.  First, it can provide information on specific acquisitions.  Second, and as importantly, it can suggest matchups that might not have occurred to you and your colleagues.  Discussions that follow will often lead to whole new categories of prospective buyers.  The basis for this research is your company’s Standard Industrial Classification (SIC) code number, along with the parameters that are most relevant, such as:

  1. That the SIC code number relates to sellers;
  2. Period of investigation (e.g. last three years)
  3. Sellers’ annual revenue range
  4. Whether to include international buyers and/or sellers

When in doubt, do not leave out any parameter, or narrow it unduly.  It is far better to have too many data points than too few.  You can always drop any that prove to be irrelevant.

The rest of this part of the process is iterative; i.e. back and forth between brainstorming and database research, until you feel that you have reached the point of diminishing returns.   At that time, shift your attention to identifying a specific executive to interview in each company.  This information should be readily available on the prospective buyer’s website.

In a relatively small company, the CEO or CFO is the most likely choice.  In a larger company, there may be an individual specifically charged with acquisitions, such as the Director (or Manager) of Corporate Development.  Since the title will vary from company to company, it may be necessary to click on the name of someone you think may have this responsibility.  His or her write-up should be very helpful in this regard, and will probably provide contact information, as well.

Once you have developed the list of companies and individuals to contact, craft a questionnaire along the lines discussed in the previous post, conduct the interviews, collate the data and, finally, analyze the results.  The product of all this effort will be the profile of the attractive strategic acquisition candidate from the perspective of the marketplace.

Good luck.

PhotoPopell This article has been contributed by Steven D. Popell. Steve has been a general management consultant since 1970. Steve is a Certified Management Consultant, business valuation expert, and inventor of ExiTrak®– a process designed to assist the privately-held company owner/manager to build an attractive strategic acquisition candidate

Business Valuation in divorce is different

by Steve Popell on April 15, 2010

In most business valuations, the standard is “fair market value.”  This method seeks to determine what a hypothetical “willing buyer” would pay a hypothetical “willing seller” in a hypothetical “free market” in which both buyer and seller are in possession of all material facts and neither is forced to make a deal.

In a divorce, however, the buyer and seller are known.  Typically, the manager-spouse “purchases” the community property interest of the non-manager-spouse through the process of community property division.  The standard of value in this case should be “investment value,” because it reflects what it is worth to the manager-spouse to own all of the community’s interest in the company, rather than just his or her community property half.

As with a fair market valuation, an investment value process analyzes a number of elements that are recognized by the appraisal community to be of particular relevance in valuing any privately held company.  Internal Revenue Ruling 59-60 lists the following:

  • Nature and history of the business
  • General economic outlook, and specific prospects for the industry
  • Net worth and financial condition
  • Earning capacity
  • Dividend paying capacity
  • Extent of goodwill, if any
  • Size of the block of stock being valued, especially if it represents a majority or minority interest
  • Whether the stock in question is voting or non-voting
  • Stock prices of comparable public companies, if any
  • Sale(s) of company stock at or near the valuation data
  • Limitations or restrictions on the stock, such as on transfer, dividends, etc.
  • Sale(s) of stock in comparable closely-held companies, if any (implied)

Of these, the two most important are earning capacity and financial condition.

When a company or individual acquires, or invests in, a business of any kind, the main reason is almost always the expectation of a return on that investment.  ROI comes from future earnings.  Sometimes, these earnings are presented as the bottom line on the Profit & Loss statement.  In other cases, the calculation may reflect cash flow.  But, the principle is identical.  Future operating performance determines the return on investment and, therefore, future earning capacity is a key factor in determining value.

Financial condition is also extremely important for a number of reasons.  {Note: a future post will discuss in detail practical financial analysis for a privately held company.}

  1. A strong balance sheet allows management to pursue opportunities for growth, either self-funded or with outside debt.
  2. Banks require the maintenance of specific financial numbers (such as Working Capital and Net Worth) and ratios (such as Current Ratio and Quick Ratio) to maintain an existing line of credit.  In today’s economy, most banks are far more rigid regarding these standards than they were previously.
  3. Regardless of the prospects for earnings growth, most companies experience occasional “bumps in the road” on the P&L.  A strong financial condition will allow the business to weather these times.  The company that has been paying last quarter’s Accounts Payable with the collection of next quarter’s Accounts Receivable has no margin for error.  The loss of a major customer or receivable can put such a company in serious financial jeopardy.

If the business being valued in a divorce is a sole practitioner professional firm, the Excess Earnings Method will often be the most appropriate.  Here, the difference between the practitioner’s earnings (salary + benefits + pre-tax profit) and “reasonable compensation” (what s/he could earn in the same position as a non-owner / non-partner employee of a comparable firm) is called “excess earnings.”  {See previous post on Reasonable Compensation.}

Excess Earnings times a multiple (reflecting the level of confidence that these excess earnings will continue in the future) equals “Goodwill”.  Goodwill plus Net Worth (minus a reasonable return on Net Worth) equals value in the Excess Earnings Method.

In most valuations, in or out of court, the expert will deliver an opinion on a specific value.  In the context of divorce, however, it is far preferable to provide an initial range of value for two important reasons:

  1. It is much easier for the spouses to agree on a range of value than on a specific dollar amount.  Once they have done that, settling on a final number becomes a much more manageable task.
  2. Often, the value of the business can be juxtaposed against, and negotiated against, spousal support.

For example, if the spouse to be supported is mid-30s with a high paying job, s/he may be keenly interested in a substantial buy-out that can be used as an investment or retirement vehicle.  Contrariwise, consider the individual in late 50s with little income history or prospects, who has been living a very comfortable lifestyle (probably supported by the business.)  This person may be far more concerned with maintaining that lifestyle (e.g. keeping the children in the same school district) and would be willing to give a little in the value of the business to achieve this objective.  A range of value assists the couple to carve out this kind of win-win.

Another important contribution that the valuation expert can make to this difficult and highly emotional process is to produce a preliminary report that is open to criticism.  If either spouse can make a persuasive case that the expert has erred in some aspect of the valuation process, and that revisiting the issue(s) could have a significant impact on the expert’s opinion, s/he should be quite open to doing that.  The only objective here is the welfare of the clients, and pride of authorship has no place.

In the final analysis, the expert’s role is to assist the divorcing couple to agree on a value for the business that they understand and believe is fair.  If the expert is able to accomplish this goal, s/he will have made an important contribution to the family and, most importantly, to any children in that family.


This article has been contributed by Steven D. Popell CMC (Certified Management Consultant.) Steve has been qualified as a business valuation expert since 1974, and has published extensively on this topic. CMC, a certification mark awarded by the Institute of Management Consultants USA, represents evidence of the highest standards of consulting and adherence to the ethical canons of the profession. Steve was a 2007 winner Collaborative Practice California Eureka Award for contributions to Collaborative Practice in this state and is a Senior Partner in Popell & Forney, with offices in Los Altos Hills and Pleasant Hill, California.

Week In Review – Mar 14 – Mar 20, 2010

by Magesh Tarala on March 21, 2010

More bang for your IT buck: Three keys to success

by Brian Superczynski, Mar 15, 2010

Making sense of financial implications of IT operations can be tricky. In fact, many organizations struggle to understand IT cost drivers and savings opportunities. To start with, IT and corporate finance should establish a meaningful partnership. But long term success depends upon applying traditional financial management practices to vendor and asset management. more…

Leadership Cancers #1: Independence, The Prisoner’s Dilemma and the Death of Cooperation

by Gary Monti, Mar 16, 2010

Imagine you have 2 resources who need to cooperate to get the task done, but are at odds with each other. This is not an atypical problem in teams. To understand the various scenarios, you can create a cost comparison matrix using the prisoner’s dilemma model in game theory. The most optimal solution may not be viable. You could tie other forms of compensations and incentives to this model to come up with the most cost effective strategy. more…

Save Energy, be on the offensive

by Guy Ralfe, Mar 17, 2010

Being a project manager can sometimes feel like playing the role of “the pack” in rugby. The opposing team can be compared to time and money. Slipping delivery dates is not uncommon. But if you don’t manage the situation carefully, your stakeholders will be calling the shots instead of you. At this point you wills tart playing defense and this will wear your team out. more…

Looking to sell your company? Don’t be in a hurry…

by Steve Popell, Mar 18, 2010

You are right on the money if you are thinking this is not the right time to sell your company. In fact, it may be three or four years before the situation is ripe for merger and acquisition market to turn around fully. In the meanwhile, focus on making your company a highly attractive strategic acquisition candidate. Have a strategic plan and periodically compare plan vs action. more…

Author’s Journey #13: Testing your book’s proposed title and subtitle

by Roger Parker, Mar 19, 2010

Test your shortlisted titles to narrow down to the best one for your book. It takes a little effort to test, but it can save you a lot of frustration down the road. You can use websites, pay-per-click options and online surveys. Follow the best practices and survey the right people. To learn more about surveys and market testing, the recommended reading is Jay Conrad Levinsonand Robert Kaden’s More Guerrilla Marketing Research. more…

Looking to sell your company? Don’t be in a hurry…

by Steve Popell on March 18, 2010

The merger & acquisition market has gone quiet. If your instincts are telling you to wait a while before trying to sell your company, give yourself a nice round of applause.  Your instincts are right on the money – pun intended, sorry.

Here is a list of 5 solid reasons for keeping your powder dry for three or four years.

  1. Buyers themselves are generally not doing particularly well.  Therefore, they will have less money to spend, and will be more risk averse.  Both factors drive lower offers.
  2. Your earnings are probably not especially robust.  How could they be in this kind of economy?  Projections of future profitability are all fine and good, but they have considerably less credibility in today’s market.  Even if the buyer believes your forecasts, why should s/he have the same truly reflect in the offer?  Better to negotiate from a position of relative strength.
  3. Companies that come out on the other side of this economic situation in one piece will find that many of their competitors will have disappeared. That means that you will have fewer rivals for the buyers’ attention and acquisition dollars once we are done with the recession… or better, when the recession is done with us!
  4. Every seller wants to differentiate his or her company from all the others in the industry.  If you have used this time to transform your company into a prime strategic acquisition candidate, it may be the #1 choice for buyers seeking acquisitions in your industry.
  5. This position as the “only game in town” (or close to it) could allow your broker to conduct an “auction” among a number of highly desirable buyers. This puts you in control of the acquisition process, and can yield enormous financial rewards.

What you need is a process that is designed to help your company to become a highly attractive strategic acquisition candidate by delivering to you the picture of this candidate as painted by people who really know – key acquisition executives in prospective buyers. What comes next is fascinating

You decide which strategic assets to acquire and/or enhance in order to get your company’s strategic profile as close as possible to what the market has identified as ideal. Like most strategic decisions, these will turn on four key elements of your business environment.

1. Money
2. People
3. Time
4. The fit with your company’s vision, mission and core values

You should begin this process at least two years before you intend to put your company on the market. Three years is preferable. Why?  Because development of solid strategic assets takes a minimum of two years and, often, longer.

Once you have made these decisions, it is time to incorporate them into a strategic plan that also includes provisions for enhancing your earnings growth and financial condition.  The standard plan, including Vision, Mission, Long-Range Goals, Short-Term Objectives, Task Assignments, Action Items gets the job done.  You should involve all personnel who will play a key role in implementing the plan.

Conduct periodic comparisons of plan and action (no less often than quarterly.) Such follow-up is critical to ensure that you maintain momentum.  The strategic plan is a living document that must remain front of mind.  Otherwise, it will gather dust, and you will have wasted a great deal of time and effort.

Go for it!

PhotoPopell This article has been contributed by Steven D. Popell. Steve has been a general management consultant since 1970. Steve is a Certified Management Consultant, business valuation expert, and inventor of ExiTrak®– a process designed to assist the privately-held company owner/manager to build an attractive strategic acquisition candidate

Week In Review – Feb 14 – Feb 20, 2010

by Magesh Tarala on February 21, 2010

Are you feeling helpless?

by Vijay Peduru, Feb 15, 2010

Going through the same situation repeatedly, unable to control it, and accepting to suffer through it is called Learned Helplessness. Once you understand this important distinction, you can recognize the situation and take action to unlearn it. Vijay illustrates this with an example of an experiment conducted on dogs by Martin Seligson, a professor at the University of Pennsylvania and the author of several books including “Learned Optimism”. more…

Change Management #4 – People: Building a team with Dr. Jekyll and Mr. Hyde

by Gary Monti, Feb 16, 2010

Implementing change in an organization will bring out the Dr. Jekyll and Mr. Hyde personas of the team members. This is part of human nature and if you do not plan for this, you will face serious problems reaching your goals. Your leadership is what will help keep the project on track. Gary provides several tips to help you understand the risk and navigate the terrain. more…

Commitments Change Over Time

by Guy Ralfe, Feb 17, 2010

One of the fundamental requirements for increasing our power and value in the marketplace is our ability to make and keep promises and commitments. A promise or commitment is between two parties. And each of them is locked into their stories viewed through their eyes. Between the time a promise is made and it is fulfilled, situations will change for both parties. It is essential to maintain the story for both parties through time or commitments will fail. more…

Selecting a Business Valuation expert

by Steve Popell, Feb 18, 2010

There are myriad reasons why the owner of a privately held company may want or need to have the company valued. Regardless of the reason, finding the right expert will pay off in the quality and utility of the opinion. In this article, Steve offers the criteria for assessment and gives some tips on how to ground your assessments. more…

Author’s Journey #9 – Cultivating the habits of writing success

by Roger Parker, Feb 19, 2010

Essential habits for writing success are Targeting, Positioning and Efficiency. In this article Roger describes how he put this theory to practice when writing his next book #Book Title Tweet: 140 Bite-Sized Ideas for Article, Book, and Event Titles. more…

Selecting a Business Valuation expert

by Steve Popell on February 18, 2010

Introduction

There are myriad reasons why the owner of a privately held company may want or need to have the company valued, including (partial list):

  1. Acquiring another company
  2. Selling the company
  3. Buy-sell agreement
  4. Repurchase of minority shares
  5. Divorce
  6. Partnership breakup
  7. Estate planning
  8. Probate

Regardless of the reason for the valuation or the urgency of the task, finding the right expert will pay off in the quality and utility of the opinion.  Here are a few tips to help you to make the best choice.

Background Check

Just as in hiring, you accept a resume on face value at your peril.  Always check references and publications.  In addition, go beyond the references provided by the expert.  You can do this simply by asking the listed references for the names of others who may have valid input on the competence and relationship skills of this individual.  These are called secondary references, and will typically be a more reliable source of information than the primary references.  You can even take it a step further by asking the secondary references the same question and, thereby, developing tertiary references.  Some questions you may want to ask will include the following.

  • Did the expert communicate clearly on all aspects of the prospective assignment at the initial meeting?
  • Did the engagement letter accurately reflect the shared understanding of the purpose of the assignment?
  • Was there a firm fee quote, or did the expert work by the hour?
  • Did the expert exhibit a genuine commitment to impartiality?  In other words, did the expert indicate clearly that s/he would simply go where the evidence led?
  • Was the request for data, including financial, reasonable?  If you didn’t have a particular document or piece of information readily available, did the expert insist on getting it, even if it seemed tangential?
  • Did the actual performance of the expert (data gathering, analysis, report, etc.) match up well with what you expected, based on the initial meeting and the engagement letter?
  • Was the report clear and easily understandable – even by non-financial people?
  • In the case of a divorce valuation, was the expert sensitive to the emotional aspects of the process?
  • How did the expert relate to other professionals on the case, such as a Collaborative Practice team, attorneys or mediator?
  • If you had to make this choice again, would you select this expert?

Absence of Ego in the Process

There is no place for ego or pride of authorship in the business valuation process.  One way to scope out this aspect of an expert’s approach is to determine if s/he is willing to submit a preliminary report that is open to criticism.  It is always possible that even the most competent expert will over-emphasize or under-emphasize some important data or, perhaps, miss something altogether.  It is also possible that something unexpected has cropped up during the valuation process that was knowable as of the valuation date, but the client(s) neglected to mention same.  The expert should be open to (even anxious for) the client(s) to provide such feedback.  The objective, after all, is the best valuation report possible, not the easiest to crank out.

Fundamental Understanding of What is Really Going On

Fair Market Value (FMV) is defined as what a hypothetical willing buyer will pay a hypothetical willing seller in a hypothetical free market in which both sides have essentially all the information they need to make an informed decision, and neither is compelled to conclude a transaction.  FMV is an appropriate standard of value in many situations, such as probate or any other circumstance in which the opinion will be presented in court or involve the IRS or other federal or state agency.  However, a number of other scenarios call for a different standard of value.

In a divorce, for example, or for a buy-sell agreement for a company with 2-4 owners, investment value is far more appropriate than fair market value.  The reason is very straightforward.  In either of these situations, the objective is not to determine what some outsider would pay for the company, or a portion thereof.  Rather, it is to ascertain what it is worth to one spouse (or one owner) to own a greater share of the company.

Avoid an expert who fails to grasp this critical distinction.

Flexible Fee Schedule

Anyone can charge several hundred dollars per hour.  It is more challenging to provide a fee schedule that offers the client genuine choices.  There are a few key questions in this regard.

  1. Will this opinion be offered in court or to some government agency?  If so, an “official” opinion will be required, and will be the most expensive.  If not, does the expert offer an “unofficial” opinion for a lot less money?
  2. Can delivering a much shorter report cut the cost significantly?
  3. Is there a choice between a broadly based analysis and report and one that considers financial documents only?  Is door #2 cheaper.

In sum, you have a right to expect quality performance from an expert with whom you have an excellent relationship, and for a cost that is commensurate with you needs.  Go for it!

This article has been contributed by Steven D. Popell CMC (Certified Management Consultant.) Steve has been qualified as a business valuation expert since 1974, and has published extensively on this topic. CMC, a certification mark awarded by the Institute of Management Consultants USA, represents evidence of the highest standards of consulting and adherence to the ethical canons of the profession. Steve was a 2007 winner Collaborative Practice California Eureka Award for contributions to Collaborative Practice in this state and is a Senior Partner in Popell & Forney, with offices in Los Altos Hills and Pleasant Hill, California.

strageic acquisition just askThe Excess Earnings Method is the most commonly used approach to valuing a sole practitioner practice in family court.  In this method, “Excess Earnings” equal practice earnings in excess of the sum of reasonable compensation and a reasonable return on the practice’s Net Assets.  Excess Earnings times a multiplier (reflecting the relative risk of the earnings stream) equals Goodwill.  Goodwill plus Net Assets equals the total value of the practice.

Since Goodwill typically represents the majority of value, the excess of practice earnings over reasonable compensation (what the practitioner could earn if employed elsewhere in the same specialty) is the key element in this process.  Unfortunately, an often substantial portion of practice earnings is counted twice in a court settlement: first, in the valuation of the practice and, second, in determining support payments.  This problem of “double dipping” raises serious questions about the fundamental fairness of the method.

How It Works

Let’s say that a female CPA (the primary breadwinner in the household) earns $200,000 per year after all expenses in her solo practice.  Her firm’s Net Assets equal $50,000, and a reasonable return on those assets would be 10%.  If she were to do the same work for a comparable practice, she would earn $120,000.  Therefore, practice earnings exceed reasonable compensation by $80,000 per year.  Since her practice earnings stream appears to be relatively secure, the multiplier is set at 4.  The calculation of practice value would be as follows:

Excess Earnings          $80,000 ($200,000 minus $120,000)

Minus              5,000 (10% of $50,000)

Equals          $75,000

Goodwill         $  75,000 (Excess Earnings)

Times            4 (Multiple)

Equals         $300,000

Practice Value          $300,000 (Goodwill)

Plus                        50,000 (Practice Net Assets)

Equals                      $350,000

So far, so good.  But, now, the question becomes how much of her earnings are used to calculate spousal support?  If the entire $200,000 is part of the calculation, $80,000 of that total is being counted twice: first, in determining Goodwill and, second, in setting support payments.

Put another way, she has already “purchased” her community property half of the $80,000 annual earnings stream from her spouse for $150,000 (the value of his 50% community property interest in Goodwill) and will pay for it again as part of spousal support.  Small wonder that many sole practitioners believe that they are getting a raw deal.

Solution

Since the culprit in this situation is the double counting of Excess Earnings, the solution lies in ensuring that Excess Earnings are counted fully only once – either in practice value or in spousal support, but not both.  Importantly, there is no compelling philosophical argument for mandating either choice in all cases.  In fact, practice value and spousal support are often negotiated as trade-offs in community property settlements.

For example, if short-term income is the supported spouse’s principal need, then additional spousal support may be far more important than higher practice value.  This couple may agree on maximum spousal support and a somewhat smaller value for the practice.  On the other hand, if the spouse has a high-paying job, the opposite may be true.  This second couple may agree to a maximum value for the practice (that the spouse can use as an investment or retirement vehicle) along with somewhat reduced spousal support.

The critical element in all this is that each party identifies and articulates his or her principal priorities.  By so doing, they are “enlarging the pie.”  In other words, rather than playing a zero sum game (my win in your loss and vice versa) they collaborate to help one another to achieve their most important objectives.

Conclusion

Double dipping is inherently unfair, because it requires the sole practitioner to pay twice for the same income stream (the amount by which practice earnings exceed what s/he could earn as an employee of a comparable practice.)  An approach that allows the parties to choose the most reasonable and appropriate combination of practice value and support payments will best serve the long-term interests of all concerned.

The couple’s ability to reach agreement on the value of the business (a typically nettlesome issue) will often “lower the temperature” in the room, thereby facilitating agreement on other issues – including non-financial ones, such as custody and visitation.  It’s not often that one gets the chance to take two bites out of such an important apple.  Go for it!

PhotoPopellThis article has been contributed by Steven D. Popell CMC (Certified Management Consultant.) Steve has been qualified as a business valuation expert since 1974, and has published extensively on this topic. CMC, a certification mark awarded by the Institute of Management Consultants USA, represents evidence of the highest standards of consulting and adherence to the ethical canons of the profession. Steve was a 2007 winner Collaborative Practice California Eureka Award for contributions to Collaborative Practice in this state

Neutral Business Valuation: Better Results, Lower Cost

by Steve Popell on November 9, 2009

There are numerous reasons why you might want to have your company valued, such as:DollarSymbol

  • Buying another company
  • Selling your company
  • Stock option plan
  • Stock purchase plan
  • ESOP
  • Repurchase of minority shares (friendly or adversarial)
  • Divorce
  • Partnership breakup
  • Buy-sell agreement
  • Posthumous circumstances

Neutral business valuation, even (perhaps especially) in an adversarial situation, will frequently be faster, cheaper and less emotionally draining than a process involving rival experts, and will offer a far better chance for a negotiated settlement.

Having one’s own business valuation expert can provide a certain measure of comfort, but this system is fraught with problems. For one thing, the valuation process itself is not an exact science. Therefore, there is a high likelihood of disagreement between objective experts. If either expert allows any measure of advocacy to enter the process, the chances for compromise become that much more remote – even out of court.

If a valuation question must be settled in court, the outcome may be influenced as much by the relative skills of the experts as witnesses as by the intrinsic value of their testimonies. Should the more skillful testifier also be somewhat more partial than his or her counterpart, the eventual judgment may be inequitable. Ironically, the feeling of added security that the parties seek when they hire their own experts may be an illusion. Or, worse, it may backfire completely on one party.

Then, there is the matter of money. Clearly, whatever the merits of having two experts, they are at least twice as expensive as one. Moreover, the presence of two experts frequently increases the time that opposing attorneys must invest in attempting to negotiate a compromise or, failing that, litigating the issue.

Any business valuation involves a certain amount of subjectivity – a principal reason for the frequent disparity in expert opinions. As a result, the more subjective the valuation task (the small professional firm, for example) the more appropriate and helpful a neutral process is likely to be. This is especially true if one party has considerably less familiarity with the company and is, therefore, justifiably insecure. If the opinions of rival experts are far apart, how it will be very easy for the positions of the parties, however misinformed, to harden to the advantage of no one.

In order for neutral business valuation to work, there must be at least a modicum of good will between the parties. This does not mean that they have to be great friends, but it does mean that there is a minimum of open hostility and mistrust. There must be a genuine desire on the part of both parties to “work it out” rather than “fight it out.”

In a neutral valuation framework, the objective of all concerned should be fairness and equity, rather than simply “winning.” It would be foolish to expect that either side will (or should) neglect to look out for Number One, with the assistance of respective counsel or informal advisors. Nevertheless, the two sides must be willing to give compromise a genuine chance to succeed, rather than simply relying on grasping and confrontation to protect self-interest.

Beyond a high degree of professional competence, the neutral business valuation expert must have considerable “people” skills. Such an individual must be able to foster trust and confidence from all parties in the very first meeting. S/he must demonstrate sensitivity to the concerns of both parties, and should provide clear leadership in the search for an equitable result.

In this regard, a range of value, rather than a specific dollar amount, can be very helpful. First of all, it is far easier for the parties to agree on a range. Second, once this preliminary agreement has been reached, the subsequent negotiation has a “container” that should go a long way in preventing one side or the other from torpedoing the process by making unreasonable demands. While the expert should stand ready to mediate the final negotiation, respective counsel or others can also perform this function.

In addition, a preliminary report from the expert that is open to criticism will help to alleviate concerns that some factor may have been over-emphasized or under-emphasized, or that something important may have been overlooked completely. If a convincing case can be made that it is appropriate for the expert to revisit one or more issues, s/he should do so cheerfully. Following any changes in the opinion, the final report is delivered. The objective of the expert must be to assist the parties to reach an amicable solution. In this context, pride of authorship must take a back seat to the interests of the parties.

There is one other advantage to a neutral business valuation; namely, the impact on the relationship between the parties after the conclusion of the process. Even if there were some serious differences early on – perhaps causing the need for the valuation in the first place – such does not have to be the legacy for the parties. Quite the contrary, if they are able to overcome such emotions to reach a fair and equitable conclusion, their personal relationship may survive and, even, grow.

It’s worth a shot.

PhotoPopellThis article has been contributed by Steven D. Popell CMC (Certified Management Consultant.) Steve has been qualified as a business valuation expert since 1974, and has published extensively on this topic. CMC, a certification mark awarded by the Institute of Management Consultants USA, represents evidence of the highest standards of consulting and adherence to the ethical canons of the profession. Steve was a 2007 winner Collaborative Practice California Eureka Award for contributions to Collaborative Practice in this state.

compensation_reward_strategy_pictureThe most frequent approach to valuing a sole practitioner’s private practice is the “Excess Earnings” Method.  In this method, excess earnings represent Total Practice Earnings (salary + bonus + company profit) in excess of the sum of “reasonable compensation” and a reasonable return on the practice’s Net Worth (Assets minus Liabilities.)  When the estimated value of excess earnings is multiplied by a factor (the multiple) reflecting the relative risk of the earnings stream, the result is goodwill.  Goodwill plus Net Worth equals the total value of the practice.

While the excess earnings method itself is quite straightforward, determining what constitutes reasonable compensation is anything but.  Even “experts” can draw vastly different conclusions on this topic.  Clearly, if there is no agreement on what level of compensation is reasonable, there can be no agreement on what is excess.  This post will seek to demystify this question and clarify the process.

The Excess Earnings Method is based on the principle that the vast majority of the value of a sole practitioner’s private practice is the capacity of the practice (the practitioner) to generate net income after all expenses.  This principle is common to virtually all types of businesses. The difference here is that this method requires that the earnings of the practice be compared to those of “comparable” practices.  The following scenario will help to illustrate the fundamental issue in this comparison.

You, the sole practitioner, have decided to take a year off and sail around the world on your boat.  {To simplify this example, we will assume that Net Worth = $0}  Your task as CEO is to hire a person with identical skills and experience to manage your business, and to provide all the services your clients require.  This individual would be neither an owner nor a partner in your firm.  What would you have to pay this person?

Let’s assume that you could hire an equally competent replacement for yourself for $150,000 per year.  If your Total Practice Earnings = $400,000, Excess Earnings = $250,000.  The difference between the non-owner’s compensation and your Total Practice Earnings reflects the benefits of ownership.  In other words, you compensate yourself at the $400,000 level not because that reflects market rates, but simply because you own the company, and you can.

While the concept and the basic calculation are easy to grasp and implement, the problem arises in determining precisely what constitutes market rates.  There are two ways to do so.

  1. Find at least one economically similar practice that employs a practitioner of comparable skills and experience to you.  Where such arms-length financial arrangements exist, they represent best evidence.  Unfortunately, such direct comparisons are typically few and far between.
  2. Much more common is to rely on the estimates of other sole practitioners in your field as to what such a non-owner employee would earn in their practices.

The lynchpin of both avenues of inquiry is the identification of one or more economically comparable practices.  By what standards does one determine comparability?

First, the practitioners must be practicing in the same or closely related specialty, however unusual or thinly populated.  To compare a transplant specialist with a cross section of general surgeons would be of little help.

Second, the backgrounds and credentials of the practitioners must be quite similar.  This does not mean that they went to the same medical school or had virtually identical residencies.  However, one cannot very well compare someone who is board certified in a specialty with one who is not.  Nor is one likely to find a helpful comparison between individuals whose time in practice varies by 15-20 years.

Third, economically comparable practitioners must function at about the same skill level, and be so recognized by their peers.  Fortunately, the narrower the specialty, the better known are the few leading practitioners and, therefore, the easier it is to obtain such judgments from colleagues.

It is important to keep in mind that we are not comparing the Total Practice Earnings of similar practice owners.  That would defeat the basic objective, which is to determine the incremental increase in Total Practice Earnings resulting from self-employment.  Only by making that determination can we determine the value of ownership in the private practice and, as a result, the value of the practice itself.

PhotoPopellThis article has been contributed by Steven D. Popell CMC (Certified Management Consultant.) Steve has been qualified as a business valuation expert since 1974, and has published extensively on this topic. CMC, a certification mark awarded by the Institute of Management Consultants USA, represents evidence of the highest standards of consulting and adherence to the ethical canons of the profession. Steve was a 2007 winner Collaborative Practice California Eureka Award for contributions to Collaborative Practice in this state.

Collaborative-PracticeThe frequently destructive effects of litigated divorce, especially on minor children, are well known. While the lawyers get much of the blame, the fault really lies with a legal system that, all too often, turns adversaries into enemies and spouses with common interests into winners and losers.

It doesn’t have to be this way.

There is an alternative that can provide all the legal protections of a court process, minus most of the downside. It is called Collaborative Practice (CP), and it deserves your close scrutiny. CP is different from litigation in three important ways.

1. The spouses agree in writing not to go to court. If either party abrogates this agreement, all professionals must withdraw.

2. The spouses agree in writing to provide all relevant information, whether requested or not.

3. While the final settlement must be filed with the court, the couple, not a judge, makes all decisions.

There is a core team of professionals, including an attorney for each spouse, a coach for each spouse, a neutral financial professional and, if there are minor children, a child specialist. When there is a family business, the couple retains a neutral business valuation specialist.

With a neutral, two draining elements are greatly reduced – cost and stress.

The Cost is cut down as the hourly rates for financial and mental health professionals are typically much lower than those of family lawyers, the cost for CP is often less than with litigation. In addition to that, neutral business valuation is much less expensive, because there is only one expert, rather than two; and finally, there is no need for depositions and court appearances and, therefore, legal fees are also cut substantially.

The Stress from a protracted battle over the value of the business can take a heavy emotional toll. The non-manager spouse can feel over matched and at sea in a situation so laden with numbers and financial concepts. The manager spouse is often genuinely afraid that buying his or her spouse’s community property interest in the business will kill the goose that is supposed to be laying the golden eggs. Rival experts can exacerbate these fears and misgivings.

Not surprisingly, the business valuation professional in the Collaborative environment is quite different from the one that delivers an opinion in court. Here are a few of the key differences.

1. The function of this professional is to help the divorcing couple to agree on a value for the business that they understand and believe is fair.

2. The professional is free to deliver a preliminary report, which is open to criticism. If either spouse can make a persuasive case that revisiting an issue, reviewing a document or interviewing a person may have a material impact on the opinion, the expert should be happy to do so. This can never happen in court, where defending one’s opinion is the order of the day.

3. The expert is also able provide a range of value, rather than a specific dollar amount. This option is advantageous for two reasons.

• It is easier for the couple to agree on a range than on a number. Once this threshold is crossed, agreeing on a point within the range should be well within their grasp.

• A range of value allows the spouses to juxtapose business value and spousal support in ways that are beneficial to both parties. For example, a young spouse with a high paying job will often want to maximize the value of the business for use in an investment or retirement vehicle. S/he would probably be willing to sacrifice something in spousal support to achieve this goal. An older spouse with limited income prospects may be primarily interested in maintaining the lifestyle that the business has supported. This individual can afford to give a little in the value of the business in order to maximize spousal support.

When retaining a neutral business valuation specialist, the couple must make two key decisions: the valuation date, and the level of service. In court, the valuation date is typically selected because it is close to the date of separation (business highly dependent on the efforts of the spouse) or to the date of trial (many others, besides the spouse, contribute to the financial performance of the company.) In Collaborative Practice, neither of these markers need be dispositive. Rather, the decision revolves around practical issues, such as proximity to the end of the calendar or fiscal year, at which time the quality of financial information is usually much better than at other times during the accounting year.

In Collaborative Practice, the expert can offer a number of choices in service that accomplish different objectives and cover a wide range of cost. For example, if a valuation opinion were for court, the IRS or some other official body, an official opinion may be required. That is almost never the case in Collaborative Practice, and an unofficial report is much less expensive. In some instances, it is necessary only to review financial documents, rather than cover the entire business landscape – another way to save money. It is not necessary to satisfy a judge in this matter. Rather, the question is: What makes sense for the couple and their available resources?

My future posts will add detail regarding business valuation in the context of Collaborative Practice. In the meantime, if you or someone you care about is entering a divorce process, Collaborative Practice should be front of mind. You can learn more about this important option by visiting the Collaborative Practice website. The site will also help you to find Collaborative professionals all over the U.S. and around the globe


PhotoPopellThis article has been contributed by Steven D. Popell CMC (Certified Management Consultant.) Steve has been qualified as a business valuation expert since 1974, and has published extensively on this topic. CMC, a certification mark awarded by the Institute of Management Consultants USA, represents evidence of the highest standards of consulting and adherence to the ethical canons of the profession. Steve was a 2007 winner Collaborative Practice California Eureka Award for contributions to Collaborative Practice in this state.