By Walter Zweifler
The good book says there is a time under the sun for everything – this applies to the valuation of limited liability partnerships, limited liability companies, closely held corporations and other securities that can be contributed to your IRA. When a business ownership interest is contributed it is imperative that you know what the contribution is worth and how the value has been arrived at. The IRS is looking over your shoulder and you want the contributed value to stand the scrutiny of their review.
Most owners are experts in operating their businesses but have little expertise in arriving at an enterprise value for it. Often a professional appraiser is retained to help with this important task. This article presents an overview of the valuation process and how to know a good appraiser when you retain him or her.
The value of any earning asset is defined by what an informed buyer will pay – no more and no less. Buyers and sellers base their bid price and offer price on the present worth of the economic benefits. Arriving at a “‘meeting of the minds” requires analysis. This requires answers to the question, how much will the enterprise earn and with what risk? “How much” is defined as the present worth of the cash flows. For answers the enterprise history speaks for itself. The opinion of future performance requires a supportable historical basis. The first step is to define what the enterprise earned for the past 12 months. Your monthly financial data (trial balances) tell you what you earned for the interim since the last financial year-end. By adding the 2012 interim amount to and deducting the same interim 2011 amount from the last full year you have a “rolling 12 month” operating statement. You also have the most current condition statement (assets, liabilities and net worth). So the answer to the question, “how is business?” can be answered with a fact, not an estimate!
If you collect several year-end financial statements for at least the past three years, together with the rolling 12-month performance at, say, April 2012, you have a factual profile – a good valuation beginning. This is the basis for building a model of future condition and performance. The history of the enterprise’s condition is reflected in the assets and liabilities (referred to as its balance sheet). The current values paid and received for all the resources should be analyzed – those used in the generation of income and those that are non-operating in character.
Similar history is available for enterprises like yours – no matter if it is privately owned and closely held. You will want an evaluation about the company’s condition and performance – standing alone and by comparison with its peers. A list of the principal customers, competitors and suppliers provides a convenient comparison and a list of those who have an economic incentive to acquire or be acquired. There could be some market experience in this regard. Many trade organizations conduct cost of doing business surveys which can be referred to.
Many times a buyer pays more than the net asset value, reflected in the financial statement, because the capitalization (multiplication) of the earnings results in a greater amount than the current net worth. This “excess” is referred to as “goodwill”. Delineating between goodwill of the owner and goodwill of the business is an important consideration in the appraisal process.
The partnership, shareholders, LLC or LLP agreement provides answers to important questions about how the subject ownership can be bought and sold among other characteristics. Of particular note is the economic reason for the partnership or LLC to be in existence and any restrictions on how this interest can be sold. Any transaction history is central to evaluations.
The valuation process is straightforward but many owners feel that it is a process that their advisors should undertake. They often turn to their attorney, accountant, or financial planner for a valuation opinion. As good as these professionals are in their professions and areas of expertise, and as expert as they might be in appraising an ownership interest, they lack objectivity credentials when they serve in multiple professional capacities that include valuation of your securities.
Independence is critical to receive IRS agreement with contributed values. This means selecting an outside appraiser. How do you know a good one from a not so good one? For starters your appraiser must be accredited by a nationwide professional society, like the American Society of Appraisers. Ask the candidate appraiser to submit a proposal with his background and client history. The proposal should define exactly what the appraiser intends to do – including a management interview and walk-though inspection of the headquarters. If and when services are required in any subsequent review the proposal should provide the terms and conditions for delivery or a submission of a subsequent proposal. The proposal must define the scope of services, that is, a clear definition of the security being valued and the purpose of the appraisal together with the delivery schedule and fee payment schedule. A complete appraisal includes the collection of financial statements (at least three operating years and the current interims required to calculate a 12-month rolling performance). The appraiser should prepare extensive analysis of these statements, and similar statements of comparable companies in a similar format. Data for public and privately owned companies is available and should be accessed.
The appraiser should formulate a range of preliminary values from at least two distinct techniques and explain each in detail at the management interview. The characteristics of the contributed securities should be analyzed. For example, are they a control, non-control, marketable or limited marketable ownership? The transaction history for the contributed securities or securities similar to them should be reviewed and analyzed. The objective of an appraisal engagement is to prepare an opinion which the owner agrees is logical, and understands and the IRS accepts on the same basis.
Walter L. Zweifler, ASA is an Accredited Senior Appraiser, practicing in New York City as the COO of Zweifler Financial Research.
Walter Zweifler
Zweifler Financial Research
110 Wall Street, 11th Floor
New York, New York 10005
212-809-6435
[email protected]
