Steve Leimberg, in Steve Leimberg’s Business Entitites Email Newsletter, recently reviewed A Reviewer’s Handbook to Business Valuation: Practical Guidance on the Use and Abuse of a Business Appraisal. The review, in its entirety, is posted below.
In Business Valuation, you don’t know what you don’t know (nor are the questions you should ask intuitive). What the advisors of a business owner should know about business valuations could fill a book.
Fortunately, LISI Commentator Team Member Paul Hood and Tim Lee have written it! In one place, you’ll find the questions to ask, real-world guidance, the most understandable practical guide on business valuation that you’ll find anywhere, and a voluminous checklist of mistakes others have made – so that you and your clients don’t.
Anyone in the legal, accounting, valuation, or financial planning profession authorizing or conducting or depending on a serious business appraisal (and they all are) should read this book. And don’t even think about testifying as an expert witness on the subject of business valuation without committing to memory this book’s “Lessons from the Trenches.”
About the Authors:
As LISI members know, I always start a book review with some background on the authors.
L. Paul Hood, who has worked over 20 years as an attorney in the areas of tax and estate planning, needs no introduction to LISI members. Just log into LISI and search our newsletter archives for his name and you’ll find dozens of articles – mostly on valuation issues – that Paul has authored. Paul has spoken at numerous law schools and estate planning councils and is a former adjunct professor of estate and gift tax planning.
Timothy R. Lee is an ASA who leads prestigious Mercer Capital’s Corporate Valuation Group. Tim has extensive experience in providing corporate valuation and investment banking services to hundreds of clients in an array of industries.
A Reviewer’s Handbook to Business Valuation is split into three parts:
Part I deals with the process of business valuation. This will provide reviewers of business appraisals a basic understanding of valuation concepts and methodology.
Part II provides a thorough summary of business valuation standards including USPAP and the IRS guidelines.
Part III is my favorite part – Lessons from the Trenches. It includes alleged errors of omission and commission by business appraisers that have resulted in adverse court decisions. It also contains a list of the “Ten Burning Issues” in business valuation – and the authors’ opinions on those issues.
Part I Foundations: Valuing a Business.
Chapter 1 Fundamental Concepts for Defining Value.
Standard of Value.
Level of Value.
Premise of Value.
Chapter 2 Defining the Engagement.
The Importance of Defining the Engagement.
Defining the Client.
The First Call.
The Subject Entity and Entity Type.
Entity Distinctions and Entity Significance in the Valuation.
State of Entity Organization or Incorporation.
Principal Business Location.
Description of the Subject Interest.
Purpose and Intended Use of the Valuation.
Date of the Valuation.
Scope of the Work Product.
Summary Assignment Definition Table.
The As of Date of the Appraisal and the Date of the Appraisal Report – Added Thoughts and Perspective.
Chapter 3 Information Collection and Due Diligence.
Importance of the Information Collection and Due Diligence Phase.
Industry and Economic Considerations.
Financial Information and Analysis.
The Management Interview.
Agenda of a Typical Management Interview.
Chapter 4 An Overview of Valuation Approaches.
Recognized Valuation Approaches.
Methodology and Level of Value, Direct and Indirect Methodology.
Chapter 5 Valuation Approaches: The Cost Approach.
The Cost Approach.
Typical Adjustments in the Cost Approach (using Tangible Net Asset Value Methods).
To Tax Affect or Not.
Chapter 6 The Income Approach to Value.
Direct Capitalization and Discrete Projection Methods.
Reconciliation of Income Methods to Market Methods.
Typical Adjustments to the Income Statement.
Adjustments That Correspond to Balance Sheet Treatments.
Reconciling or Reclassifying Interim Period Measures to Fiscal Period Measures.
Income Statement Adjustments and Considerations.
Matching the Cost of Capital to the Benefit Stream.
Developing the Cost of Capital.
Summary Examples of Developing the Cost of Equity Capital.
Growth Rate of Earnings / Net Cash Flow.
Finishing the Direct Capitalization Equation.
Developing the Single-Period Benefit (“Ongoing Earnings” and “Ongoing Net Cash Flow”) and Preparation for the Discounted Future Benefits Method.
Example of a Single Period Capitalization to Derive the Market Value of Total Invested Capital.
The Discounted Future Benefits Method (DFB).
Chapter 7 The Market Approach.
Valuation Methods under the Market Approach.
Rules of Thumb.
Guideline Public Company Method.
The Fundamental Adjustment.
Guideline Transactions Method.
Chapter 8 Correlation of Value.
Global Considerations in the Correlation Process.
Examples of Correlating a Value Indication.
Chapter 9 Valuation Discounts and Premiums.
The Levels of Value Revisited.
Perspective on the Control Premium.
Control Premiums – Substance Over Form.
Perspective of the Minority Interest Discount.
Part II Business Valuation Standards.
Chapter 10 Uniform Standards of Professional Appraisal Practice (USPAP).
Overview of USPAP Valuation Standards.
USPAP Ethics Rule.
2010-11 USPAP Competency Rule.
2010-11 USPAP Scope of Work Rule.
2010-11 USPAP Jurisdictional Exception Rule.
USPAP Business Appraisal Review (USPAP Standard 3).
Business Appraisal Development: USPAP Standard 9.
Business Appraisal Report Standards USPAP Standard 10.
USPAP Certification Requirement.
USPAP Statements on Appraisal Standards and Advisory Opinions.
Chapter 11 American Society of Appraisers (ASA) Business Valuation Standards.
ASA BVS General Preamble.
ASA BVS-I (General Requirements for Developing a Business Valuation).
ASA BVS-II (Financial Statement Adjustments).
BVS-III (Asset-Based Approach to Business Valuation).
ASA BVS-IV (Income Approach to Business Valuation).
ASA BVS-V (Market Approach to Business Valuation).
ASA BVS-VI (Reaching a Conclusion of Value).
ASA BVS-VII (Valuation Discounts and Premiums).
ASA BVS-VIII (Comprehensive Written Business Valuation Report).
ASA BVS-IX (Intangible Asset Valuation).
ASA SBVS-1 (Guideline Public Company Method).
ASA SBVS-2 (Merger and Acquisition Method).
PG-1 (Litigation Support: Role of the Independent Financial Expert).
PG-2 (Valuation of Partial Ownership Interests).
Chapter 12 The American Institute of Certified Public Accountants (AICPA) Statement on Standards for Valuation Services.
Overall Engagement Considerations.
Valuation Approaches and Methods.
Chapter 13 National Association of Certified Valuation Analysts (NACVA) Professional Standards.
Preamble; General and Ethical Standards.
Chapter 14 The Institute of Business Appraisers (IBA) Business Appraisal Standards.
Standard One: Professional Conduct and Ethics.
Standard Two: Oral Appraisal Reports.
Standard Three: Expert Testimony.
Standard Four: Letter Form Written Appraisal Reports.
Standard Five: Formal Written Appraisal Reports.
Chapter 15 Canadian Institute of Chartered Business Valuators Practice Standards.
Practice Standard 110 – Valuation Reports.
Practice Standard 120 – Scope of Work.
Practice Standard 130 – File Documentation.
Practice Standard 210 – Advisory Reports.
Practice Standard 220 – Scope of Work for Advisory Reports.
Practice Standard 230 – File Documentation for Advisory Reports.
Practice Standard 310 – Expert Reports.
Practice Standard 320 – Scope of Work for Expert Reports.
Practice Standard 330 – File Documentation Standards in Expert Reports.
Standard 410 – Limited Critique Reports.
Practice Standard 420 – Scope of Work for Limited Critique Reports.
Practice Standard 430 – File Documentation Standards for Limited Critique Reports.
Chapter 16 Internal Revenue Service (IRS) Business Valuation Standards.
IRM 184.108.40.206 – Introduction.
IRM 4.48.2 – Development Guidelines.
IRM 220.127.116.11 – Resolution Guidelines.
IRM 18.104.22.168 – Reporting Guidelines.
Addendum A USPAP 3 Comparison Chart.
Addendum B USPAP 9 Comparison Chart.
Part III Lessons from the Trenches.
Chapter 17 Alleged Errors of Omission by Appraisers.
Failure to Comply With USPAP.
Too Much Involvement by Counsel in the Appraisal Report Preparation.
Standard of Value.
The Subject Property Interest.
Sources of Data.
Pure Reliance on Case Law.
Site Visits and Management Interviews.
Failure to Provide Sufficient Explanation.
Disregard of Material Facts.
Failure to Find Available Information.
Failure to Adequately Support Selection of Beta.
Improper Sampling Techniques.
Off Financial Statement Items.
Failure to Sufficiently Explain Assumptions.
Insufficient Due Diligence.
Failure to Make Inquiries With Significant Third Parties.
Failure to List All Appraisers’ Qualifications.
Failure to Consider the Small-Stock Premium.
Failure to Factor in Income Tax.
Failure to Set Forth the Adjustments to Financial Statements in the Appraisal Report.
Failure to Have Work be Susceptible of Replication.
Failure to Identify the Multiples Selected.
Failure to Discuss Weightings in the Appraisal Report.
Failure to Distinguish Between Tax and Book Depreciation.
Failure to List Guideline Companies.
Failing to Separate Operating and Nonoperating Aspects of a Company.
Failing to Lay Foundation for Small Stock Premium.
Failing to Justify Capitalization or Discount Rates.
Failure to Think like an Investor.
Failure to Define Capital Structure.
Failure to Adequately Consider the “Willing Buyer”.
Failure to Adequately Consider the “Willing Seller”.
Failure to Accurately Describe the Subject Property.
Failure to Properly Classify the Subject Company.
Failure to Explain the Basis for a Valuation Discount.
Failure to Properly Consider the Subject Company’s Growth Rate.
Failure to Explain Market Multiples Selected For Guideline Companies.
Failure to Explain Equal Weighting of Conclusions of Value.
Failure to Consider Differences between the Subject Company and the Guideline Companies.
Failure to Utilize Data From a Guideline Company That the Appraiser’s Own Summary Chart Reflects is Closest to the Subject Company.
Failure to Explain the Selection of the Range of Performance Ratios Selected.
Failure to Adequately Explain Why Companies Selected as Guideline Companies are in Fact Comparable to the Subject Company.
Failure to Explain Why so Few Comparable Properties or Guideline Companies Were Selected.
Chapter 18 Alleged Errors of Commission.
Use of Past Publications of an Appraiser Against the Appraiser.
Using Untested Methodology.
Improper Reliance Upon a Draft Appraisal.
Conclusion of Value Offends Common Sense.
Conflicting Conclusions of Value.
Sole Reliance upon a Valuation Model.
Incorrect Usage of the Discounted Cash Flow Method.
Overemphasis on Buy-Sell Restrictions among Related Parties.
Using Historic Book Value of Assets in Net Asset Value Approach Even Though Asset Appraisals Had Been Obtained.
Misapplication of Pre and Post Tax Figures.
Ignoring the “Hypothetical” Nature of the Willing Buyer or Willing Seller.
Inconsistent Use of Commercially Available Data.
Use of Commercially Available Data That Warns of its Statistical Inaccuracy.
Misstatement of Methodology Employed by Appraisers on Whose Work the Appraiser Has Relied.
Undue Reliance Upon the Work of Another Appraiser.
Using a Valuation Method without Laying a Foundation That It Is a Legitimate Method (for example, The Business Broker Method Using Data from the IBA Market Database).
Improper Reliance on a Study That Does Not Completely Provide All of the Relevant Data.
Failure to Apply Discussion of Economic Factors to the Subject Company.
Using Commercially Available Data in a Manner Contrary To How The Data Source Says The Data Should Be Used.
Failure to Proofread Report Prior to Issuance.
Apparently Conflicting Assumptions Used for the Same General Purposes without Sufficient Explanation.
Use of Different Valuation Methods in Valuing the Same Interest in Valuation Reports Offered at Different Times without Adequate Explanation.
Making Improper Adjustments to Financial Statements.
Reliance upon the Pre-IPO Studies and the Restricted Stock Studies to Determine the Discount for Lack of Marketability for a Controlling Interest.
Misreading or Failing to Properly Consider Rev. Rul. 59-60.
Failure to Accurately State the Number of Shares Outstanding in the Subject Company.
Inconsistency in Valuation Methodology Expressed in Testimony Versus the Appraiser’s Methodology as Expressed in another Writing.
Unreasonably Low Projections.
Failure to Add Back Depreciation Included in Computation of Costs-of-Goods-Sold in the Computation of EBDIT.
Combining the Discount for Lack of Control with the Discount for Lack of Marketability.
Utilizing an Assumed Income Tax Rate That Differed From the Actual Past Tax Rates of the Subject Company.
Disconnect between Assumption as to When Revenues or Expenses Would be Received or Incurred and When Those Items Were Actually Received or Incurred.
Error in Computing Terminal Value when Using the Income Approach.
Discounting an Income Stream Only at or Close to the Risk-Free Rate.
Modifying or Abandoning Positions Taken in the Written Appraisal Report during the Appraiser’s Testimony.
Referring to a Standard Industrial Code in the Appraisal Report without Identifying That Number in the Report.
Relying Upon Guideline Companies That Were Not Comparable to the Subject Company.
Preparing and Utilizing Earnings Projections That Vary Significantly From the Earnings Projections Prepared by the Subject Company.
Use of Only One Year’s worth of Guideline Company Data.
Inappropriate Employment of a Discount to Make a Conclusion of Value under One Valuation Approach Come Out More in Line With the Conclusion of Value Reached Under another Valuation Approach.
Failing to Properly Calculate a Valuation Discount.
Inappropriate Use of a Price-to-Asset Multiple Where the Difference between Book Value and Asset Fair Market Value is not Close.
Selection of Too Few Guideline Companies or Comparable Properties.
Selection of Too Few Performance Measures in the Guideline Company Method.
Cherry Picking Valuation Multiples.
Using an Inexcusably Old Comparable Sale.
Inappropriate Reliance upon Governance Document Restrictions in Establishment of Valuation Multiples.
Stating the Wrong Date from a Comparable Sale.
Mismatching the Valuation Dates of the Guideline Companies and the Subject Company in Computing Price Multiples.
Defining “Guideline Company” Too Narrowly.
Chapter 19 Ten Burning Issues within the Appraisal Profession.
Issue 1: Methods of Determining the Discount for Lack of Marketability.
Issue 2: Applicability of Discount for Lack of Marketability to a Controlling Interest.
Issue 3: Validity of Discount for Imbedded Capital Gains.
Issue 4: Shift of “Comparability” from the Publicly Traded Arena to the Private Arena.
Issue 5: Efficient Market Hypothesis and Exceptions (for example, Small Firm Effect).
Issue 6: Value of Control vs. Value of Synergy.
Issue 7: Do Public Company Stock Prices Indicate a Marketable, Minority or a Marketable, Control Position?
Issue 8: S Corporation Tax-Affecting.
Issue 9: Factoring Financial Statement Adjustments When Estimating the Value of a Noncontrolling Interest.
Issue 10: Validity of the Capital Asset Pricing Model for Valuing Interests in Closely Held Businesses.
Chapter 20 Random Practical Valuation Tips and Thoughts.
Discovery and Privileges.
Attorney Work Product Privilege.
Tax Practitioner Privilege.
A Free Standing, Complete Report, or a Mere Letter or Restricted Use Appraisal Report?
Those Business Appraisers Must Be Identified in Time.
Should a Business Appraiser Always Follow USPAP?
How Much Input Can a Client’s Advisor Have in the Preparation of a Business Appraisal Report?
Types of Appraisers; Appraisal Associations.
Random Strategy Tips.
Appendix A Appraisal Standards Chart.
Appendix B Information Request List.
Appendix C Management Interview Checklist.
Appendix D Sample Engagement Letter.
Business Valuation Texts.
Business Valuation Journals and Newsletters.
Cost of Capital.
Equity Risk Premiums.
It’s obvious from the table of contents that there’s a lot here. And knowing what’s between the fly covers of this thoroughly cited and well-indexed resource will be one heck of an investment.
What you’ll like most about this book is the straight-forward pragmatic approach that blends a tax-attorney’s mind with that of a top notch business appraiser. The Reviewer’s Handbook to Business Valuation focuses on how to arrive at the level of value, the role of estate planners in the business valuation process, the use (and misuse) of appraisers in both estate planning and litigation, and how to find and select the appraiser who best fits your client’s situation.
Best of all, this book will help keep you safe in the trenches!
HOPE THIS HELPS YOU HELP OTHERS MAKE A POSITIVE DIFFERENCE!
For more information http://bvreviewershandbook.com
To order A REVIEWER’S HANDBOOK TO BUSINESS VALUATION: PRACTICAL GUIDANCE TO THE USE AND ABUSE OF A BUSINESS APPRAISAL: http://www.wiley.com/WileyCDA/WileyTitle/productCd-0470603402.html