Last month (April 2014) attended and spoke at the Joint Conference of the AICPA and the American Academy of Matrimonial Lawyers in Las Vegas. It was a fun conference that had record attendance for this bi-annual event. While in Las Vegas, I had a chance to attend one show with a Memphis theme and another with a Las Vegas theme, and thoroughly enjoyed both.
I spoke three times – twice as part of a panel and once in a keynote presentation. One panel focused on the views of three experts (Jim Hitchner, Nancy Fannon, and me) regarding the marketability discount, aka the discount for lack of marketability. It was moderated by Ron Seigneur. I also spoke on another panel that focused on a variety of valuation issues with Jay Fishman, Nancy Fannon and me, with Jim Hitchner as moderator.
I spoke at Thursday’s closing general session about Five Really Big Valuation Issues (the session was titled by the conference organizers).
It is difficult to talk about valuation issues, or issues of any kind, without setting the context within which the discussion will take place. Since many of the big valuation issues today – and for the last thirty years – pertain to discounts, I set the tone:
No valuation premium or discount (or adjustment) has any meaning until we understand the conceptual basis underlying the base value to which they are applied.
Then, I stated what I called the biggest valuation issue of all, which is:
Understanding what drives the valuation of an asset from the viewpoint of the relevant buyers and sellers in the market(s) for the asset and in the context of the relevant standard of value.
The standard of value sets the rules of the game for valuation. Fair market value is the most common standard of value and it involves willing buyers and sellers who negotiate on their own behalf with full knowledge and no compulsion. Business appraisers are familiar with the “rules” of fair market value. I used the following graphic to describe the valuation process set by the biggest issue above:
After a setting the context, the five issues were introduced:
- Discount rates. Discount rates are often the proverbial “gorilla in the room” in valuation. Appraisers get so caught up in their discount rate models and in attempting to measure their various components precisely that they forget that appraisers develop discount rates in the context of relevant markets. We can’t look forward to develop a discount rate without looking back, so to speak, at the relevant market(s) for the businesses we are valuing.
- Control premiums and minority interest discount rates. From the perspective of business owners, the point is that there is no such thing as an automatic control premium when selling businesses. Control premiums reflect the different expectations between purchasers, who may anticipate strategic, synergistic or financial benefits from a combination, and sellers, who operate on a stand-alone basis in the absence of a transaction. The value of a business is based on its expected cash flow, the growth of that cash flow, and the risks associated with achieving the anticipated cash flows. To the extent that synergistic or other benefits are anticipated by purchasers, and they can be negotiated to be shared with sellers, then the market’s “valuation” of a business is set.
- Adjustments to the income statement. This discussion pertained to normalizing adjustments that might be considered by appraisers and potential purchasers.
- Private and public company methods. My point here is that value is based on expected cash flow, growth and risk. Absent comparable and reasonably reliable transaction information, neither guideline public company nor guideline private company transactions can yield good results. “Comparable and reasonably reliable transaction information” is based on the judgment of an appraiser and his or her knowledge of the markets and the company under discussion.
- Fundamental adjustments to transactional indications. Often a subject business will be smaller than, for example, the similar public companies in its markets. It may have lower growth expectations and greater risk. I talked about a couple of methods that appraisers can use to help achieve reasonable results when valuing private companies in relationship to public company comparables.
All in all, it was an interesting session for me. In spite of my eloquence, presentation and material, the hit of my presentation was this short video from Berlitz to suggest that business appraisers and other advisers to business owners should be thinking about these big valuation issues. While business owners may not care directly, they are influenced by these valuation issues when their businesses are valued for many reasons, and they are interested in the results of those valuations.