Chapter 25 Checklist for Reviewing A Business Valuation Report

Transcription

1 Business Valuation Review Volume 28 Number 2 Chapter 25 Checklist for Reviewing A Business Valuation Report Shannon P. Pratt, PhD, FASA CREDENTIALS OF REPORT PREPARER(S) Academic Degrees Professional Designations INTRODUCTION (Chapters 1 and 2) ECONOMIC ANALYSIS (Chapter 14) INDUSTRY ANALYSIS (Chapter 14) FINANCIAL STATEMENT ADJUSTMENT (Chapter 12) FINANCIAL STATEMENT ANALYSIS (Chapter 13) REASONABLE COMPENSATION (Chapter 11) DISCOUNTS AND PREMIUMS (Chapter 15) METHOD(S) USED (Chapter 3) Income Approach Market Approach Asset Approach INCOME APPROACH (Chapter 5) Discounted Cash Flow Method Discount/Capitalization Rate for Equity GUIDELINE PUBLIC COMPANY METHOD (Chapter 6) Criteria for Selection Statistics Used Weightings TRANSACTION (MERGER & ACQUISITION) METHOD (Chapter 6) Criteria for Selection PAST TRANSACTION METHOD (Chapter 6) Criteria for Selection EXCESS EARNINGS METHOD (Chapter 8) VARIABLE CAPITALIZED RULES OF THUMB (Chapter 9) GOODWILL (Chapter 10) RECONCILIATION OF INDICATED VALUES (Chapter 16) OVERALL ASSESSMENT This chapter 1 is free from copyright restrictions. Readers are free to make copies of it to use as worksheets when reviewing reports of the attorney s own and/or opposing appraisers. It can also be distributed to other attorneys, clients, judges, etc. Each line item has a short line to the left, which can be used for an x, o, etc. Space is available beneath the lines to include Þ gures, notes, etc., e.g., under the heading Þ nancial statement adjustments in the Income approach, line item compensation one might enter $120,000. When reviewing your analyst s report compared with opposing analyst s report, it might be convenient to place these sheets side by side for an item-by-item comparison. This checklist was prepared by Shannon P. Pratt, CEO, and Alina Niculita, President, of Shannon Pratt Valuations, Inc., a business valuation Þ rm headquartered in Portland, Oregon. 1 This chapter appears in the Second Edition of The Lawyer s Business Valuation Handbook, American Bar Association, the official publication date is to be Fall Dr. Pratt is Chairman and CEO of Shannon Pratt Valuations, Inc., a business valuation firm located at 6443 S.W. Beaverton Hillsdale Highway, Suite 432, Portland, Oregon He can be reached at shannon@shannonpratt.com, (503) , or Page 110

2 Chapter 25 Checklist for Reviewing A Business Valuation Report Credentials of Report Preparer(s) Even though this usually is in an appendix in the back of the report, most attorneys like to look at this first so that they can have in mind whose work product it was as they review the report. Academic Degrees (Location in report page, exhibit, appendix, etc.)! PhD Doctor of Philosophy! DBA Doctor of Business Administration! MS Master of Science! MBA Master of Business Administration! BS Bachelor of Science! BA Bachelor of Arts : Professional Designations (Chapter 30 for explanations of these and others)! CFA Chartered Financial Analyst! FASA Fellow of the American Society of Appraisers! ASA Accredited Senior Appraiser! AM Accredited Member! MCBA Master Certified Business Appraiser! CBA Certified Business Appraiser! CPA/ABV Certified Public Accountant/Accredited in Business Valuation! CVA Certified Valuation Analyst Other: Introduction (Chapters 1 and 2) Effective valuation date(s)? Type of entity (e.g. Corporation, S corp., general partnership, limited partnership, etc.)? Proportion of Entity (if less than 100%, specify exact percentage or number of shares, if more than one class of ownership, e.g., common/preferred, voting/nonvoting should have a diagram showing the capitalization)? Purpose of valuation? Sources of authority? Federal or state statute (specify)? Revenue Ruling (specify)? Articles/Bylaws? Buy-sell agreement? Other agreement (e.g., arbitration agreement)? Who is the client for the appraisal? Who (what entity) performed the appraisal? Standard (definition) of value? Date appraisal completed? Was the stated standard of value appropriate for the situation? Level of value (e.g., control, marketable minority, nonmarketable minority) Economic Analysis (Chapter 14) Is it relevant? Does it tie in with and support other parts of the valuation report? Name of entity? State of incorporation or registration? Industry Analysis (Chapter 14) Is it relevant? Business Valuation Review Summer 2009 Page 111

3 Business Valuation Review Does it tie in with and support other parts of the valuation report? Financial Statement Adjustment (Chapter 12) Were there any adjustments to the subject company s financial statements? If yes, state year, item adjusted, amount, and reason. If no, was there a statement that the statements were analyzed and no adjustments necessary? Were there any adjustments to guideline company statements? If yes, state company, year, item adjusted, amount, and reason. Reasonable Compensation (Chapter 11) Was a reasonable compensation adjustment made? If yes, how much (state for each year if multiple years). Whether a compensation adjustment was made or not, was it addressed adequately? No Yes Source of information for compensation adjustment (name of source, issue, category)? Discounts and Premiums (Chapter 15) Was there a control premium? If so, how much? If no, was there a statement that the statements were analyzed and no adjustments necessary? Financial Statement Analysis (Chapter 13) Is it done on adjusted or pre-adjusted statements? (It should normally be done on statements after adjustments). Was there a discount for lack of control (sometimes called a minority discount)? If so, how much? What data and/or rationale did they use to quantify the control premium or discount for lack of control? If guideline company method was used, was there a comparative analysis table? Were the subject s strengths and weaknesses compared to the guideline companies reflected in the valuation multiples used? Was there a table comparing the subject company to industry averages? If so, what source was used for the comparison? Were the relative strengths and weaknesses reflected in the valuation multiples and/or discount rates? Was there a discount for lack of marketability? If so, how much? What database(s) did they use in support for the amount of the discount for lack of marketability? Did they apply any other premiums or discounts? If so, which one(s)? Amount of each Page 112

4 Chapter 25 Checklist for Reviewing A Business Valuation Report Method(s) used (Chapter 3) Income Approach (Chapter 5)! Discounted cash flow! Capitalization of cash flow Market Approach (Chapter 6)! Publicly traded guideline companies! Transaction method (sales of entire companies)! Past transactions in the subject company! Rules of thumb Asset Approach! Adjusted net asset value (Chapter 7)! Excess earnings method (Chapter 8) Income Approach (Chapter 5) Discounted Cash Flow Method! Source of projections! Excess assets (excess cash or nonoperating assets)! Taxes Discount/Capitalization Rate for Equity (Chapter 5)! Build-up method! Risk-free rate! Source of risk-free rate! Equity risk premium! Source of equity risk premium! Date projections prepared! Size premium! Adjustments to projections (Chapter 12)! Compensation! Source of compensation adjustment! Rent! Nonrecurring items! Discontinued items! Inventory accounting! Depreciation/amortization/depletion! Source of size premium (note: when Morningstar is used, the equity risk premium and size premium are separate numbers; when Duff & Phelps is used the equity risk premium and size premium are combined into a single number. Many analysts today use both Morningstar and Duff & Phelps).! Industry adjustment! Source of industry adjustment! Specific company adjustment! Was there adequate explanation for the company specific adjustment?! Net operating loss carry forwards! Growth rate Business Valuation Review Summer 2009 Page 113

5 Business Valuation Review! Explanation for growth rate! Equity rate (see previous pages)! Capital asset pricing method! Risk-free rate! Source of risk-free rate! Equity risk premium! Source of equity risk premium! beta! Source of beta! Size premium! Source of size premium (note: when Morningstar is used, the equity risk premium and size premium are separate numbers; when Duff & Phelps is used the equity risk premium and size premium are combined into a single number. Many analysts today use both Morningstar and Duff & Phelps).! Debt rate (pre-tax)! Source of debt rate! Tax rate! Source of tax rate! Weight of equity! At market! At book! Weight of debt! At market! Industry adjustment! At book! Source of industry adjustment! Specific company adjustment! Was there adequate explanation for the company specific adjustment?! Growth rate! Explanation for growth rate! Weighted Average Cost of Capital (WACC) (Chapter 5) components in capital structure! Is the mid-year convention used?! Year-end convention?! Is the terminal value discounted by the proper number of years?! Total value $! Amount of total value accounted for by terminal value $ Page 114

6 Chapter 25 Checklist for Reviewing A Business Valuation Report! Method of arriving at terminal value! Gordon growth model! Multiple of financial variable (specify which variable)! Dates of financial information! List of companies! List of rejects! Reasons for rejection (e.g., liquidation value) Guideline Public Company Method (Chapter 6) Criteria for Selection! Population(s) or database(s) searched (for each metric used, the time frame, e.g., latest 12 months, latest fiscal year, 5-year average, 5-year weighted average, next 12 months forecast, etc.)! MVIC/sales! Line of business! MVIC/gross profit! SIC code! MVIC/EBITDA! NAICS code! MVIC/EBIT! Size! MVIC/Book value of invested capital! Position in industry! MVIC/Adjusted book value of invested capital! Profitability! MVIC/Discretionary earnings! Capital structure! MVIC/Other! Territory! Price/Sales! Maturity of company! Price/Gross profit! Type(s) of customers served! Price/Earnings before taxes! Date of prices! Price/Earnings (net income)! Valuation date for subject company! Price/Book value Business Valuation Review Summer 2009 Page 115

7 Business Valuation Review! Price/Adjusted book value! NAICS code! Price/Other! Size Statistics Used! Mean! Median (The median is generally considered the preferable measure of central tendency among ratios, because the mean can be unduly influenced by extreme observations, especially on the upside. Sometimes analysts avoid this bias by eliminating ratios they consider not meaningful).! Position in industry! Profitability! Capital structure! Territory! Standard deviation! Maturity of company! Coefficient of variation (Generally the metrics with the lowest coefficient of variation are accorded the most weight because a low coefficient of variation indicates a tight clustering, implying that the market puts the most weight on those variables.)! Does the analyst adequately justify where each multiple applied to the subject company falls relative to the range of observed multiples?! Type(s) of customers served! Date of prices! Valuation date for subject company! Dates of financial information Weightings! Does the analyst adequately justify which variable is accorded the most weight?! List of Date of Acquirer Special companies Transaction Items Transaction (Merger & Acquisition) Method (Chapter 6) Criteria for Selection! Population(s) or database(s) searched! Line of business! List of rejects! Reasons for rejection (for each metric used, the time frame, e.g., latest 12 months, latest fiscal year, 5-year average, 5-year weighted average, next 12 months forecast, etc.)! MVIC/sales! SIC code! MVIC/gross profit Page 116

8 Chapter 25 Checklist for Reviewing A Business Valuation Report! MVIC/EBITDA! MVIC/EBIT! MVIC/Book value of invested capital! MVIC/Adjusted book value of invested capital (for each metric used, the time frame, e.g., latest 12 months, latest fiscal year, 5-year average, 5-year weighted average, next 12 months forecast, etc.)! MVIC/sales! MVIC/gross profit! MVIC/Discretionary earnings! MVIC/EBITDA! MVIC/Other! MVIC/EBIT! Price/Sales! MVIC/Book value of invested capital! Price/Gross profit! MVIC/Adjusted book value of invested capital! Price/Earnings before taxes! MVIC/Discretionary earnings! Price/Earnings (net income)! MVIC/Other! Price/Book value! Price/Sales! Price/Adjusted book value! Price/Gross profit! Price/Other! Price/Earnings before taxes Past Transaction Method (Chapter 6) This may be a good method for acquisitions made by the subject company as well as transactions in interests in the subject company.! Date of transaction! Percentage of company! Price/Earnings (net income)! Price/Book value! Price/Adjusted book value! Price/Other! Any special terms (specify)! Weightings among methods in market approach! Value Indicated $ Business Valuation Review Summer 2009 Page 117

9 Business Valuation Review! Rationale for weightings. representations of future expected returns (See financial statement adjustment earlier in this chapter). Excess Earnings Method (Chapter 8)! Basis for adjusting or reclassifying line items to fair market value! Accounts receivable! Reconciliation of blended rate of return with capitalization rate derived from build-up method or CAPM? Rules Of Thumb (Chapter 9)! Source(s) (cite which edition)! Inventory! Rule(s) used! Plant & equipment! Land Goodwill (Chapter 10)! Amount of goodwill $! How derived?! Notes payable! Off balance sheet assets and/or liabilities brought onto balance sheet (list, with amounts and explanations)! Rate of return on tangible assets! Explanation for rate of return on tangible assets! Rate of return on intangibles! Explanation for rate of return on intangibles Variable capitalized! Net cash flow! Net income! Adjustments to normalized past financial state - ments to make them as realistically as possible! Distinguished personal goodwill from enterprise goodwill?! If yes to above question,! How much (either $ or %) to personal! How much (either $ or %) to enterprise! How justified? Reconciliation of Indicated Values (Chapter 16)! If a single method dominated the conclusion, did they make a convincing case that that was the best method?! If multiple methods were used, did they use mathematical weighting or subjective weighting?! Were the weights convincingly supported? Overall Assessment! Were the steps taken in the report consistent with the stated standard of value?! If not, where did they diverge? Page 118

10 Chapter 25 Checklist for Reviewing A Business Valuation Report! Were there any contradictions (e.g., industry section not supporting valuation section)?! If so, what were they?! Did you notice any biases? (e.g., tendency toward unsupported high or low valuation multiples and/or discount rate)?! If so, explain.! Were there any mathematical errors?! If so, list:! Was the report well documented (e.g., could another analyst find the source materials and replicate it?)! If no, note areas where documentation was lacking.! Was the report fully defensible?! If no, list errors/areas of weakness. Business Valuation Review Summer 2009 Page 119