VALUATION REPORT - Mueller Prost

1 Business buyers and sellers often enter negotiations with a price in mind based on a multiple of some measure of historical revenues or profits. Although these multiples appear to be simple, they reflect complex financial, operational, marketing and legal conditions internal to the business. They also reflect economic, industry and capital market conditions external to the buyers and sellers have different impressions regarding these conditions, their multiples are usually different. The more the parties know about what goes into their multiple and the range of multiples that may apply to a company the better positioned they are for negotiation. Cash FlowMultiples reflect the expected timing and amount of future cash flows a business will generate.

2 Cash flows received by investors may vary depending on whether the transaction is structured as an asset or equity sale. Also, since reasonable minds can differ regarding the extent to which these cash flows will be affected by conditions internal and external to the company, buyers and sellers will frequently have different buyers don t have unique ways to increase the value of the business after the sale, their multiple will reflect the fair market value of the company. Fair market value is the price at which the business would change hands between willing and able buyers and sellers where neither is forced to transact and both have reasonable knowledge of the relevant facts. Fair market value is typically considered a price floor. But, when a particular buyer has unique synergies or ways to increase the value of the business after the sale, his or her multiple may be higher, reflecting the investment value to that specific buyer.

3 Investment value is often considered the price ceiling for a transaction. How Much Risk?Since value is based on expected returns, the multiple must reflect the risk or uncertainty regarding the timing and amount of these returns. Again, reasonable minds can differ regarding the extent to which internal and external conditions will affect this uncertainty. Businesses with established products and customers are often perceived as less risky than businesses without them. Lower risk would be reflected in a higher multiple. However, businesses without established products or customers are frequently attractive investments due to their significant growth potential. That growth potential sometimes drives multiples up more than the absence of established products or customers drives it , when the market is booming and both debt and equity capital are plentiful, investors may be less risk averse and, therefore, willing to use a higher multiple and pay a higher price.

4 Conversely, if investors see trouble ahead, they may become more risk averse. This may cause debt and equity capital to become more scarce, multiples to contract and prices to a MultipleValuations provide several ways to boil these conditions down to a multiple. One way, the income approach, calculates the multiple by reference to similarly sized publicly held companies adjusted for differences in risk compared to the company for sale. Another way, referred to as the guideline public company method, calculates the multiple by reference to publicly held companies with similar risks adjusted for differences in size compared to the company. A third way, referred to as the comparable company transactions method, calculates the multiple by reference to transactions of companies similar to the company in terms of both size and risk.

5 The strength of the income approach and guideline public company method is the abundance of available data. However, this strength is tempered by the sensitivity of these analyses to adjustments, which are subjective. The comparable company transactions method has the potential to minimize the effect of these subjective adjustments, but it is often undercut by the presence of a very limited amount of data. The multiples used to determine the value of a company depend on all of these factors, and multiples are just one piece of the price. A successful outcome is more likely if each party enters negotiations open to a range of potential multiples. A VALUATION analyst can help the parties understand pricing multiples by explaining how complex internal and external conditions affect the expected cash flows and risk of a business.

6 Thinking about buying or selling a business? Mueller Prost s VALUATION analysts can help you prepare for your negotiation. Give us a call at REPORT BUYING AND SELLINGU nderstand Pricing Multiples to Facilitate Negotiation VALUATION REPORT : Business VALUATION Trends and Strategies p2 ESTATE PLANNING: FLPs - Treat Them with Respect to Preserve Tax BenefitsIt s doubtful that Aretha Franklin s song, Respect, was singing about family limited partnerships (FLPs). But a lack of respect has been the downfall of many FLPs formed for estate planning problem? If the FLP isn t treated as an arm s length business or in other words, if its status as an entity isn t treated with respect it won t pass IRS scrutiny.

7 Know the RulesIn order for an FLP to be effective as an estate planning tool, it must be created and run in accordance with Section 2036 of the Internal Revenue Code. Section 2036 requires that the entity be formed and operated with a legitimate business purpose, not simply as an estate tax reduction the partnership doesn t pass IRS scrutiny, it s likely that the IRS will challenge the FLP s status and demand that the assets in the partnership be brought back into the decedent s estate at full fair market value, thus negating the tax benefits. In questioning the legitimacy of an FLP for tax purposes, the IRS is looking for the right answers to some basic questions about why the entity was formed and how it has operated. For example: Was the FLP formed for legitimate non-tax reasons?

8 If so, what were the reasons, and are they being honored by actual operations of the FLP? If not, the FLP status may be in trouble. Was the FLP operated as a separate, arm s length legal entity? It s against the rules to use FLP assets for personal living expenses or as a bank account for the founding partner/decedent. Were personal assets placed in the FLP and, if so, are they still being used for the benefit of the founding partner/decedent? For example, a personal residence still occupied by the founding partner is difficult to justify. Did the FLP make distributions? If so, were they made according to the partnership agreement? If not, it s hard to make a case for the FLP being operated according to its intent.

9 Were personal and FLP assets comingled? If so, that s a red flag for the IRS. Justify LOM and LOC DiscountsEven if the IRS agrees that the FLP s tax status is legitimate, the agency may challenge the extent of the FLP s VALUATION discounts for lack of marketability (LOM) and lack of control (LOC). While the IRS has issued a range of discounts it deems appropriate in its FLP Appeals Settlement Guidelines, each VALUATION case is considered based on its specific facts and circumstances. A number of cases with high discounts have been won by estates, so it s not impossible to prevail over IRS challenges. But, experts agree that most cases are won or lost on the basis of the VALUATION REPORT , which must be clear, compelling and credible. Ultimately, the VALUATION REPORT must convince the court that its conclusions are rational and logical, and that the FLP has been formed and operated according to the the risks of an IRS challenge, FLPs can still be worthwhile as estate planning tools.

10 Just remember to form and operate them with respect. Our team is familiar with the challenges of FLP valuations. Contact us at for more information about how to properly form and operate an the risks of an IRS challenge, FLPs can still be worthwhile as estate planning s the secret to creating and maintaining value in a company? A unique product or service helps .. think Facebook. A reputation for innovation can set a company apart .. think Apple. Being the first to market is a positive sign .. think for most companies, the formula for success is building value the old-fashioned way: by paying attention to the basic value drivers that promote sustainable growth. Here are some of the elements a VALUATION professional considers when assessing a business: Cash flowIt s trite but true: Cash really is king.