Davis/Chambers & Company, Ltd.    

Appraisal Process

Fair market value is widely understood to mean the value at which a willing buyer and a willing seller, both being informed of the relevant facts about a transaction, could reasonably be expected to conduct the transaction, neither party acting under any compulsion to do so.

Owners, directors, managers, and any other individual with a fiduciary relationship to owners of any business enterprise are charged with the responsibility to fairly maximize value to the owners.  Purchasers of business enterprises or property understandably desire to purchase the assets or securities at a value which will maximize their opportunity for a return on their investment.  These two objectives are often in conflict creating the need for an independent third party to establish a fair market value under which the transaction can be completed.  The appraisal process that follows gives a brief outline as to the steps necessary to reach a valuation conclusion that meets the definition of fair market value considering the purpose of the specific assignment and the generally accepted methodologies of both the appraisal industry and the Internal Revenue Service.

Revenue Ruling 59-60

This Internal Revenue Service ruling was issued in 1959 and established the basic structure for business appraisals that has been used for the past forty years.  When appraising the value of a closely-held company, Revenue Ruling 59-60 makes the following comments:

"A determination of fair market value, being a question of fact, will depend upon the circumstances in each case.  No formula can be devised that will be generally applicable to the multitude of different valuation issues arising in estate and gift tax cases.  Often, an appraiser will find wide differences of opinion as to the fair market value of a particular stock.  In resolving such differences, he should maintain a reasonable attitude in recognition of the fact that valuation is not an exact science.  A sound valuation will be based upon all the relevant facts, but the elements of common sense, informed judgment and reasonableness must enter into the process of weighing those facts and determining their aggregate significance."

"It is advisable to emphasize that in the valuation of the stock of closely-held corporations or the stock of corporations where market quotations are either lacking or too scarce to be recognized, all available financial data, as well as all relevant factors affecting the fair market value, should be considered.  The following factors, although not all inclusive, are fundamental and require careful analysis in each case:"

1.       The nature of the business and the history of the enterprise from its inception.

2.       The economic outlook in general and the condition and outlook of the specific industry in particular.

3.       The book value of the stock and the financial condition of the business.

4.       The earning capacity of the company.

5.       The dividend paying capacity.

6.       Whether or not the enterprise has goodwill or other tangible value.

7.       Sales of the stock and the size of the block of stock to be valued.

8.       The market price of stock of corporations engaged in the same or similar line of business having their stocks actively traded in a free and open market, either on an exchange or over-the-counter.

Basic Approaches

Within the framework set forth above, the three basic approaches to value will be analyzed.  These are as follows:

Cost - What is the replacement cost of an asset.

Net Asset Value Method - Used for holding companies that do not add additional value to the underlying assets.  Commonly used for the valuation of family limited partnerships.

Liquidation Methods - Common when a business is no longer viable.

Market - Comparing the subject to other similar companies.

Comparable Publicly Traded Company Method - Use of public, marketable, minority transactions to determine comparative pricing ratios (Price to: revenue, earnings, cash flow, enterprise or book value).

Merger & Acquisition Transactions - The use of merger and acquisition data to determine an entity's value through the use of ratios similar to those used in the previous method.

Income - Analysis of the return on investment to the investor.

Capitalization of Earnings Method - Single period capitalization of the owner's discretionary cash flow to determine an entity's value.

Discounted Cash Flow Method - Multi-period model that discounts the owner's discretionary cash flow back to the present. An assumption is the use of a terminal value calculated using the capitalization of earnings method.

The Work Process -- Going Concern Business Valuations

Each specific valuation has its unique characteristics and requires unique analysis and presentation to arrive at a supportable value for the enterprise.  In general, however, the following steps must be performed in order to complete the assignment:

1.     Determine the scope of the engagement. Who is the ultimate reader of the report and why is the valuation being performed?

2.     Compile the financial statements into a side-by-side format and restate the financial statements on a common size and growth format. By compiling the financial information in this manner, we can look for trends and anomalies to discuss with management.

3.     Interview key management personnel to get a full understanding of the company, its industry, and its outlook.

4.     Perform research on the company's industry.

ü     Locate other public companies within the same industry as the subject.

ü     Collect data on these companies (five year financial data, current market stock prices, etc.).

ü     Look for merger and acquisition transaction within the industry.

ü     Research various periodicals for an understanding of trends in the industry.

5.     Analyze various price to value ratios to aid in the valuation of the subject.

ü     Equity Ratios: Price to revenues, earnings, cash flow, book value, etc.

ü     Invested Capital Ratios: Market value of invested capital (debt plus equity) to revenues; earnings after taxes less interest; earnings before interest and taxes (EBIT); earnings before interest, taxes and depreciation (EBDITA); book value less debts, etc.

6.     Perform an analysis of value based on one of the income approach methods.

7.     Reach a conclusion of value with an eye towards Revenue Ruling 59-60's requirement that an appraiser not use a standard formula but weigh the factors discussed with his professional judgment to determine a consensus of value.

ü     Simple average of the indicated values.

ü     Weighted average of the indicated values based on the appraiser's professional judgment.

8.     Make adjustments for control, marketability, and other issues influencing value.

9.     Distill all of the above into a comprehensive written appraisal report.

The Work Process -- SFAS 141 (Business Combinations)

This process is similar to the process discussed with regard to the valuation of a going concern. However, the process requires additional steps. After determining the value of the acquired entity, the appraiser turns to the allocation of the value among the fixed assets, intangible assets and Goodwill. Intangible assets are definable intangibles that meet the requirements of FASB 141 (contracts, other legally definable assets or assets that are "separable" as defined in the Statement). The appraiser and management must work together to determine which assets are to be considered intangibles. The remaining consideration (the amount not allocated among the current assets, fixed assets and identifiable intangible assets) is assigned to Goodwill.

The Work Process -- SFAS 142 (Goodwill and Other Intangible Assets)

This process is similar to the methodology described above for FASB 141. However, the goal of this process is to determine if the values of the Goodwill and the intangible assets have been impaired. The first step in this process is to determine the value of the "Reporting Unit." If the appraised value is greater than the carrying value of the reporting unit, then the analysis is concluded.

If, however, the appraised value of the reporting unit is less than its carrying value, we must determine the extent of the impairment to the assets. Impairment is first charged to Goodwill and next allocated among the intangible assets.

The Work Process -- SFAS 144 ( Accounting for the Impairment or Disposal of Long-Lived Assets)

This process is similar to the methodology described above for FASB 142. However, the goal of this process is to determine if the values of the  "Long Lived Assets" have been impaired due to a change in the business environment. The first step in this process is to determine the value of the "Reporting Unit." If the appraised value is greater than the carrying value of the Reporting Unit, then the analysis is concluded.

If, however, the appraised value of the Reporting Unit is less than its carrying value, we must determine the extent of the impairment to the assets. Impairment is first charged to Goodwill and the intangible assets. Any leftover impairment is allocated among the fixed assets.

A complicating factor in FASB 144 analysis is that the Company can choose to reemploy the assets. If redeployment is an option, the appraiser must weigh the probabilities of the redeployment options as well as the economic cost and probabilities of a successful redeployment. The weighted redeployment analysis then becomes the comparative value for determining any write-downs.

This analysis requires considerable work and coordination between the appraiser and the Company.

The Work Process - Family Limited Partnerships

A Family Limited Partnership (FLP) is a business, but the FLP typically acts as a holding company and has specific characteristics as defined in the partnership agreement.  The partnership agreement typically defines management responsibilities, and it addresses the desires of the partners with regard to control, liability, marketability, and a host of other unique characteristics which are not generally associated with corporate structure.

The standard approach for appraising a family limited partnership is the Net Asset Value Method (NAV). The discounted cash flow method is also a possibility, but this method is normally only useful for larger, mature partnerships.

Steps in the NAV approach to valuation:

 1.     List and total the assets and liabilities of the partnership.

 2.     Segregate the list into distinguishable categories (marketable securities, real estate, undivided real estate, oil and gas interest, partnership interest, timber, annuities, life insurance, options, notes, etc.).

3.     Adjust the value of each category by comparing it to a public comparable.

4.     Make adjustments for the financial history of the partnership, including its net income, change in gross value and distributions.

5.      Sum the categories.