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A common reason business owners need to have their business or family limited partnership (or LLC) appraised is for gift and estate tax purposes. Ownership interests in closely held entities must be valued when transferred as a gift or as part of an estate. Under this scenario, the recognized standard of value is “fair market value,” defined as the amount at which the ownership interest would change hands between a willing buyer and a willing seller, where both parties have reasonable knowledge of the relevant facts. In addition to other valuation standards, valuation reports must meet the valuation guidelines established under Revenue Ruling 59-60 for gift and estate tax purposes. Valuation discounts for lack of control and lack of marketability are often applied when valuing minority interests in closely held entities under the fair market value standard. These valuation discounts, however, are often challenged by the IRS. To help minimize these challenges, it is critical to engage a valuation firm that can provide a professionally-prepared, supportable valuation report.

Income tax strategies are becoming increasingly complex and more highly scrutinized by the IRS. In addition to C to S corporation conversions, charitable contributions, and Section 409A, there are many different types of valuations for income tax planning and compliance purposes. Business dealings that involve purchase price allocations, cancellation of indebtedness, corporate reorganizations, corporate recapitalizations, or divestitures can trigger the need to obtain assistance from a qualified business valuation firm.

The fair market value of common stock in a publicly traded company is easy to obtain using market information. However, when the shares of publicly traded common stock represent a large block of stock (relative to its average daily trading volume), consideration must be given to the potential impact of such a large block of public stock. The trading volume in the open market may not be large enough to absorb the sale of the block of stock held by a particular owner without creating major downward pressure on the price of the stock. Such sale could cause the value of the block of stock to be reduced. Such reduction in the value of the block of stock is commonly referred to as a “blockage discount.” This reduction in the price of the block of stock is a result of the law of supply and demand. Economic theory dictates that when there is a given level of demand for a stock of a public company at a certain price, and if the available supply of that stock is increased, this additional supply of stock in the public company will only be bought at a reduced price that is sufficiently lower to stimulate additional demand for it by buyers.

Charitable donations are a great way to benefit charities and other non-profit organizations. Though it may seem relatively simple to make a charitable contribution, claiming such a donation for income tax purposes may be more complicated than expected if that donation is in the form of a non-cash gift. Instead of cash or other liquid assets, business owners will sometimes donate a portion of their business or investment holding entity to a charitable organization. Depending on certain factors, the IRS may require such donors to supply certain information (i.e., a business valuation) to prove a taxpayer’s right to deduct charitable contributions. Business appraisals for the IRS must be performed by a qualified business valuation professional, which the IRS defines as an appraiser who has been accredited by a national appraisal organization and regularly receives compensation for performing valuations.

A C corporation to S corporation conversion takes place when a C corporation elects to convert its income tax status to that of an S corporation. There are a number of reasons shareholders would make this election, but many advisors would agree that the main incentive is to avoid the second layer of taxes (i.e., the double taxation) on dividend distributions received from the C corporation. If the S corporation is sold or if it sells any of its assets within a certain period of time after the conversion from a C corporation, the current tax code requires that a potential built-in gain (“BIG”) tax be realized on the sale. This BIG tax is based on the unrecognized appreciation in asset value from the period of time when the entity was a C corporation. Accordingly, the fair market value of the entity and its assets as of the effective date of the S corporation election is needed. To compute and document the potential future BIG tax, IRC Section 1374 provides the entity must obtain a valuation on the conversion date. It is essential that a qualified appraiser perform this valuation.

Internal Revenue Code Section 409A (“409A”) provides comprehensive rules regulating the income tax treatment of “nonqualified deferred compensation” paid by a service recipient to a service provider. Deferred compensation is compensation that a worker earns in any given year but that is not paid out until some future year. Such deferred compensation can take the form of stock options, stock appreciation rights, or other similar financial instruments. If a company provides nonqualified deferred compensation to its employees, 409A requires the value of stock options be determined “by the reasonable application of a reasonable valuation method” with certain caveats. Under 409A, stock options issued below the fair market value of the stock can result in draconian tax consequences. While an independent appraisal of shares is not required for private company stock valuations, many companies choose to obtain an independent valuation, which provides a “safe harbor” under 409A.

Since the issuance of FASB Accounting Standards Codification Topic 718 (“ASC 718”), valuing stock-based compensation has been a challenge for private companies. For financial reporting purposes, ASC 718 (formerly FASB Statement No. 123) generally requires that all equity awards granted to employees be accounted for at “fair value.” To meet the fair value measurement objective, the valuation must be based on established principles of financial theory and reflect the characteristics of the instrument. This fair value is measured at the grant date for stock-settled awards and at the subsequent exercise or settlement date for cash-settled awards. Fair value is equal to the underlying value of the stock for “full value” awards such as restricted stock and performance shares, and estimated using an option-pricing model with traditional inputs for “appreciation” awards such as stock options and stock appreciation rights.

An ESOP is a qualified defined-contribution employee benefit plan that enables employees to own stock in the company that employs them. ESOPs are often used as a corporate finance and tax strategy, and are also used to align the interests of a company’s employees with those of the company’s owner(s). Business valuations are essential to the ESOP process. The valuations are needed both for the initial stages of the ESOP formation and implementation as well as the administration side. If shareholders of a company are considering selling shares to an ESOP, a business valuation is critical for the ESOP feasibility study. This process is an important first step that allows the owners of the company to decide whether an ESOP transaction makes sense from a business standpoint. If the owners of the company decide to pursue the ESOP structure, a fairness opinion is needed for the implementation of the ESOP (as well as if the ESOP is later sold or terminated). Once the ESOP owns the shares, the ESOP trustee is required under federal law (ERISA) to obtain an annual business valuation update to determine the value of the shares.

The valuation of private equity investments and hedge funds can be a challenging exercise due to the illiquid nature of the assets as well as other complexities involved. Moreover, private equity and hedge fund valuations have been subject to increased review from both investors and regulators. The International Private Equity and Venture Capital Valuation Guidelines, Private Equity Industry Guidelines Group, and U.S. Private Equity Valuation Guidelines help provide a framework for valuing such investments at fair value that is consistent with U.S. GAAP accounting and FASB Accounting Standards Codification Topic 820 (“ASC 820”). ASC 820 prescribes a principle-based fair value measurement that is consistent with market participant assumptions. “Fair value” is defined in ASC 820 as “the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date.” Given the complexities and increased review by investors and regulators, when determining the value of these assets, it is critical to engage a qualified business appraisal firm.

Accounting for business combinations has historically been a hot button topic in financial reporting. With the increase in number of intangible assets being acquired through business combinations, the need for better financial information has increased. FASB Accounting Standards Codification Topic 350 (“ASC 350”), formerly FASB Statement No. 142, provides guidance on financial accounting and reporting related to goodwill and other intangibles for U.S. GAAP purposes. Typically, goodwill and certain intangibles are not amortized. Rather, these intangible assets must be periodically tested for impairment at the reporting unit level. Under the old rules, if it was “more likely than not” that the fair value of the reporting unit was less than its carrying value, then a two-step impairment test was performed to identify potential goodwill impairment and measure the amount of loss to be recognized, if any. In September 2011, the FASB issued ASU 2011-08 to help alleviate the burden of the two-step impairment test process. Under the new rules, an entity has the option to first assess qualitative factors to determine whether the existence of events or circumstances leads to a determination that it is more likely than not that the fair value of a reporting unit is less than its carrying amount. If, after assessing the totality of these qualitative factors, management determines it is not “more likely than not” that the fair value of a reporting unit is less than its carrying amount, then performing the two-step impairment test is unnecessary.

Accounting for business combinations has historically been a hot button topic in financial reporting. With the increase in number of intangible assets being acquired through business combinations, the need for better financial information has increased. FASB Accounting Standards Codification Topic 350 (“ASC 350”), formerly FASB Statement No. 142, provides guidance on financial accounting and reporting related to goodwill and other intangibles for U.S. GAAP purposes. Typically, goodwill and certain intangibles are not amortized. Rather, these intangible assets must be periodically tested for impairment at the reporting unit level. Under the old rules, if it was “more likely than not” that the fair value of the reporting unit was less than its carrying value, then a two-step impairment test was performed to identify potential goodwill impairment and measure the amount of loss to be recognized, if any. In September 2011, the FASB issued ASU 2011-08 to help alleviate the burden of the two-step impairment test process. Under the new rules, an entity has the option to first assess qualitative factors to determine whether the existence of events or circumstances leads to a determination that it is more likely than not that the fair value of a reporting unit is less than its carrying amount. If, after assessing the totality of these qualitative factors, management determines it is not “more likely than not” that the fair value of a reporting unit is less than its carrying amount, then performing the two-step impairment test is unnecessary.

Many closely held businesses in the U.S. are family-owned. Many business owners spend a great deal of time building their enterprises, but a good number of them, however, fail to properly strategize their exit plan. Business exit planning is sometimes referred to as business succession planning, but there are differences. Succession planning is the process of identifying successors and providing some type of training (or passing the torch) to successfully transition management within a closely held business. Exit planning helps maximize the business owner’s investment return and minimize his/her tax liability when transferring his/her company. For most entrepreneurs, leaving their business is likely to be the biggest transaction of their lifetimes. When a business owner decides to move on either through an exit or a succession plan, it is essential that the owner obtain a professional business valuation. Going through a formal valuation process can be the cornerstone for determining what steps owners need to take to achieve their succession or exit goals. Since 1995, VSI has worked with many business owners and their advisors in helping them navigate through the business valuation process to assist them in meeting their financial goals.

Numerous closely held businesses and firms have more than one owner or partner. A sudden, unplanned departure of a co-owner can have a major impact on the future success of the business. As a result, many private companies with two or more owners enter into buy/sell agreements. A properly drafted buy/sell agreement provides a roadmap for the transfer of business interests in certain voluntary and involuntary circumstances such as retirement, disability, or death of one of the co-owners (i.e., triggering events). A buy/sell agreement can also help establish the value that one co-owner would pay another to purchase the other owner’s share in the company. Buy/sell agreements can also outline the funding and payment terms of the buyout upon certain triggering events. Typical funding mechanisms include life insurance and/or promissory notes. Valuation professionals are often involved in valuing closely held business interests pursuant to a buy/sell agreement. In addition, they may be involved in consulting engagements related to helping the attorneys draft certain provisions of these agreements. Buy/sell agreements tend to vary by type and complexity, and the parties involved should consider several factors from a valuation perspective when establishing these buy/sell agreements. Poorly drafted buy/sell agreements with ambiguous provisions can obstruct the buyout transaction and create significant costs and delays for the parties involved. Often times, the use of static formulas for this purpose in lieu of either outlining structured negotiations or seeking out third-party valuations can cause drawn-out and costly partner disputes. Business owners and their attorneys frequently rely on VSI to help in the planning stages of drafting their buy/sell agreement as well to assist with the business valuation process when a triggering event occurs pursuant to such agreement.

Intangible assets can refer to different things, but they generally signify assets that do not have physical substance or form. Intangible assets include brands, goodwill, customer relationships, royalties, trade names, copyrights, and software, just to name a few. Intangible assets can be difficult to value; to complicate matters, for intangible assets that are not producing income, the technology associated with the asset may be too new to understand how much cash flow it can generate for its owner or what competitive advantages it may offer. Intangible asset valuations are used, in particular, in accounting practice to recognize assets in business combinations at their fair value. Intangible asset valuations can also be conducted for tax compliance or planning purposes, as well as for lending purposes. When carrying out an intangible asset valuation, widely accepted methodologies based on income, market, and cost approaches should be considered.

Intellectual property (“IP”) shares many of the features associated with real and personal property. For example, IP is an asset, and, as such, it can be licensed, exchanged, bought, sold, or gifted like any other form of property. Moreover, the IP owner has the right to prevent the unauthorized use or sale of the property. IP derives its value from a wide range of major factors such as market share, legal protection, barriers to entry, IP’s profitability, growth projections, industrial and economic factors, remaining economic life, and new technologies. IP held by corporations and private businesses can be unknown, undervalued, and unappreciated assets. There are numerous reasons why an IP asset may be valued. Some of those reasons include transaction planning, financial reporting, litigation, bankruptcy, financing, and tax planning/reporting. There are three general methodologies to value IP: the cost, the income, and the market-based methods. Due to the complex nature of IP (and other intangible assets), it is important to engage a valuation firm that has the industry expertise in the valuation of intangibles and IP and understands the appropriate valuation methods and approaches to use in this area.

When a buyer seeks bank financing to purchase an existing business or applies for a loan to borrow capital for other business purposes, lenders may require some form of collateral to help reduce the negative impact of a potential default. Such forms of collateral could be the assets of the company (both tangible and intangible) or stock in the company. As part of the underwriting process, lenders may request a business valuation of the closely held business and/or its assets. There are several standards of values to consider, including fair market value, market value, net orderly liquidation value, and other values that the lender may require. Some of the specific purposes and uses of an appraisal to be used by lenders include commercial financing, SBA loans, and asset-based lending. VSI works with lenders and other financial institutions to provide thorough, accurate, and objective valuation reports so that the lenders can make prudent underwriting decisions.

A common reason for performing a business valuation is to prepare for a company’s sale, merger, or acquisition. A merger is the combining (or pooling) of two businesses, while an acquisition is the purchase of the ownership of one business by another. Shareholders in a company who are considering taking over another business must determine whether it would be beneficial to make such a purchase. Whether buying or selling a business, it is extremely important to know a company’s true value. Business valuations in merger & acquisition (“M&A”) situations are complex because they often involve issues like synergy and control, which could enhance the value of a target company. Many business owners are uncertain or unrealistic about their company’s current fair market value. Relying on gut instinct or industry rules of thumb to set an asking price could increase the risk of leaving money on the table. Also, quick-and-dirty pricing formulas can be outdated, ambiguous, or fail to take into account the unique characteristics of a specific business. During any transaction, a knowledgeable, unbiased, and well-supported valuation opinion can provide the strong foundation needed for potential negotiations.

End of life planning, transitions, and wealth transfer can sometimes create family feuds and discord. In reality, the more wealth being transferred usually means the more potential for family feuds. Every so often, unfortunately, those disputes lead to litigation. Trust and estate litigation has become increasingly common over the years, especially as the Baby Boomers continue to age. Conflicts arising between and among trustees, executors, beneficiaries, guardians, partners, agents (powers of attorney), and corporations are becoming commonplace. Trust and estate litigation matters come with unique challenges, often driven by complicated and interwoven legal, emotional, financial, and strategic issues. Estate litigation usually develops from beneficiaries contesting or attempting to nullify a will, estate, or trust. The purpose of a will contest is to obtain a legal ruling on whether the instrument is valid, as well as a verdict as to who is entitled to benefit from it. Trusts are another type of estate planning vehicle that often require litigation to resolve issues. Executors and trustees have responsibilities that require the utmost good faith, diligence, and prudence, and accordingly, they are said to hold a fiduciary duty, which requires them to not only act in good faith but also distribute assets properly and expeditiously. When there is a suspected breach of fiduciary duties, parties may seek to remove or change an executor or trustee, which sometimes lead to litigation. VSI is uniquely trained and well-positioned to work with plaintiffs, defendants, and as a financial neutral in trust and estate litigation.

Shareholder/partner disputes can be highly sensitive and complex. Shareholder disputes often involve a minority owner who believes he/she has been mistreated or disagrees with decisions made by the controlling owner. Occasionally, such disagreements can be too important to resolve peacefully and lead to costly and time-consuming litigation. The commotion caused by such a dispute can be disruptive for management and, therefore, have a deleterious effect on a business’s value. Often, these disagreements lead to a minority shareholder or business partner to exit the company. If a conflict among business partners intensifies to such an extent, that the continuation of the enterprise may be compromised, buying out one of the parties may be a solution. During this buy-out process, the valuation of the shares of the enterprise becomes an important issue. Reaching an agreement between the parties regarding valuation and other financial issues can be particularly challenging. Business valuation experts often play an important role in resolving shareholder disputes by providing independent and unbiased opinions of value for the shares in question. It is crucial to retain business valuation experts who not only have a broad range of analytical and investigative skills, but who also bring to the table the ability to create a compelling, independent case. VSI has extensive experience working with business owners and their legal counsel as independent valuation experts where negotiations have either commenced or have broken down so that litigation has been initiated.

Valuing a business or a business interest in a divorce has become one of the most common reasons for engaging a business valuation professional. When a couple goes through a marital dissolution process, it is often necessary to determine the value of any privately-held business that they owned during the course of the marriage. As part of the divorce process, the assets and liabilities will have to be divided between the parties through a process called “equitable distribution.” Essentially, a court will classify property as either marital or separate, place a value on the property, and then distribute amongst the spouses. In many cases, one of the most contentious and difficult issues in a divorce proceeding is the valuation and distribution of marital property. This is particularly true when significant assets are involved or when the matter involves high-profile individuals. When the stakes are significant, it is important to work with valuation experts that have extensive experience, skills, and a track record of success. One question that can make a valuation more complex is the issue of personal and professional goodwill as a business asset. This goodwill can attach to the enterprise or to the working owner depending on the facts and circumstances surrounding the case. Business valuation professionals must also define a standard of value before proceeding with the valuation analysis. VSI’s team of experts have over 20 years of experience in advising attorneys and their clients in complex and demanding marital dissolution matters.

Alternative dispute resolution (ADR) (including arbitration and mediation) refers to legal procedures for resolving disputes outside the court system. ADR proceedings can offer the disputing parties certain advantages including faster resolution and potentially lower legal fees. Mediation continues to grow in popularity as a means of resolving legal disputes and allows the parties to air their grievances face-to-face in a confidential setting with the help of a skilled mediator. Arbitration is a form of adjudication in which the neutral decision-maker (the arbitrator) is not a judge or an official of an administrative agency. Unlike mediation where the disputing parties determine the result, in arbitration, the arbitrator resolves the dispute based on evidence or other submissions at a hearing. An arbitration resembles litigation more than mediation; however, it is less formal and more flexible than litigation. More and more disputing parties are choosing to settle their differences through ADR proceedings in an effort to expedite dispute resolutions and minimize legal costs. As a result, the need to hire a valuation professional as an expert in ADR proceedings has increased over the years. In mediation, a valuation expert can assist in analyzing the potential theories of the case, developing damage calculations, and evaluating the range of potential damages. In arbitration, there is greater flexibility in the valuation expert’s role because there are no evidentiary rules that limit whether an expert can be used. Arbitrators are generally subject matter experts in their own right, and they will likely understand the core concepts of the case. This allows the valuation expert to concentrate his/her testimony on complex matters. VSI’s valuation professionals are available and highly qualified to provide business valuation expert opinions in mediation, arbitration, or court proceedings.

Business valuation expert witnesses can have a significant impact on the outcome of a litigation matter or an arbitration or mediation hearing. The importance of selecting the right expert witness is often underestimated – but it can be the most important decision an attorney makes in a case. Business valuation expert witnesses and consultants are often used in divorces, business dissolutions, economic losses, contract breaches, partner disputes, dissenting shareholders, and bankruptcies. Before selecting a business valuation expert witness or consultant, the attorney should consider whether they have experience as an expert witness, what professional designations they hold, their continuing education in areas such as business valuations, and their reputation as a valuation analyst. A valuation expert’s greatest asset is their reputation for objectivity. In large, complex cases, the valuation expert can provide an objective view, help find the relevant facts, strengths, and weaknesses of the case, and manage the disputing party’s expectations. For these reasons, hiring the right business valuation expert early on can be incredibly beneficial to building a strong case. VSI has extensive experience in assisting attorneys through all phases of litigation: pre-litigation planning, discovery, mediation, and trial/arbitration.

Commercial litigation cases frequently involve claims for damages measured as lost profits or loss of business value. Such economic damages can occur in many different types of commercial litigation cases, including contract disputes, intellectual property infringement, business torts, unfair competition, and negligence claims. In commercial litigation, valuation professionals are often engaged as an expert to provide an opinion on the calculation of economic damages suffered by an alleged injured party. Economic damages are meant to return the plaintiff back to his/her financial position that the plaintiff would have been in, “but for” the defendant’s alleged harmful acts. In an economic damages calculation, the two typical methods used are either a lost profit or lost business value computation. When the alleged damage is for a finite period of time and is related to a separate identifiable cash flow, a lost profits approach is generally the appropriate method to use. This approach represents the difference between profits the plaintiff would have achieved, “but for” the harmful event, and profits actually attained. A lost profits analysis is commonly employed in breach of contract, intellectual property, and general commercial litigation cases. In situations where the loss of earnings is considered or assumed to be permanent and into perpetuity, or where a business is destroyed completely, a lost business value approach is generally appropriate. This approach is typically applied in business destruction, shareholder oppression, and dissenting shareholder cases.