Valuing a business: the analysis and appraisal of closely held companies PDF
Preview Valuing a business: the analysis and appraisal of closely held companies
Valuing A Business: The Analysis and Appraisal of Closely Held Companies, Fourth Edition by Shannon P. Pratt, Robert F. Reilly and ISBN: Robert P. Schweihs 0071356150 McGraw-Hill © 2000, 960 pages Entirely revised and up-to-date, this key reference presents a set of instructions for executing any business valuation project. Table of Contents Colleague Comments Back Cover Table of Contents Valuing a Business—The Analysis and Appraisal of Closely Held Companies, Fourth Edition Preface Part I State of the Profession, the Engagement, and the Basic Theory Chapter 1 - Business Valuation Standards and Credentials Chapter 2 - Defining the Assignment Chapter 3 - Business Valuation Theory and Principles Part II Gathering and Analyzing Data Chapter 4 - Gathering Company Data Chapter 5 - Site Visits Chapter 6 - Researching Economic and Industry Information Chapter 7 - Analyzing Financial Statements Chapter 8 - Financial Statement Ratio Analysis Part III Business Valuation Approaches and Methods Chapter 9 Income Approach: Discounted Future Economic Income - Method Chapter 10 Income Approach: Capitalized Future Economic Income - Method Chapter 11 - Market Approach: Guideline Publicly Traded Company Method Chapter 12 Market Approach: Guideline Merged and Acquired Company - Method Chapter 13 - The Capitalized Excess Earnings Method Chapter 14 - Asset-Based Approach: Asset Accumulation Method Part IV Discounts, Premiums, and the Value Conclusion Chapter 15 - Control and Acquisition Premiums Chapter 16 - Discount for Lack of Control Chapter 17 - Discounts for Illiquidity and Lack of Marketability Chapter 18 - Other Valuation Discounts Chapter 19 - Valuation Synthesis and Conclusion Part V Writing and Reviewing Business Valuation Reports Chapter 20 - Writing the Business Valuation Report Chapter 21 - Sample Report Chapter 22 - Reviewing a Business Valuation Report Part VI Valuing Specific Securities and Interests Chapter 23 - Valuing Debt Securities Chapter 24 - Valuing Preferred Stock Chapter 25 - Valuing Stock Options Chapter 26 - Pass-Through Entities Part VII Valuations for Specific Purposes Chapter 27 - Valuations for Estate and Gift Tax Purposes Chapter 28 - Estate and Gift Tax Court Cases Chapter 29 - Buy-Sell Agreements Chapter 30 - Valuation for Income Tax Purposes Chapter 31 - Income Tax Court Cases Chapter 32 - Valuations for Employee Stock Ownership Plans Chapter 33 - ESOP Court Cases Chapter 34 - Valuations for Ad Valorem Taxation Chapter 35 - Dissenting Stockholder and Minority Oppression Actions Chapter 36 - Dissenting Stockholder and Minority Oppression Court Cases Chapter 37 - Valuations for Marital Dissolution Purposes Chapter 38 - Marital Dissolution Court Cases Part VIII Litigation and Dispute Resolution Chapter 39 - Litigation Support Services Chapter 40 - Expert Testimony Chapter 41 - Arbitration and Mediation Appendix A- International Glossary of Business Valuation Terms Index List of Exhibits Back Cover The Business World's Most Accurate and Indispensable Valuation Reference- -Updated for a New Century and Business Environment First published in 1981, Valuing a Business by Shannon P. Pratt, Robert F. Reilly, and Robert P. Schweihs has become today's standard business valuation reference. Look to this substantially revised, completely updated Fourth Edition for in-depth, authoritative coverage that includes: • Credentials and Standards • Theory and Principles • Gathering Company, Industry, and Economic Data • Analyzing Financial Statements • Business Valuation Approaches and Methods: Income, Market, and Asset-Based • Control and Acquisition Premiums • Lack of Marketability, Lack of Control, and Other Discounts • Writing and Reviewing Valuation Reports • Valuing Debt Securities, Preferred Stock, Stock Options, and Pass- Through Securities • Valuations for Specific Purposes: Estate and Gift Tax, Buy-Sell Agreements, Income Tax, Employee Stock Ownership Plans, Ad Valorem Taxation, Dissenting Stockholder, Minority Oppression, Marital • Dissolution • Litigation Support • Expert Witness Testimony • Arbitration and Mediation Comprehensive in coverage and authoritative in treatment, Valuing a Business is recognized worldwide as an unquestionable resource for business valuation information. With this updated edition, it maintains its role as the standard reference for defining the methodology of business valuation--for businesses of all sizes--and then arriving at an accurate and supportable estimation of value. About the Authors Shannon P. Pratt, DBA, Robert F. Reilly, MBA, and Robert P. Schweihs, MBA, are managing directors of Willamette Management Associates, one of the oldest and largest independent valuation consulting, economic analysis, and financial advisory firms in the country. Dr. Pratt, a chartered financial analyst, fellow of the American Society of Appraisers, and life member of the Institute of Business Appraisers, is also editor-in-chief of the monthly newsletters Shannon Pratt's Business Valuation Update and Judges & Lawyers Business Valuation Update. Mr. Reilly is an accredited senior appraiser (certified in business valuation), certified business appraiser, chartered financial analyst, certified public accountant (accredited in business valuation), certified management accountant, and state-certified affiliate of the Appraisal Institute. He currently serves as an editor and contributor to such professional journals as The American Bankruptcy Institute Journal and The Journal of Property Tax Administration. Mr. Schweihs, an accredited senior appraiser of the American Society of Appraisers (certified in business valuation), is a trustee of The Appraisal Foundation and is a frequent expert witness in valuation court cases and speaker to professional societies. Among them, the three have written or edited numerous professional valuation books, including Valuing Small Businesses and Professional Practices, Valuing Intangible Assets, The Handbook of Advanced Business Valuation, and J udges & Lawyers Business Valuation Handbook. Valuing a Business—The Analysis and Appraisal of Closely Held Companies, Fourth Edition Dr. Shannon P. Pratt Robert F. Reilly Robert P. Schweihs Fourth Edition Shannon P. Pratt, DBA, CFA, FASA, MCBA Managing Director Willamette Management Associates Robert F. Reilly, CPA, CFA, ASA, CBA Managing Director Willamette Management Associates Robert P. Schweihs, ASA Managing Director Willamette Management Associates Library of Congress Cataloging-in-Publication Data Pratt, Shannon P. Valuing a business: the analysis and appraisal of closely held companies / by Shannon P. Pratt, Robert F. Reilly, Robert P. Schweis. —4th ed. p. cm. Includes bibliographical references (p. ). ISBN 0-07-135615-0 1. Corporations—Valuation. 2. Corporations—Valuation—Law and legislation—United States I. Reilly, Robert F. II. Schweis, Robert P. III. Title. HG4028.V3P7 2000 657'.73—dc21 00–029948 CIP Copyright © 2000 by Shannon P. Pratt, Robert F. Reilly, and Robert P. Schweihs. All rights reserved. Printed in the United States of America. Except as permitted under the United States Copyright Act of 1976, no part of this publication may be reproduced or distributed in any form or by any means, or stored in a data base or retrieval system, without the prior written permission of the publisher. 1 2 3 4 5 6 7 8 9 0 DOC/DOC 0 5 4 3 2 1 0 The sponsoring editor for this book was Kelli Christiansen and the production supervisor was Elizabeth Strange. It was set in 11/13 Times Roman by Hendrickson Creative Communications. This publication is designed to provide accurate and authoritative information in regard to the subject matter covered. It is sold with the understanding that neither the author nor the publisher is engaged in rendering legal, accounting, or other professional service. If legal advice or other expert assistance is required, the services of a competent professional person should be sought. —From a Declaration of Principles jointly adopted by a Committee of the American Bar Association and a Committee of Publishers McGraw-Hill books are available at special quantity discounts to use as premiums and sales promotions, or for use in corporate training programs. For more information, please write to the Director of Special Sales, Professional Publishing, McGraw-Hill, Two Penn Plaza, New York, NY 10121-2298. Or contact your local bookstore. Information contained in this work has been obtained by The McGraw-Hill Companies, Inc. ("McGraw-Hill") from sources believed to be reliable. However, neither McGraw-Hill nor its authors guarantee the accuracy or completeness of any information published herein and neither McGraw-Hill nor its authors shall be responsible for any errors, omissions, or damages arising out of use of this information. This work is published with the understanding that McGraw-Hill and its authors are supplying information but are not attempting to render engineering or other professional services. If such services are required, the assistance of an appropriate professional should be sought. To Millie To Janet To Mary Beth Preface The book is designed to serve three purposes: 1. A comprehensive and updated reference for currently active business appraisers. 2. An introductory text on business valuation for both academic courses and beginning practitioners. 3. A reference for nonappraisers who use and/or evaluate business appraisals. The authors have endeavored to present the current state of the art, thinking, and practice of the business valuation profession, which has progressed significantly since the third edition in 1996. Where clear consensus on positions exist, such consensus is presented. Where there are differing opinions, we try to present the issues clearly and fairly, reflecting extensive outside review (see Acknowledgments). We also present considerable documentation of various courts' positions on controversial issues. Emphasis on Valuations That Withstand Challenge Virtually every business valuation is potentially subject to challenge from one party or another—one or more buying or selling parties, taxing authorities, ESOP beneficiaries, a spouse in a divorce, or any of a variety of interested parties. The section on valuations for specific purposes has been greatly expanded and enhanced by chapters and sections on court cases detailing which aspects of valuation in various contexts the courts have provided guidance on. These valuation contexts, with extensive discussion of legal challenges and the courts' positions include, especially: (cid:131) Gift and estate taxes. (cid:131) Income taxes. (cid:131) Employee stock ownership plans. (cid:131) Marital dissolutions. (cid:131) Dissenting stockholder and minority oppression actions. It is very enlightening to see just what methods, procedures, and data have held up under challenge and what methods, procedures, and data (or omissions in any of these categories) have caused appraisers to be admonished or rebuked by the courts. These insights should help analysts to avoid pitfalls, and should help attorneys, clients, and other users of valuations to critically evaluate valuation work products in light of the legal contexts that may govern the acceptability of these valuations. Other Changes Since the Third Edition This edition reflects the substantial advances in the tools and sophistication in business valuation that have evolved during the last half of the 1990s. These advances fall broadly into two categories: 1. Major advances in the quantity, quality, and accessibility of empirical data available to support business valuation conclusions. 2. Growing consensus within the business valuation professional community on standards, methodology, and terminology. With the publication by co-authors Robert Reilly and Robert Schweihs of the book, Valuing Intangible Assets (McGraw-Hill, 1999), which addresses in detail the important and growing business valuation–related discipline of the analysis and appraisal of intangible assets and intellectual properties, we were able to eliminate the three-chapter intangible asset section that had appeared in the third edition of this book. This has allowed space for additions and expansions in many other important areas: (cid:131) Extensive court case analysis and citations, as noted in the previous section. (cid:131) An added chapter on valuing stock options. (cid:131) The new International Glossary of Business Valuation Terms (see Appendix A), jointly developed by the five North American professional business valuation organizations. (cid:131) Greatly expanded data for the market approach. (cid:131) For privately held company mergers and acquisitions, Pratt's Stats (entirely new since the third edition) and Bizcomps, IBA Market Database, and Done Deals (considerably expanded since the third edition). (cid:131) For guideline publicly traded companies, EDGAR (the SEC Electronic Data Gathering and Retrieval System). (cid:131) New chapters on control and acquisition premiums and other discounts. (cid:131) A section on mediation added to the chapter on arbitration. (cid:131) A revised chapter on reviewing a business valuation report, which has been adopted by the American Society of Appraisers for peer review of business valuation reports submitted for accreditation. (cid:131) Hundreds of updated data sources and bibliographical references. Business Valuation Continues to Be Dynamic The momentum of business valuation developments of the last five years is sure to continue into the new millennium. Very importantly, the positions of various courts on many business valuation issues continue to evolve. We will reflect these developments in future editions. Please address your comments, observations, and suggestions to any of us at the addresses below. In the meantime, Shannon Pratt will continue to provide timely updates through his two monthly newsletters: Shannon Pratt's Business Valuation Update and Judges and Attorneys Business Valuation Update and the Business Valuation Online Library (www.BVLibrary.com). Readers may receive complimentary current issues of these newsletters by contacting Shannon Pratt at the telephone number or e-mail address listed below or at (888) BUS-VALU. Shannon P. Pratt Willamette Management Associates 111 S.W. Fifth Avenue, Suite 2150 Portland, Oregon 97204 (503) 222-0577 (503) 222-7392 (fax) [email protected] Robert F. Reilly Willamette Management Associates 8600 West Bryn Mawr Avenue, Suite 950 Chicago, Illinois 60631 (773) 399-4300 (773) 399-4310 (fax) [email protected] Robert P. Schweihs Willamette Management Associates 8600 West Bryn Mawr Avenue, Suite 950 Chicago, Illinois 60631 (773) 399-4300 (773) 399-4310 (fax) [email protected] Acknowledgments As with previous editions, this fourth edition has benefited immeasurably from peer review by a dedicated group of professionals who provided valuable input and assistance. In addition to review by a diverse group of practitioners in the business valuation community, the tax, family law, and shareholder dispute chapters have benefited from review by leaders in the respective specialties in the legal community. We wish to thank the following individuals who have reviewed the entire manuscript and provided commentary and suggestions for this edition. We believe this volume truly represents a consensus of a broad cross section of the practitioners from all facets of the business valuation community: R. James Alerding Gilbert E. Matthews Clifton Gunderson LLC Sutter Securities Incorporated Stephen J. Bravo Richard M. Wise Apogee Business Valuations Inc. Wise, Blackman M. Mark Lee KPMG Peat Marwick Portions of the manuscript were also reviewed by the following individuals: Mel H. Abraham James S. Rigby Jr. The Accounting Offices of The Financial Valuation Group Mel H. Abraham Ronald D. Aucutt Bruce L. Silverstein McGuire Woods Battle & Boothe LLP Young Conway Stargatt & Taylor, LLP The Hon. William A Christian Gary R. Trugman Chief District Court Judge Trugman Valuation Associates Inc. State of North Carolina 11th District Several members of the staff of Willamette Management Associates provided assistance with this edition. The sample report (Chapter 21) was prepared by Brian M. Swift, an associate in our Chicago office. Chapter 6, Gathering Economic and Industry Data, was prepared by Victoria A. Platt, senior research associate in our Chicago office, and Charlene M. Blalock, research associate in our Portland office. Matthew S. Maudlin, an associate in our Portland office, checked the accuracy of the mathematical formulas and calculations and prepared several exhibits. Charlene Blalock prepared the chapter bibliographies. Other members of the Willamette Management Associates staff reviewed or prepared portions of chapters. Thomas J. Millon, director of our McLean, Virginia, office reviewed portions of the manuscript. Chapter 32, Valuations for Employee Stock Ownership Plans, was prepared by Kim S. Abello, a senior associate in our Chicago office. Curtis R. Kimball, director of our Atlanta office, reviewed the estate tax chapters. We also would like to thank Portland office senior associate Terry G. Whitehead and Portland office associate Karen J. Damiano for their contributions. The authors have reviewed and edited all of the chapters written and updated by others and take final responsibility for their content. Mary McCallister was responsible for typing most of the manuscript. This was a monumental task that she performed well under very tight time schedules. Charlene Blalock served as the project manager for this undertaking. This included acting as a liaison and coordinating with the authors, the publisher, and the outside reviewers. She was responsible for obtaining permission to use material reprinted in this book from other sources. Charlene also prepared the index and edited and proofread the manuscript. This book would simply not have been completed without Charlene's dedication and project management. We wish to thank Kelli Christiansen, acquisitions editor at McGraw-Hill, for her assistance and patience with this project. We also wish to thank Laurie Hendrickson of Hendrickson Creative Communications who was responsible for the layout and typesetting of this book. For permission to use material previously published, we especially wish to thank: Applied Financial Information, LP The Appraisal Foundation Business Valuation Review The Canadian Institute of Chartered Business Valuators Ibbotson Associates John Wiley & Sons McGraw-Hill Prentice-Hall Standard & Poor's Corporation Warren, Gorham Lamont We express our gratitude to all of the people singled out above as well as to all those who have written letters and had discussions with us about many conceptual and technical points since the last edition. As always, final responsibility for all content and judgments rests with the authors. Shannon Pratt Robert Reilly Robert Schweihs Portland, Oregon Chicago, Illinois Chicago, Illinois About the Authors Dr. Shannon P. Pratt is a managing director and one of the founders of Willamette Management Associates. Founded in the 1960s, Willamette Management Associates is one of the oldest and largest independent valuation consulting, economic analysis, and financial advisory firms in the country. It has regional offices in Chicago; New York; Atlanta; San Francisco; McLean, Virginia; and Portland, Oregon. Willamette Management Associates is well known for its extensive research library, which has a constantly updated collection of books, articles, transactional data sources, and court cases involving valuation and economic analysis issues. This book draws heavily on that resource. In addition to this book, Dr. Pratt is a co-author of Valuing Small Businesses and Professional Practices, 3rd ed. (McGraw-Hill, 1998) and a co-author of Guide to Business Valuations, 10th ed. (Practitioners Publishing Company, 2000). He is also the author of Cost of Capital: Estimation and Applications (John Wiley & Sons, 1998), Business Valuation Body of Knowledge (John Wiley & Sons, 1998), and Judges and Lawyers Business Valuation Handbook (American Bar Association, 2000). Dr. Pratt is editor-in-chief of Shannon Pratt's Business Valuation Update and Judges & Lawyers Business Valuation Update, monthly newsletters covering current developments in the field of business valuation; Business Valuation Online Library, an on-line source of court cases, articles, laws and regulations; and Pratt's Stats, a database of private company sale transaction details. Dr. Pratt holds a doctorate in finance from Indiana University and a bachelor of arts in business administration from the University of Washington. He is a chartered financial analyst, an accredited senior appraiser (certified in business valuation) and fellow of the American Society of Appraisers (the highest designation awarded by that society), and a master certified business appraiser of the Institute of Business Appraisers. Dr. Pratt has held many offices of the various professional societies and has served on numerous committees. Currently, he is a life member emeritus of the Business Valuation Committee of the American Society of Appraisers, a life member emeritus of the Valuation Advisory Committee of The ESOP Association, and a life member of the Institute of Business Appraisers. He is a recipient of the Magna Cum Laude award of the National Association of Certified Valuation Analysts. He served for two three-year terms as a trustee of The Appraisal Foundation (the entity responsible for establishing, issuing, promoting, and improving the Uniform Standards of Professional Appraisal Practice, under the authorization of Congress). He is frequently called upon to testify in disputed business valuation matters. Robert F. Reilly is a managing director of Willamette Management Associates. He is a certified public accountant, a certified management accountant, a chartered financial analyst, a certified business appraiser, and an accredited senior appraiser of the American Society of Appraisers (designated in business valuation). He is an accredited tax advisor and an enrolled agent. And, he is a certified real estate appraiser, a certified review appraiser, a state certified general appraiser, and a state certified affiliate of the Appraisal Institute. He also serves as an issues resource panel member of The Appraisal Foundation. Mr. Reilly provides consulting services relating to business valuation, intangible asset appraisal, security analysis, and damages analysis. He has testified as an expert witness in federal, state, and international courts on numerous occasions, and he regularly provides clients with litigation support and dispute resolution services. Mr. Reilly has also served as a court-appointed arbitrator. He is the co-editor of The Handbook of Advanced Business Valuation (McGraw-Hill, 2000) and a co-author of Valuing Small Businesses and Professional Practices, 3rd ed. (McGraw- Hill, 1998), Valuing Intangible Assets (McGraw-Hill, 1999), and Valuing Accounting Practices (John Wiley & Sons, 1997). He has authored chapters in numerous books related to specialized topics, such as ad valorem property taxation, matrimonial law and marital dissolution, and employee owned corporations. He also has written over 300 articles on various valuation-related topics that have been published in various professional journals. Mr. Reilly is often called upon to speak at seminars and conferences of various professional groups. He also has taught courses in business valuation both in the United States and abroad. Prior to joining Willamette Management Associates, Mr. Reilly was a partner and national director of the Deloitte & Touche Valuation Group. Before that, he was vice president of Arthur D. Little Valuation, Inc., a national appraisal firm. He received an MBA in finance from the Columbia University Graduate School of Business and a B.A. in economics from Columbia University. Robert P. Schweihs is a managing director of Willamette Management Associates. He is an accredited senior appraiser of the American Society of Appraisers (designated in business valuation). He is also a member of The ESOP Association, the Institute of Property Taxation, and the Association for Corporate Growth. Mr. Schweihs also serves as a trustee of The Appraisal Foundation. Mr. Schweihs provides consulting services relating to business valuation, intangible asset appraisal, security analysis, and damages analysis. He has testified as an expert witness in federal and state courts and regularly provides clients with transactional fairness opinions, solvency analyses, economic analyses, financial advisory services, and litigation support services. He is the co-editor of The Handbook of Advanced Business Valuation (McGraw-Hill, 2000) and a co-author of Valuing Small Businesses and Professional Practices, 3rd ed. (McGraw- Hill, 1998), Valuing Intangible Assets (McGraw-Hill, 1999), and Valuing Accounting Practices. (John Wiley & Sons, 1997). He also has written numerous articles on valuation- related topics that have been published in various professional journals. Mr. Schweihs is often called upon to speak at seminars and conferences of various professional groups. He has taught courses in business valuation both in the United States and abroad. Prior to joining Willamette Management Associates, Mr. Schweihs was a partner and national director of Deloitte & Touche Valuation Group. Before that, he was a manager of Arthur D. Little Valuation, Inc., a national appraisal firm.
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