Size premium driving middle market M&A activity
Data published in GF Data’s Second Quarter 2011 Report reveal unprecedented differentials in the valuations and debt multiples between small and large transactions, according to a recent GF Data press release. The gap “indicates the resurgence of an even more severely bifurcated market that is less accommodating to smaller transactions,” the GF Data sources add. “The size premium also extends to, and to some extent is caused by, disparities in debt availability to larger and smaller businesses,” says B. Graeme Frazier IV, Principal and Co-Founder of GF Data. “While this is not apparent in the overall data, when you look at Total Debt/EBITDA multiples for deals in the $10-25 million TEV range, they are on par with 2010 levels in the high two’s, [and] yet for larger deals, Total Debt/EBITDA went from an average of 2.8x in 2010 to 3.9x in the first half of 2011.”
SOX costs have shifted private firms exit strategy, new study says
The costs of complying with the Sarbanes-Oxley Act of 2002 (SOX) for private firms that are still trying to find an efficient if not profitable exit strategy is the subject of a new study by Francesco Bova and Gordon Richardson (Univ. of Toronto), Miguel Minutti-Meza (Univ. of Miami), and Dushyantkumar Vyas (Univ. of Minnesota). Among its principal findings: First, SOX appears to have shifted the firms’ exit incentive from an IPO to a public acquisition. The costs of SOX compliance may be larger for IPO firms, which need to create SOX infrastructure from scratch, than for acquired firms, which can leverage on their acquirer’s existing SOX infrastructure.
Second, private targets that invest more in pre-acquisition SOX compliance post larger deal multiples. This suggests that pre-sale SOX compliance “bumps up” a target’s valuation multiples due to its predicted lower compliance costs after the acquisition. By the same token, private firms with less SOX compliance may post lower acquisition multiples.
Download a working version of the paper, “The Sarbanes-Oxley Act and Exit Strategies of Private Firms” here.
Can you move up the list of most reputable companies?
The Reputation Institute and Global RepTrak Pulse recently released their findings of the world’s 100 most reputable multinational companies. Forty eight thousand consumers across fifteen markets participated in the study. “Reputation has become an increasingly critical intangible asset,” says Dr. Charles Fombrun, now Chairman of the Reputation Institute.
Companies are scored on:
- emotional indicators, i.e., trust, esteem, admiration, and good feeling
- dimensions of reputation, i.e., perceptions of the corporation’s workplace, governance, citizenship, products, services, innovation, financial performance, and leadership.
Google, Apple, Disney, BMW, and Lego “won.” (You can view the entire list at the Reputation Institute press release.)
All this of course, begs the question, is your company operating effectively in the reputation economy? This and other relevant questions will be addressed in an upcoming BVR webinar featuring Dr. Nir Kossovsky titled Reputation: Business Case For IP Professionals.
Expert tells WSJ two reasons why now is a great time to gift private equity
“Because not only do you not have to pay gift tax, but the discount for marketability has shot up, too,” Lance Hall (FMV Opinions) told the The Wall Street Journal, in the recent article, “How Volatility Eases Estate Planning.” The IRS generally allows a 30% to 35% discount on transfers of private company stock, the article quotes Hall as saying. “But when the publicly traded markets are more unpredictable than usual,” the article adds, “owners of private stock have successfully argued for larger discounts on the value of their holdings as well. Mr. Hall has used an indicator of market volatility known as the VIX to defend larger discounts on transfers of stock in private companies.”
Need market comps for your family business?
If you want to see what sort of values businesses are getting in the market now, we’ve just added over 400 new private company transactions to BIZCOMPS, bringing the total in the database to over 12,000. BIZCOMPS focuses on small company transactions; the median selling price of the companies added is $166,000. So, it’s a perfect resource for market comparables when your subject company is a “mom and pop” or sole proprietorship.
Another major new feature enhancement: In addition to calculating arithmetic means and medians, search results now also provide the harmonic mean, a better measure of central tendency that gives equal weight to each valuation multiple.
You can do a single search of comparable transactions for $139, and low cost subscriptions are available. BIZCOMPS subscriptions now include the BIZCOMPS/BVR Deal Review, a special publication that analyzes general trends, valuation multiples and operating ratios for transactions in the BIZCOMPS database.
FASB ‘simplifies’ impairment testing
The Financial Accounting Standards Board (FASB) approved a revised accounting standard that’s intended to simplify how an entity tests goodwill impairment. BV.com asked Brad Pursel (Brown Smith Wallace) to comment:
The 72 comment letters submitted to FASB regarding the April 2011 exposure draft reveal two common elements: 1) reducing costs for financial statement preparers, particularly smaller, private companies, is a worthy objective; but 2) the application of a qualitative assessment to impairment testing will be difficult to implement in many instances.
FASB intends to release the final ASU in September; click here for project updates.
More restaurants sold in the last few months than any other type of business
Pratt’s Stats has just added 511 transactions in the past two months, taking its deal total to 17,554. The median net sales of the newly collected transactions equaled $438K with a median selling price of $200K. Here’s how the deals break down by major industry:
| Industry | Count |
| Restaurants | 98 |
| Tech companies | 44 |
| Insurance agents | 21 |
| Lawn and garden services | 20 |
| Drinking places | 20 |
Each transaction includes up to 89 data points. Access all the data via a one year subscription or by purchasing a single search.
Buy-sell agreement withstands “unconscionable” valuation formula
Special Legal Report to businessvaluation.com by Sherrye Henry, Esq., Legal Editor, Business Valuation Update
Estate of Cohen v. Booth Computers, 2011 WL 2694288 (N.J. Super)(July 13, 2011)
After amassing a considerable fortune in publishing and other industries, a father created an income-producing partnership on behalf of his three children. His attorneys drafted the partnership documents and the beneficiaries signed the paperwork without consulting independent counsel.
Among other properties, the partnership owned an oceanfront estate in Palm Beach, Fla., originally purchased in 1976 for $750,000. It also acquired two commercial warehouses in New Jersey and a real estate holding company in Massachusetts. In keeping with its closely held nature, the partnership agreement precluded the partners from transferring any shares and provided that, on their divorce or death, the remaining partners “shall” repurchase the divorced/deceased partner’s shares at the “true value” of the partnership, defined as “net book value” plus $50,000. The buyout clause further provided that “net book value” would be “as shown on the most recent partnership financial statement” as of the date of valuation.
One of the partners divorced in 1994, but the two remaining children declined to invoke the buyout provisions, because the divorce did not threaten the partnership. In 1997, one of the partners died, and at that time, the partnership paid the estate $97,650 for the deceased partner’s one-third interest, based on book value plus $50,000.
Palm beach property worth millions. When one of the two remaining children died in 2007, the oceanfront property had appreciated to $45 million. An appraiser for the deceased partner’s estate estimated the “full” or fair market value of the partnership at just over $23 million, based on the net asset approach, which when added to the appraised value of all the real properties exceeded $68 million.
Nevertheless, the partnership paid the deceased partner’s estate just over $177,800, based on the “net book value” of the 50% interest as shown on the most recent balance sheet and income statement as of the date of death. The estate sued the partnership, requesting specific performance of the buyout provision but at its “true value,” based on its $68 million in combined appraisals. Given the gross disparity between fair market value and net book value, any other interpretation was unconscionable and voided the buy-sell provision, the plaintiffs said.
At trial, the partnership presented a CPA expert, who concluded that the purchase price of $177,800 reflected the partnership’s book value, as set forth in its financial records. These reflected the partnership’s cost value, he explained; determining its fair market value would require a full appraisal. Moreover, from an accounting perspective, it would have been “completely erroneous” for the partnership to reflect the fair market value of the Palm Beach property on its books, the CPA expert explained, because the tax code as well as generally accepted accounting principles require investment property to be recorded at cost.
The plaintiff’s appraiser argued the partnership’s financial records were “fraught with numerous errors,” but nevertheless the court accepted them, in particular finding that the partnership’s financial statements had never reflected the market approach to value but had consistently used a cost approach. This historic treatment of the partnership’s value comported with the “plain language” of the buyout provision, in which there was no reference to market value but rather a value clearly pegged to book value, as determined by standard business practices. The book value formula was properly applied when one of the partners died in 1997, the court noted. Applying any “fair value” or “market value” would invite “exactly the sort of disruptive family litigation” that occurred in this case.
Finally, there was nothing “inherently offensive” in the buyout formula at book value. Book value may be artificial, but it was easily ascertainable and applicable in this case to any partner who divorced or passed away. Under these facts, the trial court did not find the buy-sell provision unconscionable, and the estate appealed.
“We recognize the disparity between net book value and fair market value,” the appellate court observed, “yet the controlling factor as to which buyout method is applicable is the language of the partnership agreement.” That language was plain and unambiguous, and comported with standard definitions of book value (including the one in Valuing a Business, by Shannon Pratt, Robert Reilly, and Robert Schweihs, 4th edition, 2000). When a buy-sell provision is clear, the disparity between book value and fair market value alone was not sufficient to “shock the judicial conscious,” the court held, and affirmed the buyout at net book value.
What should the CEO be paid?
A private company owner’s compensation is among the most contested issues in business valuation, right up there with discount and premium issues. Where can you find reliable data to support the compensation adjustments in your valuation conclusion?
The CEO and Executive Compensation Report for Private Companies, published by Chief Executive Group (CEG) – publishers of CEO Magazine, presents benchmarking data and best practices on over 1,600 private company CEO and senior executive positions from 789 companies across the US. Use the report to benchmark a company’s compensation practices against those of companies with comparable profiles and equity compensation plans. Learn more about components in the compensation mix and uncover salary, bonus, benefits and perquisites for key senior executives.
The report is separated into two parts, Part I: CEO Compensation and Part II: Senior Executive Compensation. They can be purchased individually or as a complete package.
What’s important about your company’s IP…?
The editor of Intellectual Asset Magazine (IAM) raised some great points in another post this week. This was the result of questions he asked numerous speakers at the recent Intellectual Property Business Congress regarding their views on important IP-related issues. His summary:
1. Why do you believe IP is an important corporate asset?
a. It is core to our ability to differentiate from competitors, sell premium products with healthy margins, and protect investment in R&D.
b. If the prime objective of corporations is to sustainably generate and grow profits for shareholders, then the importance of any asset should be measured against their contribution to that objective. Take a look up and down the balance sheet of any corporation and think about what assets they own that enable them to create and maintain an advantage against their competitors. What you will find is there are precious few assets that corporations hold that make any difference to their ability to compete. The glaring exception is IP!
c. IP allows us to capture and share innovations and data and work with partners in a responsible manner.
d. IP is important as a defensive asset and my company does not want to be impeded in fulfilling its mission by those wielding IP as an offensive weapon.
2. When you think of the term IP value, what does it mean to you?
a. This is a measure of what IP adds to the bottom line for a company, the problem is, measuring it!
b. I think of IP value as a strategic concept measured by how IP contributes to the company’s long term goals and protects it from disruptions.
c. IP is difficult to quantify, but if our IP can serve and protect our company’s businesses and allow the company to achieve its mission, then we have achieved high IP value.
3. What do you believe is the key issue in IP at the moment?
a. Measuring IP value and communicating it to the c-suite.
b.It’s the need to eliminate the huge backlog of applications at the USPTO because the patent office is the biggest job creator they never heard of.
c. It’s how quickly we can get to a place where senior management are as comfortable managing IP assets as they are managing the rest of their business.
Share your thoughts..