|EXECUTIVE SUMMARY |
| A CPA/VALUATOR PLAYS A PIVOTAL ROLE in merger and acquisition (M&A) engagements. He or she helps to organize the transaction, mitigate trouble spots, establish an objective marketplace value for a client’s business and structure the deal along with attorneys, appraisers, bankers, financiers and regulators.
A BUYER’S VALUATOR enters the process early and researches purchase opportunities, which include publicly held and privately held companies, divestitures from diversified companies, purchases of partial or minority interests, liquidations of assets and venture capital investments.
THE THREE MAIN APPROACHES to valuing businesses are the market approach (what other people have paid for similar businesses), the asset-based approach (what the equipment and real estate are worth) and the income approach (how much money a buyer could make from the business). Each one has tangential considerations.
A TARGET MIGHT WANT TO SELL if it lacks management successors or needs to create liquidity for an estate. A large company making a divestiture—which can happen quickly once a decision is made—usually is a motivated seller.
CPAs ALSO PERFORM DUE DILIGENCE, tax planning, preparation of pro forma financial statements, analysis and financial projections. The trajectory of a BV engagement offers practitioners service opportunities at several junctures.
A MAJOR OBJECTIVE IN STRUCTURING A DEAL is to create a transaction that appears to meet the seller’s price expectations, on terms and within constraints that are suitable to the buyer. The price will not matter if the terms are right for the buyer.
|GARY R. TRUGMAN, CPA/ABV, is a principal of Trugman Valuation Associates Inc., a firm specializing in business valuation. He is the author of Understanding Business Valuation and A CPA’s Guide to Valuing a Closely Held Business, both published by the AICPA. Mr. Trugman lectures nationally on BV topics. |
CPA/valuator familiar with merger and acquisition (M&A) transactions can be a tremendous asset to a client, bringing into focus facts that help bridge the needs of both buyers and sellers. To perform business valuation in M&A, you work with management to research and analyze information, prepare reports and advise on the pros and cons of different choices. Besides establishing an objective marketplace value for a client’s business, you organize the overall process, mitigate trouble spots and structure the deal along with attorneys, appraisers, bankers, financiers and regulators. Both buyers and sellers hire teams of several professionals to represent them, and the cast of characters can be quite large. In BV, CPAs also perform due diligence, tax planning and preparation of pro forma financial statements, analysis and financial projections.
This article describes what a CPA/valuator does in the M&A valuation advisory process from the earliest point—primarily from the buyer’s perspective. In doing so, it reveals junctures at which different types of CPA skills come into play. CPAs who want to develop BV skills need training and credentials, available from a number of sources (see “ Train to Be an ABV ” and “ Resources ”).
A buyer needs to be clear about what it hopes to gain in a merger or acquisition. As valuator for the buyer, your role may require you to work with the client to refine its goals and develop a well-defined set of criteria for suitable candidates (see “ Buyer’s Analysis Checklist ”). Screening for the right target is like pouring specifications into a giant funnel—you start with a universe of all the businesses in the marketplace and gradually narrow the number to a few and then to one that meets the client’s objectives.
|Buyers may commission a CPA/valuator as soon as they decide to acquire a business, or they may call in help later. Sellers might not use one until they get an offer. The order and degree of effort may vary, but here’s what you would do in a merger or acquisition.
|In this article, the terms valuator/intermediary/adviser, buyer/acquirer and seller/target are used interchangeably. |
Identify an acquisition target.
Find out whether it’s interested.
Perform an in-depth analysis and review.
Price the transaction.
Structure it (as a merger, acquisition or asset swap, for example).
Negotiate the final terms.
Close the deal.
If a buyer already knows the acquisition candidate, it may prefer to go it alone. If not, the CPA/valuator can provide the client with strategic information, sources of capital, staff to dedicate to the project, independence from in-house political considerations and enough distance to preserve anonymity during initial overtures. Brokers may offer a range of prospective sellers too, so many companies use brokers to identify deals and advisers such as CPAs to analyze them.
|CPA/valuators charge on a contingent, fixed-fee, hourly or per diem basis or some combination. They find out the scope of services the client wants and specify the basis on which fees will be paid and whether the arrangement is exclusive. They draft an engagement letter that spells out the details and clearly defines “transaction value” (which likely will determine the amount they are paid). Contingent compensation by itself can create a conflict of interest for a seller’s intermediary, influencing it to recommend closing a deal too quickly.
Once you know what the client wants to accomplish, your next step is to discover what businesses are available and rate their suitability. There are a number of ways to go about it.
| A Growing Niche |
In 1997 the number of ABV credential holders was 520; at fiscal yearend 2001, that number had increased to 1,438.
Acquisition leads. Investment opportunities include publicly held and privately held companies, divestitures from diversified companies, purchases of partial or minority interests, liquidations of assets and venture capital investments. You can start an acquisition search by consulting Moody’s, Standard & Poor’s and D&B; industry publications such as trade association directories and product catalogs; company data such as annual reports and SEC filings; online databases; and people including management, sales staff, industry specialists and others knowledgeable about potential areas.
Databases. Most companies are closely held, so buyers’ intermediaries use databases to identify targets. Databases don’t necessarily have information on the same companies, and because industrial classification codes differ among them, data may be organized differently for the ones they list in common. Databases are good for early screening, but none is perfect. Compensate by using several. Sites such as masource.org and BVMarketData.com offer extensive leads.
Candidates. Once you provide your client with a manageable pool of candidates, you must rank their overall desirability. To value essential criteria, use a weighting system, assigning points for factors such as a target’s main business, geographical concentration of sales, transportation access, reputation, sales volume, profitability and other important features. For example, a chemicals manufacturer that needs storage terminals would give more points to a facility close to a preferred rail line than to one less desirably located.
Purchase price. This of course depends on the individual target, where it is in its life cycle and the health of its industry. In general, companies sell for a percentage of annual sales volume. For a manufacturer this might be 30% of sales, and for a service business, it might be 100% of sales. Whatever the amount, the buyer should be prepared to put down at least 20% to 25%. Transaction costs can add more than 5%, and the buyer will incur significant closing costs even if the deal derails.
Regulations. Most transactions are subject to some degree of regulation. For smaller ones, that may consist of little more than filing property-transfer deeds and income tax forms. More complex deals may be subject to the scrutiny of the SEC, Federal Trade Commission and state or industry regulators. Be aware of which regulations apply. (For more information, see “ Looking at Mergers the Way Federal Regulators Do,” JofA , Dec.99, page 59.)
|Buyer’s Analysis Checklist
CPA/valuators can use answers to this set of questions as a starting point
to clarify the acquirer’s present position and future goals.
It’s best if a mutual contact can introduce you to the target’s owner. If not, you must make contact very discreetly to ask whether he or she would consider a sale; in many closely held businesses, the person running the company has devoted his or her life to it and doesn’t want to feel vultures are circling overhead. Publicly held companies always are careful about M&A discussions, since the information must be disclosed. All companies will be concerned that rumors of a potential sale could disrupt business, affect their stock price and be misused or misinterpreted by customers, employees, suppliers or competitors.
Before making an overture, you should have reason to believe the target might want to sell. Conditions such as a lack of management successors or a need to create liquidity for an estate are good indicators. A large company that wants to divest certain assets—which can happen quickly once a decision is made—usually is a motivated seller.
Once the two businesses are at the table, you need to confirm the target’s financial and operational health (see “ Profile the Target ”). This is the due diligence phase—the essential in-depth analysis that’s the platform for negotiating final terms.
Before the acquirer performs due diligence, it frequently will issue a nonbinding letter of intent. This preliminary agreement describes the buyer-seller understanding on a number of important features such as the bid price; the potential structure of the deal (purchase, merger, stock or asset transfer); the timing of due diligence and the closing; the acquirer’s financing; and the responsibility for fees and expenses. Although buyer and seller invariably modify it as negotiations continue, it’s the basis for the transaction and keeps both sides moving in the same direction.
Proceed to due diligence. The different types of due diligence performed in M&A engagements include financial, operational and legal. During this stage, your role as CPA/valuator is to
Identify items that could break the deal (hidden liabilities).
Verify the accuracy of the seller’s information.
Obtain a detailed understanding of the business.
Develop information that will be vital to negotiating the transaction, obtaining financing, getting board approval, establishing the tax and accounting basis of the assets and integrating the acquired entity into the buyer’s business.
In due diligence the CPA/valuator searches for sufficient information to enable the buyer to decide whether to complete the transaction. You look for details about appraisals, contracts, customer information, loan agreements, accounting and other important data—such as proprietary technology or processes in the industry, exclusive contracts with suppliers or customers and ISO 9000 approval. If you have questions about technical issues such as environmental problems or pension obligations, you may have to bring in qualified experts to review those areas. You also may recommend the buyer bring in auditors to review the financial statements.
Be discreet. To complete the due diligence process, you’ll spend time in the seller’s workplace. Keep a low profile. The target’s management is one of the most overlooked assets in an acquisition (often harder to obtain than investment financing), and preventing needed employees from bolting is important to a deal’s viability. Staff members who learn their company is being sold often assume they’ll be out of work when the sale is complete. Talk about the company’s plans only to those who need to know. ( Note: Management of a publicly held company cannot protect its privacy by deceiving the public about whether it is for sale.)
|Sometimes a seller forbids inquiry into certain areas, particularly during preliminary due diligence. If the information can wait, fine. But if a target is unwilling to provide it even later on, advise the acquirer to walk away from the deal. It isn’t unusual for a seller to have a prospective buyer sign a confidentiality agreement before it shares company data. It may even insist on the return of all materials, including notes and copies of documents, in the event the transaction falls through. It’s important not to sign anything that can’t be honored.
Both sides may need reassurance. A detailed due diligence program can be costly. Besides out-of-pocket expenses, there’s the time it takes personnel to provide and review information. For that reason, buyers or sellers sometimes require breakup fees to reimburse them in the event the other party withdraws. To discourage nonserious buyers, sellers often ask buyers for a nonrefundable deposit as evidence of good faith. Conversely, some buyers may demand a commitment fee from the seller after signing a letter of intent. There aren’t any set rules about this.
If you’re working for the target company, perform due diligence on the buyer, as well. The seller needs to confirm the buyer has the financial capacity and strategic incentive to purchase the company. Look at a buyer’s financial statements, interview its senior management to get a feel for its character and motives, and tour the buyer’s facilities.
The standard definition of fair market value is the cash price at which property changes hands between a knowledgeable buyer and a seller under no duress. Valuation methods set price expectations , but a business is worth only as much as somebody is willing to pay for it. Price ultimately depends on the negotiating skills of the buyer and seller. The process described so far is the groundwork CPA/valuators use to find a solid basis of value for the businesses in play.
|Train to Be an ABV
Business valuation (BV) and litigation services are among the fastest growing, most important consulting services offered by the top 100 accounting firms, says a recent survey in Accounting Today, and CPAs should consider how to participate in them.
When a BV expert testifies before U.S. Tax Court Judge David Laro, his first consideration is the expert’s qualifications. Judge Laro says a CPA who intends to practice BV should get the credentials, education and experience that impart credibility. The AICPA’s Accredited in Business Valuation (ABV) designation is such a credential. CPAs who get it learn about valuations for mergers and acquisitions, marital dissolutions, estate and gift taxes, damages litigation, employee stock ownership plans (ESOPs) and many others.
The AICPA’s two core courses—Fundamentals of Business Valuation, Part I (FBV-I) and Fundamentals of Business Valuation, Part II (FBV-II)—provide in-depth, rigorous training. It’s best to take FBV-I prior to FBV-II. Each three-day course is taught by valuation professionals and offers interactive participation.
FBV-I is an overview of the valuation process, including the issues associated with defining the interest to be valued, the standard of value, the premise of value, who controls the business, its degree of marketability and other areas. The course focuses on the income approach, valuation research and quantitative and qualitative information analysis.
FBV-II covers asset-based and market approaches to business valuation. Participants are taught valuation adjustments, such as discounts and premiums, to be able to reconcile multiple approaches and methods and determine a final value for a business. The program also covers report writing and expert-witness matters. A case study is woven into both halves of the FBV courses, so participants can integrate what they learn and apply the information in a complex, multipart valuation.
After the foundation courses, ABV candidates can take the two-day ABV Review Course, often taught by scholars, authors and practitioners in the field. To ready candidates for the ABV exam, about one-third of the course is devoted to knowledge contained in the test’s “Content Specification Outline.” It’s the only exam among those offered by the nation’s leading business valuation organizations that defines the specific areas a candidate must know. The remaining two-thirds of the program readies participants for the test and includes a self-study workbook of extended mock case studies. The practice problems simulate the ABV exam—currently held in early November of each year.
For information about the ABV credential and the exam, go to the following AICPA Web page: http://www.aicpa.org/members/div/mcs/abv.htm .
The three main approaches to valuing businesses are the market approach (what other people have paid for similar businesses), the asset-based approach (what the equipment and real estate are worth) and the income approach (how much money a buyer could make from the business). These approaches encompass a number of methods such as guideline-company, transactional, adjusted-book-value, capitalization-of-benefits, discounted-benefits and leveraged-buyout methods. Each one has advantages and disadvantages. There’s ample guidance on widely used valuation formulas (for more information, see “ Resources ”).
When the buyer and seller agree on price, it’s time to address the structure of the trade. This is where differences between a merger and an acquisition come up. In a merger, both parties to the transaction wind up with common stock in a single merged entity. In an acquisition, the buyer purchases the common stock or assets of the seller. (See “ Differences Between Mergers and Acquisitions .”)
A major objective in structuring a deal is to create a transaction that appears to meet the seller’s price expectations, on terms and within constraints that are suitable to the buyer. If the terms are right for the buyer, the price will not matter. Once buyer and seller agree on the amount and structure of the trade, the next issue is how the buyer will compensate the seller before handing off the business. Payment can be cash, common stock, a special class of common stock, preferred stock, installment payments, earnout payments, options or warrants and/or convertible securities.
Cash is easiest. Payment in common stock of a closely held company raises a valuation question: The seller must evaluate the future prospects of the buyer. Additional questions arise with respect to voting rights, liquidity and rights of first refusal if shareholders plan to sell their stock at a later date.
Earnout payments, options, warrants or convertible securities often are used to bridge the parties’ different levels of risk tolerance. Their value is linked to future performance: The buyer makes earnout payments to the seller in future periods if the company achieves predefined goals based on revenues, operating income, net income or cash flow.
Several other factors influence the transaction. Make sure any deal covers
Terms of payout.
Management-consulting arrangements if applicable.
Allowing the seller to retain a partial interest in the company.
Agreements to lease property from the seller or to conduct business with entities related to the seller.
Postacquisition adjustments to increase or reduce the purchase price, based on factors such as audited inventory or accounts receivable collections.
Escrow funds that are released only on certain terms and conditions.
|Profile the Target
To determine whether an acquisition candidate is right for a buyer,
a CPA/valuator must gather information about the following.
A CPA adviser who has valuation expertise and is familiar with the M&A process can be an invaluable resource to a client, offering value and security by understanding the client’s business goals, analyzing how to attain them and helping to steer a transaction toward a profitable and well-structured outcome. To choose the right methods and standards for a valuation engagement is a responsibility that starts with understanding the entity you represent—and ensuring you have adequate expertise to do the job well. The AICPA Code of Professional Conduct requires members to provide only services they can complete with professional competence, and CPA/valuators also must comply with the professional and technical standards under the Statement on Standards for Consulting Services. Training is the essential step to opening a door to interesting, profitable valuation engagements.