| 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 ”).
THE BASICS
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.
Obtain financing.
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.
THE HUNT
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. Source: AICPA.
| |
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. | |
ANGLE OF APPROACH
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.
OPEN WIDE AND SAY AHH…
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.
FINALLY…THE PRICE
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 .”)
SET THE TERMS
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.
Employment contracts.
Management-consulting arrangements if
applicable.
Noncompete agreements.
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.
Indemnification provisions.
| Profile the Target
To determine whether an
acquisition candidate is right for a
buyer,
a CPA/valuator must gather
information about the following.
|
OFFER EXCELLENT SERVICE
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. |
What
are the motives for
the acquisition? 
Preparing the statement of cash flows
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