ClarityBV Blog

Unfortunately, we can’t always be “nice guys” when it comes to valuation work. Much as I dislike requesting what can seem like an excessive amount of information, it pays to avoid tempting shortcuts.

Simple Due Diligence Example

In a recent project, it would have been easy to rely on ownership percentages from tax returns. However, by obtaining and reading the company’s stock ledger, we discovered that the interest to be valued might be a 21% ownership interest, not a 6% ownership interest!

Just that one “little” change may make a $1.8 million difference in value – $2.5 million as compared to $0.7 million. Rhetorical question: Is that material?

Recommended Financial Fiction

On a related note, like Aswath Damodaran, I too enjoy “financial fiction.” I’ve just begun a novel within the genre that I think I can already safely recommend. Stone’s Fall: A Novel by Iain Pears appears to be an intriguing blend of finance, mystery, and old-fashioned storytelling. It also provides a good reminder to wear one’s detective hat when performing business valuations.

Looking at my last post, I think I can shed more light through a public company example. Let’s say a project involved the valuation of a publishing business – Daily Journal Corp. (DJCO).

Recent Acquisition: Take 2

Imagine that you wanted to determine the fair market value per share of DJCO as of 12/15/08. Also, imagine that as of 12/1/08, DJCO had acquired a business. What were the terms of the hypothetical acquisition? Pretend that…

• DJCO spent $4 million of its $21 million cash and short-term investments to purchase the operations of a similar business (the “target company”).
• The target company operated in an adjacent market area.
• The target company had annual sales of $13 million and DJCO’s annual sales were $41 million.
• Both companies had similar growth prospects (unfavorable based on economic/industry issues).
• The target company’s EBITDA for the trailing twelve months (“TTM”) was $2 million and DJCO’s TTM EBITDA was $13 million.
• The motive for the deal was to gain scale/cost benefits through consolidation of operations.
• Finally, assume the business cultures are compatible and acquisition integration is not a major concern.
• The hypothetical acquisition appears to corroborate DJCO’s recent market multiple of enterprise value (“EV”) to EBITDA (2.0x-2.5x).

Would you give a recent acquisition like this substantial weight in a valuation analysis? What if it was the same set of circumstances, but involving a non-publicly traded company?

Remotely related thought – DJCO and the subject company that inspired these posts seem to be real-world examples of “too good to be true” businesses!

How would you value a company that made a major acquisition a few weeks prior to the date of a valuation?

Background Info

The acquirer was about three times larger than the target. The companies were competitors, with similar margins and growth prospects. The transaction was at arm’s-length.

The interest to be valued is a noncontrolling ownership interest in the acquirer. The standard of value is fair market value with a going concern premise of value.

Possible Approaches

One option is to prepare a pro forma analysis combining the acquirer and target business.

A second option is to analyze the acquirer’s past results on a stand-alone basis; then, add the amount paid for the target business to the indicated value.

Finally, one could apply pricing multiples from the acquisition to the acquirer or the combined business. Adjustments may be necessary for differences in size and risk.

In reconciling the values, adjustments for lack of control and/or marketability of the subject interest may also be necessary.

Question

In a case like this, does the price paid for the target business say as much about the value of the acquirer than anything else does?

Over the weekend, I read a great book entitled, The Seven-Day Weekend: Changing the Way Work Works by Ricardo Semler. “Inc.” magazine reprinted chapter one of the book back in 2004. In addition, MIT has a video of a talk by Semler, “Leading by Omission” from 2005.

One compelling idea was that we resist political authoritarianism, but willingly embrace it in business. If Semco can pull off business democracy, especially through massive economic upheaval, why can’t professional service firms in the U.S.?

The Semco “Survival Manual” is a terrific read on its own. For example, “Employee Timesheet Control – At the Semco Group, each person controls their own working hours. This is a method of transferring responsibility to each person.” (See also VeraSage: Why get rid of timesheets?)

I enjoyed The Seven-Day Weekend so much that I plan to read Semler’s earlier book, Maverick: The Success Story Behind the World’s Most Unusual Workplace.

Can an appraiser be confident putting a price on a business enterprise when they can’t put a price on their own services?

It seems ironic that many valuation firms will gladly tell you what your business is worth, but won’t provide a fixed price quote upfront due to the “difficulty” of estimating their fees.

Recent Experience

I recently encountered a proposal from a national firm with a fee quote that ranged +/- 25% plus direct and indirect expenses. Correction: The fee ranged 25% top to bottom, which would be +/- 12.5%. There was no estimate of how much the direct expenses might be. The “indirect” expenses consisted of an additional charge of 5% of fees. Why couldn’t these indirect expenses simply have been included in the initial quote?

Oh, and the proposal didn’t state exactly what valuation standards would be followed. At best, this seems gimmicky. At what point does pricing like this become bait and switch?

Thoughts

The experience above and my personal frustration with the “billable hour” are just some of the reasons the VeraSage Institute has captured my attention of late.

Of course, there are situations where a client prefers an hourly or variable pricing arrangement. In my experience, that is rarely the case though.

Questions

• What has your experience been as a consumer or provider of professional services?
• Have you ever seen a firm bill much less than the upper end of their quoted range?
• How should these things work in an “ideal” world?
• Are there any pricing resources you’ve found to be especially helpful?