How Do You Value a Business in a Buy-Sell Agreement?

Close up on hand writing on notepad with pen

 

If a company has multiple owners, it will most likely have some form of a buy-sell agreement in place. A buy-sell agreement is designed to protect the interests of an individual owner’s estate as well as the interests of the other owners and the company as a whole. It also ensures that the owners don’t have to work with heirs that don’t possess the same passion or knowledge of the company as an owner had.

A buy-sell agreement is essential as it prepares for the unexpected and safeguards against potential losses from a key owner dying by establishing the rules for ownership transition. Finally, a buy-sell agreement protects the estate of the deceased owner by ensuring the heirs get paid from the proceeds of the life insurance policy an amount stipulated per the agreement.

The Business Valuation Provision and Why Formula and Fixed Price Approaches Don’t Always Work

 

One of the key components of any good buy/sell agreement is having an accurate means of assessing fair market value. There are a number of approaches that can be taken. For one, the owners could agree on a formula valuation, like a multiple of earnings. However, formula valuations can be inaccurate if the formulas aren’t updated. For example, a formula that worked well for when the agreement was made might not fit as well ten or fifteen years down the road.

The fixed price approach, in which owners agree on a price per share that can be updated later on, similarly, suffers from the same problems. If a company does wish to do a fixed price approach on a buy/sell agreement, the price of the shares should be negotiated and updated yearly to ensure the valuation isn’t too high or too low.

Finally, another approach that could produce the most fair and accurate valuation is a defined process approach. This valuation is one that typically includes an independent appraisal from a third-party valuation service provider. An independent appraisal ensures the valuation is unbiased and reflects the current condition of the company.

A Note about Intellectual Property Valuation

 

At Appraisal Economics, we provide asset valuation services for a variety of different business transactions. If the owners of a company have decided to use a defined process approach where there is an independent appraisal, the company’s intangible assets, like intellectual property, will also need to be assessed to determine the fair market value of a company. Our intellectual property valuation team can provide accurate valuations of intellectual property, such as trademarks, copyrights or patents, to ensure a company’s next steps go smoothly when a key owner passes away.

How Do Valuation Firms Determine Trademark Value?

trademark sign and padlock

 

A good trademark can add inherent value to a company. When you consider the level of competition and number of choices out there, a distinguishing name, symbol, or phrase is essential to create brand awareness and produce a following. We can easily name a few brand names or symbols associated with everything from computers to cereal. The goal for businesses of all sizes is to develop strong trademarks, and valuing them correctly is paramount to determining overall value for a wide variety of applications, including mergers and acquisitions, venture funding, and taxation purposes.

 

Types of Trademarks

 

Fanciful Trademark: This is the most easily defendable. It is a made-up word, phrase, or symbol designed specifically for a brand, product, or service.

 

Arbitrary Trademark: This is where the word, phrase or symbol has a common meaning, but it is not associated with the type of products and services provided.

 

Suggestive Trademark: Word, phrase, and symbols that are not meant to directly describe a product or service but shine it in a particular light.

 

Descriptive Trademark: A word, phrase, or symbol that describes goods or services. It could potentially have a secondary meaning differentiating the business but not necessarily.

 

Generic Trademark: A word, phrase, or symbol that describes a product category or service. This is not defendable in court.

 

Valuation Approaches

 

Every valuation firm will have its own specific formula and set of processes for IP valuation. In general, there are three different valuation approaches. The first is the income approach, which takes the estimated cash flows from the trademark and deducts any risks or costs spent developing it. The second is the market approach. This takes a look at relevant transactions in the market, like buying/selling or licensing, to determine a value. The third is the cost approach. This consists of reviewing the historic cost of creating the trademark and the cost it would take to replace it.

 

When looking for a valuation firm, consider using a firm that has specialized experience in your industry and has shown relevant success in assessing trademark value. Appraisal Economics is proud to offer IP valuation services that are current with emerging market trends, and we have the skills, expertise, and resources to help your organization determine trademark value for your shareholders, management, and financiers. Given the importance of valuing intangible assets like trademarks accurately, choosing the best firm for your needs is crucial to success.

 

Contact us today to learn more about our IP valuation services.

What Goes into Patent Valuation?

man hand bulb in nature

 

A truly new concept for goods or services might be able to receive patent protection and could be worth billions of dollars. Many are worth much less.  Valuation experts provide patent valuation services to determine the values of individual patents and patent portfolios, and many other related services. Patents are a form of intellectual property (IP) and – for companies like Apple and Tesla – may even be the company’s primary assets.

 

In addition to affecting the value of the overall business, patent appraisers advise clients with such matters as buying and selling patents, determining appropriate royalty rates and terms for patent licensing, and assessing whether and to what extent patents may serve as collateral for lending purposes. The factors that influence the value of a patent depend on the type of patent, the industries in which it could be used, and other variables.  Some general things to consider:

 

What is the Status of the Patent Filing? The value depends on the stage of the patent filing, whether it was approved, is pending, or is an earlier stage.  Thorough research involves gaining a detailed understanding of a company’s IP holdings, including the patent application itself, any foreign patent applications that relate to the invention, litigation history, etc.

 

How Impactful is the Patent? Some patents are revolutionary; others are slight modifications on existing ideas and inventions that may affect an industry more marginally. It is the job of the valuation team to assess the potential of the patent. They will look at the industry and other patents and inventions to estimate the effect of the subject patent on the marketplace.

 

How Defensible is the Claim? A well­-constructed patent claim may be more valuable if it likely to withstand potential challenges from competitors.  Although the service of a patent attorney is not required to file a patent, the guidance of experienced professionals may result in a stronger claim that is more defensible, which is worth more to a potential buyer or licensee.

 

How Will the Patent Generate Cash Flow? There are many different ways that a company can monetize a patent.  An owner can research, develop, manufacture, distribute, and retail a product that relies on the patent, essentially building an integrated business around the patents.  Alternatively, it could license the use of the patent to others for royalties, which can be structured in various ways (up­-front, annual, as a percent of sales or profits, etc.). A valuation firm should consider who will ultimately use the patent and how it will be used.

 

Clearly, although the concept of how firms generate profits using patents is fairly straightforward, determining a value for a specific patent can be quite complex and requires experienced appraisers. Appraisal Economics has deep experience working with clients around the world in practically all industries, and we have a staff that consists of engineers as well as appraisers. Contact us today to learn more about our patent valuation services.

What Is Portfolio Valuation and Why Are Firms Turning to Third Party Valuation Services?

 

Word Cloud "Leverage"

Private equity funds, hedge funds, and other institutional asset managers are increasingly engaging independent valuation experts to perform various portfolio valuation services rather than conducting the portfolio valuations internally.  A portfolio valuation is done to determine and report alternative investments’ performance, which is often required for financial reporting and tax compliance, and also affects the investment manager’s compensation.

Determining the fair market value of illiquid assets is notoriously difficult because – by definition – there isn’t a market to determine the price, unlike many stocks, bonds, and other traditional investments.  Additionally, there are various laws, regulations, and policies governing valuations to protect investors against abuse.  The IRS has valuation requirements to prevent individuals and organizations from underreporting their incomes to pay less in taxes.

Why Independent Portfolio Valuation Makes a Lot of Sense for Illiquid Assets

 

Many private equity funds, pension funds, hedge funds and other institutional investors do their portfolio valuation in‑house, but this can foster the perception of a conflict of interest.  Investors of those funds who may be considering putting in new capital want transparency.  They want to know that there is no bias in the valuation and that values and performance are being reported accurately.  Even if there is no actual conflict of interest or bias, investment managers often prefer independent valuations to demonstrate the lack of bias – especially for capital calls and interfund transfers.

Increased regulations make independent portfolio valuation a smarter decision for illiquid assets.  Dodd-Frank requires hedge fund advisors to now register with the SEC.  This is intended to prevent another financial crisis like the one in 2008‑2009.  European regulators are doing the same thing in response to the global financial crisis.

Finally, independent portfolio valuation is often preferred by the auditors who ensure that the financials, which rely on the portfolio valuations, conform to Generally Accepted Accounting Principles (GAAP).   Auditors have been put under increasing pressure to ensure the integrity of the financial statements, making third-party portfolio valuation desirable as audits can be more efficient when the analysis is prepared by a firm that is experienced in performing and documenting the work.

Appraisal Economics can tailor portfolio valuation services to meet a client’s individual needs.  We have worked with a number of different firms on assignments that included preferred and common equity, variable‑rate municipal and convertible corporate bonds, limited partnership interests in private equity and hedge funds, and tangible and intangible assets.  We can provide our results in several different forms, and we have a proven methodology and experience with these illiquid assets to ensure an accurate and efficient process.  Contact our valuation team at +1 201 265 3333 to learn more about our services.

 

The Top 4 Worst Mergers and Acquisitions

Newspaper with headline "Merger!"When considering a merger or acquisition, there will always be a certain amount of speculation involved. However, with enough research into markets, trends, and revenue streams, and the use of valuation services, companies can take a great deal of the guesswork out of any venture and make a sound investment.

The alternative is not pretty, and can cost your company thousands, millions, or even billions of dollars, or perhaps bankrupt you. Here are some of the worst-case scenarios that Appraisal Economics seeks to help companies avoid.

1.  AOL & Time Warner – No such list is complete without mentioning the colossal failure of the AOL-Time Warner merger. The timing could not have been worse:  The deal went through for just over $160 billion in 2000, but the dot.com bubble burst not long afterward and, when combined with a decline in the popularity of dial-up and clashing corporate ideals, spelled disaster for the newly merged company. The two companies have since gone their separate ways.

2.  Quaker Oats & Snapple – This is the sort of story that particularly emphasizes the role that research and planning have to play in M&A. First and foremost, Quaker paid $1.7 billion for Snapple, an amount that was deemed to be about $1 billion too high by market experts. Secondly, they failed to recognize that the market for their new line of products was significantly different from what they had anticipated. They were hoping to tempt larger retailers like supermarkets and franchise restaurants with Snapple products, when the largest market was actually small retailers like convenience stores. This gross miscalculation led to Quaker selling the company for $300 million after only a little more than two years.

3.  eBay & Skype – When eBay bought Skype in 2005 for $2.6 billion, they thought that adding a video chat option to the service would enhance communications between buyers and sellers. As it happened, eBay users were pretty happy just keeping things simple, and did not see a particular need for extras like Skype. When the option never caught on as intended, eBay sold Skype in 2009 for a loss of $700 million.

4.  New York Central & Pennsylvania Railroad – This 1968 train wreck of a merger was intended to help both companies reduce costs in a changing industry landscape that was starting to heavily favor air and highway travel. However, the newly-formed Penn Central could not turn a profit and just two years after the initial deal, the company announced that it was filing for bankruptcy. Several factors potentially influenced this outcome aside from the changing market, including regulations preventing customer-facing rate adjustments and corporate cultures that had been at odds when they were rivals.

These are just some of the best examples of why an analysis of current markets and their trajectories is not only ideal, but necessary before any merger or acquisition. Appraisal Economics can do a thorough review of the companies involved in a potential deal and help determine the appropriate sale or purchase price. Contact us today!

Determine Whether to Lease a New Stadium

When sports team owners are considering the possibility of moving stadiums, there are a lot of different factors to take into account. In many cases, teams will be staying in the same general area in order to preserve their loyal fan base, but some have moved further afield in search of less expensive locations and rents. But how can owners determine ahead of time whether such a move will be financially prudent? One of the most trusted and accurate methods is to employ an independent valuation firm to provide documented support for moving to a new stadium.

crowded stadium

Calculation methods

What does a firm like Appraisal Economics use to determine the worth of a potential stadium lease? Three different approaches, as it turns out, which, when used in tandem, offer a more complete picture of the financial risks and benefits of everything from leasing a new stadium to acquiring a player. The Income Approach is used most often with assets that make a direct and immediate profit; the Market Approach is used for marketable tangible assets and some specific intangibles; the Cost Approach covers assets that cannot be assigned an obvious price point. These methods can each be employed based on the specific asset being valued so that the resulting conclusions are more precise.

While some comparisons can be made using statistics from recent stadium transactions in other cities, a lot of the analysis will be made based on local data, as population and disposable income levels in different areas can vary widely. Our company will do a thorough examination of additional income that the new venue and its team would generate, including concessions, corporate suites, tickets, and parking, as well as naming rights and signage income. Other advantages that a new stadium brings include higher-profile players and naming rights. These would be balanced out by any additional expenditures to get a clear picture of the true value of a new lease.

A Case Study

A new stadium was under construction and scheduled to be completed by the start of the Major League Baseball season. The team had been dissatisfied with the existing venue for a number of years as it was a multi-purpose venue shared by a local NFL football team and lacked the intimate setting that characterized most of the more recently constructed ballparks. Moreover, from an economic standpoint, the old lease agreement provided rights to many of the revenue streams derived from baseball activities such as concessions, signage rights and suite rentals, to the stadium owner instead of the team.

The cost of the new stadium was underwritten by the state and legislation was approved for the construction of a new specific-use ballpark. As groundbreaking and construction began, the original cost estimate continued to be modified and based on revised engineering and other analyses, an additional $50 million was added to the stadium cost. The team’s portion was about 20 percent of the total, with public funding picking up the remainder. Additional scope changes included a Skybox Club premium priced area, a special children’s area, and closed-circuit television, to enhance the overall baseball fan experience at the ballpark. The team expected to garner revenue from certain activities in the new stadium for which it did not have any such rights under the old stadium.

We estimated the additional operating income as the difference between the actual operating income in the existing stadium and that projected in the new stadium. We computed total revenue and total cash operating expenses (excluding player salaries, as they are discretionary) in the two venues, then capitalized this difference into a value. Finally, we deducted the team’s share of stadium financing costs, equal to the sum of the team’s actual debt financing associated with the new stadium plus the present value of unfunded stadium costs, to conclude a value of the new stadium rights. A positive value less any lease rental expense indicates the lease value for the new stadium.

For more information on our sports team valuations, contact us today at Appraisal Economics!

The Importance of Solvency Opinions in Mergers and Acquisitions

When your company is contemplating either a merger or a business acquisition, there are many factors to consider; however, the first and foremost concern will be whether or not the move will benefit your company, now and in the future. You’ll want to ensure that any action taken is monetarily justifiable and that you have an expert opinion to support your decision, so that the banks loaning you the money feel that they are making a worthwhile, secure investment.

men shaking hands next to statistics

Solvency opinions can help you to achieve this. A solvency opinion evaluates a business’s assets, potential sources of revenue and free cash flow, and existing and projected liabilities. This analysis is often performed by a third-party valuation provider to ensure that the merged company will have the financial resources to sustain its operations in the future. This includes the company’s ability to service indebtedness transferred as part of the merger or acquisition, as well as additional indebtedness incurred to finance the proposed transaction.

Finding a Reliable Solvency Opinion Provider

Often, these assessments are requested prior to a merger or acquisition by the company in question on behalf of its financing bank, as the bank needs reliable information in order to make an educated decision. This makes the importance of finding a company with a record of accuracy paramount.

If the merged company ultimately fails, it will put a lot of different people in jeopardy: banks providing financing run the risk of not being repaid; the company itself may reach bankruptcy and its shareholders may be at risk; and any third-party provider of the solvency may be liable for its inaccuracy. A qualified firm will be able to look at the facts and figures of the case and make an accurate financial prediction as to the solvency of a company. In addition, this valuation can also be admitted in court as evidence of solvency – something that goes a long way in bankruptcy cases in which your company has a priority position for any repayment.

If your company needs a solvency opinion, Appraisal Economics can assist. We use an in-depth, highly refined process to measure the financial tests for solvency, analyzing your assets, liabilities, and capital adequacy and those of the company you are merging with or acquiring. This will yield information that can be used to determine the potential profitability of a venture for the use of your financial backers.

The Importance of Intellectual Property Valuation to Your Legal Counsel

company leaders meeting with lawyers

Intellectual property disputes are becoming an increasingly common phenomenon, and for good reason. As more and more of our ideas and technological developments go virtual, the ways in which they can be utilized, transmitted, and shared become increasingly hard to regulate. Concepts are snapped up and passed along, often going viral or becoming a major component in a product or service before the company or individual who pioneered them has time to react.

If your company has a trademark, patent or copyright on something, you were obviously trying to protect your intellectual property. However, if it was used or copied in some way and you weren’t consulted or compensated, should you seek legal redress? Only your lawyer can truly answer that question, but we can supply information that may help them and you come to a conclusion as to the profitability of a suit and also aid your case.

We do this through a process called intellectual property valuation. This is exactly what it sounds like: we determine the economic value of your intellectual property through various means. For instance, we meet with your management team to get an overall view of the issue and details, and evaluate the financial history and projections associated with the specific IP. Appraisal Economics will check out every detail of your use of the intellectual property, from the amount of advertising you invest in it, to competition, and the values of comparable IP. Once we have analyzed the data to the fullest, we provide a value for the intellectual property, as well as fair royalty rates.

When in the process of considering legal action, accurate information about your IP’s value is crucial in several ways. For one thing, it can help you and your lawyer come to a conclusion about the relative effectiveness of a suit. For instance, if a long, drawn-out court case would cost much more than the property is worth, it’s good to have that information going in. This can help you weigh your options against your odds of success. This works in reverse, as well, and knowing how much you stand to win can make legal action more tenable. This, of course, is a separate issue from the legal precedent any ruling would set about IP, which is being redefined constantly.

Once you have already decided to bring a suit against an entity who is potentially utilizing your property unlawfully, an IP valuation can still help your case. If it can be demonstrated that your intellectual property had a perceived value on the market, this can go a long way towards establishing how and why the infringing party may have used it. If their unfair use is decreasing the value of your IP, it can also be proven in part by our analysis and testimony.

intellectual property conceptAny information about IP values can also help your legal team set a fair settlement or award amount. If your company is winning the case and the defendant is considering a settlement, your lawyer may be able to use an IP valuation to negotiate with the opposing counsel. Likewise, an impartial valuation can help the presiding judge award an appropriate amount in damages, if the lawsuit goes through and you win the case.

There are many types of cases in which an IP valuation could be used. Take last year’s KIND LLC v. Clif Bar & Co. suit. In that case, the KIND snack bar maker sued their competitor for trademark infringement over what is known in the industry as “trade dress.” This is essentially the specific look of the packaging that distinguishes it from others of its type and identifies the brand. KIND is known for using clear packaging so that consumers can see the ingredients within. When Clif started using clear packaging, KIND felt that their product and its recognizability was sufficiently threatened to warrant a lawsuit. A great deal of this case hinged on whether or not the packaging style was really the sole property of KIND and how closely the one resembled the other; however, a valuation and evidence that profits went down due to product confusion could have validated the suit. In this particular case, a settlement was reached, but this is just one example of the potential uses of IP valuation.

The intellectual property valuation process is vital to a great deal of modern litigation, but it’s just one of the many valuation services that we offer at Appraisal Economics. Contact us here for more information.

Shareholder Buyout Disputes

Unfortunately, shareholder buyout disputes can and do happen. It’s important to prevent these disputes from threatening the success of your business’ future, while resolving or minimizing the impact of these disputes. Settling buyout agreement problems, whether over distributions, dividends or compensation, easily and quickly will only benefit your company.

Why do these disputes happen?

Many reasons could be to blame for such disputes. Perhaps physicians within a practice can’t agree on compensation as part of a business partner dispute, or maybe a business owner admits to fraud leading to the dissolution of the company. Sometimes it has to do with dissenting shareholder actions, which involve appraisal rights to minority shareholders, or forcing third-party buyouts of said shareholders. The issue could involve control of the company, or it could have to do with simple friction between partners that can’t easily be dissolved. Many times it comes down to money: who has it, who wants it and who gets it. Whether it involves the dissolution of a company or a negotiated buyout, these conflicts need a guided hand to bring them to a fair close.

The Key Factor

Having a professional who is skilled in arbitrating shareholder disputes is critical in bringing the matter to a conclusion. The key to stopping shareholder disputes in their tracks and ensuring a positive outcome is to have a solid shareholder’s agreement in place and signed before any disagreements can come up. Buyouts are the most common way to bring about a resolution, led by professionals skilled in representing the best interests of minority and majority stakeholders, owners, equal and silent partners, and any other stakeholder that feels unjustly oppressed.

Working with a firm like Appraisal Economics can ensure that the price being agreed upon is fair to all parties. As a third party independent advisor, Appraisal Economics is able to step in and show the selling shareholder(s) that the price they are receiving for their business is fair. And if in the future there are any other disputes regarding the sale price, the document provided by Appraisal Economics will showcase that the price was fair.

Reasons for Buyouts

There are several events that can happen which necessitate a buyout agreement, including:

  • Personal bankruptcy
  • Death/retirement of the shareholder
  • Divorce
  • Disability
  • Terminated shareholder
  • Debt foreclosure

Famous Cases

There have been many famous shareholder buyout disputes over the years. An example of a landmark employment buyout contract was the case of Pedro vs. Pedro in Minnesota back in 1992 whereby a wrongfully terminated stockholder was granted his lost wages until he hit age 72. More recently, in 2013, a lawsuit emerged from 5,000 former Tribune Co. shareholders seeking lost money. Unsecured creditors sought judgments against each former shareholder who sold at least $50,000 worth of the company’s stock during a 2007 leveraged buyout, according to the Chicago Tribune.

In the end, creating a contingency plan for buying out an unhappy shareholder is the most effective way to avoid a lawsuit, points out the Houston Chronicle. Having an independent valuation opinion provided by Appraisal Economics is a major part of that plan. Being prepared is the key to avoiding unfortunate circumstances that result in messy shareholder buyout disputes.

The Difference Between Valuation Methods

It has been said in the world of navigation that “before you chart a course for where you’re going, you must first determine where you are.”  Such an adage would appear to be true in managing a business, as well. Without knowing vital information such as spending, inventory, or forecasts, we would all be shooting in the dark when it comes to developing a successful business strategy. And a tremendously helpful tool for determining these corporate vitals is a Business Valuation.

Whether your goals are to buy, sell, or improve upon your current business, determining its value will set a course for making your idea a reality and further set the tone for its success.  And with multiple approaches to determining your company’s value, you can effectively and accurately assess its current capital structure so as to optimize  the Business Enterprise Value.

Asset Approach

Also known as “The Cost Approach,” the Asset Approach is rooted in the principle of substitution, which states that a prudent investor would pay no more for an existing business than the cost to replace its underlying assets new. This is especially useful when considering the startup costs for creating a new business from scratch; acquiring new equipment, supplies, facilities, or other imperative elements for conducting business as usual. Essentially, the asset approach compares the cost of purchasing “used versus new.” In this scenario, all tangible assets are assessed based on the cost to replace them with a new asset, minus allowances for physical depreciation, and any functional and economic obsolescence. Intangible assets that are self-created, as opposed to acquired, typically do not appear on the balance sheet, as their cost to create is usually expensed rather than capitalized. Furthermore, estimating the cost to replace intangible assets can be problematic, as reliable historical cost information may not be available.  Similarly, liabilities are typically carried  at face (versus market) value while contingent liabilities, like intangibles,  may not be posted on the balance sheet. The nature of this approach makes it an appropriate  choice for companies considering liquidation as a strategy, or whose assets can be readily monetized, such as real estate or investment holding companies.

Market Approach

As the  name implies, the Market Approach considers identical or directly comparable assets (and liabilities) in the  marketplace, to derive a value amount for the business. Value is estimated by a process of comparison and correlation between the subject asset and other similar assets, either on an individual or aggregate basis. Assets are typically sold in aggregate as a going concern business, with price indications based on sales of entire companies or fractional interests therein. Considerations such as time and conditions of sale are analyzed and adjusted. The market approach is most suitable when it is possible to identify a marketplace for the assets being appraised. Implied valuation multiples are computed for the comparable assets and used as a baseline for comparison with the subject assets.  Differences in size, growth, profitability, leverage, and other investment risk characteristics are analyzed to determine appropriate multiples for the subject assets.

Income Approach

The Income Approach can take different forms, such as discounted cash flow or capitalization of cash flow methods. The appropriate form depends on the nature of the business and the industry in which it competes, as well as its stage of development. This method requires the estimation of either future cash flows over a discrete time period, or a normalized level of cash flow along with an estimate of a long-term growth rate.

With so many areas of focus to consider, accuracy and thoroughness are of utmost importance in determining Business Enterprise Value. At Appraisal Economics, we’ve helped a multitude of companies as their valuation expert, from Fortune 500 caliber companies to small, privately held firms. Speak with one of our professional team members today and to see how we can help your company.