MAY/JUNE 2019 That the ability to defend data is essential to its credibility. Does workplace stress impact valuations? IN GOD WE TRUST All others must bring data. Care must be taken to ensure that all factors are considered when deriving blue sky value. rule of thumb in valuation... not always reliable When a CEO states that they want to grow, what does it mean? ValExCov_M-J_2019_1.indd 16/14/19 9:52 AM PRSRT STD U.S. POSTAGE PAID SAL T LAKE CITY , UT PERMIT NO. 6563Association News The Association News contains valuable information about the Association and its members. The Association News is free for members and non-members alike. The Value Examiner® The Value Examiner is an independent, professional development journal dedicated to the exploration of value and its ramifications for consultants. It is the singular source of timely, technical, in-depth articles written for consultants by practitioners and academics at the top of their respective fields. QuickRead® Readers of the weekly QuickRead will come to appreciate it as a primary source for current news and information highlights in areas of interest to the financial consultant, and for immediate use in their practice. Journal of Forensic and Investigative Accounting (JFIA) The JFIA is an open access journal showcasing articles which focus on creative and innovative studies employing research methodologies; improve forensic accounting research skills, tools, and techniques; and stimulate discussion and experimentation in instructional means in the fields of forensic accounting and fraud. Around the Valuation World® The Around the Valuation World webcast is the next generation method of obtaining the latest updates, news, trends, and activity occurring in the rapidly evolving business valuation and financial forensics profession. Each month, a team of industry experts cover the profession’s leading publications and deliver an online summary of all you need to know. To learn more about these publications and how to subscribe, visit publications or call Member/Client Services at (800) 677-2009. Build Your Reputation Authoring Articles for the Industry's Publishing Juggernaut NACVA stands alone from other professional valuation organizations in its commitment to publishing. Write an Article, Earn CPE, and Gain Recognition Many of these publications give authors the opportunity to get published, earn valuable CPE credit, and share their expertise with their peers. To learn more on this opportunity, ValExPubAd S-O18.indd 110/11/18 1:44 PMA PROFESSIONAL DEVELOPMENT JOURNAL for the CONSULTING DISCIPLINES on the cover in this issue … t h e v a l u e e x a m i n e r MAY | JUNE 2019 3 14 MAY/JUNE 2019 That the ability to defend data is essential to its credibility. Does workplace stress impact valuations? IN GOD WE TRUST All others must bring data. Care must be taken to ensure that all factors are considered when deriving blue sky value. rule of thumb in valuation... not always reliable When a CEO states that they want to grow, what does it mean? ValExCov_M-J_2019_1.indd 16/14/19 9:52 AM 6 HOW NOT TO USE DUFF & PHELPS DATA By Roger J. Grabowski, FASA; Jaime d’Almeida, ASA, CFE; and Debra Jacobs, Vice President, Duff & Phelps “In God we trust. All others must bring data.” This famous quote implies that when data is presented, the conclusion can be trusted. However, the Ohio District Court’s decision in Rover Pipeline, LLC v. 10.55 Acres of Land, More or Less, in Ashland County, Ohio, et al., demonstrates that data is only trustworthy if it is understood and applied correctly. This article gives an overview of what not to do and subsequently trust. Association News The Association News contains valuable information about the Association and its members. The Association News is free for members and non-members alike. The Value Examiner® The Value Examiner is an independent, professional development journal dedicated to the exploration of value and its ramifications for consultants. It is the singular source of timely, technical, in-depth articles written for consultants by practitioners and academics at the top of their respective fields. QuickRead® Readers of the weekly QuickRead will come to appreciate it as a primary source for current news and information highlights in areas of interest to the financial consultant, and for immediate use in their practice. Journal of Forensic and Investigative Accounting (JFIA) The JFIA is an open access journal showcasing articles which focus on creative and innovative studies employing research methodologies; improve forensic accounting research skills, tools, and techniques; and stimulate discussion and experimentation in instructional means in the fields of forensic accounting and fraud. Around the Valuation World® The Around the Valuation World webcast is the next generation method of obtaining the latest updates, news, trends, and activity occurring in the rapidly evolving business valuation and financial forensics profession. Each month, a team of industry experts cover the profession’s leading publications and deliver an online summary of all you need to know. To learn more about these publications and how to subscribe, visit www.NACVA.com/ publications or call Member/Client Services at (800) 677-2009. Build Your Reputation Authoring Articles for the Industry's Publishing Juggernaut NACVA stands alone from other professional valuation organizations in its commitment to publishing. Write an Article, Earn CPE, and Gain Recognition Many of these publications give authors the opportunity to get published, earn valuable CPE credit, and share their expertise with their peers. To learn more on this opportunity, visit www.NACVA.com/article. ValExPubAd S-O18.indd 110/11/18 1:44 PM By Matt Stelzman, CVA, MAFF, ASA They say the first step in solving a problem is admitting you have a problem. The author admitted he had a problem in early 2013 when he realized that using blue-sky multiples to value automobile dealerships just was not going to cut it anymore. In this article, he shares that insight with you. DEALERSHIP VALUATION: MOVING BEYOND THE GUESSING GAME OF THE BLUE-SKY APPROACH ACADEMIC INSIGHTS ACADEMIC REVIEW Guest Editor: Matthew D. Crane, DBA, ASA, CPA The purpose of this column is to provide the readers of The Value Examiner summaries of contemporary research in business valuation and forensic accounting. Guest editor, Matthew Crane, fills in for Peter Lohrey, PhD, CVA, CDBV, in this issue. 20 LEGAL INSIGHTS WILL YOUR BV RESEARCH HOLD UP IN COURT? SIX TIPS FOR BETTER BV RESEARCH By Jan Davis, President, Blue Sage Research Research is an essential component of business valuation, and the Internet has made it less problematic to find the data needed to support your value conclusion. It may be easy and inexpensive to find comps from Yahoo! Finance, off-the-shelf industry reports, and compensation data from a free government source, but can you rely just on this data? This article explores ways in which practitioners should approach their reports and the tools needed to do it right. 24A PROFESSIONAL DEVELOPMENT JOURNAL for the CONSULTING DISCIPLINES EDITORIAL STAFF CEO & Publisher: Parnell Black Senior Editor: Nancy J. McCarthy Associate Editor: Lynne Johnson EDITORIAL BOARD Chairman: Lari B. Masten, MSA, CPA, ABV, CFF, CVA, ABAR, MAFF Past Chairman: Michael Goldman, MBA, CPA, CVA, CFE, CFF Ashok Abbott, MBA, PhD John E. Barrett Jr., MBA, CPA, ABV, CVA, CBA Gary W. Baum, MBA, CPA, CVA Neil J. Beaton, CPA, ABV, CFF, CFA, ASA Rod P. Burkert, CPA, ABV, CVA, MBA Lorenzo Carver, MS, MBA, CVA Wolfgang Essler, CVA (Germany) Richard W. Goeldner II, ASA, CBA, CVA Judith Heim O’Dell, CPA, CVA Andrew M. Malec, PhD Danny A. Pannese, MST, CPA, ABV, CVA, CSEP Kevin Papa, CPA, CVA, ABV Donald Price, CVA, ASA Angela Sadang, MBA, CFA, ASA Keith Sellers, CPA, ABV Richard Trafford, MSc, FAIA, FCT, CVA, CFE, MAFF, PGCLTHE, FHEA (U.K.) Sarah von Helfenstein, MBA, CVA Todd Zigrang, MBA, MHA, FACHE, ASA The Value Examiner® is a publication of: National Association of Certified Valuators and Analysts® (NACVA®) 5217 South State Street, Suite 400 Salt Lake City, UT 84107 Tel: (801) 486-0600, Fax: (801) 486-7500 E-mail: ANNUAL SUBSCRIPTION United States—$215 International—$255 U.S. Funds Free to accredited university libraries The Value Examiner® departments 4 MAY | JUNE 2019 t h e v a l u e e x a m i n e r SUBMISSION DATES Issue Submission Dates Publish Dates May/June Apr. 15 July 1, 2019 Jul./Aug. Jun. 15 Sept. 1, 2019 Sept./Oct. Aug. 15 Nov. 1, 2019 Nov./Dec. Oct. 15 Jan. 1, 2020 ALL SUBMISSIONS The Value Examiner is devoted to current, articulate, concise, and practical articles in business valuation, litigation consulting, fraud deterrence, matrimonial litigation support, mergers and acquisitions, exit planning, and building enterprise value. Articles submitted for publication should range from 500 to 3,000 words. Case studies and best practices are always welcome. SUBMISSION STANDARDS All articles should be thoroughly edited and proofread. Submit manuscript by e-mail (in standard word processing format) to Nancy Include a brief biography to place at the end of the article and a color photo of the author. See authors’ guidelines and benefits pdf. The Value Examiner accepts some reprinted articles, if accompanied by appropriate reprint permission. REPRINTS Material in The Value Examiner may not be reproduced without express written permission. Article reprints are available; call NACVA at (800) 677-2009 and/or visit the website: Production: Mills Publishing, Inc.; President: Dan Miller; Art Director/Production Manager: Jackie Medina; Magazine Designer: Jackie Medina; Graphic Designers: Ken Magleby, Katie Steckler, Patrick Witmer; Advertising Representatives: Paula Bell, Dan Miller, Paul Nicholas, Chad Saunders Administrative Assistant: Caleb Deane. Mills Publishing, Inc., 772 East 3300 South, Suite 200, Salt Lake City, Utah 84106, (801) 467-9419. Inquiries concerning advertising should be directed to Mills Publishing, Inc. Copyright 2019. For more information please visit millspub.com. PRACTICE MANAGEMENT WORKPLACE STRESS AND CORPORATE VALUE: IS THERE A LINK? By Nancy Neal Yeend, Dispute Management Strategist Stress is a significant and yet often hidden factor, which can negatively impact a business’s bottom line, stock prices, and its overall value. There is a direct link between stress in the workplace and rising healthcare costs. Also, stress contributes to increased absenteeism and lower productivity—all of which impact corporate worth. The author, a frequent speaker at the annual NACVA/ CTI conferences, provides some insights into how stress can impact the value of a business TELLING YOUR STORY: EDITORIAL BOARD MEMBERS AND CONTRIBUTORS TO THE VALUE EXAMINER SAY WHY THEY WRITE (PART II OF II) Compiled by Nancy McCarthy, Senior Editor, The Value Examiner Kindra Hall, a motivational speaker and one of the keynotes at the 2019 NACVA and the CTI's Annual Consultants' Conference presented a unique topic: “The Power of Storytelling on Your Journey to the Top.” In the last issue of The Value Examiner, contributors and board members gave insights into why they write. In this issue, we hear from several more professionals who write as part of their business life. GROWING REVENUES VS. GROWING EQUITY VALUE: LEARNING THE DIFFERENCES By George Sandmann. President & CEO of Consulting Software System LLC, dba CoreValue Understanding the CEO’s goal is the predicate for planning an engagement since a plan without a goal is a voyage without a destination. Goals drive strategy. This article which appeared first as part of a blog created by the author reprinted by permission of the author in a slightly expanded version—discusses what it means when a CEO says they want a business to grow. PRACTICING SOLO: JOSEPH EMANUELE By Rod P. Burkert, CPA, ABV, CVA, MBA Rod interviews Joseph Emanuele, CPA, CFA, ASA, CFE, from Laguna Niguel, CA. 34 33 42 30(800) 246-2488 | The Profession's Leading Authority in Valuation Data, Research, and Support Purchase a Database à la Carte or Bundle and Save À LA CARTE PRICE ValuSource Market Comps (Formerly IBA Market Data) (Downloads Per Year) $575 7 UnlimitedUnlimitedUnlimited BIZCOMPS® (Downloads Per Year) $569371010 Duff & Phelps Cost of Capital Navigator Basic (Downloads Per Year) $2953710 Unlimited Navigator Pro# IRS Corporate Ratios $275 RMA Valuation Edition (Includes 10 Years of RMA Data) $995 Duff & Phelps Cost of Capital Navigator Pro $595 Unlimited Pluris DLOM DatabaseTM $595 DoneDeals® $595 Mergerstat Review Premiums and Discounts $125 Mergerstat Review Price to Earnings Ratios $125 Guideline Public Company Database (Downloads Per Year) 710UnlimitedUnlimited National Economic Reports (Monthly and Quarterly Reports) Valuation Reports Library Around The Valuation World ® (AVW) (Monthly) Additional Fee for CPE Credit† Archived Industry and Metro Reports (1,100+ Reports) Business Valuation Articles (7,400+ Articles) Federal & State Law Cases (2,200+ Cases) Conference Presentations (700+ Presentations) Compensation Data S-1 Filings (68,000+ Filings) Expert Witness Profiler À La Carte Data Sources Discounts (Excludes Duff & Phelps) 5%10%15%N/A 15% Off Valuation Software Subscription TOTAL BUNDLE VALUE‡ $845$1,240$1,759$3,005$5,954 Through its five web-based annual subscription packages, KeyValueData® offers Internet-based access to thousands of dollars in essential valuation data, research, and tools— all for a single, low annual subscription fee.* SAVE 68% SAVE 60% SAVE 50% SAVE 53% ECON ASSIST SILVER BUNDLES GOLD PLATINUMTITANIUM Bundle Add-Ons (Additional Fee Required) First Research UnlimitedYearly / Monthly § $1,099 / NA $1,099 / $100 $1,044 / $95 $990 / $90$935 / $85 Unlimited CPE On-Demand WebinarsYearly / Monthly § $995 / NA$795 / $72$595 / $55$395 / $38$195 / $20 Surgent CPE: NASBA Qualified Self-Study CoursesYearly / Monthly § $240 / $20$240 / $20$240 / $20$240 / $20 Note: Prices are subject to change. * See website for details, conditions, and upgrading to unlimited BIZCOMPS. 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Single-user / Yearly Monthly§ Multi-user / Yearly# Monthly§# Actual Bundle Price { $445$745$1,545$2,795 $40$70$140$250 $685$1,165 $2,445 $4,475 $65$105$220$400 FREE with NACVA membership KVDGrid-MasterFile2019.indd 15/30/19 2:55 PMA PROFESSIONAL DEVELOPMENT JOURNAL for the CONSULTING DISCIPLINES 6 MAY | JUNE 2019 t h e v a l u e e x a m i n e r VALUATION /////////////////////////////////////////////////////////////////////////////////////////////////////////////////////////////////////////////////////////////////////////////////////////// /////////////////////////////////////////////////////////////////////////////////////////////////////////////////////////////////////////////////////////////////////////////////////////// Dealership Valuation: Moving Beyond the Guessing Game of the Blue-Sky Approach By Matt Stelzman, CVA, MAFF, ASA They say the first step in solving a problem is admitting you have a problem. I admitted I had a problem in early 2013 when I realized that using blue-sky multiples to value automobile dealerships just was not going to cut it anymore. Coming from an extensive background in performing valuations for litigation purposes, I knew that eventually, I was going to get called on my methodology, so I figured I would take my destiny into my own hands and stop solely relying on the widely accepted but poorly supported “blue-sky method” for valuing automobile dealerships. For far too long, business appraisers have been relying solely upon publications such as Haig Partners, Presidio Group, and the Kerrigan Report to obtain multiples, which are applied to the subject company’s ongoing pretax income to yield a value for the goodwill. This goodwill value is what people in the dealership industry refer to as blue-sky. These publications provide multiple ranges based upon the manufacturer brand and can vary as much as thirty-three percent for certain brands. Even Alan Haig and Erin Kerrigan will tell you they go through a much more extensive process of due diligence when pricing a dealership than merely applying a multiple to reported earnings. Historically, the appraiser will make the appropriate adjustments to operations to derive an ongoing pretax income for the subject company. The appraiser will then be tasked with selecting a multiple from within the range of published multiples, couple that with the derived ongoing pretax income to derive the value of the blue-sky. To this value, they add the adjusted net asset value of the subject company to derive the total equity value of the business. This is what many well-known dealership appraisers in the industry refer to as “the blue-sky approach.” Though it has served to aid in many transactions within the dealership industry over the years, this approach is nothing more than a rule of thumb approach. However, before we jump into all the ways this approach is substandard, let's first lay the groundwork regarding rules of thumb. A rule of thumb is defined in the International Glossary of Business Valuation Terms as: “a mathematical formula developed from the relationship between price and certain variables based on experience, observation, hearsay, or a combination of these; usually industry specific.” As we see, a rule of thumb is based upon many variables, most of which are unknown to the end user. These unknowns are what make rules of thumb so unreliable and, thereby, an unsupported methodology by many credentialing agencies. The American Institute of Certified Public Accountants (AICPA) states in VS Section 100 that: “Although technically not a valuation method, some valuation analysts use rules of thumb or industry benchmark indicators in a valuation engagement. A rule of thumb is typically a reasonableness check against other methods used and should generally not be used as the only method to estimate the value of the subject interest.” Other business valuation credentialing agencies take a much firmer position. The National Association of Certified Valuators and Analysts states in their practice standards: “Typically, a rule of thumb or benchmark indicator is used as a reasonableness check against the values determined by the use of other valuation approaches. For Valuation Engagements, it should not be used as the only method to determine the value of the subject interest. The source of rule of thumb should be documented.”A PROFESSIONAL DEVELOPMENT JOURNAL for the CONSULTING DISCIPLINES t h e v a l u e e x a m i n e r MAY | JUNE 2019 7 THE PURPOSE OF THE STANDARDS What these standards are intended to prevent is reliance upon information that is undocumented and potentially not comparable to the subject company being valued. Haig Partners, Presidio Group, and Kerrigan Partners are business brokers who actively participate in the transaction of numerous dealerships per year. As with most brokers, these organizations are paid based upon sales price, which means the higher the transaction price, the higher the commission payment to these groups. Also, these groups have connections with individual buyers or groups of investors who frequently look for deals to consummate for various purposes, one of which includes consolidation. Consolidation often leads to the payment of a higher than normal multiple since consolidators can increase cash flow from current operations by reducing expenses. As a result, blue-sky multiples derived from these transactions may reflect “investment value” rather than “fair market value.” Under fair market value standards, the appraiser is required to assume that there is no compulsion to buy or sell. The glaring difference between fair market value and investment value is compulsion. If we consider that the transactions within the Haig, Kerrigan, and Presidio publications contain both fair market value as well as investment value transactions, it would seem prudent to assume that a valuation under fair market value standards would tend to fall near the lower end of the multiple ranges rather than at the higher end of the range. It is also within the multiple that you will find many appraisers adjusting for the overperformance or underperformance of the subject dealership. 1. Haig Partners (year end 2017). The Haig Report: Trends in Auto Retail and Their Impact on Dealership Values. 2. Kerrigan Advisors (March 2018). The Blue-Sky Reports: A Kerrigan Quarterly 2017 Full Year Report. 1. 2. BELOW ARE EXCERPTS FROM THE HAIG PARTNERS AND KERRIGAN BLUE-SKY REPORTS.8 MAY | JUNE 2019 t h e v a l u e e x a m i n e r A PROFESSIONAL DEVELOPMENT JOURNAL for the CONSULTING DISCIPLINES Since underperforming stores are viewed as having upside potential, they tend to trade for a higher multiple to pretax income. However, making this adjustment should not be performed blindly, if at all. Adjusting for underperforming stores considers many factors that appraisers typically do not take the time to understand. For example, let’s assume you are valuing a minority interest in the subject company, and the majority shareholder is the dealer/operator. The store has been in operation for fifteen years, had never made more than $150,000 in profit in any given year, and the manufacturer has never voiced concern about how the dealer is running the store. How do you, as an appraiser, determine that the store is underperforming, and is it even appropriate to adjust for an underperforming store in this situation? What if you were valuing a controlling interest? Would it then be appropriate to adjust the cash flows? How much should they be adjusted? These are all questions you should be asking yourself. We have seen some appraisers’ suggested answers to these questions, which we will discuss a little later in this article. In my years of specializing in automotive dealership valuation, I have seen numerous ways that appraisers have attempted to justify their selection of a multiple within the range provided by any of these publications. Many times, you will see a large listing of items that have been considered about the subject company that justifies a multiple near the top or the bottom of the range. The resulting multiple remains a guess since the appraiser is completely unaware of what factors were utilized to obtain the multiple ranges in the first place. This is the precise reason as to why rules of thumb are highly discouraged as the sole method for valuing a business. WHAT DO WE RELY UPON? Assume that you are a buyer looking to purchase a dealership. After talking to a business broker, you are told that dealership transactions consist of four main parts. The first is the purchase of the furniture, fixtures, and equipment report (FF&E) and parts, which is determined by an appraisal of the assets themselves. The second is the purchase of the blue- sky (goodwill) as it relates to the brand(s) sold. The third is the purchase of the vehicle inventory. However, this amount is usually offset by floor plan financing, so it is a wash. The fourth is the infusion of a working capital amount that is required by the manufacturer to keep the business funded. This is what is required of the buyer if they want to purchase the assets of the existing dealership and place them in a new entity. But is that the assignment that you, as a business appraiser, have been tasked with? In most cases, the answer to that question is no. Typically, the business appraiser is tasked with valuing an interest in a dealership as it stands, not as a new entity. This is where we frequently see appraisers go wrong, but more on that later. So, how do we meld together the details of how dealerships trade with how we as appraisers should be valuing them? First, let’s look at how we arrive at the fair market value of blue-sky based upon what someone would be willing to pay or has paid, which is reflected in the published blue-sky multiples discussed earlier. DERIVING BLUE-SKY VALUE The entire purpose of this article is to explain how to independently derive a value of a dealership using traditional valuation methods without having to rely on published blue- sky multiple ranges to determine its blue-sky value. This is not to say that the published multiple ranges are in any way inaccurate. Published blue-sky multiples have now been put to the test in the recent article titled Multiples Used to Estimate Automotive Dealerships Market Value published in the Winter 2018 edition of Business Valuation Review.3 The point I am making is that deriving your own blue-sky multiple that has a basis in known valuation theory, that is then compared to industry rules of thumb, is a far more supportable and defendable methodology. As mentioned previously, the first step in dealership valuation is to derive the value of the goodwill based upon what someone is willing to pay. This is where appraisers typically use an ongoing pretax income amount, apply a subjective blue-sky multiple from the published range, and derive value. To move beyond that methodology to something far more supportable, we need to work toward deriving our own blue- sky multiple independent of rules of thumb. So enough with the talking, let’s get to the numbers (Exhibit 1). Assume that you have calculated the following cash flow multiple based upon the subject company’s risk profile and capital structure. 3. Gineette McManus, PhD; Rajneesh Sharma, PhD; and Ahmet Tezell, PhD, "Multiples Used to Estimate Automotive Dealerships Market Value." Business Valuation Review, Volume 37, Issue 4, Winter 2018: 144–149A PROFESSIONAL DEVELOPMENT JOURNAL for the CONSULTING DISCIPLINES t h e v a l u e e x a m i n e r MAY | JUNE 2019 9 EXHIBIT 1: COMPANY RISK PROFILE AND CAPITAL STRUCTURE Let’s further assume that our calculated ongoing cash flow to invested capital holders is as shown in exhibit 2. Cost of Equity Capital: Risk-Free Rate of Return 2.58% Long-Term Equity Risk Premium 6.04% Size Risk Premium 8.41% Unsystematic (Company-Specific) Risk Premium 1.00% Total Cost of Equity Capital 18.03% Cost of Debt Capital: Average Pretax Cost of Debt 4.77% Estimated Tax Rate 18.00% After-Tax Cost of Debt 3.91% Capital Structure: Equity Weighting 75.00% Debt Weighting 25.00% Total Invested Capital 100.00% Weighted Average Cost of Capital (WACC) 14.50% Less: Long-Term Growth Rate -4.57% Capitalization Rate 9.93% Capitalization Multiple (1/Capitalization Rate) 10.07 Ongoing Pretax Income $ 610,050 Plus: Interest Expense (excluding floor plan interest) 61, 980 Ongoing EBIT (afi)* 672,030 Less: Estimated Tax Rate/Liability 18% (120,965) Subtotal 551,065 Add/Subtract Depreciation and Amortization Add/Subtract Ongoing Capital Expenditures Subtract Expected Necessary Increases in Working Capital (89,318) Ongoing Cash Flow to Invested Capital (Earnings Power) 461,747 Ongoing Cash Flow to Invested Capital (Earning Power) for Next Year 4.57% 482,848 Capitalization Multiple 10.07 Indicated Market Value of Invested Capital (MVIC) $ 4,862,350 *Ongoing EBIT (afi) - Ongoing earnings before interest and taxes but after floor plan interest. EXHIBIT 2: DEVELOPMENT OF ONGOING CASH FLOW TO INVESTED CAPITOLNext >