< PreviousA PROFESSIONAL DEVELOPMENT JOURNAL for the CONSULTING DISCIPLINES 10 SEPTEMBER | OCTOBER 2021 t h e v a l u e e x a m i n e r owner’s portion of the benefit costs reduces the income he or she could have received and may be considered part of the self-employed person’s income. This is an area in which self-employed individuals are able to move their income from one category (W-2 wages) to another (K-1, nonpassive income). An expert must research how the person has been compensating himself or herself to fully assess the damages incurred. Some experts argue that only the W-2 income should be used to estimate lost earnings. They reason that the S corporation’s net income reflects a return on the investment made by the owner. I believe this ignores reality. In many small businesses, the owner is the key person. It is his or her human capital and effort that generates the rate of return, not the assets of the business. It is also the owner who determines the amount of dollars allocated to wages and the amount allocated to the bottom line as net income in a profitable business. If an expert believes a rate of return on the assets should be considered, a model similar to the one used for estimating excess earnings could be applied to the assets of the business. A rate of return determined by the expert could be multiplied by the business’s assets. The result would then be subtracted from the business’s reported net income. I would argue that any excess earnings should then be allocated to the owner as his or her additional earnings. As the number of S corporations has grown, courts have found corporate lost profits provide proper evidence to be used in estimating a self-employed individual’s lost earning capacity. In Keiser-Long v. Owens (Ill. App. 2015), the court found that “evidence of corporate lost profits is relevant to determination of injured plaintiff’s lost earning capacity where the corporation is closely held by plaintiff (whether C or subchapter S corporation), her labor is [the] predominant factor in earning profits, and there is no risk of double recovery.”9 In Behrens v. Metropolitan Opera Association, Inc. (New York, 2005), the plaintiff was an injured opera singer. “Plaintiff was president and sole shareholder of Canta Fidelia, a subchapter S corporation. All of plaintiff’s earnings from performance contracts with Metropolitan Opera were paid to Canta Fidelia; all the profits of Canta Fidelia came from plaintiff’s earnings. Proof of the lost profits of Canta Fidelia [is] relevant to proof of plaintiff’s lost earnings, which are a proper element of recovery.”10 Therefore, with proper support of the owner’s input in the generation of the corporation’s profits, the nonpassive income reported on the K-1 along with the W-2 wages may be used to estimate lost earnings for an injured self- employed person. Other Methods for Estimating Loss Other methods may be used to estimate the economic loss to a self-employed individual. One of the most commonly used methods is to use the average income for workers providing similar services to an employer as a proxy for the self-employed individual’s earning capacity. This method is most often used to 9 See Dunn, Recovery of Damages for Lost Profits, 6th ed. supplement (March 2021), 193–194. 10 Ibid., 194. Some experts argue that only the W-2 income should be used to estimate lost earnings. They reason that the S corporation’s net income reflects a return on the investment made by the owner. I believe this ignores reality.A PROFESSIONAL DEVELOPMENT JOURNAL for the CONSULTING DISCIPLINES t h e v a l u e e x a m i n e r SEPTEMBER | OCTOBER 2021 11 assess lost earning capacity for self-employed individuals who perform “blue collar” work. The data for these jobs may be obtained from the U.S. Bureau of Labor Statistics or local workforce commissions. Assume, for example, that an injured self-employed person is an electrician. A review of data from the Texas Workforce Commission shows the annual mean (average) income for an electrician in Texas is $51,351.11 This annual income may be used to demonstrate the injured person’s earning capacity. Although the self-employed individual may not have reported this level of income, data shows workers performing the same work as “regular” employees earn the reported amount. Relying on this data assumes the injured self-employed person could have worked as an employee earning average pay. Therefore, this level of income would have been his or her earning capacity prior to the injury. This data may also be fine-tuned to provide more specific income information by Metropolitan Statistical Area (MSA). The Texas Workforce Commission database shows the annual mean income for electricians in the Dallas-Fort Worth-Arlington MSA is $49,843.12 By using this data, an expert can make the estimate more precise by targeting information specific to the area in which the injured person lives. Another method for estimating the economic loss to a self- employed person is the replacement cost. In most cases involving replacement costs, the injured self-employed person is able to return to work but not at full capacity. This calculation estimates the money spent to hire someone to provide support to the injured person. This replacement may be temporary or permanent. I have provided expert reports for many cases where replacement costs were used to estimate a self-employed individual’s loss. In one matter, an injured retail store owner was to be off work for six months. Her loss was the cost of hiring a person to work the store while she was recovering. The estimated loss was less than $7,000. In another matter, a physician was able to return to work but needed to hire a nurse practitioner to assist him in seeing patients. Because the injured physician was young, the replacement cost period ran for nearly twenty years. Even after discounting to present value, the replacement cost exceeded $2 million. 11 Texas Wages and Employment Projections, Electricians, Texas Workforce Commission, 2020, https://texaswages.com/MSAWages. 12 Ibid. In Vincent v Landi (New York, 2014), the court held that the plaintiff was entitled to recover lost profits because he “contributed his own labor to the farm business,” including milking the cows, and his injuries caused severe pain that prevented him from resuming this task. The court concluded that the plaintiff had presented evidence that proved “with reasonable certainty that the cost of hiring the employee was a direct result of plaintiff’s injuries.”13 This case is one example of how the cost of hiring additional employees to replace the contribution being made by the owner may be used to estimate the injured self-employed person’s losses. Mitigation Injured individuals have an obligation to attempt to mitigate (offset) their income loss. Some return to work at their previous jobs. Others are unable to return to their pre-injury jobs and find other employment. Some are unable to return to work. The self-employed are no different. As with other personal injury cases, a financial expert will benefit from a vocational expert’s analysis of the injured person’s ability to work and what jobs might suit his or her post-injury abilities, skills, and limitations. If it appears the injured self-employed person will return to work as an employee, data for such jobs and various levels of annual income may be found through the U.S. Bureau of Labor Statistics or state workforce commission websites.14 If the self-employed individual’s business had been profitable, it is more likely than not that he or she will return to work at the business in some role, either with the same responsibilities as before the injury or in some diminished role. This work is an effort to mitigate his or her loss, and should result in a reduction of the business’s lost profits. Because the injured person has returned to work at the business, no offsetting income needs to be shown, just the lesser amount of lost profits to demonstrate lost personal income. The cost of hiring additional employees to offset the loss of work performed by the self-employed owner prior to his or her injury can also provide the basis not for mitigation but for the economic loss. This cost is the replacement cost discussed earlier. 13 See Dunn, Recovery of Damages for Lost Profits, 6th ed. supplement (March 2021), 195. 14 For example, this data may be found in the U.S. Bureau of Labor Statistic’s Occupational Outlook Handbook at https://www.bls.gov/ooh/.A PROFESSIONAL DEVELOPMENT JOURNAL for the CONSULTING DISCIPLINES 12 SEPTEMBER | OCTOBER 2021 t h e v a l u e e x a m i n e r Worklife and Retirement Self-employed individuals tend to work continuously and retire later than wage and salary workers. Therefore, worklife expectancy tables may underreport the time a self-employed person may participate in the workforce. A retirement age may be the best alternative for capturing the period the injured person would have been in the workforce. To estimate the period to retirement, an expert will need to gather information from the injured self-employed person or his or her family. The key question is, “was there an exit plan in place?” In other words, did a key person or family member plan to purchase the business? Was the owner planning to sell to someone else? Or had there been just a general discussion of when the self-employed person would retire? The answers to these questions will help the expert model the loss calculation to reflect the facts of the case. Without such information, the expert is left to rely on more traditional retirement ages, such as age 65, when people qualify for Medicare enrollment, or age 70, when a person no longer accrues additional benefits for delaying Social Security retirement income.15 A study by The Transamerica Center for Retirement Studies (TCRS) provides support for assuming a retirement age above 65 for a self-employed person. Only 26 percent of the self-employed are “very much” looking forward to retirement according to findings from Self-Employed: Defying and Redefining Retirement, a new study released...by nonprofit [TCRS].... The survey of 755 respondents explores the retirement outlook of individuals who are primarily self-employed.… Many intend to work beyond traditional retirement age, while others have no intentions of ever retiring…Sixty-eight percent are planning to work past age 65, including 40 percent who expect to retire after age 65 and 28 percent who do not plan to retire. Moreover, 62 percent plan to continue working in retirement. The majority of the self-employed (74 percent) envision either continued work or a gradual transition into retirement, including 28 percent envisioning working as long as possible, and 46 percent thinking they will reduce their work hours or work in a different capacity that is less demanding and/or brings greater personal satisfaction. Only 11 percent of the self-employed plan to immediately stop working when they retire.16 15 See Melissa A. Z. Knoll and Anya Olsen, “Incentivizing Delayed Claiming of Social Security Retirement Benefits Before Reaching the Full Retirement Age,” Social Security Bulletin 74, no. 4 (November 2014), https://www.ssa.gov/policy/docs/ssb/v74n4/v74n4p21.html. 16 Laurel Hood, “The Self-Employed Are Defying Retirement While Overlooking Essential Preparations,” Transamerica Center for Retirement Studies, July 24, 2019, https://transamericacenter.org/ docs/default-source/retirement-survey-of-workers/tcrs2019_pr_self-employed-retirement.pdf. The cost of hiring additional employees to offset the loss of work performed by the self- employed owner prior to his or her injury can also provide the basis not for mitigation but for the economic loss.A PROFESSIONAL DEVELOPMENT JOURNAL for the CONSULTING DISCIPLINES t h e v a l u e e x a m i n e r SEPTEMBER | OCTOBER 2021 13 Discounting to Present Value In any civil suit showing future income losses, the future losses must be presented in present value form. Because the economic damages incurred by the self-employed individual are personal damages, future damages must be discounted in a format consistent with personal damages claims. In most states, this means the discount rate will be based on a risk-free rate.17 The U.S. Supreme Court addressed the issue of discounting future lost earnings as early as 1916. We do not mean to say that the discount rate should be at what is commonly called the “legal rate” of interest; that is, the rate limited by law, beyond which interest is prohibited. It may be that such rates are not obtainable upon investments on safe securities, at least without the exercise of financial experience and skill in the administration of the fund; and it is evident that the compensation should be awarded upon a basis that does not call upon the beneficiaries to exercise such skill, for where this is necessarily employed the interest return is in part earned by the investor rather than by the investment. This, however, is a matter that ordinarily may be adjusted by scaling the rate of interest to be adopted in computing the present value of the future benefits; it being a matter of common knowledge that, as a rule, the best and safest investments, and those which require the least care, yield only a moderate return.18 The Court reaffirmed this position in 1983. The discount rate should be based on the rate of interest that would be earned on “the best and safest investments.” [Citation omitted.] Once it is assumed that the injured worker would definitely have worked for a specific term of years, he is entitled to a risk-free stream of future income to replace his lost wages; therefore, the discount rate should not reflect the market’s premium for investors who are willing to accept some risk of default.19 17 For example, Pennsylvania requires the expert to assume the total offset method in most personal damages cases. This means the growth rate and interest rate are the same and discounting is not required. In Pennsylvania, discounting with a risk-free rate is required for medical malpractice cases. A few states have statutes requiring the use of specific interest rates to discount future damages in personal damages cases. An expert should consult with the retaining attorney regarding local rules on discounting if unfamiliar with the state’s standards. 18 Chesapeake & O.R. v. Kelly, 241 U.S. 485, 490–91 (1916). 19 Jones & Laughlin Steel Corp. v. Pfeifer, 462 U.S. 523, 537 (1983). Many experts argue that applying a risk-free rate to the lost profits created by the injury to a self-employed individual fails to consider the risk related to operating a profitable business. It is common for risk premiums to be applied to the risk-free rate when determining the discount rate used to discount future lost profits to present value. However, because the damages incurred by a self-employed individual are personal damages, risk premiums should not be included in the discount rate. This does not mean an expert may not consider the risk taken on by a business to generate its profits. Dunn and Harry provided an option for this situation in their 2002 article, “Modeling and Discounting Future Damages.” While this article relates to the discounting of lost profits, its concepts may be applied to the estimate of a self-employed person’s lost profits before discounting them as lost wages. Some CPA experts project the plaintiff’s hoped-for income stream, modify those losses to a realistic expectation by factoring in future risks and then discounting the adjusted future losses to a present value at a risk-reduced, relatively low discount rate. Other experts project the hoped-for-but-lost amounts and then apply a higher discount rate that already incorporates risk or uncertainty to determine the present value.20 The modification of the losses is called “modeling.” The authors go on to argue that modeling provides a more accurate approach for presenting the present value. Modeling includes “examining the interactive components of a financial outcome” and analyzing various input factors with a sensitivity analysis.21 The authors provide four steps for estimating the present value of the projected future income of a business. 1. Prepare a spreadsheet with the plaintiff’s envisioned successful outcome. This would include lost sales revenue, saved expenses, and lost net profits. These data should be arranged in interim time segments, like year by year, throughout the recovery (loss) period. 20 Robert Dunn and Everett Harry, “Modeling and Discounting Future Damages,” Journal of Accountancy 193, no. 1 (January 2002): 49–55, https://www.journalofaccountancy.com/issues/2002/jan/ modelinganddiscountingfuturedamages.html. 21 Ibid.A PROFESSIONAL DEVELOPMENT JOURNAL for the CONSULTING DISCIPLINES 14 SEPTEMBER | OCTOBER 2021 t h e v a l u e e x a m i n e r 2. Identify the risks associated with lower than hoped-for results, like lower sales or higher input prices. 3. Adjust the spreadsheet for these risks. The objective is for the results to show a stream of undiscounted lost profits that “reasonably approximates the most likely or expected but-for outcome.” 4. Calculate the present value using the appropriate discount rate.22 By following the first three steps, an expert can model the lost business income for a self-employed individual. This lost income becomes the personal lost income, which may then be discounted to present value at a risk-free rate, knowing risks relating to generating the business income have been considered. Lost Business Value Sole proprietorships range in size from one employee, the owner, to companies with numerous employees. For many self-employed individuals, the value of their business is the liquidation value of their vehicles and tools. Their books of business (customers) have value, but not like that of a professional practice (such as a physician or dentist). For other self-employed individuals, the business itself has value. Typically, in these businesses, the owner is not the primary producer of business profits, but is the driving force and overseer of the work performed by others. The profits of these businesses are generated by the employment of capital, the labor of others, and similar variables. With these facts, the business profits may not be used to show the lost earning capacity of the self-employed person. A review of the language in Smith v. Corsat (North Carolina, 1963) may help clarify situations in which a business’s profits may not be used to calculate the self- employed person’s lost earning capacity. It is a generally accepted proposition that evidence of the profits of a business in which the injured party in a personal damage suit is interested, which depend for the most part upon the employment of capital, the labor of others, and similar variable factors, is inadmissible in such suit and cannot be considered for the purpose of establishing the pecuniary value of lost time or diminution of earning capacity, for the reasons that a loss of such profits is not the necessary consequence of the injury and such profits are uncertain and speculative.23 In these situations, the self-employed person’s lost earning capacity may be shown through W-2s or partnership draws, but the expert may find the larger loss is in the value of the business. This is because the self-employed owner has lost the source of his or her retirement funds. An injury to the self-employed owner may upend these plans and create a separate loss calculation, the loss of the value of the business at retirement. One example of this type of business is a restaurant, which can be owned and operated by a self-employed individual. The restaurant may have various 22 Ibid. 23 Smith v. Corsat, 260 N.C. 92, 96, 131 S.E.2d 894, 897–98 (N.C. 1963). In these situations, the self-employed person’s lost earning capacity may be shown through W-2s or partnership draws, but the expert may find the larger loss is in the value of the business.A PROFESSIONAL DEVELOPMENT JOURNAL for the CONSULTING DISCIPLINES t h e v a l u e e x a m i n e r SEPTEMBER | OCTOBER 2021 15 assets, including tables, fixtures, kitchen equipment, food inventory, dishes, silverware, computers, and software for bookkeeping. It also may have various liabilities, including a working capital loan, utilities, a lease, supplier payments, and payroll and payroll tax responsibilities. In this example, assume the restaurant is well known and has consistent revenue and income. Because of an injury, the owner has to sell the business or its assets. The business’s future value is gone, along with the money on which the owner had relied for retirement. This is an additional loss to the injured self- employed person. The methodology for valuing a business does not change because the firm is a sole proprietorship. Many experts perform such valuations for the transfer of ownership from one generation to another or to determine the value of a business for purposes of sale. However, the calculation of the self-employed owner’s loss includes some additional steps. First, the business must be valued in the future. But for the injury to the owner, the business would not have been sold until he or she reached retirement age. In addition, there likely would have been one or two years of transition in which the self-employed owner would have remained with the business to help retain the book of business or customer base sold to the new owner. Because the sale is to take place in the future, the net selling price needs to be discounted to present value. And from that discounted present value, the net value received from the sale of the business or its assets as a result of the self-employed person’s injury must be subtracted. This means the expert will show lost income (earning capacity) for the injured self-employed individual through the projected sale date and any assumed transition period, and the net lost value of the business based on the difference between the present value of the future sale less any money received from selling the business or its assets due to the injury. Conclusion Estimating the lost earning capacity of an injured self- employed individual requires the same methodologies used to estimate the lost earning capacity of an injured wage or salaried employee. But assessing the lost earning capacity of a self-employed person is more complex because it also requires a lost profits assessment to determine lost earnings. The use of tax returns may provide income information needed to estimate the economic loss. However, if the business owner returns to work in a lesser role, the cost of an additional employee or employees to fill the roles given up by the self-employed person may provide the best estimate of the loss. Plans for transitioning from working to retirement must be considered when setting the loss period. Finally, an expert must determine if the injury to the self-employed individual caused a loss of business value. This loss of business value is the future value of the business at the projected time of retirement, discounted to present value, less the money received from the sale of the business or assets post-injury. This article has reviewed many of the issues related to assessing the economic damages incurred by an injured self- employed person. Each case will offer different facts and circumstances, which must be considered and incorporated into an expert’s analysis. Remember that the ultimate loss is an estimate of personal damages that incorporates lost profits as a base for lost earnings. By keeping this in mind, an expert can provide a relevant and reliable report to the trier of fact and dodge the pitfalls that plague many lost earning capacity reports for the self-employed. VE Allyn Needham, PhD, CEA, is a partner at Shipp Needham Economic Analysis, LLC, a Fort Worth-based litigation support, consulting expert services, and economic research firm. Prior to joining Shipp Needham, he worked in the banking, finance, and insurance industries. As an expert, he has testified on matters relating to commercial damages, personal damages, business bankruptcy, and business valuation. Dr. Needham has published articles on financial and forensic economics, and provided continuing education presentations at professional economic, vocational rehabilitation, and bar association meetings. Email: aneedham@shippneedham.com. Assessing the lost earning capacity of a self-employed person is more complex because it also requires a lost profits assessment to determine lost earnings.A PROFESSIONAL DEVELOPMENT JOURNAL for the CONSULTING DISCIPLINES 16 SEPTEMBER | OCTOBER 2021 t h e v a l u e e x a m i n e r VALUATION /////////////////////////////////////////////////////////////////////////////////////////////////////////////////////////////////////////////////////////////////////////////////////////// /////////////////////////////////////////////////////////////////////////////////////////////////////////////////////////////////////////////////////////////////////////////////////////// Going Concerns “Going Concerns” provides a forum for sharing ideas and opinions—both popular and unpopular—about the valuation profession. The purpose is to stimulate healthy debate and discussion about current and emerging issues in valuation theory and practice. If you would like to join the dialogue, please send article submissions to DanS1@NACVA.com, with Going Concerns in the subject line. Company-specific risk (CSR) is often misunderstood by the courts—as well as by some business valuators. In its essence, CSR is that additional incentive to induce an investor to invest in the subject company instead of alternative investments. In his book, Basic Business Appraisal,1 Ray Miles sets forth three fundamental principles of business valuation. The first is the principle of alternatives, which states that in “any contemplated transaction, each party has alternatives to consummating the transaction.” Implied when we use the build-up method using the risk-free rate and equity risk premium is that the alternative investments to our subject company are publicly traded companies. If this were an interactive presentation, I would ask: How many of you have an investment in an unrelated closely-held business, that is not a tech or biotech start-up, with a value less than $10 million? $5 million? $1 million? I suspect any of you who do are outliers. There is a reason for this: We ourselves perceive these businesses as being too risky. Business risks associated with these businesses include: • Risk of failure. According to reports published by the Bureau of Labor Statistics, approximately 20 percent of businesses fail in the first year, only 50 percent remain after five years, and only 33 percent remain after 10 years. • Risk of random owner behavior. Owners do not always behave rationally, and they make mistakes. In one litigation case I worked on, a family reseller shipped a bad lot. Instead of dealing with the supply 1 Raymond C. Miles, Basic Business Appraisal (New York: John Wiley & Sons, 1984). issue, family members fought with each other and the supplier. Ultimately, they lost their exclusive rights to the product and, in turn, most of their profits. Owners also die or become unable to work. • Cash flow risks. Owners may take too much money out of the business, creating cash flow problems. We assess this at the valuation date, but there are no guarantees the owner will not behave differently in the future. • Key person risks. The business may rely on a key employee or employees with hard-to-retain skill sets. Market conditions change. • Competition risks. The business may not be effective in assessing and responding to competition. • Poor access to capital. The business does not have access to the same capital sources as publicly traded companies. Large companies have better access to bank loans, may be able to leverage payment terms with vendors, and may have better access to private capital markets (angel investors). • Inadequate financial information. Small businesses tend to be less transparent in regard to their financial information and, when such information is available, there may be questions as to its reliability. What is a reasonable range for a CSR premium (CSRP)? In a classic business valuator response, it depends. I find the typical equity risk premium using the 10th decile size premium and before the CSRP is around 15 percent. According to Implied Private Company Pricing Line (IPCPL) data, the average implied equity return is 18–19 percent. This implies that the CSRP is 3–4 percent. But there is a problem with relying on market transaction data. (This can be the subject of another Company-Specific Risk: It May Be Greater than You Think By David H. Goodman, CPA, CVAA PROFESSIONAL DEVELOPMENT JOURNAL for the CONSULTING DISCIPLINES t h e v a l u e e x a m i n e r SEPTEMBER | OCTOBER 2021 17 column.) The data is self-selective on at least two counts: (1) it only reflects companies that sold, and (2) it only reflects companies that survived and succeeded long enough to be sold. If you think about the fact that in 10 years only one- third of the companies that started this year will still be around, that suggests a higher risk than 3–4 percent. So, what range do I use? I perform an analysis in which I look at the various attributes of risk and make a determination for each attribute whether it is neutral as to risk, increases risk, or decreases risk in regard to the subject company. Based on this analysis, I assign a CSRP percentage. (This analysis helps counter the idea that the CSRP is a means by which business valuators get the end result they are looking for.) In practice, the range has been as low as 3 percent to as high as 40 percent. In determining the specific company risk from your analysis, I recommend starting with an expected CSRP. For example, if your typical range is 0–5 percent, you might start with an expected CSRP of 3 percent. If your range is 3–6 percent, you might start with an expected CSRP of 4–5 percent. Then review your analysis. Does the weight of your responses suggest lower risk, higher risk, much higher risk? Then pick an amount you feel comfortable defending. Some people use a scoring system. Cross-examining attorneys love to pick on this approach. Something I am thinking about is whether the multi-attribute utility model (MUM) could be used to develop the CSRP. VE David H. Goodman, CPA, CVA, of Jesson, Oslin & Associates, LLP, in Boston, has over 20 years of experience in performing business valuations and forensic accounting services for family law and business disputes. He also has prepared business valuations for tax and buy-sell purposes. Mr. Goodman has an MBA from the Tuck School of Business at Dartmouth College. He is a past president of NACVA’s Massachusetts State Chapter, past chair of the Massachusetts Society of Certified Public Accountants Litigation and BV committee, and past board member and treasurer of the Massachusetts Collaborative Law Council. He has presented on business valuation and tax issues related to divorce to all three organizations. As a financial neutral, Mr. Goodman has helped divorcing couples reach peaceful, equitable solutions. He has testified as an expert witness in court and arbitration. Email: dgoodman@joacpa.com. The Value Examiner®—May/June 2021 CPE Exam Office Use Only: Invoice #: The Value Examiner CPE Rev 05/20/2021–Page 1 Earn five hours of NACVA CPE* by reading The Value Examiner and completing this exam. For CPE credit, visit www.nacva.com/valueexaminer and log in; or scan and e-mail to: CPE@NACVA.com; or fax to: (801) 486-7500; or mail to: 1218 East 7800 South, Suite 302, Sandy, UT 84094 Cost: $80.00 Name: Designations: NACVA Member #: Firm Name: IBA Member #: Address: City: State: ZIP: Tel: Fax: E-mail: Check #: (payable to: NACVA) or ❑ VISA ❑ MasterCard ❑ AMEX ❑ Discover Credit/Debit Card #: Expiration Date: Credit card billing address: ❑ Same, or Address: City: State: ZIP: Authorized Signature‡ Date: ‡By signing, you authorize the National Association of Certified Valuators and Analysts (NACVA) to charge your account for the amount indicated. NACVA can also initiate credit entries to your account in the event a credit or correction is due. Your signature authorizes NACVA to confirm the above information via e-mail and/or fax and to use either for future communication. NACVA will not disclose or share this information with third parties. * This exam does not qualify for NASBA QAS CPE credit. Important note: Although this exam qualifies for NACVA CPE, it may not be accepted by all state boards or accrediting organizations. Therefore, individuals should contact their state board or accrediting organization to determine if passing an exam after reading a book/magazine meets their CPE requirements. State CPE Sponsor #:_______________. Valuing Brands in the Tech Sector Using an Apportionment Framework By Doug Bania, CLP, and Brian Buss, CFA, CPVA 1. The income approach to brand valuation is usually the most appropriate in the tech industry because: a. It measures historical product revenue to forecast future revenue b. It quantifies the present value of future economic benefits, which is especially relevant when considering product life cycles c. It involves reviewing valuation indications from transactions involving similar assets d. Stakeholders in potential sales and investment transactions are usually most concerned with the income realized from products 2. What sources should be used for identifying a business’s key assets? a. Conversations with management b. Financial reports c. Stakeholder communications d. Marketing materials e. Company website f. All of the above The Value Examiner ®—January/February 2021 CPE Exam Office Use Only: Invoice #: The Value Examiner CPE Rev 02/04/2021–Page 1 Earn five hours of NACVA CPE* by reading The Value Examiner and completing this exam. For CPE credit, visit www.nacva.com/val ueexaminer and log in; or scan and e-mail to: CPE@NACVA.com ; or fax to: (801) 486-7500; or mail to: 1218 East 7800 South, Suite 302, Sandy, UT 84094 Cost: $80.00 Name: Designations: NACVA Member #: Firm Name: IBA Member #: Address: City: State: ZIP: Tel: Fax: E-mail: Check #: (payable to: NACVA) or VISA MasterCard AMEX Discover Credit/Debit Card #: Expiration Date: Credit card billing address: Same, or Address: City: State: ZIP: Authorized Signature‡ Date: ‡By signing, you authorize the National Association of Certified Valuators and Analysts (NACVA) to charge your account for the amount indicated. NACVA can also initiate credit entries to your account in the event a credit or correction is due. Your signature authorizes NACVA to confirm the above information via e-mail and/or fax and to use either for future communication. NACVA will not disclose or share this information with third parties. * This exam does not qualify for NASBA QAS CPE credit. Important note: Although this exam qualifies for NACVA CPE, it may not be accepted by all state boards or accrediting organizations. Therefore, individuals should contact their state board or accrediting organization to determine if passing an exam after reading a book/magazine meets their CPE requirements. State CPE Sponsor #:_______________ . Taking the Leap from Valuation Analyst to Value Growth Advisor By Kevin A. Papa, CPA, CVA, ABV, CVGA 1. When beginning a consulting engagement to assist a business in growing value, the consultant should: a. Analyze the company's historic financial statements for unusual activity b. Estimate the company-specific risk premium of the business c. Ask thought-provoking questions of management and require them to grade themselves d. Present an initial valuation analysis to the owner 2. A company with very low risk in the fundamental category of planning, will: a. Be ready to convert its ideas into a completed business plan b. Have many customers with consistent ordering history driving sales c. Have a succession plan that outlines the company’s future ownership structure d. Be operating in accordance with a written business plan, fully developed by management, citing a clear vision, objectives, and tactics The Value Examiner®—March/April 2021 CPE Exam Office Use Only: Invoice #: The Value Examiner CPE Rev 02/04/2021–Page 1 Earn five hours of NACVA CPE* by reading The Value Examiner and completing this exam. For CPE credit, visit www.nacva.com/valueexaminer and log in; or scan and e-mail to: CPE@NACVA.com; or fax to: (801) 486-7500; or mail to: 1218 East 7800 South, Suite 302, Sandy, UT 84094 Cost: $80.00 Name: Designations: NACVA Member #: Firm Name: IBA Member #: Address: City: State: ZIP: Tel: Fax: E-mail: Check #: (payable to: NACVA) or VISA MasterCard AMEX Discover Credit/Debit Card #: Expiration Date: Credit card billing address: Same, or Address: City: State: ZIP: Authorized Signature‡ Date: ‡By signing, you authorize the National Association of Certified Valuators and Analysts (NACVA) to charge your account for the amount indicated. NACVA can also initiate credit entries to your account in the event a credit or correction is due. Your signature authorizes NACVA to confirm the above information via e-mail and/or fax and to use either for future communication. NACVA will not disclose or share this information with third parties. * This exam does not qualify for NASBA QAS CPE credit. Important note: Although this exam qualifies for NACVA CPE, it may not be accepted by all state boards or accrediting organizations. Therefore, individuals should contact their state board or accrediting organization to determine if passing an exam after reading a book/magazine meets their CPE requirements. State CPE Sponsor #:_______________. Business Value in Use: Differentiating Value to the Owner from Value in Exchange By James A. Lisi, CVA, MBA, CPIM 1. Under the legal concept of property, how many overarching utilities exist for a business enterprise? a. Utility is immaterial; the client and appraiser determine the type and definition of value b. One; only one true value exists for any business c. Two; a value if sold and a value if not sold d. Many; utilities are not exclusive; different levels of value exist driven by the purpose of the valuation 2. Which of the following elements differentiates value-in-exchange and value-to-the-owner? a. Intellectual property b. Growth rate c. Capital structure d. Competition 3. The test to evaluate if a factor is dependent to ownership, and applies to value-to-the-owner engagements, is whether, after a transfer: a. The buyer could change it slowly over a long period of time b. The equity holders object to changing it c. The seller can no longer change it d. The buyer can change it immediately Visit www.NACVA.com/ValueExaminer and log in to access an exam. Online exams are available for The Value Examiner issues from 2014 to current. You will be able to purchase, complete, and earn five hours of NACVA CPE* for each exam. You will instantly receive a certificate of completion for each exam you pass. Earn CPE Online by Reading The Value Examiner®! * This exam does not qualify for NASBA QAS CPE credit. Individuals should contact their state board or accrediting organization to determine requirements for acceptance of CPE credit. To learn more, please visit www.NACVA.com/ValueExaminer, or call Member/Client Services at (800) 677-2009. The Value Examiner CPE exam can now be taken online! CPE_examVEad.indd 1CPE_examVEad.indd 16/30/21 12:08 PM6/30/21 12:08 PMA PROFESSIONAL DEVELOPMENT JOURNAL for the CONSULTING DISCIPLINES 18 SEPTEMBER | OCTOBER 2021 t h e v a l u e e x a m i n e r As consultants, we must sell our services and expertise. But to do so successfully, we must be able to explain and defend our own value. For some, having the lowest rates means not having to “sell” their services. They want their low rates to do the selling for them. But with some skills and confidence, we can all ask for and receive reasonable compensation for our expertise. The book, How to Sell at Margins Higher than Your Competitors, by Lawrence L. Steinmetz, PhD, and William T. Brooks, provides invaluable guidance on selling services at higher rates.1 One key message of the book is that no matter how much we want to increase our revenue, not everyone is a desirable client. It is particularly important to avoid clients who are looking for the lowest possible fee, and that attitude is something to listen for when talking with prospects. Watch for those who seem to be saying, “you are not going to make any money off of me.” It would be foolish to waste our valuable time trying to encourage people with that mindset to engage our firm. Avoid Price-Buyers Steinmetz and Brooks provide eight reasons consultants should not waste time on people seeking the lowest fee; those they refer to as “price-buyers.” 1. Price-buyers have no qualms about wasting our time. They do not value our time and therefore do not respect it. They would rather spend our time than their money. 2. Price-buyers tend to complain more than other clients because they have learned that complaining often works. This goes for the novice whiner as well as the most sophisticated business owner. The authors note that anyone who has studied 1 Lawrence L. Steinmetz, PhD, and William T. Brooks, How to Sell at Margins Higher than Your Competitors: Winning Every Sale at Full Price, Rate, or Fee (Hoboken, NJ: John Wiley & Sons, 2006), available at Amazon ($26.41, hardcover). negotiation skills has learned to ask for concessions, but after getting a discounted price, they may expect a full measure from us. And once they successfully obtain a price concession, they often begin asking for other special accommodations. 3. Price-buyers often “forget” to pay. Not only do they want a low price, but they may also want more time to pay an invoice. This follows naturally when their money is their highest priority. 4. Price-buyers may tell our other prospects or clients how little they paid for our services. This can quickly hurt our other client relationships and our brands. 5. Price-buyers can distract us and wear us down to the point that we have less time and energy to provide superior service to other clients. Anyone who has been in the consulting business for a while has probably experienced this type of client. 6. Price-buyers are unlikely to maintain long-term relationships with us unless we continue to offer discounts. Pure price-buyers are loyal to only one vendor: the one who is offering the lowest price at the moment. So, even if we provide great service, they may jump ship the next time services are needed. 7. After taking on price-buyers, we may need to make new investments to meet their needs, such as purchasing additional software or subscriptions for which we are not likely to be reimbursed. This is especially problematic for large engagements. Steinmetz and Brooks point out that some of the most tragic small business failures occur when their owners become mesmerized by being associated with big clients that eventually squeeze the life out of their businesses. The authors suggest that if one Getting Full Value for Your Expertise By Stephen D. Kirkland, CPA, CMC, CFF BOOK REVIEW /////////////////////////////////////////////////////////////////////////////////////////////////////////////////////////////////////////////////////////////////////////////////////////// ///////////////////////////////////////////////////////////////////////////////////////////////////////////////////////////////////////////////////////////////////////////////////////////A PROFESSIONAL DEVELOPMENT JOURNAL for the CONSULTING DISCIPLINES t h e v a l u e e x a m i n e r SEPTEMBER | OCTOBER 2021 19 client accounts for more than 10 percent of a firm’s revenue, the firm may be vulnerable to unreasonable demands from that client. 8. Price-buyers may steal any ideas, information, and intellectual property they can get their hands on. They may say, “show me what you can do” or “give me your best ideas and then I will think about it,” and when they say “give” they mean it literally. The authors caution professionals to avoid a common ploy: prospects who suggest that fees be reduced “this time” based on a verbal offer to see if they can pay more in the future. Should we be willing to cut our fees to get a foot in the door? The authors say no, finding it highly unlikely that a client who has received a discount will later offer to make it up. If they planned to pay us fairly, they would do so from the start. Professionals should also watch out for prospects who claim they can get similar services at a lower price from someone else. If that is true, then why aren’t they doing so? The fact is, they want our superior expertise and service at another firm’s lower price. The bottom line, according to Steinmetz and Brooks, is that no one should give their time to someone who is not ready, willing, and able to pay fair value in exchange. If our expertise has value, our clients should pay for it. Compete on Delivery, Not Price Rather than competing on price, the authors strongly recommend competing on delivery if we want to consistently enjoy higher rates than our competitors. They emphasize that great reputations are built by consistently delivering what was promised on time. So, we should accept new clients only when (1) they appreciate us, and (2) we are sure we can provide excellent service. If deliverables are not what was expected, clients do not care why we let them down. Of course, this is not to suggest simply telling clients what they want to hear. It means delivering what was promised, which should be accurate information and honest opinions. Understand the Distinction between Commodities and Professional Services Steinmetz and Brooks point out that providers of commodities, like Walmart and Amazon, can cut their prices to very low margins and make it up on volume. But professional service providers are limited in how much they can produce while still doing quality work. The authors also remind readers that it is often possible to raise rates and make more money even after losing some volume, although they believe that we may not lose as much volume as we expect after increasing our rates. Clients want the best for themselves and usually associate higher prices with higher quality. “Price is virtually always more important in the mind of the seller than in the mind of the buyer,” the authors observe, so professionals should focus more on margin than on volume. Ask for Higher Rates Steinmetz and Brooks point out that to get higher rates, we must first be willing to ask for them. They recommend raising rates periodically and being willing to discuss price with prospects even before they ask about it. According to the authors, any Any hesitancy on our part to discuss price is seen by prospects as an indication that we believe our price is too high.Next >