Understanding 409A Valuations in New York

1.jpgGenerally speaking, we all have a pretty solid idea of how much our businesses are worth based on its overall success. Ultimately, however, this idea is highly inaccurate, despite how much faith we may have in our own ideas. There may come a time where you’ll need an accurate business valuation. You might find yourself wanting to sell your company, and you need to know just how much it’s really worth. Perhaps you have to know it for your taxes, or you might even be dealing with a litigation. Whatever the case, you’ll want an accurate valuation.

There are five steps involved in getting a proper valuation:

  • Preparing and Planning
  • Financial Adjustments
  • The Different Valuation Methods
  • Applying the Methods
  • Coming to a Value Conclusion

Step 1: Planning and Preparation

The key to any good valuation is organization, and where that begins by knowing why you need the valuation in the first place, and then assembling all the required information based on that reason. It’s important to know that valuations are not absolute. They can tell you about what the company is worth, but not the exact amount.

You should remember these things as you go:

  1. See how the business operates. Is the structure tax-efficient, and can you improve it? Are sales on the rise or on the fall? What size is the demographic of your company?
  2. A business valuation is more than subtracting your liabilities from your assets, as part of the value comes from assets that are intangible.
  3. Carefully choose your appraisal team. Doing it yourself can be taxing, and therefore increase the likelihood of errors occurring. Find an accountant that does good work, then consider bringing in a professional broker and attorney.

In many cases, company owners want to sell their companies to make extra profit. In this situation, they’re treating the sale more like an auction, waiting for the highest bidder to come along and seal the deal. Your main focus is to find the fair market value, or the amount that a buyer could reasonably be expected to offer.

In other cases, rival companies might approach the company owner to buy, whether the owner had intended to sell or not. These companies may be looking for resources to supplement themselves. This is called a synergistic buyer. This is done by applying the investment standard. In this scenario, they’re assuming the value of the business themselves based on public information.

The final, and unfortunately more common cases, a company needs to liquidize as a result of bankruptcy, natural disasters, and other company killing events. In this case the owner must sell as quickly as possible, and is unable to take their time waiting for the best offer.

Now that you know why you need the valuation you can understand what you need to gather to understand the worth of your business. You may need staff records, business plans, vendor information, financial statements, and operational procedures. While some of these may give you a quick and basic range, you’re gonna have to do a bit of math if you want a more accurate number.

Click here to read more about New York 409A valuations.

Step 2: Adjusting the Finances

Company financial information provides key inputs into the process. You’re going to need your balance sheets, which show the relationship between the owner’s equity, assets, and liabilities, and then the income statements, which are reports that show all the profitable operations from the past or the present. An accurate valuation requires at least three years worth of these statements.

Given that owners have a great deal of discretion in how they use and recognize assets, income, and expenses, the statements may need to be readjusted or recast. So it’s important to construct the relationship between business assets, expenses and income that these assets are capable of producing. You’ll need to recast these to get an input for use in valuation.

Step 3: The Different Valuation Methods

Once the data has been assembled you can finally choose which procedure you’d like to follow. There are a number of accepted methods, but the best thing you can do is to utilize as many as you can, so that you can cross-check and reference all of your results. If all the results you get are close to each other then you can expect that you’ve done an accurate valuation.

Some of the popular methods include:

The Asset Valuation Method

This method is used to determine the value of the assets that are currently owned by the business. While this method can be quite valuable, it likely won’t give you enough information for a truly accurate value, especially if your business is small. No matter how many assets you have, if they aren’t producing income then the company is simply sitting on resources. However, you may only have a few assets, but those could be create a lot of profit. This method is best suited to larger companies, as it’s not always the best at showing you your business operations.

Some off-balance sheet assets that are included in the Asset Accumulation valuation are:

  • All products and services that are a part of your intellectual property.
  • Key distribution and customer contracts.
  • Strategic partnership agreements.

Typical unrecorded liabilities that are included in the valuation are:

  • Pending legal judgments.
  • Property and income tax obligations.
  • {Environmental compliance costs.|The cost of complying with environmental standards.|Your costs for environmental standard compliance.

The Liquidation Value Method

This method looks at what the business would be worth on an open market, ignoring the reputation of the owners or business itself. It takes into account the physical assets, things like equipment, inventory, and real estate.

Comparable Company Analysis


This is normally the easiest method to perform. You will have to have publicly traded securities, so that the company’s value can be compared against that of other companies more easily.

This is best used for small additions are being done or considered, ones that don’t change the control of the company. This does not include times where the power balance is shifted from one person to another. When a change isn’t occurring this method is the most used technique.

Discounted Cash Flow Analysis

DCF (discounted cash flow analysis) is used to ascertain the amount of money the company will generate in the future, and base the value off of that. This is arguably the most correct method to be using.

However, there are inherent obstacles with this method. What DCFs can offer are estimates based on theory and computation, but they can also lose out in accuracy of the exact value of the company. Simply because you are looking at future money it’s become a difficult method to work with. By attempting to predict the future you’ve already based your numbers off of speculations and assumptions, and knowing that you’ll find it harder to get an accurate number the further in the future you look. The company’s value is easily changed depending on the assumptions made. Something like an established utility company, a company that’s reliable and has an extremely stable and predictable income, are the best to use with this method.

Precedent Transaction Analysis

Another fairly easy valuation method to perform. This requires that you’ve had a prior acquisition, and that you know the number of shares taken and amount of debt you’ve assumed. You should assume this is the company that was acquired had previous publically traded instruments.

Precedent Transactions are designed to attempt to ascertain the difference between the value of the comparable companies acquired in the past before the transaction and after the transaction (the difference between the market value of the company before the transaction is announced vs. the amount paid for the company in a control-transferring purchase). This difference is the premium paid in order to acquire control of the business. Precedent Transaction analysis should typically be one of the valuation methods used in the realm of acquisitioning other companies.

Leveraged Buyout Analysis

Leveraged buyouts (LBO) are the acquisition of a private or public company that has a large amount of borrowed funds. LBOs are typically used when looking to acquire companies inexpensively with the idea that they can be sold at a higher profit within a couple of years. These are usually conducted by private equity firms that are attempting to maximize returns from these investments by using as much borrowed capital as possible (otherwise known as debt financing) to fund the acquisition of a company. You can do an LBO analysis in three different ways:

  1. Assume a minimum return for a sponsor as well as a reasonable equity/debt ratio, and use this to impute a company value.
  1. Impute the necessary ratio of debt to equity based on an appropriate company value and the minimum expected return for the financial sponsor.
  1. Assume a reasonable equity/debt ratio and the company value, then calculate the expected return from the investment.

Step 4: Applying the Methods

Once you have all of the data assembled, it’s finally time to assess the true value of your company. None of these methods will yield a completely accurate result, so you should use a few of them. As well, thanks to having multiple sets of information for the different methods you use you’ll be able eliminate some of the possibility that there were clinical or calculation based errors, ensuring your company has an accurate assessment. It may mean a lot more homework for you, but you’ll have a more accurate valuation.

Step 5: Coming to a Value Conclusion

Using the results from your chosen valuation method you can finally discern what your business is worth. This is known as the business value synthesis. Knowing that no one method is going to be completely accurate it might behoove you to use multiple methods and then look at all the results to come to a conclusion. The value is going to be subjective, no matter what you do. Remember that you’ll often place a higher value on your company when others may be more than happy to tear it apart. You’re going to want to reconcile that difference that you see in your company’s value between the different methods. If you spend the time to research your company’s earnings, their actual assets and their projected future growth, you will come to an agreement close to the figures that you provide. All that remains is the art of the deal.

 

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