DGC Enewsletter 6-10

Business Valuation Series – General Trends
In the coming weeks DGC will be interviewing various business valuation specialists for their insights on specific topics. For the first article in our series, we spoke with Chris Mellen, president and founder of Delphi Valuation Advisors and co-author of the book, Valuation for M&A: Building Value in Private Companies, recently published by Wiley.

DGC: What is driving the demand for business valuations in the current economic environment?

CM: In today’s market, demand seems to be led by estate tax planning, purchase price allocations for financial reporting purposes, and valuation-based strategic planning. There is always demand for litigation-related valuation work, regardless of the economic environment.

With regard to estate planning, there has been a tremendous opportunity over the past two years to gift assets given declines in value of underlying assets and lower interest rates. However, the window is starting to close as the economy improves and as the future viability of estate planning vehicles, such as GRATs and family partnerships, are threatened by pending tax law changes.

Over the past decade the fastest growth area within the business valuation profession has been in financial reporting. Last year, there was a spike in goodwill impairment work (FASB Statement 142, now referred to as ASC 350) given a decline in values. With much of goodwill written off the books of companies whose values declined during the recession, coupled with values having since increased for many companies, demand for this work has since waned. It has been replaced with purchase price allocation work and the need to value the intangible assets of companies acquired in compliance with FASB Statement 141, now referred to as ASC 805, given the increase in merger and acquisition activity.

Related to the demand for valuation services for purchase price allocation work after a transaction is completed, valuation-based strategic planning is needed prior to the purchase or sale of a business. The message that has been extended to both business owners and business acquirers that it is a good idea to get an independent opinion of value on a company in, or potentially in, play for an M&A has finally been heard. As a fee-for-service, appraisers have no bias in opining on the value of a company.

DGC: The three general approaches to value are the income, market, and cost approaches. How has the use and applications of these approaches in valuing a company been impacted by changes in the economic environment over the past two years?

CM: The answer depends on the type of business being valued. However, generally speaking, I have found an increase in the use of the cost approach and a decrease in the use of the market approach. Despite changes in the economy over the last 2-3 years, the income approach remains the principal approach relied upon to value a business. However, for a company whose cash flows in recent years and in the foreseeable future indicate a value less than its book value, the cost approach may be more applicable. With regard to the market approach, use of multiples from transactions occurring between 2005 and 2008 may not be applicable to today’s market. Given recent market improvements, 2009 data may also be questionable, depending on trends in a given industry and the facts and circumstances of those transactions.

DGC: Can you provide an example of one of the technical challenges you are currently facing in completing valuations?

CM: Forecasting expected future cash flows is always a challenge, but it is even more of a challenge in today’s market given all its uncertainties. It is important to understand that whenever the income approach is applied, a forecast is being done. For example, if an appraiser is taking the average of the past five years to determine value, he is forecasting that the company will achieve that level of cash flow over the next year, grown by a rate that is typically 2-5%. If that average includes cash flows that reached all-time highs in 2006 and 2007 that are not foreseeable anytime soon, he runs the risk of incorrectly overvaluing the company. Business appraisers analyze the past, but they value the future. The past is only relevant to value to the extent that it is indicative of future expectations.

DGC: What should our clients look for in hiring an appraiser?

CM: Experience in business valuation, valuation-specific credentials, and adherence to professional business valuation standards. When your clients hired DCG, they knew you are a firm of experienced CPAs who adhere to AICPA standards. Business valuation is a separate profession with distinct standards and certifications. When hiring a business appraiser, the client should expect him or her to hold the ASA, CBA, ABV, and/or CVA designations. There is a wide disparity in terms of requirements to get each of these designations, the subject of another discussion. Some of that disparity relates to experience in conducting business valuation assignments. The professional societies that award these certifications each have professional standards. One such standard is independence. An appraiser must be completely independent to prepare a credible appraisal. Even if there is no conflict, but one is perceived, acceptance of that appraisal may be in jeopardy.

In sum, there are five basic questions your clients should ask a business appraiser they might consider to hire: (1) How many full-time equivalent years of business valuation experience do you have? (2) What percentage of your time is spent valuing businesses? (3) What is your experience in completing valuations for the purpose that I need an appraisal? (4) Do you belong to any business valuation professional societies and, if so, do you possess any designations? (5) Are you up-to-date on your membership dues in each society and in your continuing professional education (CPE) requirements?

If you have any questions related to business valuation matters, please contact Lenny DiCicco at lndicicco@dgccpa.com or David Sullivan at dsullivan@dgccpa.com.

Nonprofits Face Revocation of Tax-exempt Status
By Todd Ellis, CPA

Are you connected with a PTA/PTO, little league or other organization that is tax-exempt under the Internal Revenue Code? If so, your organization has annual compliance requirements (regardless of its size) with both the Internal Revenue Service (IRS) and the Massachusetts Attorney General. Importantly, rules put into effect in 2006 require the IRS to automatically revoke the tax-exempt status of organizations that have not filed returns for three consecutive years starting May 15th, 2010.

The purpose behind this rule was to "clean up" the IRS books and eliminate thousands of exempt organizations not complying with the law. If your organization has its tax exempt status revoked, it will no longer be able to receive charitable contributions, and it will also be required to pay income, sales and property taxes just as any other for-profit company. In order to reinstate an organization to tax exempt status after revocation, a new application for exemption will need to be completed and a user fee paid.

In order to avoid this very costly and time consuming revocation from taking place, stakeholders of tax-exempt organizations must understand the rules and make sure their organizations are in compliance.

For organizations whose gross receipts are normally $25,000 or less, the IRS requires the completion and submission of Form 990-N (e-postcard) on an annual basis. For larger organizations, a Form 990/990-EZ is required. Charities which are organized, operating or soliciting funds in Massachusetts are required by the Massachusetts Attorney General to prepare and file an annual report with a copy of Form 990/990-EZ on an annual basis regardless of the size of the organization.

Even though the May 15th deadline has passed, it may not be too late to bring your organization into compliance. Please contact Todd Ellis, CPA at tellis@dgccpa.com or 781-937-5300 for more information.

Are You Prepared For a Tax Audit?
By Danielle Grimes and Stephen Colella, CPA

During the latter part of 2009, the Internal Revenue Service ramped up their efforts to aggressively target high-wealth individuals when IRS Commissioner Douglas Shulman announced the creation of a new specialized industry "Global High Wealth Industry Group." Although the IRS has not specifically defined "high-wealth" individuals, they have indicated that they will focus on individuals and families with "tens of millions of dollars" in assets or income.

This High-Wealth Task Force is housed within the Large and Mid-Size Business (LMSB) Division because the IRS is going to look at everything that may be connected to a single taxpayer, including trusts, private foundations, partnerships, equity-sharing arrangements, and privately held and related entities where the taxpayer may have actual or beneficial ownership.

The new exams will not bear any resemblance to those of the past where the examining agents were often "over their heads" when it came to the more sophisticated tax issues. The new exams are expected to be run by a team of agents who as a group will have the experience and seasoning necessary to identify and analyze the relevant issues and more than hold their own against the tax advisors representing taxpayers. The IRS has hired flow-through specialists and international examiners and is considering hiring economists, appraisal experts, and industry specialists. These specialists will not only review the taxpayers' individual returns, but also the returns for their related entities.

In addition to the IRS, state taxing authorities are also increasing efforts to collect tax dollars. For example, the Massachusetts Department of Revenue recently tried to require New Hampshire businesses to withhold Massachusetts Use taxes on purchases made by Massachusetts shoppers. Fortunately the courts rejected this, but it shows the lengths to which governments are willing to go these days to collect taxes.

Because of these increased efforts by the IRS and state taxing authorities, it is more important than ever to make sure all of your tax records are in order. As such, you should be proactive and start working with your tax advisors to build and organize your historical tax files with the strategy being to build up your defenses before the fighting actually begins. By doing so you increase your chances of a successfully supporting the positions taken on your tax returns and reduce the stress you will have if you are selected for exam.

Please feel free to contact Danielle at dgrimes@dgccpa.com, Steve at scolella@dgccpa.com, or a member of your client service team, if you have further questions or if would like to review with us whether your tax records are in order.

June 10 - Association for Corporate Growth (ACG) – Growth Conference 2010
June 10 - Cambridge Chamber - Excellence in Business Awards
June 10 - Greater Boston Chamber - Government Affairs Forum - Charlie Baker
June 14 - Massachusetts Nonprofit Network – Nonprofit Awareness Day luncheon
June 17 - Turnaround Management Association (TMA) – Cocktail Reception
June 22 - Greater Boston Chamber - Executive Forum - Bill Swanson
June 24 - Greater Boston Chamber - Women's Network Breakfast
June 29 - Real Estate Finance Association – Industry Leaders Series
June 29 - Greater Boston Chamber – Boston After Five