Florida Personal Goodwill

Transcription

-1-1-1-1-1Personal Goodwill: Does the
-1- Non-Propertied Spouse
Personal
Goodwill:
Does
the
Non-Propertied
Spouse
Personal
Goodwill:
Does
the
Non-Propertied
Spouse
Really
Lose
the
Battle?
Personal
Goodwill:
Does
the
Non-Propertied
Spouse
Personal
Goodwill:
Does
the
Non-Propertied
Spouse
Really
Lose
the
Battle?
Really
Lose
the
Battle?
Personal
Does
the
Non-Propertied
Spouse
By: GaryGoodwill:
R. Trugman
CPA*/ABV,
MCBA,
ASA,
MVS
Really
Lose
the
Battle?
Really
Lose
the
Battle?
By:
Gary
R.
Trugman
CPA*/ABV,
MCBA,
ASA,
By:
Gary
R.
CPA*/ABV,
MCBA,
MVS
Really Lose
the Battle?
By:
Linda
B Trugman
Trugman
CPA*/ABV,
MCBA, ASA,
ASA, MVS
MBA
By:
Gary
R.
Trugman
CPA*/ABV,
MCBA,
ASA,
MVS
By:
Gary
R.
Trugman
CPA*/ABV,
MCBA,
ASA,
MVS
By:
Linda
B
MBA
* Regulated CPA*/ABV,
by the State of Florida
By:
B
MBA
By: Linda
Gary R.
Trugman
MCBA,
ASA,
MVS
By:
Linda
B
Trugman
CPA*/ABV,
MCBA,
ASA,
MBA
*
Regulated
by
the
State
of
Florida
By:
Linda
B
Trugman
MCBA,
ASA,
MBA
By: Linda B Trugman
MCBA,
ASA,
MBA
* Regulated by the State of Florida
Introduction
* Regulated by the State of Florida
Introduction
Introduction
Introduction
Introduction
From
1991, when the Supreme Court of Florida ruled that professional (personal) goodwill was not
Introduction
From
1991,
whenthrough
the Supreme
Supreme
Court
of
Florida
ruled
that of
professional
(personal)
goodwill
was
not1
a marital
asset,
2005, Court
when of
the
District
Court
Appeals of(personal)
Florida ruled
in the
Held
From
1991,
when
the
Florida
ruled
that
professional
goodwill
was
not
From
1991,
when
the
Supreme
Court
of
Florida
ruled
that
professional
(personal)
goodwill
was
not11
a
asset,
through
2005,
when
the
District
Court
of
Appeals
of
Florida
in
Held
decision
that
a non-solicitation
agreement
should
be
the same
as aruled
non-competition
From
1991,
when
the Supreme
of
Florida
ruled
thattreated
professional
goodwill
was
not1
a marital
marital
asset,
through
2005, Court
when
the
District
Court
of
Appeals
of(personal)
Florida
ruled
in the
the
Held
From
1991,
when
the
Supreme
Court
of
Florida
ruled
that
professional
(personal)
goodwill
was
not
a
marital
asset,
through
2005,
when
the
District
Court
of
Appeals
of
Florida
ruled
in
the
Held
decision
a
non-solicitation
agreement
be
treated
the
as
a
agreement,
which
could 2005,
be anwhen
indication
ofshould
personal
goodwill,
thesame
ofnon-competition
what
personal
a marital that
asset,
through
the District
Court
of Appeals
ofquestion
Florida
ruled
in the
Held11
decision
that
a
non-solicitation
agreement
should
be
treated
the
same
as
a
non-competition
a
marital
asset,
through
2005,
when
the
District
Court
of
Appeals
of
Florida
ruled
in
the
Held
decision actually
thatwhich
a non-solicitation
be goodwill,
treated
the
as avaluation
agreement,
could
beitan
an
indication
ofshould
personal
thesame
question
ofnon-competition
what personal
personal
goodwill
is, could
and how
canagreement
be quantified
has troubled
attorneys
and their
experts.
decision thatwhich
a non-solicitation
agreement
should
be goodwill,
treated
the
same
as aof
non-competition
agreement,
be
indication
of
personal
the
question
what
decision
that
a
non-solicitation
agreement
should
be
treated
the
same
as
a
non-competition
agreement,
which
could
be
an
indication
of
personal
goodwill,
the
question
of
what
personal
goodwill
actually
is,
and
how
it
can
be
quantified
has
troubled
attorneys
and
their
valuation
experts.
Without
proper
valuation
techniques
being of
employed,
the
non-propertied
spouse
may come
out
agreement,
which
beitan
personal
goodwill,
the question
of what
personal
goodwill
actually
is, could
and how
canindication
be quantified
has troubled
attorneys
and their
valuation
experts.
agreement,
which
could
beitan
indication
of
personal
goodwill,
the question
of what
personal
goodwill
actually
is,
and
how
can
be
quantified
has
troubled
attorneys
and
their
valuation
experts.
Without
proper
valuation
techniques
being
employed,
the
non-propertied
spouse
may
come
out
as the big
loser valuation
inis,the
distribution
of the
business.
goodwill
actually
andequitable
how
it can
be quantified
hasmarital
troubled
attorneys and their
valuation
experts.
Without
proper
techniques
being
employed,
the
non-propertied
spouse
may
come
out
goodwill
actually
is,
and
how
it
can
be
quantified
has
troubled
attorneys
and
their
valuation
experts.
Without
proper
valuation
techniques
being
employed,
the
non-propertied
spouse
may
come
out
as the
the big
big
loser valuation
in the
the equitable
equitable
distribution
of the
the marital
marital
business.
Without
proper
techniques
being employed,
thebusiness.
non-propertied spouse may come out
as
loser
in
distribution
of
Without
proper
valuation
techniques
being employed,
thebusiness.
non-propertied spouse may come out
as
the
big
loser
in
the
equitable
distribution
of
the
marital
To
put big
things
into
paper willofbegin
with abusiness.
brief overview of what goodwill is, and
as the
loser
in perspective,
the equitablethis
distribution
the marital
as the
big
loser
in perspective,
the equitablethis
distribution
ofbegin
the marital
business.
To
put
things
into
paper
will
with
a
brief
overview
what
is,
where
caseperspective,
law has taken
through
Aftera we
perform
thisof
we will provide
To
put Florida
things into
thisuspaper
will today.
begin with
brief
overview
ofreview,
what goodwill
goodwill
is, and
and
To
put
things
into
perspective,
this
paper
will
begin
with
a
brief
overview
of
what
goodwill
is, and
where
Florida
case
law has
has taken
taken
uspaper
through
today.
After
we
perform
thisconsider
review,
we
will provide
provide
you
with
some
suggestions
asthis
tous
what
the
business
valuer
needs
to
in valuing
the
To
put
things
into
perspective,
will today.
begin
with
a we
brief
overview
ofreview,
what goodwill
is, and
where
Florida
case
law
through
After
perform
this
we
will
To
put
things
into
perspective,
this
will today.
begin
with
a we
brief
overview
ofreview,
what goodwill
is, and
where
Florida
case
law has taken
uspaper
through
After
perform
thisconsider
we
will provide
you
with
some
suggestions
as
to
what
the
business
valuer
needs
to
in
valuing
the
personal
portion
of
goodwill,
i.e.
the
portion
of
the
marital
pot
that
the
non-propertied
spouse
may
where
Florida
law has taken
through
After
we perform
thisconsider
review, we
will provide
you
with
somecase
suggestions
as tous
the today.
business
valuer
needs to
in valuing
the
where
Florida
case
law has taken
uswhat
through
today.
After
wethat
perform
thisconsider
review, we
will provide
you
with
some
suggestions
as
to
what
the
business
valuer
needs
to
in
valuing
the
personal
portion
of
goodwill,
i.e.
the
portion
of
the
marital
pot
the
non-propertied
spouse
may
not
piece
ifgoodwill,
valued incorrectly.
you get
witha portion
some of
suggestions
as the
to what
theof business
valuer
needs
to consider in spouse
valuingmay
the
personal
of
i.e.
portion
the
marital
pot
that
the
non-propertied
you
with
some
suggestions
as
to
what
the
business
valuer
needs
to
consider
in
valuing
the
personal
i.e. the portion of the marital pot that the non-propertied spouse may
not
get a
a portion
piece of
ofof
ifgoodwill,
valued incorrectly.
incorrectly.
personal
portion
ofif
goodwill,
not
get
piece
valued
personal
not get a portion
piece ofofifgoodwill,
valued incorrectly.
not
get a piece of if valued incorrectly.
Goodwill
not
get a piece of if valued incorrectly.
Goodwill
Goodwill
Goodwill
Goodwill
Let’s
start off with some basics. What is Goodwill? Goodwill is defined as ““…the value of a trade
Goodwill
Let’s
start
with some
basics.
What
is
defined
““…the
value
or business
on expected
customerGoodwill
patronage
to itsas
reputation,
any
Let’s
start off
offbased
with
some
basics. continued
What is
is Goodwill?
Goodwill?
Goodwill
is due
defined
asname,
““…the
value of
of a
aortrade
trade
Let’s
start
off
with
some
basics.
What
is
Goodwill?
Goodwill
is
defined
as
““…the
value
of
a
trade
or
business
on
expected
continued
customer
patronage
to
its
any
other
factor…”
[See
IRS
Publication
BusinessGoodwill
Expenses,
Chapter
9,““…the
Cat.reputation,
No.
15065Z].
A
Let’s
start
offbased
with
some
basics.
What535:
is Goodwill?
is due
defined
asname,
value
of aor
trade
or
business
based
on
expected
continued
customer
patronage
due
to
its
name,
reputation,
or
any
Let’s
start
offbased
with
some
basics.
What535:
is Goodwill?
Goodwill
is due
defined
asname,
““…the
value
of aortrade
or
business
on
expected
continued
customer
patronage
to
its
reputation,
any
other
factor…”
[See
IRS
Publication
Business
Expenses,
Chapter
9,
Cat.
No.
15065Z].
A
subset
of goodwill
isonpersonal
goodwill
which
represents
the value
of to
theitsenterprise
stemming
or
business
based
expected
continued
customer
patronage
due
name,
orfrom
any
other
factor…”
[See
IRS
Publication
535:
Business
Expenses,
Chapter
9, Cat.reputation,
No.
15065Z].
A
or
business
based
onpersonal
expected
continued
customer
patronage
due
to itsenterprise
name,
orfrom
any
other
factor…”
[See
IRS
Publication
535:
Business
Expenses,
9, Cat.reputation,
No.
15065Z].
A
subset
of
goodwill
is
goodwill
which
represents
the
value
of
stemming
an
individual’s
personal
to that
business.
It is
owned
byChapter
thethe
individual,
the
business
other
factor…”
[See
IRSservice
Publication
535:
Business
Expenses,
Chapter
9, Cat. not
No.
15065Z].
A
subset
of
goodwill
is
personal
goodwill
which
represents
the
value
of
the
enterprise
stemming
from
other
factor…”
[See
IRSservice
Publication
535:
Business
Expenses,
Chapter
9, Cat. not
No.
15065Z].
A
subset
of goodwill
is personal
goodwill
which
represents
the value
of
the
enterprise
stemming
from
an
individual’s
personal
to
that
business.
It
is
owned
by
the
individual,
the
business
itself.
subset
of goodwill
is personal
goodwill
which
represents
the value
of
the
enterprise
stemming
from
an
individual’s
personal
service
to
that
business.
It
is
owned
by
the
individual,
not
the
business
subset
of goodwill
is personal
goodwill
represents
the value
enterprise
stemming
from
an
individual’s
personal
service
to thatwhich
business.
It is owned
by of
thethe
individual,
not
the business
itself.
an individual’s personal service to that business. It is owned by the individual, not the business
itself.
an
individual’s personal service to that business. It is owned by the individual, not the business
itself.
When performing a business valuation, the business valuer has to make two determinations
itself.
itself.
When
performing
business
valuation,
the
has
make
two
determinations
regarding
goodwill.a
is there
any? Second,
if there valuer
is goodwill,
what
value
does
it have? Of
When
performing
a First,
business
valuation,
the business
business
valuer
has to
to
make
two
determinations
When
performing
a First,
business
valuation,
the business
valuer
has to
make
two
determinations
regarding
goodwill.
is
there
any?
Second,
if
there
is
goodwill,
what
value
does
it
have?
Of
course,
the
valuer
has
to
go
much
further
after
there
is
a
determination
made
that
there
goodwill
When
performing
a First,
business
valuation,
the business
valuer
has to
make
two
determinations
regarding
goodwill.a
is there
any? Second,
if there valuer
is goodwill,
what
value
does
it is
have?
Of
When
performing
business
valuation,
the business
has to
make
two
determinations
regarding
goodwill.
First,
is
there
any?
Second,
if
there
is
goodwill,
what
value
does
it
have?
Of
course,
the
valuer
has
to
go
much
further
after
there
is
a
determination
made
that
there
is
goodwill
value,
asthe
he
or shehas
will
have
to separate
goodwill
into
two separate
components,
enterprise
regarding
goodwill.
First,
is much
there
any? Second,
ifvalue
there
is goodwill,
what
value
does
it is
have?
Of
course,
valuer
to
go
further
after
there
is
a
determination
made
that
there
goodwill
regarding
goodwill.
First,
is much
there
any? Second,
ifvalue
there
is goodwill,
what
value
have?
Of
course,
the
valuer
has
to
go
further
after there
is ainto
determination
made
thatdoes
thereit is
goodwill
value,
as
he
or
she
will
have
to
separate
two
separate
components,
enterprise
and
personal
goodwill.
course,
the
valuer
has
to
go much
furthergoodwill
after there
is ainto
determination
made
that there is
goodwill
value,
as
he
or
she
will
have
to
separate
goodwill
value
two
separate
components,
enterprise
course,
go much
furthergoodwill
after there
is ainto
determination
made
that there is
goodwill
value,
asthe
hevaluer
or shehas
willto
have
to separate
value
two separate
components,
enterprise
and
personal
value,
as he orgoodwill.
she will have to separate goodwill value into two separate components, enterprise
and
personal
goodwill.
value,
as he orgoodwill.
she will have to separate goodwill value into two separate components, enterprise
and
personal
Very
often, wegoodwill.
hear someone say that this business has a lot of goodwill. That may be the case,
and personal
and
personal
goodwill.
Very
often,
we
hear
someone
say
that
has
a
That
be
the
but
does
that the
has goodwill
For goodwill
have
the
Verythat
often,
we not
hearmean
someone
say goodwill
that this
this business
business
has value.
a lot
lot of
of goodwill.
goodwill.
Thattomay
may
bevalue,
the case,
case,
Verythat
often,
we not
hear
someone
say goodwill
that
this the
business
has
aits
lot other
of goodwill.
That
may
bevalue,
the case,
but
does
mean
that
the
has
goodwill
value.
For
goodwill
to
have
the
business
must
generate
earnings
above
return
on
assets.
For
example,
if
Verythat
often,
we not
hearmean
someone
say goodwill
that this business
has value.
a lot of goodwill.
Thattomay
bevalue,
the case,
but
does
that the
has goodwill
For goodwill
have
the
Very
often,
we not
hear
someone
say goodwill
that this the
business
has
aits
lot other
of goodwill.
That
bevalue,
the case,
but that
does
mean
that
the
has return
goodwill
value.
Forto
goodwill
tomay
have
the
business
must
generate
earnings
on
For
example,
ifif the
owner
invests
inabove
equipment,
he or she
expects
get a return
on investment.
but that does
not
mean$100,000
that
the goodwill
has return
goodwill
value.
Forassets.
goodwill
to have
value,
business
must
generate
earnings
above
the
on
its
other
assets.
For
example,
the
but
that does
not
mean$100,000
that
the goodwill
has return
goodwill
value.
Forassets.
goodwill
to have
value,
business
must
generate
earnings
above
the
on
other
For
example,
if the
business
owner
invests
in
equipment,
he
or
she
expects
a
return
on
If
we assume
that
a 10 percent
return
is reasonable,
the
firstits
$10,000
ofget
profit
would
be investment.
attributable
must
generate
earnings
above
the return
on
its
other to
assets.
For example,
if the
business
owner
invests
$100,000
in
equipment,
he
or
she
expects
to
get
a
return
on
investment.
business
must
generate
earnings
the return
on
its
other to
assets.
For example,
if the
owner
invests
$100,000
inabove
equipment,
heprofit
or she
expects
get
a return
on
investment.
If
we
assume
that
a
10
percent
return
is
reasonable,
the
first
$10,000
of
profit
would
be
attributable
to
the
equipment.
If
there
is
additional
profit,
that
would
be
the
result
of
other
assets.
After
business
owner
invests
$100,000
in equipment,
he the
or she
expects
toofget
a return
on
investment.
If
we assume
thatinvests
a 10 percent
return
is reasonable,
firstexpects
$10,000to
profit
wouldon
be investment.
attributable
business
owner
$100,000
in equipment,
heprofit
or she
get
a return
If
we
assume
that
a
10
percent
return
is
reasonable,
the
first
$10,000
of
profit
would
be
attributable
to
the
equipment.
If
there
is
additional
profit,
that
would
be
the
result
of
other
assets.
After
allwe
other
assets
are
accounted
for, anything
leftover
is attributable
toofgoodwill.
If
assume
that
a 10
percent
return
is reasonable,
the
first
$10,000
profit would
beassets.
attributable
to
the
equipment.
there
is additional
that profit
would
be the
result
otherbe
After
If
we
assume
that
aIf
percent
return
is profit,
reasonable,
the
first
$10,000
ofgoodwill.
profitof
would
attributable
to
the
equipment.
If10
there
is additional
profit, that profit
would
be the
result
of
other assets.
After
all
other
assets
are
for,
anything
is
attributable
to
to
the
equipment.
Ifaccounted
there is additional
profit,leftover
that profit
would be the
result of other assets. After
all
other
assets
are
accounted
for,
anything
leftover
is
attributable
to
goodwill.
to
equipment.
there is additional
profit,leftover
that profit
would be the
result of other assets. After
all the
other
assets areIfaccounted
for, anything
is attributable
to goodwill.
all other assets are accounted for, anything leftover is attributable to goodwill.
all other assets are accounted for, anything leftover is attributable to goodwill.
1
Held v. Held, 2005 Fla. App. LEXIS 14138 (Fla. 4th DCA 2005)
th DCA 2005)
Held v.
v. Held,
Held, 2005
2005 Fla.
Fla. App.
App. LEXIS
LEXIS 14138
14138 (Fla.
(Fla. 4
4th
Held
DCA 2005)
Florida
New Jersey
Held v. Held, 2005 Fla. App. LEXIS
14138 (Fla. 4th
th DCA 2005)
Held v. Held, 2005 Fla. App. LEXIS 14138 (Fla. 4th DCA 2005)
Held
Held, 2005
Fla. App. LEXIS
14138
(Fla.
DCA 2005)
8751 W. Broward Blvd. • Suite
203v.• Plantation,
FL 33324
2001 Rte.
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310 •4Parsippany,
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O: 954-424-4343 • F: 954-424-1416
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1
1
1
1
1
844-TRUGMAN
www.trugmanvaluation.com
- -22 -2employees,
all offering
accounting
and professional
onparts
Then
the
part.
theory
separating
goodwill
component
Then comes
comesand
the hard
hard
part. Valuation
Valuation
theory regarding
regarding
separating
goodwill into
into its
itsservices
component
parts
is
something
relatively
new,
mainly
due
to
various
types
of
litigation
around
the
country.
Valuation
is something relatively new, mainly due to various types of litigation around the country. Valuation
behalfcaught
of T&A.with a definitive methodology of how the valuer is supposed to make
treatises
treatises have
have not
not caught up
up with a definitive methodology of how the valuer is supposed to make
the
separation
between
enterprise
the separation between enterprise goodwill
goodwill and
and personal
personal goodwill.
goodwill. We
We can
can only
only use
use case
case law
law and
and
common
sense
to
try
to
help
us.
common sense to try to help us.
11.
At all times relevant hereto, T&A held itself out to the public, and
Overview
Overview of
of Florida
Florida Case
Case Law
Law
represented to the Plaintiffs herein, that it was an accounting firm
We
cover
on
subject,
so
are
give
appraisers’
We cannot
cannot possibly
possibly
cover every
every case
case
on this
this
subject,and
so we
we
are going
going to
to
give you
you our
ourcorrect
appraisers’
which
possessed
special
expertise
knowledge
concerning
view
on
the
subject.
A
brief
summary
of
the
leading
cases
in
Florida
involving
this
view on the subject. A brief summary of the leading cases in Florida involving this issue
issue is
is
contained
on
the
next
several
pages:
contained onand
the next
several
pages: valuations for purposes of the formation and
lawful
fair market
Florida’s
arises
Thompson
Thompson,
So.
267
establishment
ESOPsv.
that any576
such
valuation
would Following
be in in
Florida’s standard
standard
arises from
from of
Thompson
v.so
Thompson,
576
So. 2d
2d
267 (Fla.
(Fla. 1991).
1991).
Following
in
the
footsteps
of
Thompson
are:
the footsteps of Thompson are:
conformance with all Generally Accepted Accounting Practices, and
Young
v.
Young,
So.
1140
DCA
1992)
Young
v.applicable
Young, 600
600 laws,
So. 2d
2d including
1140 (Fla.
(Fla. 5th
5th
DCA
1992)
all
but
not
limited
to, ERISA § 406, 29
Weinstock
v.
Weinstock,
634
So.
2d
775
(Fla.
5th
Weinstock v. Weinstock, 634 So. 2d 775 (Fla. 5th DCA
DCA 1994)
1994)
Walton
v.
657
Walton
v. Walton,
Walton,
657 So.
So. 2d,
2d, 1214
1214 (Fla.
(Fla. 4th
4thnd DCA
DCA 1995)
1995)
U.S.C.
§ 1106(a).
nd
Williams
Williams v.
v. Williams,
Williams, 667
667 So.
So. 2d
2d 915
915 (Fla.
(Fla. 2
2 DCA
DCA 1996)
1996)
Christians
v.
Christians,
732
So.
2d
47
(Fla.
4th
DCA
Christians v. Christians, 732 So. 2d 47 (Fla. 4th DCA 1999)
1999)
Held
Held v.
v. Held,
Held, 2005
2005 Fla.
Fla. App.
App. LEXIS
LEXIS 14138
14138 (Fla.
(Fla. 4th
4th DCA
DCA 2005)
2005)
12.
At all times relevant hereto, Stephen Jones (hereinafter “Jones”) was
Thompson
Thompson v.
v.
Thompson
a Thompson
licensed, certified public accountant and a partner, shareholder
th
The
this
from
4
District
The issue
issue in
in and/or
this appeal
appeal
from the
the of
4th T&A.
District was
was “In
“In marriage
marriage dissolution
dissolution proceedings
proceedings to
to which
which an
an
employee
owner
of
a
professional
association
is
a
party,
may
the
value
of
the
professional
association’s
owner of a professional association is a party, may the value of the professional association’s
goodwill
goodwill be
be factored
factored in
in determining
determining the
the professional
professional association’s
association’s value?”
value?”
13.
At all times
relevant hereto,
Jones held
himself out
to the public,
and
Mr.
Mr. Thompson
Thompson was
was a
a plaintiff’s
plaintiff’s attorney
attorney specializing
specializing in
in personal
personal injury
injury and
and medical
medical malpractice
malpractice and
and
was
owner
association.
Since
this
was
the
first
time
that
the
Florida
was the
the sole
solerepresented
owner of
of a
a professional
professional
association.
Since
this
was
the
first
time
that
the
Florida
to the Plaintiffs herein, that he was an accountant who
Supreme
states
Supreme Court
Court had
had dealt
dealt with
with this
this issue,
issue, itit relied
relied on
on case
case law
law from
from many
many other
other
states that
that had
had
2
2 The Court stated,
already
addressed
this
topic.
Relying
on
the
Missouri
case
of
Hanson,
possessed
special
expertise
knowledge
concerning
correct
already addressed
this topic.
Relying
on theand
Missouri
case of
Hanson, The
Courtand
stated,
“Irrespective
“Irrespective of
of the
the setting
setting in
in which
which it
it is
is found,
found, the
the meaning
meaning of
of goodwill
goodwill does
does not
not change.
change. It
It is
is
lawful
fair
market
valuations
for
purposes
of
the
formation
and
property
property which
which attaches
attaches to
to and
and is
is dependant
dependant upon
upon an
an existing
existing business
business entity;
entity; the
the reputation
reputation and
and
skill
is
skill of
of an
an individual
individual entrepreneur
entrepreneur –
– be
be he
he a
a professional
professional or
or a
a traditional
traditional businessman
businessman –
is not
not a
a
establishment
of ESOPs
so
that
any such
ESOP
valuation
would– be
component
of
the
intangible
asset
we
identify
generally
as
goodwill.”
component of the intangible asset we identify generally as goodwill.”
in conformance with all Generally Accepted Accounting Practices, and
The
The Court
Court went
went on
on to
to discuss
discuss that
that ifif goodwill
goodwill exists,
exists, it
it would
would
contribution
of
the
attorney’s
spouse
to
the
development
of
applicable
but not limited
contribution all
of the
attorney’slaws,
spouseincluding
to the development
of that
that
However,
However,
be
be inequitable
inequitable to
to ignore
ignore the
the
goodwill
during
the
29
to, ERISA
§ 406,
goodwill
during
the marriage.
marriage.
U.S.C. § 1106(a).
It
It should
should be
be emphasized
emphasized that
that such
such goodwill,
goodwill, to
to be
be a
a marital
marital asset,
asset, must
must exist
exist
separate
separate and
and apart
apart from
from the
the reputation
reputation or
or continued
continued presence
presence of
of the
the marital
marital litigant.
litigant.
on
presence
of
individual,
such
goodwill
depends
on the
the continued
continued
presenceAxelrod
of a
a particular
particular
individual,
such
14.IfIf goodwill
At all depends
times relevant
hereto, Michael
(hereinafter
“Axelrod”)
goodwill,
by
definition,
is
not
a
marketable
asset
distinct
from
the
individual.
Any
goodwill, by definition, is not a marketable asset distinct from the individual. Any
was a licensed, certified public accountant and a partner, shareholder
2
2
and/or employee of T&A.
Hanson
Hanson v.
v. Hanson,
Hanson, 738
738 S.W.2d429,
S.W.2d429, 434
434 (Mo.
(Mo. 1987).
1987).
- -33 15.valueAt
all times
relevant
hereto,
Axelrod
heldofhimself
out
to therepresents
public, and
which
attaches
to the entity
solely
as a result
personal
goodwill
nothing more than probable future earning capacity, which, although relevant in
represented to the Plaintiffs herein, that he was an accountant who
determining alimony, is not a proper consideration in dividing marital property in a
dissolution
proceeding.
possessed
special expertise and knowledge concerning correct and
lawful fair
market valuations for purposes of the formation and
The Court concluded
as follows:
establishment
of ESOPs
soover
thatand
anyabove
suchitsESOP
valuation
would
If a law
practice has monetary
value
tangible
assets and
casesbe
in progress
which is separate
and distinctAccepted
from the Accounting
presence of Practices,
the individual
in conformance
with all Generally
and
attorney, then a court should consider the goodwill accumulated during the marriage
as a marital
asset. The
determination
the existence
andto,
value
of goodwill
is a29
all applicable
laws,
includingofbut
not limited
ERISA
§ 406,
question of fact and should be made on a case-by-case basis with the assistance
U.S.C.
§ 1106(a).
of expert
testimony
(emphasis added).
It then went on to say,
17.
In November 1993, Fisher and Jones met with Plaintiffs for the
Numerous methods for valuing goodwill have been advanced in cases and the
purposes
presenting
Plaintiffs
with the
benefits
forming
ABC
literature
on thisofsubject.
The clearest
method
would
be theoffair
marketan
value
approach, which is best described as what would a willing buyer pay, and what
wouldESOP.
a willing seller accept, neither acting under duress for a sale of the business.
The excess over assets would represent goodwill. We prefer this method and direct
that it be the exclusive method of measuring goodwill of a professional association.
comparable
are not 7,
required,
longbyasand
a reliable
andPlaintiffs,
reasonableas
18.ActualOn
or about sales
December
1993, so
ABC
through
basis exists for an expert to form an opinion.
officers of ABC, in reliance on the advice and representations of
Young v. Young
Green and Smith, Fisher, T&A, and Jones, decided to form an ESOP.
Dr. Young owned a sole practitioner obstetrics and gynecology practice. The trial court determined
that Dr. Young’s practice had a marital value of $250,000 and awarded half of that to Mrs. Young.
20. judge
The
ESOP
formally
23, 1993.
The trial
stated
that was
she was
boundestablished
by Thompsonon
to December
make an equitable
distribution of the
husband’s medical practice.
Two 22.
expert witnesses
presented
valuation
testimony
at the
trial.
Dr. Young’s
expert valued
Based upon
Fisher’s
advice,
Plaintiffs
also
retained
the services
of the
tangible assets at $88,547. Using the excess earnings method, he calculated the value of goodwill
at $204,599.T&A
The expert
testified,
usinga the
accounting
approach
the supreme
and Jones
to “that
perform
correct
and lawful
fair required
market by
valuation
court in Thompson left him no way to determine what amount of the excess earnings should be
of ABC
for purposes
of the ESOP.
allocated to the
husband
for his personality,
presence and reputation. If Dr. Young were taken
away from the practice, he testified, then ‘there is no data to support any amount as [goodwill] in
this $204,000.’”
24.
Jones gave advice and provided services to Plaintiffs, both in their
Mrs. Young’s expert used a rule of thumb that he created to calculate goodwill and added this to
capacities
asthe
Trustees
ESOP
and
officers
of ABC.The trial judge did
the tangible assets.
He set
value of of
thethe
goodwill
at no
less
than $400,000.
not agree with either expert and set the value of goodwill at $250,000.
On appeal, the appellate court ruled that the trial judge had misconstrued the Thompson ruling. It
25.
Plaintiffs relied on the advice of Fisher and Jones, and Fisher and
stated, “That decision does not require a finding of goodwill; it merely provides that goodwill may
be an asset subject
equitable
if there
is evidence
to support
its existence
Jonestowere
welldistribution
aware that
they
relied on
their advice
whenapart
the from
ESOP was formed. In fact, Fisher and Jones represented to the
Plaintiffs that if Plaintiffs followed their advice and counsel, the ESOP
- -44 would
conform
withpracticing
all applicable
laws,
including
butProof
not limited
to
the reputation
and presence
of the
party and
the tangible
assets.
of the existence
of goodwill is the first step.”
ERISA § 406, 29 U.S.C. § 1106(a).
The Court went on to state:
27.ProofOne
purpose
ofofthe
ESOPis was
to effectuate
the inpurchase
of the
of the
existence
goodwill
particularly
troublesome
a professional
context. This difficulty is a product of the fact that the reputation of the individual
outstanding
shares
of Clifford
Morris
(hereinafter
“Morris”),
a copractitioner
and theABC
goodwill
of his
enterprise
are often
inextricable
interwoven.
Because
of the difficulties
in separatingand
the reputation
of the
professional
founder
of ABC, inherent
who personally
along with
various
family
from that of his enterprise, evidence that other professionals are willing to pay for
goodwill
when acquiring
a practice
in our view,
the only acceptable
of
members,
at that
time, is,
owned
approximately
47% evidence
(forty-seven
the existence of goodwill. Thus, as a matter of proof, the existence of goodwill is
percent)
of there
ABC’s
shown
only when
is shares.
evidence of a recent actual sale of a similarly situated
professional practice, an offer to purchase such a practice, or expert testimony and
testimony of members of the subject profession as to the existence of goodwill in
practice
in the relevant
andto
professional
market.
Absent
such
28.a similar
Another
purpose
of thegeographic
ESOP was
restructure
ABC’s
corporate
evidence, one can only speculate as to the existence of goodwill. Divisions of
debt,
whereby
thebe
ESOP
for practical
purposes,
assume
said
marital
property
may not
basedwould,
on speculation
as to the
very existence
of the
property being divided.
debt to take advantage of certain tax benefits.
The Court reversed the trial court’s goodwill award and stated, “even assuming the existence of
goodwill had been demonstrated, neither expert gave competent, credible testimony as to the value
of that
goodwill.”
31.
Jones and T&A were retained to perform a correct fair market
valuation
ABC
so that
the ESOP
didfairnot
unlawfully
moreadopted
than in
In a concurring
opinion,ofthe
judge
suggests
that the
market
value pay
approach
Thompson required the court to determine the amount of money that a willing buyer would pay a
consideration
Morris’
shares
orwhich
the newly-issued
willing seller.adequate
“It is obvious
that a willing for
buyer
would ABC
not pay
for that
he is not getting. A
willing seller ABC
of theshares
assets of
a
professional
association,
once
he
sells,
is
no
longer part of the
pursuant to ERISA § 406, 29 U.S.C. § 1106(a).
business, and therefore the seller’s reputation cannot be part of the goodwill a willing buyer is
purchasing. Thus, the fair market value method has, by definition, separated professional
reputation from the remaining elements of goodwill, such as established patients, referrals,
32. associations,
Jones and
final valuation
March
15, 1994, and
location,
andT&A’s
office organizations
whichwas
maydated
attach to
the buyer.
should have incorporated information available to them as of that
Therefore, the Young court established a two-prong test. There must be proof of the existence of
goodwill, separate
date. and apart from reputation. If that proof exists, then there must be proof of its
value.
Weinstock v. Weinstock
33.
Axelrod served as an independent reviewer of the valuation prepared
34.
On March 15, 1994, based upon the valuation performed by T&A and
Dr. Weinstock
and operated a dental practice. Dr. Weinstock used the same appraiser as
byowned
Jones.
Dr. Young had. The appraiser used the same methodology to determine the value of Dr.
Weinstock’s practice and came to the same conclusion (there was no way to separate the value
of Dr. Weinstock’s personal goodwill from the goodwill of the practice).
Mrs. Weinstock’s expert was a dentist who had become a consultant to dentists who needed a
Jones, and reviewed by Axelrod, and arrangements made by Green
valuation for sales, purchases, loans and dissolution proceedings. This expert valued the practice
at $405,000; and
of thatSmith
amount,
$300,000
utilized sales
of 11
Florida dental
and
Crain was
andgoodwill.
Crain,This
theexpert
two SPAs
(Stock
Purchase
practices that had sold in 1991 and 1992.
Agreements - added by author for clarification) were closed. The
Plaintiffs, as Trustees, participated in the closing of the SPAs in
- -55 reliance
of the representations
the ESOP
In his testimony,
Mrs. Weinstock’s
expert indicated of
thatsaid
in theDefendants
sales data thatthat
he utilized,
the selling
dentist remained with the practice for a year or two after the sale. The selling dentist’s presence
transaction comported with all applicable laws, including but not
was not discontinued immediately after any of the sales.
limited to, ERISA § 406, 29 U.S.C. § 1106(a).
The appellate court concluded,
The comparables used cannot serve as competent evidence of value in view of the
39.language
On September
14,that
1998,
Thomas
etmarital
al. v. Robert
B. Jackson,
of Thompson
‘such
goodwill,Sacks,
to be a
asset, must
exist
separate and apart from the reputation or continued presence of the marital litigant.’
al. United
Court,
Jacksonville
Division,
Civil
The et
wife’s
expert States
opinion District
also would
not W.D.KY,
be competent
evidence under
Judge
Goshorn’s
in Young since
there was no
attempt
to Complaint”
deal with the problem
Actionreasoning
No. 3:WP-591-C,
(hereinafter
the
“Sacks
or “Sacks
of the continued presence of the dentists after the comparable sales took place.
litigation”) was filed, with claims arising, in relevant part, out of
We believe that husband’s counsel asked appropriate questions upon crossPlaintiffs’
as former
Trustees
of the ESOP.
examination
of roles
the witness
that may
have ferreted
out the proper method for
determining the value of goodwill. She asked whether any of the comparables were
for a dentist who ‘just quit.’ The purest form of comparable in the sale in any
a sale in which, on the day of closing, the seller picks up the
41.business
The would
SacksbeComplaint
alleged that Plaintiffs violated their fiduciary
sales proceeds and retires or moves out of the area, thus eliminating any further
influence
theby
seller
could have
on the business.
duties
agreeing
to cause
the ESOP to purchase ABC stock from
The Morris
inclusionand
of goodwill
as a and
marital
asset
improper
because
the evidence
his family
ABC
atwas
more
than the
fair market
value,
failed to establish a value for this goodwill apart from the husband’s continued
causing financial loss to the ESOP and Plaintiffs in the Sacks litigation
presence.
who
were
beneficiaries
of the
ESOP.
Judge Sharp
issued
a dissenting
opinion
indicating
that the evidence at trail was sufficient to
support the trial court’s opinion. He stated, “the findings that goodwill existed in this professional
practice was based on expert testimony consistent with Thompson v. Thompson. Indeed, if the
finding
in this case,
question over
whether
a finding
be sustained
in any
58.was erroneous
After a bench
trial I lasting
tensuch
trial
days,can
which
spanned
thecase
involving a sole professional practice.” He went on to state,
period of April 16, 2001 to February 26, 2002, on or about July 30,
In my view, I do not consider the necessity for a non-compete and non-solicitation
2002, inUnited
District
Judge
Ronstadt
agreement
order toStates
produce
a willingCourt
purchaser
of a Jennifer
dental practice
as fatalissued
to the a
trial judge’s
conclusionOpinion
that this dental
practice
Nor which
do I think
Memorandum,
and Order
in had
thegoodwill
Sacks value.
litigation
held
Griggs’ comparable sales data should be thrown out as insufficient because in most
of the
sales,
the selling
dentist remained
with the practice
for a short
of time.
inter
alia,
that Plaintiffs
had violated
their duties
as period
Trustee
of the
Based on his testimony, the only essentials were a non-compete and nonESOP.agreement,
However,toatprevent
that time
Judge
Ronstadt
didtonot
decide
solicitation
a seller
from
being able
destroy
a whether
dental
practice, after having sold it.
the ESOP had sustained any monetary loss as a result, and
Walton v. Walton
appointed a Special Master to determine damages, if any.
Mr. Walton operated a sole proprietorship CPA firm that employed two other CPAs and two support
staff. However, most contact with the clients was by Mr. Walton and Mr. Walton brought in most
of the
60.new clients.
On January 26, 2004, the Special Master in the Sacks litigation issued
an Opinion
which
estimated
that
the damages
sustained
to theassets
ESOP
The husband’s
expert used
a liquidation
value
method,
which values
the tangible
of the
business. He did not find any professional goodwill attributable to the practice other than the
were approximately 9.9 million dollars, plus interest and attorneys
fees.
- -66 According
to the Order
of the of
United
States However,
District Court,
District
of Arkansas,
personal reputation
and efforts
the husband.
severalWestern
years earlier,
the husband
had
submitted a loan
application
that
included a 1,
value
of $300,000
for the
substantially
greaterB.
Jacksonville
Division,
dated
December
2004,
and signed
bypractice,
the Honorable
Jennifer
than the tangible assets.
Ronstadt in the matter of Thomas Sacks, et al. v. Robert Jackson et al., Civil Action No.
The wife’s expert used an excess earnings method and what he called a market approach
97-123-C.
(although he did not use comparable sales). He calculated total goodwill, and then determined that
15 percent of this goodwill was institutional goodwill. He did not explain how he derived the 15
percent.
On July 29, 2002, this court found the defendants liable for breach of
Neither
expert used
sales
similar businesses,
and the
wife’s
expert testified,
fiduciary
dutycomparable
in their roles
as of
trustees
of an employee
stock
ownership
plan “Most
of the(“ESOP”)
time if oneinisviolation
going to of
sellERISA
his practice
there
is
going
to
be
a
non-compete
agreement.
§ 406,29 U.S.C. § 1106. Sacks v. Jackson.
Nobody is going to buy a practice and let that accountant go across the street and practice
The court determined that in the case of such a breach, ‘loss will be
basically.”
measured as the difference between what the ESOP paid for the ABC stock
fair level,
market
the time
of transaction,
plustointerest.’
at 881.
At theand
trialits
court
thevalue
court at
found
the wife’s
expert’s value
be correct,Id.finding
that the
(footnote
omitted).
husband’s own valuations gave evidence that the practice had value in excess of the tangible
assets. However, the appellate court found that the trial court “did not make the key distinction that
only that part of the value independent of the husband’s continued presence in the business
Aamounted
Special Master
wasasset.”
appointed to review the reports and testimony of several valuation
to a marital
professionals, Mr. Jones being one of them. The Court adopted the Special Master’s
The appellate court went on to say the following:
findings and commented “Having found the special master’s final report, with its
First, there was no proof of the existence of goodwill separate from the husband’s
supplement
to be The
thorough
and name
well reasoned,
will adopt
special
reputation.
husband’s
was the onethe
‘oncourt
the door,’
and thethe
other
C.P.A.master’s
were there to assist in the work, not garnering clients. The most telling
findings employees
in their entirety.”
evidence of a lack of any institutional goodwill was the wife’s expert’s testimony that
no one would buy the practice without a noncompete clause. If the business
only has value over and above its assets if the husband refrains from competing
The Court’s
citing
Special
Master’s
report
was
ofisthe T&A
withinOrder,
the area
that the
he has
traditionally
worked,
then
it isextremely
clear that critical
the value
to thethat
personal
reputation ofwere
the husband.
Secondly,
report. attributable
Findings were
the conclusions
“not credible”
andthe
thatvaluation
“the valuation
testimony of the expert was not supported by competent substantial evidence.
methods were applied improperly in his report SMR at 7,19.” While discussing the
In short, as in Young and Weinstock, we find no competent evidence from which
“discounted
future
earnings”
method,
Thethe
Court
noted of
“The
special
master
found
the trail
court
could have
determined
existence
goodwill
separate
from
the Jones’
reputation
of the
husband. Any
1 testimony in that regard is sheer speculation. On
testimony
that such
an adjustment
was unnecessary not credible. SMR at 16.”
remand, we direct the court to exclude any value of goodwill attributable to the
business.
We
are notv.going
to reiterate the Court’s or the Special Master’s findings in this report by
Williams
Williams
analyzing the Order or the Special Master’s report. However, our independent analysis of
The Williams case was similar to Walton. Mr. Williams owned a professional practice in which he
was
the report
only accountant.
the there
trail level,
thesubstantially
court found that
$43,200
of goodwill
subject
to
the
T&A
indicatesAtthat
were
more
problems
thanwas
were
pointed
equitable distribution.
out in the earlier litigation. We will highlight these problems as we proceed in this report.
Citing, Thompson, Young and Walton, the appellate court found that the evidence failed to show
the existence of goodwill separate and apart from the reputation and continued presence of Mr.
Williams.
1
The adjustm ent had to do with the subtraction of debt from the value to determ ine the
equity value of ABC.
- -77 Clearly,
Mr.v. Jones’
opinions were discarded as lacking credibility, validity and
Christians
Christians
reasonableness. In a footnote on page 7 of the Order, The Court stated:
This was the first case that considered personal goodwill in a non-professional practice setting.
Mr. Christians’ business called Flying Trapeze, constructed and serviced trapeze equipment for
lease or sale exclusively to Club Med. The trial court, based on expert testimony, determined that
With
regard
testimony,
the court
intangible
its liability
opinion
expressed
the fair
market
valuetoofJones’
Flying Trapeze
included
only its
assets
and inventory
and its
that the
business
no goodwill
valuethe
for the
purposesof
of marital
wife appealed
ownhad
concerns
about
credibility
Jones’distribution.
testimony,The
including
his the
decision.
downplaying of time restraints, his testimony concerning the existence of a
lower draft valuation, the vagueness of his testimony, and his inability to
Although there was an error in the calculation of the tangible assets of the business which the court
recall whether evidence of preliminary calculations was contained in the files.
corrected, it determined that the trial court’s failure to assign goodwill value was not in error. Citing
Williams and Young, the court ruled that “The record contains competent evidence to support the
trial court’s conclusion that any goodwill of Flying Trapeze ‘rests solely on the Husband’s wellknown reputation and abilities and the continued existence and involvement [in the business].’”
Held v. Held
This was another case of a non-professional practice. Mr. Held owned an insurance agency that
specialized in selling high-risk hazard insurance to beachfront condominium associations in Florida.
At the time of the original hearing, the company maintained 60 customer accounts, which
generated large commissions.
The trial court determined that the entire value of the company was a marital asset. Central to this
determination was the court’s assumption that
in any sale of the business, the husband would sign a non-solicitation/non-piracy
agreement preventing him from doing business with the Company’s existing
customers. The trial judge reasoned that the non-solicitation agreement had nothing
to do with personal goodwill of the business, but was part of enterprise goodwill.
The court wrote that
[A]s part of the sale of enterprise goodwill, ... a non-solicitation/non-piracy
agreement would need to be signed by Husband but not a covenant not to compete.
Contrary to the Husband’s assertions, such a requirement is not indicative of
personal goodwill, as a non-compete clause might be. The non-solicitation/nonpiracy clause prevents the seller from soliciting only those clients which he has just
sold, but enables him to continue in the same trade or business, even if across the
street. Specifically, a non-solicitation/non-piracy clause is a clause that prevents the
Husband from stealing back the book of business to be sold as part of the ...
($10,500,000) to the theoretical buyer.
The trial court based its valuation of enterprise goodwill on expert testimony. The expert utilized
sales of insurance companies that it obtained from a transaction database. However, the expert
could not state whether the comparables used were predicated on the principal’s continued
involvement in the business or, alternatively, upon the principal’s agreement to refrain from
participating in a like business, by way of a non-solicitation, non-competition, or non-piracy
agreement.
- 8 -8-
OPINIONS
The trial judge made her ruling by attempting
to distinguish between a non-solicitation/non-piracy
agreement and a covenant not-to-compete. However, the appellate court ruled, “For the
purpose of distinguishing enterprise goodwill from personal goodwill in the valuation of a
business, there is no distinction between ‘a non-solicitation/non-piracy agreement’ and a
covenant not to compete.”
In our opinion, T&A, Steven Jones and Michael Axelrod (hereafter collectively referred to
The court continued as follows:
as T&A, Mr. Jones or Mr. Axelrod) have breached their duty to render various services in
Both
a putative with
seller’s
to do
with existing
clients ofaccountants
the
a manner
thatlimit
is consistent
the ability
standard
of business
care required
of professional
business. In this case, the husband’s personal relationship with his clients allows
and advisors
the rendering
valuation
to ABC
andmethod
the ABC
ESOP.
him toin
obtain
their repeatof
business.
Theservices
trial court’s
valuation
inserted
into
enterprise goodwill an aspect of personal goodwill, the value of the husband’s
personal relationship with the 60 clients. This method of valuation contravened
Thompson,
emphasized
that
to be a marital
asset,
goodwill
In our opinion, the which
valuation
services
performed
by T&A
for ABC
and‘must
the exist
ABC ESOP
separate and apart from the reputation or continued presence of the marital litigant.’
violated accounting and valuation standards. In our opinion, Rule 201 of the American
The court ruled that there was no evidence to support a value above the agreed upon adjusted
Institute
of of
Certified
Public Accountants’ (AICPA) Code of Professional Conduct was
book value
$2,918,000.
violated as T&A did not comply with the following:
Other Florida Cases of Interest
In addition to the six leading cases in equitable distribution discussed above, the following cases
A. significant
Professional
are also
and shouldCompetence.
be considered: Undertake only those professional
services that the member or the member's firm can reasonably expect
to
be completed
with
Akins v. Akins,
659 So. 2d
330professional
(Fla. 5th DCA competence.
1995)
M.A. Hajianpour MD, PA v. Khosrow Maleki, 932 So. 2d (Fla. 4th DCA 2006)
v. Hough,
793 So. 2dCare.
57 (Fla.Exercise
2nd DCA 2001)
B.HoughDue
Professional
due professional care in the
rd
Makowski
v.
Makowski,
613
So.
2d
924
(Fla.
3
performance of professional services.DCA 1993)
Spillert v. Spillert, 564 So. 2d 1146 (Fla. 1st DCA 1990)
v. Mitchell,and
435 So.
2d 797 (Fla. Adequately
1983)
C.SwannPlanning
Supervision.
plan and supervise the
performance of professional services.
Akins involves the valuation of a commercial artist where the name was not proven to have value
separate and apart from the individual. M.A. Hajianpour MD, PA was instituted by Hajianpour’s
D.an action
Sufficient
Relevant
Data.
Obtain
sufficient relevant
data torespective
afford a rights
filing of
for declaratory
relief
seeking
a determination
of the parties’
reasonable
basis between
for conclusions
or and
recommendations
in arelation
to for
under an employment
agreement
Hajianpour
Maleki. Maleki filed
counterclaim
anticipatory breach
of contract, fraud,
declaratory
judgment, and breach of contract. The decisive
any professional
services
performed.
issue at trial and in this appeal was the value of Hajianpour’s medical practice. The key issue that
was ultimately addressed by the court was that “Under Thompson, a valuation of enterprise
Ingoodwill
addition,
T&A
failed
to comply
with
the Uniform
Standards
of Professional
Appraisal
may
not be
‘predicated
on the
principal’s
continued
involvement
in the business’
or the
principal’s agreement to refrain from participating in any like or competing business.”
Practice (USPAP), an industry standard that all appraisers are guided to follow in
In Hough, the
had to consider
the impact
of following:
Mr. Hough’s personal goodwill in his vending
ofcourt
the AICPA,
with respect
to the
publications
business. In Makowski, the court required the fair market approach to be used in the determination
of value. Spillert involved the valuation of a plastic surgery practice. The court found that one of
the experts used an unreliable methodology and the court’s averaging of the two experts’ values
was unacceptable. In Swann, the plaintiff instituted this action for wrongful dissolution of a
partnership and sought to be paid for a portion of the capital surplus, the value of the goodwill, the
- -99 9 successor to the partnership, and an accounting and damages for wrongful
stockSTANDARD
of the corporate
dissolution.
In developing a business or intangible asset appraisal, an appraiser must be
So Where
We Today? and correctly employ those recognized methods and
awareAre
of, understand,
procedures that are necessary to produce a credible appraisal.
Florida case law has certainly evolved over the last 15 years. We have witnessed the following:
Standards Rule 9-1
1991
Thompson
Established principal of personal goodwill as non-divisible in equitable
distributionor intangible asset appraisal, an appraiser must:
In developing a business
1992
Young
Established two-step process to identify and value personal and
Walton
Established concept that personal goodwill may be represented by
(a)
1994
1995
(b)
1999
be aware enterprise
of, understand,
goodwill. and correctly employ those recognized
methods and procedures that are necessary to produce a credible
Established use/misuse of comparable transactions as basis of value
Weinstock
appraisal;
existence
of a non-competition
agreement or commission that
not commit
a substantial
error of omission
significantly
affects an appraisal;
Broadens concept into non-professional service businesses
Christians
2005(c) Held
of non-competition
indication
of
not renderEndorsed
appraisalconcept
services
in a careless oragreement
negligentasmanner,
such
and rejectedindividually,
distinction between
nonas a seriespersonal
of errorsgoodwill
that, considered
may not
significantly
solicitation/non-piracy
agreements
with
non-compete
agreements
affect the results of an appraisal, but which, when considered
in the
aggregate, would be misleading.
As a result of these cases, the legal and valuation community must now use this framework to
define the marital assets, quantify those assets, and divide the marital estate.
Standards Rule 9-2
So, What Does All Of This Mean?
In developing a business or intangible asset appraisal, an appraiser must
observe
the following
specific
appraisal
guidelines:
The court
decisions
that have been
issued
require the
business valuer to allocate goodwill value
between the enterprise and the individual. This is no easy task since that are no definitive
guidelines
the appraiseridentify
to follow the
to accomplish
Each situation
will depend
on the
facts and
(a) foradequately
businessthis.
enterprise,
assets,
or equity
under
circumstances
surrounding
the
appraisal.
If
we
represent
the
business
owner,
the
task is
consideration, define the purpose and the intended use of the
considerably easier. All we have to do is determine that “she is the business.” We can call those
appraisal, consider the elements of the appraisal investigation,
business contacts that our client puts us in contact with who will sing the praises of our client. Of
any
special limiting
conditions,
and identify
the else.
effective
course, all of consider
the goodwill
is personal!
“I would
not do business
with anyone
If shedate
goes, so
of
the
appraisal;
do I.” This really puts the nonbusiness spouse at a terrible disadvantage.
The Thompson
court the
wants
the valuer
use the “fair market approach” to value the business, but
(b)
define
value
beingtoconsidered.
it does not understand the fact that implied in fair market value is a covenant not to compete. A
business will (i)
not sell in
the buyer can
up nextenterprise
door and steal
was just
if the
themarketplace
appraisal if concerns
a open
business
orwhat
equity
sold. However, in most instances, the allocation that is made in the sales contract towards a
interests, consider any buy-sell agreements, investment letter
covenant has no economic reality to it. It is a made up number between the buyer and the seller.
stock
restrictions,
restrictive of
corporate
or parties
partnership
With the change in the
tax laws
regarding amortization
intangible charter
assets, the
do not have
agreement
clauses,
and
any
similar
features
or
factors
that
to be as careful as they once did.
may have an influence on value.
Another fallacy in the case law is that the valuation should be conducted as if there would be no
transition between
and the buyer
The vast
majority
willing sellers
assist
in a smooth
(ii) the
if seller
the appraisal
concerns
assets,
theofappraiser
must
consider
transition to maximizewhether
the selling
price
that
could
be
achieved
in
the
market.
In
the
rare
situation
the assets are:
(1)
(2)
appraised separately; or
appraised as parts of a going concern.
- -1010 (iii) suddenly
if thedies,
appraisal
business
where the seller
the impactconcerns
of the loss equity
of a key interests
person mayinbe afelt,
but even that
consider
extent to which the interests do or do
impact is rarely moreenterprise,
than 15 percent
of the the
value.
not contain elements of ownership control.
It should
be remembered
that the concept of fair market value assumes a hypothetical willing buyer
Standards
Rule 9-3
and a hypothetical willing seller. This concept implies that these two parties would conduct a
transaction under normal market conditions with both sides looking out for their own best interests.
In developing
a business
intangible
asset
relating
to antoequity
This means
that the willing
buyer’sorattorney
would
mostappraisal
likely not allow
a closing
take place
interest
with
the
ability
to
cause
liquidation
of
the
enterprise,
an
appraisernot to
without the proper protection for the client. This protection would include a covenant
must
investigateis the
possibility
thatThe
thewilling
business
may
compete
if competition
a potential
problem.
buyer enterprise
will also require
thehave
willingaseller
to assist
in a smooth
transition
if the circumstances
requireoperation
it. This is the
world. concern
Many of these
higher
value in
liquidation
than for continued
asreal
a going
transactions
require
either
an
employment
contract
or
a
consulting
contract
that
assistsisin the
absent contrary provisions of law of a competent jurisdiction. If liquidation
creation
the transition
to the
new owner.any
To assume
anything
to the contrary,
fliesto
in be
the face
theofindicated
basis
of valuation,
real estate
or personal
property
of the manner in which the marketplace operates.
liquidated must be valued under the appropriate standard.
The Held court took covenants not to compete one step further by considering non-solicitation
Standards
9-4 Once again, the willing buyer will almost always require the seller to
agreements
to be Rule
the same.
either not solicit customers or employees as part of the deal. Although the court has indicated that
the facts
need to be a
addressed
case by case
basis,
the lack of
covenant and
a nonIn developing
businessonora intangible
asset
appraisal,
anaappraiser
must
solicitation
agreement
would render
every
businessguidelines
worth not much
than the value of the
observe
the following
specific
appraisal
whenmore
applicable:
tangible and the separately identifiable intangible assets, other than goodwill.
(a)
consider all appropriate valuation methods and procedures.
Many businesses have intangible assets other than goodwill that need to be included in the
valuation process. However, in most instances, these types of assets are not separately valued
collect
analyze
relevant
regarding:
in the(b)
process.
Mostand
of the
time, there
is nodata
reason
to have to allocate the value among its
(i)
the
nature
and
history
of
the
business;
components. Financial and tax reporting requirements call for the allocation of a purchase price
(ii) offinancial
and for
economic
conditions
affecting
business
to different classes
assets in order
depreciation
and amortization
to bethe
properly
measured.
It is rare that this “slicing
and
dicing”
of
the
overall
value
has
to
be
performed
by
the
appraiser.
enterprise, its industry, and the general economy;
However, n order
personal
goodwill
to be properly
estimated,
the allocation
of value
(iii) for past
results,
current
operations,
and future
prospects
of becomes
the
a critical step in the valuation
process.
business enterprise;
(iv)
past sales of capital stock or other ownership interests in the
Allocation of Purchase
Price
business
enterprise being appraised;
(v)
sales of similar businesses or capital stock of publicly held
Addressing the allocation of goodwill and other intangible assets is something that we have to deal
similar
businesses;
with in the accounting
field on
a regular basis. In financial reporting, the allocation of intangible
(vi)Statement
prices,of terms
and
conditions
affecting
past
sales
of Effective
similar July
value falls under
Financial
Accounting
Standards
No. 141
(“FAS
141").
business
assets;
1, 2001, the rules regarding
business
combinations were changed, and the purchase method of
accounting is now required. This means that the amount paid for the business must be allocated
to theStandards
assets and Rule
liabilities
9-5that were part of the combination. These are to be recorded at fair
value.
In developing a business or intangible asset appraisal, an appraiser must;
The purchase price is allocated in the following order:
(a)
(b)
select and employ
one
or more
approaches
! Net
Working
Capital
Assets that apply to the specific
appraisal assignments.
! Fixed and Tangible Assets
! Other Tangible Assets
! Identifiable
Assets
consider and reconcile
theIntangible
indications
of value resulting from the
!
Goodwill
various approaches to arrive at the value conclusion.
- -1111 STANDARD
10intangible nature must meet the separability criterion. They generally have
Assets
that are of an
to arise from a contract, or if non-contractual, they must be capable of being separated or divided.
Separability
is based
upon
specificoffacts
and circumstances.
In reporting
the
results
a business
or intangible asset appraisal an
appraiser must communicate each analysis, opinion, and conclusion in a
manner that is not misleading.
Identifiable Intangible Assets are categorized as follows:
! Marketing Related
Standards Rule 10-1 ! Customer Related
! Artistic Related
! Contract
Each written or oral business
or Based
intangible asset appraisal report must:
! Technology Based
(a)
clearly
and accurately
setcategory
forth the
in a manner
thatAssets.
will notThis
Non-competition
agreements
fall into the
of appraisal
Marketing Related
Intangible
be of:
misleading.
group consists
! Trademarks
and to
tradenames
contain sufficient
information
enable the intended user(s) to
! Service marks, collective marks, certification marks
understand it. Any
specific limiting conditions concerning information
! Trade dress (unique color, shape, or package design)
should be noted.
! Newspaper masthead
(b)
! Internet domain names
! Non-competition
clearly and accurately
disclose agreements
any extraordinary assumption that
(c)
directly affects the appraisal and indicate its impact on value.
In addition to financial reporting requirements, there are also tax reporting requirements. Internal
Revenue Code (“IRC”) Section1060 provides guidance for the allocation of purchase price among
the business assets acquired (see also IRC Section 338 for stock acquisitions with asset elections).
Standards Rule 10-2
Non-Competition Agreements Under Florida Law
Each written business or intangible asset appraisal report must comply with
There
been many
casesreporting
in Florida that
address how to handle the value of covenants not to
thehave
following
specific
guidelines:
compete and personal goodwill. “…In Held, as in Walton, no attempt was made to subtract a fair
value for the covenant from other evidence of value……It might still be possible, however, for
(a) expert
identify
and case
describe
thewith
business
enterprise,
assets
equity
beingand
another
in a future
to begin
the mixture,
subtract the
value or
of the
covenant,
appraised.
testify that the
difference is enterprise goodwill.”
There
to bethe
uniform
agreement
that the value
to a covenant not to compete is
(b)seems
state
purpose
and intended
useattributable
of the appraisal.
attributable to personal goodwill.
(c) To avoid
define
the value to be estimated.
these abuses, courts in states which treat individual goodwill as separate
property must begin to adopt more realistic principles for determining the effect of
(d) a covenant
set forth
effective
date
the appraisal
andgoodwill.
the dateWhen
of the
report.
notthe
to compete
upon
theof
valuation
of enterprise
a sale
price includes a covenant, or another valuation method assumes a covenant, the
should the
certainly
be upon
spouse who
relies upon
the sale or offer to
(e) burden
describe
extent
of thetheappraisal
process
employed.
prove and exclude a fair value for the covenant. But, the mere presence of a
covenant does not justify a finding that no enterprise goodwill is present.3
(f)
(g)
set forth all assumptions and limiting conditions that affect the
analyses, opinions, and conclusions.
3
Brett R. Turner, Covenants Not to Compete and Valuation of Marital Businesses,” Divorce
setLitigation
forth 18,
theno.information
considered, the appraisal procedures
2 (September 2006): 149.
followed, and the reasoning that supports the analyses, opinions and
conclusions.
- -1212 (h)
set
forth 542.335,
any additional
that clauses
may beentered
appropriate
to July
show
Florida
Statute
Section
effectiveinformation
for non-compete
into after
1, 1996,
compliance
or clearly
identify and
explain
provides for “valid
restraintswith,
of trade
or commerce.”
In order
to bepermitted
binding, thedepartures
contract must be
reasonable infrom,
termsthe
of time,
area and the
of business.
requirements
ofline
Standard
9. It is only enforceable if committed to
writing.
(I)
set forth the rationale for the valuation methods and procedures
The term
‘legitimateand
business
interest’ includes, but is not limited to:
considered
employed.
1.
2.
Trade secrets, as defined in s. 688.002(4).
Valuable confidential business or professional information that otherwise
does not qualify as trade secrets.
Each of 3.
these provisions
be addressed
in detail
within ourorreport.
Substantial will
relationships
with specific
prospective
existing customers,
patients, or clients.
4.
Customer, patient, or client goodwill associated with:
a.
Anof
ongoing
or professional
practice,the
by way
of tradehave
name,suffered
But for the negligence
T&A, business
Mr. Jones
and Mr. Axelrod,
plaintiffs
trademark, service mark, or "trade dress";
significant economic
Judge Ronstadt
b.
Adamages.
specific geographic
location; orfound that the ABC ESOP overpaid
c.
A specific marketing or trade area.
$8,139,116
the stock, based
on a valuation
at $26.31 million. In addition, prejudgment
5. for Extraordinary
or specialized
training.
interest was also added to this amount.
Any restrictive covenant not supported by a legitimate business interest is unlawful
and is void and unenforceable.
The statute provides minimum and maximum time periods for the covenant to be deemed
reasonable. These are:
BASIS FOR OUR OPINIONS
1.
In
In the case of a restrictive covenant sought to
be enforced against a former employee,
orderagent,
for Trugman
Valuation
Associates,
or independent
contractor,
and not
associated with the sale of all or a part of:
Reasonable Period
Unreasonable Period
6 months or less
More than 2 years
Inc. to form our opinions in this matter,
numerous documents were reviewed. In addition, Gary R. Trugman CPA/ABV, MCBA,
a. The assets of a business or professional
ASA, MVS,
principal
practice,
or in charge of this engagement, attended the deposition of Steven
The shares of a corporation, or
Jones onb.
January
24, 25, 27 and 28, 2005. The documents reviewed in this matter include
c. A partnership interest, or
d. A limited liability company membership, or
the following:
e. An equity interest, of any other type, in a
business or professional practice
1.
Second Amended Complaint and Petition for Declaration of Rights in the matter of
Robert B. Jackson and Milton D. Thompson, Jr. v. Goldberg and Simpson, P.S.C.
and Steven A. Crain and John J. Fox and Sherry P. Crain and Prison Systems, Ltd.
and Tennet Axelrod & Bressler, P.S.C. and Michael Axelrod and Stephen Jones
in Washington Circuit Court, Division 1, Jacksonville, Arkansas, Case Number 12123456.
2.
Valuation report of ABC Jail Company, Inc. as of November 30, 1993 as prepared
by Tennet & Axelrod, P.S.C. (TA 159 - TA 218).
- -1313 3.
2.
4.
Letter of March 15, 1994 from Tennet & Axelrod, P.S.C. to Board of Directors and
Reasonable Period Unreasonable Period
Trustees of ABC Jail Company, Inc., updating
the valuation of ABC Jail Company,
Inc.
to case
March
1994 covenant
(TA 155).
In the
of a15,
restrictive
sought to
1 year or less
More than 3 years
be enforced against a former distributor,
dealer, franchisee,
or licensee
a trademark
Memorandum
from
SteveofJones
dated December 1, 1993 regarding ABC Jail
or service mark and not associated with the
Company,
of an employee stock ownership plan (TA 676 - TA
sale of all orInc.’s
a part establishment
of:
694).
a. The assets of a business or professional
or
A practice,
representation
letter dated March 7, 1994 to Tennet & Axelrod, P.S.C. referencing
b. The shares of a corporation, or
the
valuation
ofinterest,
ABC Jail
c. A
partnership
or Company, Inc., Inc. (no specific valuation report indicated)
signed
by J.liability
Clifford
Morris,
Milton Thompson
and Robert B. Jackson on March 10,
d. A limited
company
membership,
or
e. An equity interest, of any other type, in a
1994.
business or professional practice,
5.
6.
3.
Valuation Report Checklist from the workpapers of Tennet & Axelrod, P.S.C.
In the case
of a valuation
restrictive covenant
sought to
3 years
or less
More
7 years
relating
to the
as of November
30,
1993
dated March
7,than
1994
(TA 485 be
enforced
against
the
seller
of
all
or
a
part
TA 489).
of:
7.
8.
Report
of theof Special
in the matter of Thomas Sacks, et al. v. Robert
a. The assets
a businessMaster
or professional
practice,
or
Jackson, et al. in the United States District Court, Western District of Arkansas at
b. The shares Division,
of a corporation,
Jacksonville
Civil or
Action: 6:97:CV-123-C.
c. A partnership interest, or
d. A limited liability company membership, or
Amended
Master
report
inathe matter of Thomas Sacks, et al. v. Robert
e. An equitySpecial
interest, of
any other
type, in
business
or
professional
practice,
Jacksonville Division, Civil Action: 6:97:CV-123-C.
Goodwill Opinion
And Non-Competition
Agreements
Are Not
Just et
Anal.Equitable
9.Personal
Memorandum
and Order in the
matter Thomas
Sacks,
v. Robert
Distribution
Concept
Jacksonville Division, Civil Action: 97-123, signed by the Honorable Jennifer B.
The issue of personal goodwill has been addressed in non-matrimonial circumstances. The
Ronstadt on July 29, 2002.
Internal Revenue Service has caused this area to be addressed in the income tax arena.
Internal Revenue Service has caused this area to be addressed in the income tax arena.
According to Revenue Ruling 64-235, C.B. 1964-2, 18:
10.
11.
12.
Order in the matter of Thomas Sacks, et al. v. Robert Jackson, et al. in the United
States
Court, Western
District
at Jacksonville
Civil
…It is District
well established
that personal
skillofisArkansas
not a salable
capital asset.Division,
See
Providence
Mill Supply
Commissioner,
2 BTA 791
a
Action:
97-123,
signedCo.
by v.the
Honorable Jennifer
B. (1925).
RonstadtHowever,
on December
1,
number
of
court
decisions
indicate
that
in
appropriate
factual
circumstances
a
2004.
professional practice or other business may possess salable goodwill even though
success is solely attributable to the skill, integrity and other characteristics of the
its
Correspondence
dated April 26, 1996 from Stephen D. Jones to Steve Crain (GS
owner. See, for example, Merle P. Brooks, et ux. v. Commissioner, 36 TC 1128
106-0900).
(1961), acquiescence in result only, C.B. 1959-2, 5; and James M. Herndon, et ux.
v. Commissioner, TC Memo 1962-184. In light of these decisions, the Service will
Deposition
transcript
of Stephen
Jones
in the
matter professional
of Thomas practice
Sacks, et al. v.
no longer take
the position
that, as aD.
matter
of law,
a one-man
Robert
et al.
in the can
United
States
District
Court,
Weston District
of
or any Jackson,
other one-man
business
not have
salable
goodwill.
In disposing
of
cases involving
the sale of an
entire professional
practice,
the extentdated
to which
the
Arkansas
at Jacksonville
Division,
Civil Action:
3:WS-667-C
February
25,
proceeds of sale can be allocated to goodwill will be determined on the facts rather
2000.
than by whether the business is, or is not, dependent solely upon the professional
skill or other personal characteristics of the owner….
- -1414 13.
Deposition
transcript
of Stephen
D. Jones
in the regarding
matter ofpartial
Thomas
Sacks,
et al.
This Revenue
Ruling
was modified
by Revenue
Ruling 70-45,
sales,
however,
thisv.
Robert
Jackson,
al.enforceable
in the United
States
Western
guidance
remains
the validetand
position
of theDistrict
Internal Court,
Revenue
Service. District of
Arkansas at Jacksonville Division, Civil Action: 3:WS-667-C dated March 23, 2000.
In Martin Ice Cream Co. v. Commissioner, 110 T.C. 189 (1998), the issue was over the split-off of
a
StrassbergDay
Ice Cream
Distributors,
(“SIC”).Sacks
Strassberg
developed
personalv.
14. subsidiary,
Trial transcript,
II, in the
matter ofInc.
Thomas
and Ferman
Houston
relationships with customers over the previous 25 years, and was instrumental in the design of new
Robert E. Jackson and Milton Thompson, in the United States District Court,
ice cream packaging and marketing techniques. He was responsible for the introduction of
Westernproducts
District into
of Arkansas
at retail
Jacksonville
Case Number 3:97-CV-1234
Haagen-Dazs
high volume
stores in Division,
New Jersey.
from April 17, 2001, testimony of Stephen Jones.
There was an oral agreement with Haagen-Dazs for Strassberg to distribute products in New
15.
Trial
transcript,
VIII, inofthe
of Thomas
Sacks
and
Houston
Jersey.
Strassberg
soldDay
the assets
SICmatter
to Haagen-Dazs
in 1988.
The
TaxFerman
Court ruled
that thev.
oral contract
and
personal
relationships
were
never
assets
of
Martin
Ice
Cream,
but
owned
Robert E. Jackson and Milton Thompson, in the United States District solely
Court,
by Strassberg.
Upon
sale
of
those
assets
to
Haagen-Dazs
Strassberg
received
capital
gains
Western District of Arkansas at Jacksonville Division, Case Number 3:97-CV-1234
treatment.
from July 18, 2001, testimony of Stephen Jones.
There is a substantial body of statutory authority, judicial precedent and administrative rulings
16.
Trialthe
transcript,
IX, in the matter
of Thomas
Sacks andThe
Ferman
regarding
valuation Day
and amortization
of non-compete
agreements.
InternalHouston
Revenuev.
Robert
Jacksontest
andforMilton
Thompson,
in the United
States District
Court,
Service
has aE.four-part
recognition
of a non-compete
agreement
(see Forward
Western
District
of
Arkansas
at
Jacksonville
Division,
Case
Number
3:97-CV-1234
Communications v. US, 78-2 USTC Para. 9542, also see the sample report at the end of this paper
from October
9, which
2001,asks
testimony
of Stephen
Jones.
for a detailed
analysis),
the following
questions:
17.
1.
Is compensation
for the covenant
severable fromofthe
price Pension
for goodwill?
Copies
of
the proposedpaid
regulations
of the Department
Labor,
Welfare
2.
Was
the
party
to
the
covenant
attempting
to
repudiate
an
amount
by both
the
Benefits Administration, 29CFR Part 2510 faxed from Steve Crain tofixed
Stephen
Jones
the seller for the covenant?
(TA 490buyer
- TA and
501).
3.
18.
Did both parties actually intend, when they signed the sale agreement, that some
portion of the price be allocated to the covenant?
An
letter economically
between Tennet
& Axelrod,
P.S.C. and ABC Jail Company,
4. engagement
Is the covenant
real and
meaningful?
Inc. regarding the possibility of forming an employee stock ownership plan, dated
November
30, 1993
and signed
on December
1993.
Revenue
Ruling 77-403
addressed
the issue
of whether a13,
cash
payment for a covenant not to
compete was a separate asset or part of the real property sold. The facts are as follows:
19.
A presentation for ABC Jail Company, Inc. about the employee stock ownership
! dated
P bought
real property
from
S for $12x
plan,
December
6, 1993
as faxed
from Steve Crain to Stephen Jones (TA 695
!
P also paid S $3x for covenant not to compete
- TA 707).
!
20.
21.
S was obligated for a defined period of time not to participate directly or indirectly
in the construction, purchase or management of competing properties within a
Various specified
researchdistance
materials
valuation
of stock for an ESOP (some of
fromregarding
property sold
to P
which
appears
to
be
from
Tax
Management,
Inc.)
(TAnot
708
- TA
715). capable of
!
S had constructed and sold many buildings but did
have
personnel
managing rental property, had never managed real property, and irrespective of the
existence
of non-compete,
did &
notAxelrod,
intend to construct,
or manage
rentala
Hand written
notes
from Tennet
P.S.C.’s purchase
workpapers
regarding
property
meeting on November 30, 1993 (TA 750 - TA 752).
The test is that in order for a payment for a covenant not to compete to be separate from the cost
22.
Deposition transcript of the testimony of Stephen Jones in the matter Robert v.
of property, the non-compete has to have a demonstrable value. The tests for determining a
Jackson,
et al.include:
v. Green and Smith, P.S.C., et al., Washington Circuit Court, Division
demonstrable
value
One, Case Number 12-123456 dated January 24, 2005.
23.
!
whether, in the absence of the covenant, the covenantor would desire to compete
Deposition
of the testimony of Stephen Jones in the matter Robert v.
withtranscript
covenantee;
Jackson, et al. v. Green and Smith, P.S.C., et al., Washington Circuit Court, Division
One, Case Number 12-123456 dated January 25, 2005.
- -1515 24.
Deposition
transcript
of covenantor
the testimony
of Stephen
Jones
thecovenantee
matter Robert
!
the ability
of the
to compete
effectively
withinthe
in the v.
Jackson,
et al. v.
Green and
Smith, P.S.C., et al., Washington Circuit Court, Division
activity
in question;
and,
!
the
feasibility,
in
view
of
the dated
activityJanuary
and market
in 2005.
question, of effective competition
One, Case Number 12-123456
27,
by the covenantor within the time and area in the covenant.
25.
Deposition transcript of the testimony of Stephen Jones in the matter Robert v.
28.
Prospectus of Esmor Correctional Services, Inc. (TA 54 - TA 112).
The Internal Revenue issued an ISP Coordinated Issue Paper for All Industries on May 7, 1992.
Jackson, et al. v. Green and Smith, P.S.C., et al., Washington Circuit Court, Division
This Paper addressed the issue that consideration paid for a bona fide covenant not to compete
One,ordinary
Case Number
dated
January deduction
28, 2005.to the buyer for the duration
represents
income to12-123456
the seller and
an amortizable
of the covenant. If the amount paid under a covenant is intended to compensate for lost earnings,
26.
Financial
results
of Prison
Systems,
for the third
1993surrounding
(TA 4 - TAthe
18).
it constitutes
ordinary
income
to the seller
and isLtd.
amortizable
to thequarter
buyer. Facts
allocation to covenants must be scrutinized to ascertain if the covenant is separable from goodwill,
and that
value represents
economic
reality.
The most
factSystems,
is whetherLtd.
the covenant
is the2,
27.
Illegible
workpaper
indicating
market
priceimportant
of Prison
from March
product
of bona
1994
(TA fide
19). bargaining arrangement rather than a sham. Economic reality theory is
primarily concerned with business realities which would cause reasonable persons, genuinely
concerned with the economic future, to bargain for the covenant not to compete.
This ISP was revised by the Internal Revenue Service in 1996 due to a change in the tax law
29.
Research
faxed
Smith
Barney
to§197).
Stephen
March
7, new
1994
(Omnibus
Budget materials
Reconciliation
Act from
of 1993,
specifically
IRC
TheJones
concernon
was
that the
regarding
the
Esmor
initial
public
offering.
tax law might result in the under-valuation of covenants not to compete. Factors to be considered
in the recognition and valuation of the covenant include:
30.
Two page summary of financial highlights of Prison Systems, Ltd. for the period
!
Did the seller
have
theand
ability
to compete?
ended
December
31,
1993
1992
(TA 116 - TA 117).
!
31.
Was the payment intended as compensation to the seller in lieu of his employment
in a competing venture?
Information
about ABC Jail Company, Inc. entitled ABC - A Public/Private
!
Are there any other factors that reflect the economic reality of the covenant?
Partnership (TA 118 - TA 153).
IRC §197 (d)(1) specifically includes covenants not to compete, but provides for a 15-year
32.
Correspondence
Stephen
D. Jones
Harper
at ABC Jail Company, Inc.
amortization
period whichfrom
is probably
different
from to
theGary
duration
of covenant.
dated July 12, 1994 (TA 154).
There are several recognized methods to quantify the value of a covenant. These include:
33.
34.
Fax transmittal form with confirmation dated April 22, 1997 (TA 156 - TA 157).
!
Total Business Approach - value of business with and without the covenant
!
Lost Sales Approach - value of the lost earnings from sales lost
Business
valuation
instructions
(TA 158).
!
Lost
Margins processing
Approach - value
of lost earnings
from costs absorbed
35.
Cover
dated
December
17, 1993
from The
Milton
Thompson
to Stephen
Each of
theseletter
methods
is a form
of the Income
Approach.
calculation
is intended
to deriveJones
the
transmitting
information
(TA 220).
present
value of therequested
lost earnings
attributable from
to thethe
lackcompany
of a covenant.
Factors
to be considered
to establish
the value of
non-competition
the
covenantor
generally
36.
Balance
Sheet of ABC
Jail Company,
Inc.
as of Octoberfor
31,
1993
with building
and
include:
land at appraised values (TA 221 - TA 222).
!
Age, health and educational background
!
Need for specialized equipment, tools or other devices
!
Legal capacity to compete after the deal
37.
of October
31, 1993 (TA 223 - TA
Balance
Sheet of
ABCto Jail
Company,
!
Financial
ability
compete
against Inc.
buyerasafter
deal
224).
!
Technical expertise and know-how to engage in competition
38.
!
Business
contacts
and
control
of the client/customer
base 31, 1993 (TA 225 - TA
Income
Statement
of ABC
Jail
Company,
Inc. as of October
!
Intention to actually compete after the deal
231).
39.
Audited financial statements of ABC Jail Company, Inc. for December 31, 1992 and
1991 as audited by We Do Numbers, CPAs (TA 232 - TA 243).
- -1616 40.
Audited
financial reputation
statements
of ABC
Jail Company, Inc. for December 31, 1991 and
!
Business
in the
community
Identification of the specific impact that each covenantor would have on the business if no covenant
were in
place isfinancial
an important
consideration.
It usually
varies with
each
41.
Audited
statements
of ABC
Jail Company,
Inc.
forperson.
December 31, 1990 as
audited by We Do Numbers, CPAs (TA 254 - TA 23).
The issue of a covenant not to compete is not just applicable to service oriented businesses (e.g.
accounting, medicine, investment, advertising, etc.). The central issue regarding the earnings
42.
Audited financial statements of ABC Jail Company, Inc. for February 28, 1990 and
source (i.e. client/customer) is who owns that source? Is it owned by the business or controlled
as audited
byless
Weinstitutionalized
Do Numbers, the
CPAs
(TA 264 - the
TA greater
277). the value of the
by the1989
covenantor?
The
environment,
covenant. The business may not be marketable in the absence of a covenant. The test, however,
43.
statements
of ABC Jail Company, Inc. for February 28, 1989 and
is not Audited
always anfinancial
“All or Nothing”
proposition.
Conclusion
44.
Form 1120S, U.S. Income Tax Return for an S Corporation for ABC Jail Company,
46.
ThereInc.
is nofor
easy
way(TA
to separate
personal
1993
292 - TA
329). goodwill from that if the enterprise. Court decisions,
such as Thompson and Held, while intending to be fair regarding the division of marital property,
place the non-business owner spouse at a significant disadvantage. While we agree with the
45.
1120S,
U.S.
Income
Tax
for an
S Corporation
for to
ABC
Jail Company,
notionForm
that the
business
owner
should
notReturn
pay for what
cannot
be transferred
a willing
buyer, we
Inc. forthat
1992
(TA must
330 -make
TA 372).
also believe
fairness
the court re-evaluate its previous attitude about covenants
not to compete and non-solicitation agreements.
Beginning
on the
next
page,
have
included
two different
scenarios
how personal
Inc. for
1991
(TA
373we
- TA
376)
(all attached
schedules
areregarding
not included).
goodwill can be addressed in the valuation under current case law. Neither is foolproof, as a skilled
attorney
can 1120S,
always attack
expert.
The
only hope
is that
the court can for
seeABC
the reasonableness
47.
Form
U.S. the
Income
Tax
Return
for an
S Corporation
Jail Company,
of the calculations.
Inc. for 1990 (TA 377 - TA 380) (all attached schedules are not included).
48.
Inc. for 1989 (TA 381 - TA 386) (all attached schedules are not included).
49.
Miscellaneous Schedules K-1, Form 1120S for 1992 (TA 387 - TA 392).
50.
Hand written notes from the Tennet & Axelrod, P.S.C. workpapers (TA 394 - TA
395).
51.
Stock Purchase Agreement by and between ABC Jail Company, Inc. Employee
Stock Ownership Plan and Trust and ABC Jail Company, Inc. as of December 1993
(no date) (TA 396 - TA 422).
52.
Hand written notes from the Tennet & Axelrod, P.S.C. file relating to consulting and
non compete agreement of Cliff Morris (TA 424).
53.
Consulting and Non-Competition Agreement by and between ABC Jail Company,
Inc. and J. Clifford Morris dated January 1, 1994 (TA 425 - TA 429).
54.
Employment Agreement by and between ABC Jail Company, Inc. and Milton
Thompson as of January 1, 1994 (TA 431 - TA 436).
- -1717 55.
Employment
Agreement
Scenario
1 - The Dental
Practiceby and between ABC Jail Company, Inc. and J. Clifford
Morris as of January 1, 1994 (TA 437 - TA 442).
An approach that we recently used in a dental practice valuation appears below. This used
covenant
not to compete
data fromby
a transaction
database
allocate
the goodwill.
56.
Employment
Agreement
and between
ABCtoJail
Company,
Inc. and Robert
Jackson as of January 1, 1994 (TA 443 - TA 448).
A covenant not-to-compete (non-compete agreement) is an intangible asset based on a contractual
agreement. Typically, the seller of a business, the covenantor, agrees not-to-compete with the buyer of the
57.
Various
hand written
workpapers
Tennet
Axelrod,
P.S.C.’s
(TA 449 - TA
business,
the covenantee,
in a defined
industryfrom
or market
for a&specific
period
of time,files
in a geographically
defined454).
area. A non-compete agreement has value to the buyer to the degree that it protects the assets
(tangible and intangible) from loss of value by restricting competitive actions of the seller. From an economic
perspective,
the value of a non-compete
agreement
is dependent
several
including theand
ability
of
58.
Correspondence
dated March
11, 1994
betweenonthe
Bankfactors,
of Jacksonville
The
the seller to compete, the derivation of the non-compete agreement, and the losses the company would suffer
ABCcompeted.
Jail Company, Inc. and the ABC ESOP (TA 468 - TA 478).
if the seller
In the instance
where letter
the seller
hascorrespondence
the ability to compete,dated
the relevant
question
becomes,
impact Jones
would
59.
Transmittal
with
March
8, 1994
from what
Stephen
competition
from
the
seller
have
on
the
business?
The
answer
to
this
question
depends
on
a
myriad
of
to James C. Ferran at the Bank of Jacksonville, providing an opinion of the value
factors. Chief among them are: 1) the seller being in possession of relationships that could redirect business
ofcompany
the ABC
Jail
Inc. stock
to be acquired
by theand
ESOP.
from the
to a
newCompany,
company established
or invested
into by the seller,
2) the seller having either
sufficient knowledge or technology to allow him or her to bring competitive services to market.
60.
Fax transmittal sheet and account workpapers under cover dated March 14, 1994
62.
1.
ABC JailACompany,
508 - that
TA the
510).
recital to the Inc.
effectESOP
that it issummary
the intent of(TA
the parties
Covenant not-to-compete is
63.
Research material from CCH - Standard Federal Tax Reporter regarding interest
That
the subject
is notemployees’
merely for the securities
purpose of protecting
purchase
on certain
loans
usedcovenant
to acquire
(TA 522the
- TA
535).goodwill.
The value
of non-compete
in theT.
purchase
and
sale of a company
been
the subject of
to Stephen
Jonesagreements
from Charles
Mitchell
Company
(TA 481has
- TA
484).
numerous court cases involving the Internal Revenue Service (“IRS”) and taxpayers. According to Neil C.
Kelly, ASA, CFA, the IRS maintains a theory called the “mass asset” rule. Prior to tax reform, this theory held
61.
An engagement
between Tennet
& Axelrod,
P.S.C.
and
the ABC
Jail
that certain
intangible assetsletter
were “non-depreciable
as a matter
of law, because
such
intangible
properties
aggregate,
has no determinable
usefulof
lifethe
andcommon
is either
Company,
1993 regarding
the valuation
are part
of a single Inc.
massdated
asset, December
which, in the 6,
inextricably
linked
to
goodwill
or
self
regenerating.”
According
to
Mr.
Kelly,
for
a
non-compete
agreement
to
equity in ABC as of November 30, 1993 (TA 503 - TA 504).
not fall under the mass asset rule, it must have the following components:
2.
3.
separate and distinct from any goodwill the seller may be selling.
That the Covenant has an independent basis-value.
64.
Miscellaneous workpapers from Tennet & Axelrod, P.S.C.’s files (TA 536 - TA 538).
65.
Cover
Bank of That
Jacksonville
regarding
estate
(TA 539).
a specific monetary
sumreal
is being
paidappraisals
for the Covenant.
4.
5.
6.
66.
That the Covenant was expressly bargained for – separate and distinct from the goodwill of
the seller.
letter
dated March 7, 1994 from Paul E. Donough to James C. Ferran at the
7.
That the Covenant
for a specified
period
of time
- which goes
to the permissible
amortized
Correspondence
datedisMarch
4, 1994
from
Charles
A. Brown,
Jr. to James
C.
period.
Ferran, Jr. at the Bank of Jacksonville regarding real estate appraisals (TA 540 - TA
552). That the Covenant to compete restrains a key individual from competing with the purchaser,
67.
becauseworkpapers
of the key person’s
and &
competitive
Miscellaneous
fromability
Tennet
Axelrod,activities.
P.S.C.’s files (TA 553 - TA 554).
8.
68.
That even in the event of the death of the grantor of the Covenant, such will not entitle the
A summary
of ABC facility operations (TA 555 - TA 556).
purchaser to depreciate or recover the cost of such Covenant over a period shorter than the
69.
Correspondence dated January 7, 1994 from Steven A. Crain to Stephen Jones
regarding a preliminary offer to purchase the business of ABC Jail Company, Inc.
(TA 557).
and if same is not accomplished, that the purchaser will suffer an economic detriment
term of such a Covenant.
- -1818 70.
9.
71.
10.
ProposalThe
toamount
recapitalize
ABC isJail
Company,
Inc. (TA
558).
the purchaser
paying
for the Covenant
not-to-compete
is depreciable over the
life of the Covenant regardless of whether the purchaser makes payments for such Covenant
over aregarding
period shorter
than
the life of the Covenant.
Workpapers
ABC
revenue/cost
from the periods 1991 through 1996, both
actual and
projected
(TA that
559the
- TA
572).
A recital
to the effect
value
allocated to the Covenant has economic reality or
substance.
72.
Correspondence dated December 10, 1993 from Stephen Jones to Milton Roberts
In addition,
guidance
can be found
in theneeded
four teststo
that
the courts the
havevaluation
historically (TA
applied
to -non-compete
relating
to additional
items
complete
573
TA 574).
agreements in determining whether it could be amortized for federal income taxes. The four tests were
summarized in Forward Communications Corp. v. U.S., 78-2 USTC Para. 9542, as follows:
73.
Schedule of officers’ compensation from 1989 through 1992 (TA 575).
74.
Article
Privatization?” (TA 576 - TA 586).
1.
2.
Whether the compensation paid for the covenant is severable from the price paid for the
acquired
entitled goodwill.
“Are ‘Doing Well’ and ‘Doing Good’ Contradictory Goals of
Whether either party to the contract is attempting to repudiate an amount knowingly fixed by
both the buyer and seller as allocable to the covenant.
75.
Depreciation report for ABC Jail Company, Inc. (TA 587 - TA 595).
76.
A
3.
Whether there is proof that both parties actually intended, when they signed the sale
that someto
portion
of the in
price
be assigned
the covenant.
partialagreement,
contract relating
facilities
Arkansas
(TAto 596
- TA 634).
4.
Whether the covenant is economically real and meaningful.
77.
A memorandum of understanding with the Department of Correction from the State
The first
was effectively
established in9,Marsh
Commissioner, 51 T.C. 56 (1968) aff’d
oftest
Florida
dated November
1993& McLennan,
(TA 635 -Inc.
TAv.637).
on other grounds, 420 F.2d 667 (3d Cir. 1969). In this case, the court looked at whether the compensation
paid for the covenant is separable from the price for goodwill. Where goodwill and the covenant not-to78.
A copy of Florida Legislation (TA 638 - TA 640).
compete are closely related, the benefits of the elimination of competition may be permanent or of indefinite
duration and, hence, the value of the covenant is not exhaustible or a wasting asset to be amortized over a
limitedCorrespondence
period.
79.
from Robert Studebaker of Mahoney & Company, P.C. to Stephen
Jones regarding the ESOP valuation of privately operated prisons (TA 641 - TA
In Commissioner v. Danielson, 378 F. 2d 771 (3d. Cir.) cert. Denied 389 US 358 (1967), the courts looked at
645).
whether either party was attempting to repudiate an amount knowingly fixed by both as allocable to the
covenant, the calculable tax benefit of which may fairly be assumed to have been a factor in determining the
80.
Hand written notes from the workpapers of Tennet & Axelrod, P.S.C. (TA 646 - TA
final price.
651).
In Annabelle Candy Co. v. Commissioner, the courts looked at whether the covenant played a real part in the
negotiations.
81.
A blank valuation information request form (TA 652 - TA 657).
Of particular importance, is whether the covenant was at issue in the negotiation process. This relates to the
economic
of the covenant
and its economic
significance.
According
Kelly,
the following are factors
82.
Lifereality
insurance
cost summary
for ESOP
plan (TA
658 - to
TA
660).
which are important in determining the economic reality of a non-compete agreement.
83.
1.
Newspaper
regarding
prisons
(TA 661 - TA
672).
The presencearticles
of a grantor
of the covenant
not-to-compete
having
business expertise evidencing a
84.
Agenda for November 30, 1993 ESOP meeting (TA 675).
85.
3.
Workpaper
contents from Tennet & Axelrod, P.S.C. files dated June 30, 1994 (TA
Grantor’s possession of sufficient economic resources to compete;
753 - TA 862).
2.
4.
86.
5.
6.
87.
formidable capability to compete;
Grantor’s ownership of technology and machinery necessary to compete;
Legal enforceability of the covenant for the term of the particular covenant under state law;
Valuation workpapers from Tennet & Axelrod, P.S.C. files dated December 31,
Grantor’s legal capacity to compete;
1994
(TA 863 - TA 1016).
Covenant having sufficient scope to assure non-competition without overreaching;
Valuation report of ABC as of December 31, 1994 (TA 865 - TA 920).
- -1919 -197.
88.
7.
8.
Not
of
Valuation
reportage
checklist
dated June 21, 1995 (TA 1017 - TA 1021).
Not too
too advanced
advanced
age
of grantor;
grantor;
Good health of grantor;
8.
89.
Good health of grantor;
Miscellaneous
workpapers relating to 1995 and 1996 valuations (TA 1022 - TA
1269).
Payments
Payments for
for covenant
covenant that
that are
are not
not pro-rata
pro-rata to
to the
the grantor’s
grantor’s stock
stock ownership
ownership in
in the
the seller;
seller;
10.
10.
90.
Purchaser’s
of
covenant
not-to-compete;
Purchaser’s policing
policing
of the
the &
covenant
not-to-compete;
Workpapers
of Tennet
Axelrod,
P.S.C. relating to the ABC forecast engagement
from
1994 payments
to 2003 under
(TA 1270
- TA 1349).
Structuring
the covenant
to occur over time and to cease upon breach of such
9.
9.
11.
11.
91.
12.
12.
92.
13.
13.
14.
14.
93.
15.
15.
Structuring payments under the covenant to occur over time and to cease upon breach of such
covenant;
covenant;
Miscellaneous workpapers from Tennet & Axelrod, P.S.C.’s files (TA 1410 - TA
Vigorous
Vigorous negotiations
negotiations over
over the
the covenant
covenant and
and negotiations
negotiations over
over its
its value
value should
should be
be recited
recited in
in the
the
1472).
agreement;
agreement;
Printout
ofspecific,
the schedules
from
thecovenant
ValuSource
computer system relating to the
A
and
not-to-compete;
A detailed,
detailed, specific,
and carefully
carefully drafted
drafted covenant
not-to-compete;
November 30, 1993 valuation (TA 1464 - TA 1561).
Independent
Independent appraisal
appraisal of
of the
the value
value of
of the
the covenant
covenant not-to-compete;
not-to-compete;
Valuation
report
as of November
30, 1993 by
Tennet & Axelrod,
P.S.C.the
(TA 1563 Some
Some degree
degree of
of reasonableness
reasonableness in
in the
the percentage
percentage of
of the
the considerations
considerations allocated
allocated to
to the covenant
covenant
TA
1623).
and
and other
other items.
items.
The importance
importance
ofstatement
the covenant
covenantprocessing
not-to-compete
having economic
economic
was
delineated
by
94.
Financialof
instructions
for thesubstance
year ended
December
31, 1995
The
the
not-to-compete
having
substance
was further
further
delineated
by a
a
Bureau
of
National
Affairs'
paper
on
the
subject
published
in
1992.
The
paper
stated:
Bureauwith
of National
Affairs'
paper
on
the
subject
published
in
1992.
The
paper
stated:
financial statements for the ABC Jail Company, Inc.’s ESOP (TA 1626 - TA
1634).
The most important factor is whether the covenant is economically real, that is, whether the
95.
covenant is
is the
the product
product of
of bona
bona fide
fide bargaining
bargaining rather
rather than
than a
a sham.
sham. The
The economic
economic reality
reality
covenant
theory
is
primarily
concerned
with
business
realities
which
would
cause
reasonable
persons,
Atheory
checklist
for financial
reporting
regarding
contribution
retirement
plans (TA
is primarily
concerned
with business
realities defined
which would
cause reasonable
persons,
genuinely concerned
concerned with
with their
their economic
economic future,
future, to
to bargain
bargain for
for the
the covenant
covenant not-to-compete.
not-to-compete.
genuinely
1635 - TA 1641).
Among the
the facts
facts to
to be
be considered
considered are
are whether
whether the
the seller
seller could
could actually
actually compete
compete with
with the
the purchaser.
purchaser. Where
Where
Among
96.
Other
Tennet &
Axelrod,
P.S.C. workpapers
relating
to services
the
the seller
seller
is, objectively,
objectively,
likely
to be
be a
a competitor,
competitor,
the paper
paper states
states
that courts
courts
have also
alsoperformed
looked at
at the
the for
actual
the
is,
likely
to
the
that
have
looked
actual
contract
negotiations
to
determine
if
the
parties'
intentions
were
for
the
covenant
not-to-compete
to
have
ABC
ESOP (TA
1642 - ifTA
contract
negotiations
to determine
the8799).
parties' intentions were for the covenant not-to-compete to have
value.
value.
In addition,
addition, the
the amount
amount allocated
allocated to
to the
the covenant
covenant not-to-compete
not-to-compete may
may not
not reflect
reflect economic
economic
In
reality.
The
taxpayer
has
the
burden
of
proving
that
he
is
entitled
to
the
deduction.
Welch
The taxpayer
has the issues
burden ofinproving
that he
is entitled
towell
the deduction.
Welch
In order reality.
to
address
the
various
the
T&A
reports,
as
as
the
conduct
v. Helvering,
Helvering, 290
290 U.S.
U.S. 111
111 (1933).
(1933). Courts
Courts have
have frequently
frequently found
found that
that covenants
covenants have
have no
no
v.
value
or,
at
least,
substantially
less
value
than
the
purchaser
attributes
to
them.
The
same
valuethat
or, atare
least,
substantially less
than the
the purchaser
attributes towhere
them. The
same
assignment
problematic,
wevalue
will cite
page reference,
possible,
factors as
as above
above have
have been
been considered
considered for
for this
this purpose.
purpose. Further,
Further, courts
courts have
have looked
looked at
at the
the
factors
actual
contract
negotiations
to
determine
if
the
parties
intended
the
covenant
to
have
any
on the bates
stamp
on
each
page.
actual contract negotiations to determine if the parties intended the covenant to have any
value. For
For example,
example, ifif the
the parties
parties agreed
agreed to
to pay
pay a
a certain
certain amount
amount for
for the
the assets
assets of
of the
the seller
seller
value.
and
the
purchase
price
is
not
altered
when
a
covenant
not-to-compete
is
later
added,
the
and the purchase price is not altered when a covenant not-to-compete is later added, the
covenant
has
no
or
minimal
value.
covenant has no or minimal value.
of this
based
First and foremost, the lack of qualifications of the appraiser must be noted. In our opinion,
Other guidance on determining the value of a covenant not-to-compete is given in Revenue Ruling 77-403.
T&A
Jones
and Axelrod
the requisite
skills,
knowledge
and credentials
The and
rulingMessrs.
states that
that
the relevant
relevant
factors for
forlacked
determining
the value
value of
of
a non-compete
non-compete
agreement
include:
The
ruling
states
the
factors
determining
the
a
agreement
include:
that demonstrate
competence
required
to perform
the to
valuation
portion
1) Whether professional
in the absence of
the covenant the
covenantor
would desire
compete with
the of their
1) Whether in the absence of the covenant the covenantor would desire to compete with the
covenantee; 2)
2) the
the ability
ability of
of the
the covenantor
covenantor to
to compete
compete effectively
effectively with
with the
the covenantee
covenantee in
in the
the
covenantee;
engagement.
According
to 3)
thethe
T&A
reportin (TA
173):
view
of
the
activity
and
market
in
question,
of
activity
in
question;
and
feasibility,
activity in question; and 3) the feasibility, in view of the activity and market in question, of
effective
competition
by
the
covenantor
within
the
time
and
area
specified
in
the
covenant.
effective competition by the covenantor within the time and area specified in the covenant.
Based on
on the
the issues
issues presented
presented by
by Kelly
Kelly in
in regard
regard to
to the
the mass
mass asset
asset rule,
rule, the
the covenant
covenant is
is a
a distinguishable
distinguishable
Based
asset
that
can
be
valued
separately
from
goodwill.
asset that can be valued separately from goodwill.
-20- 20 -
QUALIFICATIONS
OF
In essence, a covenant not to compete
is used to protect
theAPPRAISER
goodwill that is associated with the practitioner
that would allow that individual to compete with the purchaser of the practice. In the valuation performed in
this matter,
indicated value
of $702,000
can
broken down
tangible andnumerous
intangible value as
Sincethefounding
in 1980,
Tennet
& be
Axelrod,
PSCbetween
has performed
follows:
valuations of closely held entities. A significant number of valuations are
performed in our Jacksonville
and Lexington,$208,000
Arkansas, offices for clients
Tangible Value
throughout the region. Valuation opinions have been rendered for a variety
Intangible Value
of purposes including mergers
and acquisitions,494,000
employee stock ownership
plans, marital dissolutions
tax purposes.
Total and
Valueestate and gift $702,000
Our clients include other business professionals, individuals, and closely held
The normalized balance sheet was used to derive the value of the net tangible assets. Therefore, by
entities
representing
many
different totypes
ofassets.
industries.
Industries
subtraction,
any remaining
value would
be attributable
intangible
This would
be the maximum
represented
include
financial
institutions,
amount
that a willing buyer
would be professional
looking to protect inpractices,
an acquisition of
Johnson Dental
Care. In order to
estimate
the amount of personal
goodwill associated
with Johnson
Dental Care,and
the appraiser
manufacturing
and distribution
concerns,
retail industries,
various looked
other for two
separate
factors
which
would
provide
market
evidence
as
to
the
value
of
a
non-compete
agreement.
service industries.
CONTRACT FOR SALE BETWEEN DR. SCOTT SMITH AND DR. MARK JONES (JULY 1989)
Several Tennet & Axelrod personnel have completed various courses
concerning
valuations
closely
held businesses
and
professional
As indicated
earlier in the
this report,
the assetof
purchase
agreement
that involved Dr.
Smith
included a restrictive
covenant.
In fact, according
to the allocation
page three oftraining,
this agreement,
the $366,000
purchase price
practices.
In addition
to thisontechnical
we have
substantial
was allocated between tangible and intangible assets as follows:
experience with respect to the buying and selling of businesses through
years of working
with our
clients. This combination
Tangible
Assets
$153,720provides us with the
combination of technical training and practical experience of dealing with
Intangible
Assets
212,280
"willing buyers and
sellers"
and the ability to value
businesses.
Total
$366,000
Tennet & Axelrod, PSC personnel have qualified and testified as expert
witnesses in numerous courts. Additionally, they have assisted many large
The intangible assets were broken down between patient records and restrictive covenant as follows:
legal and accounting firms throughout the country with their valuation
experience. OurPatient
reports
are prepared in accordance
Records
$131,760 with standards as
promulgated by the American Institute of Certified Public Accountants.
Covenant
Biographical andRestrictive
qualifications
information on our 80,520
individual professionals is
available upon request.
Total
$212,280
AtThis
theindicates
time of
acceptance
of this
engagement,
is allocated
our belief
none
of the
thatthe
approximately
22 percent
of the
purchase priceitwas
to a that
restrictive
covenant
($80,520 $366,000).
personnel, and particularly the partner in charge of the engagement, Steven Jones, had
MARKET EVIDENCE FROM THE PRATT’S STATS DATABASE
any credentials in business valuation. When questioned about his qualifications at his
Included in the detail of the Pratt’s Stats database is information relating to whether or not a covenant not
deposition,
Mr. Jones responded as follows (January 24, 2005, beginning at page 22, line
compete was granted, and if so, how much of the sale price was allocable to this covenant. An analysis was
performed of the transactions resulting in the information provided in Table 19.
18):
Q.
Okay. Now, on the time – at the time you took on this assignment to
value ABC Jail Company, were you a certified business appraiser
designated by the Institute of Business Appraisers?
- -2121 A.
Q.
No.
At the time
of ABC, were you
an accredited senior appraiser designated byPricethe
Price- American Society
Employ
Liabilities
&
NonCompete
Employ Liabilities &
NonCompete
of Appraisers?Sale
Business
Sell
Liabilities Agree Employment Noncompete
to Selling
Business
Description
Description
A.
TABLE 19
PRATT’S STATS TRANSACTIONS
COMPETE INFORMATION
youWITH
tookNON
on the
valuation assignment
No.
Sale
Date
Date
Sell
Price
Price
Liabilities
Assumed
Assumed
Agree
Value
Value
Employment
Agreement
Agreement
Noncompete
Value
Value
to Selling
Price
Price
Dental Practice
Practice
1/22/1999
443,500
0
0
443,500
175,933
39.67%
Dental
1/22/1999
443,500
0
0
443,500
175,933
39.67%
Dental Practice
Practice
11/2/1999
20,000
0
0
20,000
5,000
25.00%
Dental
11/2/1999
20,000
0
0
20,000
5,000
25.00%
Dental Practice
Practice
General
Family
9/7/1999
314,262
0
0 assignment
314,262
10,000
3.18%
Dental
-- General
Family
9/7/1999
314,262
0
0
314,262
10,000
3.18%
Q.
At
the
time
you
took
on
the
valuation
for
ABC
Jail
Dental Practice
Practice -- General
General Family
Family 10/5/1999
10/5/1999
222,500
0
0
222,500
10,000
4.49%
Dental
222,500
0
0
222,500
10,000
4.49%
Company, Inc.,
were 287,000
you a certified
analyst
designated
by 0.35%
Dentist
10/24/1997
287,000
0 valuation
0
287,000
1,000
0.35%
Dentist
10/24/1997
0
0
287,000
1,000
Dentist, General
General the National
5/1/1997
482,000
0
0
482,000
33,000
6.85%
Dentist,
5/1/1997
482,000
0
0
482,000
33,000
6.85%
Association
of Certified
Valuation
Analysts? 15,000
Dentist, General
General
4/1/1998
150,000
0
0
150,000
10.00%
Dentist,
4/1/1998
150,000
0
0
150,000
15,000
10.00%
Dentist, General
General
4/1/1998
120,000
0
0
120,000
20,000
16.67%
Dentist,
4/1/1998
120,000
0
0
120,000
20,000
16.67%
Dentist, General
General
1/1/1998
210,000
0
0
210,000
20,000
9.52%
Dentist,
1/1/1998
210,000
0
0
210,000
20,000
9.52%
A.
No.
Dentist, General
General
2/1/1998
210,000
0
0
210,000
40,000
19.05%
Dentist,
2/1/1998
210,000
0
0
210,000
40,000
19.05%
Dentist, General
General
4/1/1997
173,000
0
0
173,000
20,000
11.56%
Dentist,
4/1/1997
173,000
0
0
173,000
20,000
11.56%
Dentist, General
General
1/1/1998
137,000
0
0
137,000
10,000
7.30%
Dentist,
1/1/1998
137,000
0
0
137,000
10,000
7.30%
QGeneral At the time10/1/1997
you took147,000
on the valuation
assignment
for12,000
ABC Jail 8.16%
Dentist, General
10/1/1997
147,000
0
0
147,000
12,000
8.16%
Dentist,
0
0
147,000
Dentist, General
General Company, Inc.,
2/1/1998
60,000
0
0
60,000
20,000
33.33%
did you60,000
hold a degree
from
any60,000
university20,000
or college33.33%
Dentist,
2/1/1998
0
0
Dentist, General
General
10/1/1997
28,000
0
0
28,000
3,000
10.71%
Dentist,
10/1/1997
28,000
0
0
28,000
3,000
10.71%
in valuation10/15/1998
sciences?
Dentist: Orthodontist
Orthodontist
10/15/1998
119,000
0
0
119,000
10,000
8.40%
Dentist:
119,000
0
0
119,000
10,000
8.40%
Dentist: Orthodontist
Orthodontist
6/15/1999
342,000
0
0
342,000
11,000
3.22%
Dentist:
6/15/1999
342,000
0
0
342,000
11,000
3.22%
Family Dentistry
Dentistry
5/28/1998
176,677
0
0
176,677
5,000
2.83%
Family
5/28/1998
176,677
0
0
176,677
5,000
2.83%
Family A.
Dentistry No.
9/15/1998
105,500
0
0
105,500
10,000
9.48%
Family
Dentistry
9/15/1998
105,500
0
0
105,500
10,000
9.48%
Family Dentistry
Dentistry &
& Implantology
Implantology
5/1/1998
752,000
0
0
752,000
50,000
6.65%
Family
5/1/1998
752,000
0
0
752,000
50,000
6.65%
General Dentist
Dentist
8/15/1998
132,000
0
0
132,000
11,000
8.33%
General
8/15/1998
132,000
0
0
132,000
11,000
8.33%
General Dentist
Dentist
6/15/1999
350,000
0
0
350,000
30,000
8.57%
General
6/15/1999
350,000
0
0
350,000
30,000
8.57%
Not
onlyDentist
did Mr. Jones not
have any
credentials00 in business
valuation, 10,000
he did not belong
General Dentist
6/15/1999
130,000
0
130,000
10,000
7.69%
General
6/15/1999
130,000
0
130,000
7.69%
General Dentist
Dentist
5/15/1999
79,000
0
0
79,000
4,000
5.06%
General
5/15/1999
79,000
0
0
79,000
4,000
5.06%
to General
any appraisal
organizations
time of this00 valuation.
His
testimony
was as follows
General
Dentist
2/15/1999at the
301,000
0
301,000
11,000
3.65%
Dentist
2/15/1999
301,000
0
301,000
11,000
3.65%
General Dentist
Dentist
7/15/1999
68,000
0
0
68,000
6,000
8.82%
General
7/15/1999
68,000
0
0
68,000
6,000
8.82%
General Dentist
Dentist
3/15/1999
277,000
0
0
277,000
25,000
9.03%
(January
24, 2005, beginning
on page
24, line 12):
General
3/15/1999
277,000
0
0
277,000
25,000
9.03%
General Dentist
Dentist
1/15/1999
202,000
0
0
202,000
20,000
9.90%
General
1/15/1999
202,000
0
0
202,000
20,000
9.90%
General Dentistry
Dentistry
12/1/1998
115,001
0
0
115,001
10,000
8.70%
General
12/1/1998
115,001
0
0
115,001
10,000
8.70%
General Dentistry
Dentistry
6/15/1999
300,000
0
0
300,000
35,000
11.67%
General
6/15/1999
300,000
0
0
300,000
35,000
11.67%
General Dentistry
6/1/1997
277,000
0
0
277,000
50,000
18.05%
Dentistry
6/1/1997
0
0
277,000
50,000
18.05%
General
time you 277,000
took
valuation
assignment
of10,000
ABC, did11.11%
12/1/1998
90,000 on the 0
0
0
90,000
10,000
11.11%
General
Dentistry
GeneralQ.
Dentistry Now, at the12/1/1998
90,000
0
90,000
General Dentistry
Dentistry you have any
10/13/1997
399,369
0
0
399,369
60,000
15.02%
General
10/13/1997
399,369
0
0
399,369
credentials
that qualified
you
specifically
in 60,000
the field of15.02%
General Dentistry
Dentistry
4/1/1998
135,000
0
0
135,000
20,000
14.81%
General
4/1/1998
135,000
0
0
135,000
20,000
14.81%
General Dentistry
Dentistry business valuation?
4/1/1999
115,000
0
0
115,000
10,000
8.70%
General
4/1/1999
115,000
0
0
115,000
10,000
8.70%
General Dentistry
Dentistry
4/15/1999
250,000
0
0
250,000
20,000
8.00%
General
4/15/1999
250,000
0
0
250,000
20,000
8.00%
General Dentistry
Dentistry
5/15/1999
100,000
0
0
100,000
10,000
10.00%
General
5/15/1999
100,000
0
0
100,000
10,000
10.00%
credentials,
no.
GeneralA.
Dentistry No specific 6/15/1999
6/15/1999
550,000
0
0
550,000
35,000
6.36%
General
Dentistry
550,000
0
0
550,000
35,000
6.36%
General Dentistry
Dentistry
5/15/1999
325,000
0 200,000
200,000
125,000
30,000
24.00%
General
5/15/1999
325,000
0
125,000
30,000
24.00%
General Dentistry
Dentistry
4/1/1999
250,000
0
0
250,000
20,000
8.00%
General
4/1/1999
250,000
0
0
250,000
20,000
8.00%
GeneralQ.
Dentistry-At
Family
Prac.time
11/24/1998
229,357
0
0
229,357
154,000
67.14%
the
you took
on the assignment
to
value 154,000
ABC, what67.14%
General
DentistryFamily
Prac.
11/24/1998
229,357
0
0
229,357
General Family
Family Dentistry
Dentistry
6/14/1999
344,782
0
0
344,782
15,000
4.35%
General
0
0
344,782
15,000
4.35%
professional6/14/1999
business344,782
valuation organizations
did
you belong
to?
General Family
Family Dentistry
Dentistry
7/26/1999
196,366
0
0
196,366
10,000
5.09%
General
7/26/1999
196,366
0
0
196,366
10,000
5.09%
General Family
Family Dentistry
Dentistry
9/8/1999
286,000
0
0
286,000
10,000
3.50%
General
9/8/1999
286,000
0
0
286,000
10,000
3.50%
General Family
Family Dentistry
Dentistry
4/12/1999
240,000
0
0
240,000
5,000
2.08%
General
4/12/1999
240,000
0
0
240,000
5,000
2.08%
At the time,3/18/1999
I don't -- I125,000
don't recall in
if125,000
any, we belonged
to60.00%
GeneralA.
Family Dentistry
Dentistry
3/18/1999
125,000
0 '93 what,
0
125,000
75,000
60.00%
General
Family
0
0
75,000
General Family
Family Dentistry
Dentistry
7/9/1999
157,180
0
0
157,180
93,000
59.17%
at that point7/9/1999
in time. 157,180
General
0
0
157,180
93,000
59.17%
General Family
Family Dentistry
Dentistry
1/26/1999
426,031
0
0
426,031
220,000
51.64%
General
1/26/1999
426,031
0
0
426,031
220,000
51.64%
General Family
Family Dentistry
Dentistry
10/22/1999
152,800
0
0
152,800
16,800
10.99%
General
10/22/1999
152,800
0
0
152,800
16,800
10.99%
GeneralQ.
Dentistry Sitting here7/18/1997
7/18/1997
376,150
0 any organizations
0
376,150
50,000
13.29%
General
Dentistry
0
0
376,150
today, you376,150
can't think of
you50,000
belonged13.29%
Oral and
and Maxillofacial
Maxillofacial Surgery
Surgery
12/1/1997
400,000
0
0
400,000
20,000
5.00%
Oral
12/1/1997
400,000
0
0
400,000
20,000
5.00%
to in
1993?3/1/1998
Oral and
and Maxillofacial
Maxillofacial
Surgery
3/1/1998
800,000
145,000
0
655,000
50,000
7.63%
Oral
Surgery
800,000
145,000
0
655,000
50,000
7.63%
Oral and
and Maxillofacial
Surgery
2/1/1998
500,000
0
0
500,000
25,000
5.00%
Oral
2/1/1998
500,000
0
0
500,000
25,000
5.00%
Oral and
and Maxillofacial
Surgery
5/15/1999
1,000,000
0
0
1,000,000
50,000
5.00%
Oral
5/15/1999
0
0
1,000,000
50,000
5.00%
A.Maxillofacial
NotSurgery
from a 5/15/1999
valuation1,000,000
standpoint.
Oral and
and
Maxillofacial
Surgery
5/15/1999
425,000
0 200,000
200,000
225,000
40,000
17.78%
Oral
425,000
0
225,000
40,000
17.78%
Oral and
and Maxillofacial
Surgery
5/15/1999
550,000
103,000
0
447,000
40,000
8.95%
Oral
5/15/1999
550,000
103,000
0
447,000
40,000
8.95%
- -2222 Q.
Okay. Did you belong, in 1993,
upon
TABLE
19 taking this assignment to value
PRATT’S
STATS
TRANSACTIONS
ABC in 1993, belong
to the
Institute
of Business Appraisers?
WITH NON COMPETE INFORMATION
A.
No.
Business
Sale
PriceEmploy Liabilities &
NonCompete
Sell
Liabilities Agree Employment Noncompete
to Selling
valuation
assignment
1993, did you
Price
Assumed
Value inAgreement
Valuebelong to
Price
Q.Description
Upon taking on
this
Date
the American Society of Appraisers?
Oral and Maxillofacial Surgery
1/15/1999
400,000
0 200,000
200,000
40,000
1/15/1999
675,000
0 525,000
150,000
40,000
Oral and
0 180,000
220,000
30,000
A.Maxillofacial
No.Surgery 12/31/1998 400,000
1/15/1999
300,000
0 150,000
150,000
35,000
2/15/1999
175,000
0
0
175,000
25,000
Oral and
Surgery
4/15/1999
35,000to
Q.Maxillofacial
Upon
taking
on this 275,000
assignment 0in200,000
1993, did75,000
you belong
6/15/1999
550,000
0
0
550,000
40,000
National
of
Certified Valuation
Oral and Maxillofacial
Surgery Association
4/1/1998
500,000
0
0 Analysts?
500,000
45,000
3/15/1999
2,000,000
0
0
2,000,000
50,000
4/1/1998
325,000
0
0
325,000
40,000
A.Maxillofacial
No.Surgery 6/15/1999
Oral and
300,000
0
0
300,000
30,000
12/1/1998
330,000
0
0
330,000
30,000
1/15/1999
650,000
17,000 450,000
183,000
42,000
When
questioned about business
valuation
education,
Oral Surgery
11/15/1997
175,000
0
0 Mr. Jones
175,000 was unable
50,000
Orthodontia
7/15/1999
200,000
0
0
200,000
20,000
Orthodontist
4/1/1998
any
information about the
courses 400,000
that he had 0taken 0to get400,000
educated25,000
in this
Orthodontist
2/1/1998
175,000
0
0
175,000
20,000
Pediatric Dentistry
3/1/1998
375,000
0
0
375,000
40,000
response
was (January 24,
2005, beginning
at page
25,
line265,000
13):
Periodontal Practice
1/5/1998
265,000
0
0
50,000
20.00%
26.67%
13.64%
23.33%
14.29%
the 46.67%
7.27%
9.00%
2.50%
12.31%
10.00%
9.09%
22.95%
to provide
28.57%
10.00%
field.6.25%
His
11.43%
10.67%
18.87%
Average
Q.
Now, at the time you took on this assignment to value ABC, what
Q.
Need you to list them for me, Mr. Jones. I need the year you took
CONCLUSION
business valuation courses
that you attended prior to November
1993.
14.29%
Table 19 reflects
the sellingvaluation
price of Thecourses
Practice minus
any liabilities
assumed
and employment agreement
business
had you
attended,
if any?
values that were specifically allocated as part of the selling price in order to determine the price of the
practice, net of the liabilities and of the employment agreement. We then compared this amount to the result
A. allocated
Oh,towe
yes,ofIthe
had
attended agreement.
some thatThe
were
sponsored
by either
the value
the-value
non-compete
average
non-compete
agreement
that was
to the net selling
price
amounted
to
14.29
percent.
We
further
analyzed
this
data
and
removed
all
specialty
Arkansas Society of CPAs and/or the AICPA. And probably others.
practices to see
what
impact,
if
any,
these
had
on
the
average.
The
average
went
up
to
14.74
percent.
I don't recall the -Therefore, the market evidence indicates that of these transactions, between 14 and 15 percent is indicative
of the non-compete values.
Clearly, the best indication of the value of a non-compete agreement would be using market data involving
Dr. Smith himself. Although the transaction was from 1989, clearly, it is within the range of reasonableness
A.
I don't14.74
know
if we have
still evidence.
at the -- inTherefore,
our filesit at
the that
(22 percent
versus
percent)
based those
on the records
other market
appears
approximately office.
20 percent
of
the
purchase
price,
or
$140,400
($702,000
x
20
percent)
would
be
a
reasonable
I can check.
indication of the value of the non-compete. Therefore, in our opinion the value of Johnson Dental Care that
should be subject to equitable distribution as of March 23, 2000 would be $561,600.
Q.
Is there anything in your work papers that would show you that?
Scenario 2 - The Durable Medical Equipment Business
A.
No.
This is a unique situation. The husband and wife agree to the value of the business ($5 million)
and amicably
resolved
distribution
without a Society
trial. Twoofweeks
after
theyou
divorce
was put
Q.
Now,
youequitable
mentioned
the Arkansas
CPAs.
Do
recall
through, the wife
received
a
FedEx
package
addressed
to
the
husband
that
had
closing
documents
anybody from the Arkansas Society of CPAs who put on such a
that he sold his
company to a publicly traded entity for almost $17 million. By the time this matter
course?
got back into the court based on fraud, the argument was over how much of the value was
attributable to personal goodwill? Parts of the report have been omitted due to space constraints.
- -2323 A.
Well,
most
of their courses
are,
I'll sayAssociates
national Inc.
courses
developed
DESCRIPTION
OF THE
ASSIGNMENT:
Trugman
Valuation
was retained
by Maryby
Smith to
determine the equitable
distribution
value
of
Smith
Respiratory
Services,
Inc.
(“SRS”
or
the
“Company”)
as
the AICPA that the various state societies contract with to have
of March 9, 1995,
as well as tocome
determine
the and
valuegive
of thethe
covenant
not-to-compete that was part of an actual
instructors
down
courses.
transaction involving certain assets of the Company. We have also been requested to opine on whether the
value ascribed to the covenant not-to-compete is corporate, personal, or a combination of both.
During that time frame, there were a limited number of courses that were sponsored by the
In order to accomplish the assignment at hand, the following steps were taken by the appraiser:
AICPA, and in turn, the state CPA societies offered limited educational courses in
1.
Determine the fair market value of SRS;
3.
Determine the fair market value of the identifiable intangible assets of SRS;
2.
Determine
the fair
market
value ofSociety
the tangible
assets of
SRS;
business
valuation.
The
Arkansas
of CPAs
only
offered one course during 1992
4. no courses
Subtract the
fair market
the tangible 3,
and1992,
identifiable
intangible
assetswas
of SRS
from the
and
during
1993.value
On of
September
an AICPA
course
offered
byfair
the
market value of the total enterprise.
Arkansas Society of CPAs entitled Developing Your Business Valuation Skills: An
The result of this process will be to determine the residual, or unidentifiable intangible value that makes up
Engagement
Approach.
there
were other courses that Mr. Jones took, which he
the balance of the
fair market Unless
value of the
enterprise.
could
not document,
his education
during
this time
frame
was
almostdistribution
nonexistent.
DEFINITION
OF EQUITABLE
DISTRIBUTION
VALUE:
For this
matter,
equitable
value of the
equity of SRS has been determined as a result of an actual transaction involving certain assets of the
Company. Other assets were kept by the sole shareholder.
One more item is worth noting regarding the qualifications of the appraiser. T&A indicates
The equitable distribution value has been determined and is referenced in the “Order on Motion to Vacate
Finalreports
Judgment
of Dissolution
signed by
thestandards
Honorable Robert
Jones on July 24,
The value
“Our
are
preparedofinMarriage”
accordance
with
as promulgated
by1996.
the American
established in paragraph (8) of this order is $16,900,000.
Institute of Certified Public Accountants.” This statement is not only false, but when
DEFINITION OF FAIR MARKET VALUE: The most commonly used definition of fair market value is located
questioned
aboutService
it, Mr.Revenue
Jones,Ruling
once
again,
his fair
lack
of knowledge
of
in Internal Revenue
59-60.
Thisdemonstrated
revenue ruling defines
market
value as
business...the
valuation.
Histhe
deposition
testimony
included
theafollowing
24, 2005,
price at which
property would
change hands
between
willing buyer(January
and a willing
seller when the former is not under any compulsion to buy and the latter is not under any
beginning
at pageto42,
line
9):parties having reasonable knowledge of relevant facts. Court
compulsion
sell,
both
decisions frequently state in addition that the hypothetical buyer and seller are assumed to
be able, as well as willing, to trade and to be well informed about the property and concerning
the
for such
property.
Q. market
Okay.
Now,
continuing with Exhibit 307 on the page of qualifications
of appraisal -- appraiser, page 173, last paragraph, do you see where
you have written "our reports are prepared in accordance with
1.
As a going
concern,
and Institute of Certified Public
standards as promulgated
by the
American
2.
As
if
in
liquidation.
Accountants." Do you see that?
VALUATION METHODOLOGIES: There are two fundamental bases on which a company may be valued:
The value of a company is deemed to be the higher of the two values determined under a going concern or
A. valuation.
Yes, sir.
a liquidation
This approach is consistent with the appraisal concept of highest and best use, which
requires an appraiser to consider the optimal use of the assets being appraised under current market
conditions.
business
price to
as ado
going
concern
then it should
as such.
Q. If aTell
me will
-- command
what I'da higher
ask you
here
is would
you be
listvalued
those
Conversely, if a business will command a higher price if it is liquidated, then it should be valued as if in orderly
standards for me?
liquidation.
the
my head,
I'm not
for sure
can the
quote
themhas
verbatim,
butgreater
In this A.
instance,Off
SRS
willtop
be of
valued
on a going
concern
basis Isince
company
significantly
value as a going
concern.
This
has
been
evidenced
by
a
transaction
that
took
place
where
certain
assets of
the standards that are outlined in the code of conduct that state
SRS were purchased.
This
transaction
is
discussed
in
greater
detail
later
in
this
report.
exercise due care, that you obviously not take on engagements that
you're not qualified
do,approaches
and thatthat
you
follow
all thebynecessary
VALUATION APPROACHES:
The threeto
basic
must
be considered
the appraiser are:
guidelines of the American Institute in preparing your report.
- -2424 The AICPA did not have specific
standards
that
related to business valuation assignments
1.
The Market
Approach,
2.
The Asset Based Approach, and
in 1993. However, the AICPA
Statement
on Standards for Consulting Services
3. had issued
The Income
Approach.
No.
1 that referenced Rule 201 of the AICPA Code of Professional Conduct. Furthermore,
Within each of these approaches there are many acceptable valuation methods available for use by the
Appraisal standards suggest that an appraiser test as many methods as may be applicable to the
atappraiser.
that time,
the AICPA had published Practice Aid 93-3, Conducting A Valuation of a
facts and circumstances of the property being appraised. It is then up to the appraiser's informed judgment
as
to how
these
various values
maystated
be reconciled
in ultimately deriving a final estimate of value.
Closely
Held
Business,
which
the following:
THE MARKET APPROACH: The market approach is fundamental to valuation. Fair market value is
determined by the market. Under this approach, the appraiser attempts to find guideline companies traded
13/115
on a public
stockBUSINESS
exchange, in aVALUATION
same or similar EDUCATION
industry as the appraisal subject, that allows a comparison
to be made between the pricing multiples that the public company trades at and the multiple that is deemed
appropriate for the appraisal subject.
.01
In performing business valuation engagements, practitioners are
advised
determine
whether
competency
provisions
of rule
Another
common to
variation
of this approach
is tothe
locate
entire companies
that have been
bought201,
and sold in
General Standards
oforthe
AICPA Code
of Professional
met. that
the marketplace,
publicly traded
closely-held,
that allows
the appraisers toConduct,
determine are
the multiples
resulted
as part of accountants
the transaction. have
Theseamultiples
canunderstanding
then be used, withof
orfinancial
without adjustment,
depending
Although
thorough
statements
on the and
circumstances,
for
the
appraisal
subject.
related matters, they also need to be proficient in the area of appraisals
to competently
completeThe
anasset
engagement.
Usually,
being
proficient
requires
THE ASSET
BASED APPROACH:
based approach,
sometimes
referred
to as the
cost approach,
an in-depth
knowledge
ofthan
finance,
economics,
and security
analysis of
and
an
is an asset
oriented approach
rather
a market
oriented approach.
Each component
a business
is
valuedunderstanding
separately, and summed
up
to
derive
the
total
value
of
the
enterprise.
of appraisal principles and methods.
The appraiser estimates value, using this approach, by estimating the cost of duplicating or replacing the
.02elements
In order
for the property
practitioner
to obtainitem
thebycompetency
individual
of the business
being appraised,
item, asset by required
asset. Thetotangible
a business
valuation
engagement,
appropriate
education
assetsaccept
of the business
are valued
using this
approach, although
it cannot be
used alone is
asrequired.
many businesses
have intangible
as well, which
be applied
to.
Coursesvalue
sponsored
by this
theapproach
AICPA,cannot
the easily
American
Society
of Appraisers
(ASA), and The Institute of Business Appraisers Inc. (IBA) will provide
THE INCOME APPROACH: The income approach, sometimes referred to as the investment value approach,
practitioners with the minimum education necessary to perform there types
is an income oriented approach rather than an asset or market oriented approach. This approach assumes
engagements.
Self-study
courses
maycharacteristics,
help reinforce
a not
level
of the
that anof
investor
could invest in a property
with similar
investment
although
necessarily
knowledge; however, they are usually insufficient as the sole method of
same business.
education.
The computations, using the income approach generally determine that the value of the business is equal to
the present value of the future benefit stream to the owners. This is generally accomplished by either
singlethe
period
income
or by discounting
a series of
income streams
on a multiA capitalizing
statementa that
report
is instream
accordance
with standards
promulgated
bybased
the AICPA
was
period forecast.
T&A’s attempt to copy a portion of the certification that is required by the appraisal
Since estimating the future income of a business is at times considered speculative, historical data is generally
used as a startingas
point
in several
of the
acceptable
methods under
premise that history
will repeat
itself.
organizations,
well
as the
Uniform
Standards
of the
Professional
Appraisal
Practice
The future cannot be ignored, however, since valuation is a prophecy of the future.
(USPAP), which appeared in most of the valuation treatises that were published at that
REVENUE RULING 59-60 - VALUATION OF CLOSELY-HELD STOCKS: Among other factors, this
time.
USPAP
was all
also
addressed
the AICPA
Aid 59-60
93-3,which
where
it stated:
appraiser
considered
elements
listed in in
Internal
RevenuePractice
Service Ruling
provides
guidelines
for the valuation of closely-held stocks. Revenue Ruling 59-60 states that all relevant factors should be taken
into consideration, including the following:
.06 Standards 1 through 8 of USPAP, which are broad standards, must be
1.
The nature of the business and the history of the enterprise from its inception.
adhered
to when
an appraisal
is performed
a federally
related
2.
The
economic
outlook in general
and thefor
condition
and outlook
of transaction
the specific
involvingindustry
real in
estate
and other tangible property. The Preamble and
particular.
3.
The9book
the stockprovide
and financial
condition
of the business.
Standards
andvalue
10 ofofUSPAP
specific
guidelines
for developing and
4.
The earning capacity of the company.
reporting business valuations. Professional valuers recommend that
- -2525 -255.
paying
of the
USPAPThe
bedividend
followed
forcapacity
all types
ofcompany.
engagements, even if they are not
5.
The
dividend
paying
capacity
of
the
company.
6.
Whether
or not
the enterprise
has
goodwill
or other intangible value.
federally
related.
(Emphasis
added).
6.
Whether
or not
theand
enterprise
goodwill
value.
7.
Sales of the
stock
the sizehas
of the
block or
of other
stock intangible
to be valued.
7.
Sales
of
the
stock
and
the
size
of
the
block
of
stock
to
be
valued.
8.
The market price of stocks of corporations engaged in the same or similar line of
8.
The market
pricetheir
of stocks
corporations
in the
same
or similar
of
business
having
stocksofactively
traded engaged
in a free and
open
market
either line
on an
As will be pointed
out
in
much
more
detail
throughout
this
report,
T&A
used
software
and
business
having
their
stocks
actively
traded
in
a
free
and
open
market
either
on
an
exchange or over the counter.
exchange or over the counter.
attempted to provide a business valuation report without understanding the principles of
Since determining the fair market value of a business and allocating its purchase price are the questions at
Since determining
the fair market
value of a business
and individual
allocating case.
its purchase
are
the
questions
at
issue,
one must
theinputs
circumstances
of each
Thereprice
isit no
setusing
formula
to the
valuation,
whatunderstand
the
correct
into the valuation
software
programs
was
should
issue,
one
must
understand
the
circumstances
of
each
individual
case.
There
is
no
set
formula
to
the
approach to be used that will be applicable to the different valuation issues that arise. Often, an appraiser will
approach
to bewhat
used that
will
be applicable
to
the
different
valuation
issues
that
arise. or
Often,
an appraiser
will
have
been,
the
outputs
the
software
meant,
or the
amount
of research
and
find
wide
differences
of opinion
as tofrom
the fair
market
value
of a particular
business
business
interest.
In
find
wide
differences
of
opinion
as
to
the
fair
market
value
of
a
particular
business
or
business
interest.
In
resolving such differences, one should recognize that valuation is not an exact science. Revenue Ruling 59resolving
such
differences,
one
should
recognize
that
valuation
is
not
an
exact
science.
Revenue
Ruling
59analysis
that
was
required
to
produce
a
credible
valuation
report.
Mr.
Jones,
almost
11
60 states that "a sound valuation will be based on all relevant facts, but the elements of common sense,
60 statesjudgment
that "a sound
valuation will bemust
based
on into
all relevant
facts, weighing
but the elements
of common
sense,
informed
enter
the
those
facts
and determining
years later,
sat inand
hisreasonableness
deposition and
was
unable
toprocess
answerof
questions
about
standards
with
informed
judgment
and
reasonableness
must
enter
into
the
process
of
weighing
those
facts
and
determining
their aggregate significance."
their aggregate significance."
any certainty. This comes from an individual who claimed to have “substantial” experience
The fair market value of specific shares of stock in an unlisted corporation will vary as general economic
The
fair market
value
of specific
shares
ofWhen
stock
inhe
an
unlisted
corporation
will income
vary
as from
general
in performing
business
valuations.
asked
many
appraisals
heeconomic
would
conditions
change.
Uncertainty
as to the
stability
orwas
continuity
of how
the future
the
business
conditions
change.
Uncertainty
as
to
the
stability
or
continuity
of
the
future
income
from
the
business
decreases its value by increasing the risk of loss in the future. The valuation of shares of stock of a company
decreases
itsto
value
by
increasing
the
risk
of
loss in thehis
future.
The The
valuation
of shares
of
of(January
atocompany
have
to do
have
“substantial
experience,”
response
was
“Fifteen,
with
uncertain
future
prospects
is a
highly
speculative
procedure.
judgment
must twenty.”
bestock
related
all of the
with
uncertain
future
prospects
is
a
highly
speculative
procedure.
The
judgment
must
be
related
to all of the
factors affecting the value.
24, Page
37, line
factors
affecting
the 19).
value.This would equate to substantially less than a full year of experience
There
is no single
formula
acceptable
for determining
thehours
fair market
value of a The
closely-held
business,
and
assuming
that the
average
assignment
takes 60
to complete.
American
Society
There
is nothe
single
formula
acceptable
forrelevant
determining
theinfair
market
value ofthe
a closely-held
business,
and
therefore,
appraiser
must
look to all
factors
order
to establish
business’ true
fair market
therefore,
the
appraiser
must
look
to
all
relevant
factors
in
order
to
establish
the
business’
true
fair
market
value
as of a given date.
Thetime,
Internal
Revenue
Service has also
a training
manual, which
is in excess
of Appraisers,
at that
and
subsequently,
Theissued
Institute
of Business
Appraisers,
value
of a given
date.inThe
Internal
Serviceinhas
also issued
a training
manual, which
is in excess
of
oneas
hundred
pages,
order
to aid Revenue
representatives
accurately
valuing
a closely-held
business.
of
one hundred
in order
to aid representatives
accurately valuing
a closely-held
business.
required
five pages,
full years
of business
valuationinexperience
(10,000
work hours)
to earn a
NATURE AND HISTORY OF THE COMPANY
credential (in addition toNATURE
passingAND
examinations
HISTORY OFand
THE submitting
COMPANY work product for peer
Smith
Respiratory Services, Inc. was incorporated on June 10, 1981. The Company began operations in Plant
review).
Smith
Respiratory
Services,
Inc.medical
was incorporated
June
10, 1981.
The Company
operations
in to
Plant
City, Florida,
providing
durable
equipmenton
and
respiratory
therapy
productsbegan
to patients
referred
the
City,
Florida,
providing
durable
medical
equipment
and
respiratory
therapy
products
to
patients
referred
to
Company by their doctors. Products were sold primarily to elderly patients through Medicare, Medicaidthe
or
werethe
sold
primarily of
to a
elderly
patients
throughMr.
Medicare,
or
Company
by their doctors.
private insurance.
SRS wasProducts
formed after
dissolution
partnership
between
and Ms.Medicaid
Smith, and
private
insurance.
was
formed
the dissolution
ofvaluation
a partnership
between
Mr.oxygen
and Ms.concentrator
Smith,
and
Mr. Jones
alsoa SRS
could
not
recall
which
business
treatises
he
relied
on.
One
William
Johnson,
pharmacist
in
theafter
Orlando
area.
Mr. Johnson
was involved
in the
William
Johnson,
a
pharmacist
in
the
Orlando
area.
Mr.
Johnson
was
involved
in
the
oxygen
concentrator
business. The partnership was formed in late 1980. Ms. Smith had left her job at Saron Pharmacal, Inc.
business.
The
partnership
washis
formed
in late 1980.
Ms. any
Smithdocumentation
hadformed
left herwith
jobthe
at
Saron
Pharmacal,
reason
for
this
is abecause
workpapers
lacked
from
these
treatises
where
she
had
been
marketing
representative.
The
partnership
was
understanding
that Inc.
Ms.
where
she
had
been
a
marketing
representative.
The
partnership
was
formed
with
the
understanding
that
Ms.
Smith would bring her existing patient referral base to the partnership. Mr. Johnson furnished the Smiths with
to support
whather
heexisting
did in performing
the
ABC
valuation.
AnMr.
experienced
appraiser
knows
Smith
would
bring
patient
referral
base
to the
partnership.
Johnson
the Smiths
a
vehicle,
equipment,
and billing
services.
The
Smiths
worked
Ms. Smiths’
existingfurnished
patient referral
base with
and
a
vehicle,
equipment,
and
billing
services.
The
Smiths
worked
Ms.
Smiths’
existing
patient
referral
base
and
developed
new
referrals.
exactly what
resources are in its reference library. This is especially true in business
developed
new referrals.
valuation
because
there
a limited
of authors
thatdue
would
beSmiths’
regularly
Late
in 1980,
Ms. Smith
wentare
to work
for Dr.number
Edgar Randolph
four and
daystexts
per week
to the
poor
Late
in 1980,
Ms. Smith
went was
to work
for Dr.by
Edgar
Randolphprior
fourtodays
week dueattoSaron
the Smiths’
poor
financial
situation.
Ms. Smith
employed
Dr. Randolph
her per
employment
Pharmacal,
financial
situation.
Ms.aSmith
was
employed
by
Dr.
Randolph
prior publications
to
her employment
at relied
Saron Pharmacal,
referred
to as reference
Not
knowing
which
were
onreferred
is an
Inc.
Dr. Randolph
had
large materials.
geriatric
patient
base,
many of
whom
required
oxygen.
Dr.
Randolph
Inc.
Dr.
Randolph
had
a
large
geriatric
patient
base,
many
of
whom
required
oxygen.
Dr.
Randolph
referred
these patients to the Smiths, initially in their partnership with Mr. Johnson and later to SRS.
indication
that
he Smiths,
probably
did not
consult
any ofwith
these
materials.
In fact,
if he did consult
these
patients
to the
initially
in their
partnership
Mr. Johnson
and later
to SRS.
When
the Smiths he
left their
partnership
with Mr.
Johnson,
they needed
money
finance
SRS. Ms.
Smith
took
the materials,
maypartnership
have avoided
making
many
of the money
errorstoinfinance
judgement
thatSmith
will took
be
When
the Smiths
left their
Johnson,
they needed
Ms.
out a second
mortgage
on her home inwith
theMr.
amount
of $20,000
to provide theto
CompanySRS.
with financing.
After
out
a
second
mortgage
on
her
home
in
the
amount
of
$20,000
to
provide
the
Company
with
financing.
After
operating
out of
the
marital
home for the next three years, SRS had become successful enough to require
pointed out
inthe
thismarital
report.
operating
outforofits
home
for the
next
three
years,
SRS
had become
successful
enough
to require
more
space
operations.
In 1984,
Ms.
Smith
went
to Dr.
Randolph,
and using
her personal
relationship
more
space
for
its
operations.
In
1984,
Ms.
Smith
went
to
Dr.
Randolph,
and
using
her
personal
relationship
with him, asked him for a loan of $200,000. This money was used to build a facility in Plant City for SRS’
with
him, asked him for a loan of $200,000. This money was used to build a facility in Plant City for SRS’
operations.
operations.
Based on our review of the T&A report and workpapers, it is obvious that they did little
Afterwards,
SRS
opened
threeaadditional
locations,
in Lakeland,
Zephyrhills, and as
Sebring,
Florida. for
Each
of
more thanSRS
enter
data into
computer
program
and use management
justification
notof
Afterwards,
opened
three
additional
locations,
in Lakeland,
Zephyrhills,
and
Sebring,
Florida.
these locations
was
opened
after
Mr. Smith
and his marketing
team
determined
that
the location
wasEach
viable,
these locations was opened after Mr. Smith and his marketing team determined that the location was viable,
- -2626 fulfilling
obligations Each
as a of
business
valuer.was
Throughout
deposition,
Mr.leased
Jonestokept
based ontheir
its demographics.
the SRS facilities
owned by Mr.the
Smith
personally, and
the
Company.
stating that he discussed things with management, the directors or the trustees. However,
At the valuation date, SRS was operating in Hardee, Hernando, Highlands, Hillsborough, Pasco, and Polk
hecounties,
has little-to-no
notes of all of these supposed conversations that took place. The first
selling items such as beds, wheelchairs, walkers, and respiratory therapy products. Sixty percent
of SRS’
came from respiratory
30 percent
from durable medical
equipment,
and 10
thing
thatsales
accountants
are taughttherapy
is theproducts,
importance
of documentation,
particularly
when
the
percent from miscellaneous products. Management estimated that 70 percent of its revenues resulted from
rentals,
and 30 is
percent
from sales.
data received
oral versus
written. Part of the standard involving Sufficient Relevant Data
1 presents
SRS’ the
equipment
and medication
mixdocumenting
as of October 31,
1994.
isTable
not only
gathering
information,
but also
it in
the workpapers. T&A failed
in this regard.
TABLE 1
EQUIPMENT AND MEDICATION USAGE
Equipment/Therapy
Number of Patients
T&A did little more than rely on a software program to end up with a result that was
Nebulizers
340
Medications
680
Portable Oxygen
966
improper, illogical and unsupported. Although there is nothing in the standards that
precludes an appraiser from using a valuation software package, the appraiser must
accept responsibility for allConcentrators
tools that are used in the application
of the assignment. T&A,
957
Mr. Jones and Mr. Axelrod failed to exercise due professional care by not being familiar
Payment for products and medications came from four sources: Medicare, Medicaid, private insurance, and
retail.
sources
percent,
18 percent,
10 percent, and
percenttoofadequately
payments,
with
the These
tool that
was represented
relied on in70this
assignment.
Furthermore,
they2 failed
respectively. SRS developed a reputation for delivering high quality service to its patients. Services included
supervise
each
other
others
performing
this
assignment.
guaranteedeither
one hour
delivery,
24or
hours
a daywhile
service,
and educating
patients
in the use of their equipment.
This was very important in differentiating SRS from the rest of the market. Other companies in the durable
medical equipment market competed with SRS. In Plant City and Hillsborough County, competitors included
Respitch, Inc. and Lincare. In Lakeland, SRS’ competition included MediHealth, Inc., Lincare, Americare, Inc.,
Despite
Jones
toinhaving
substantial
in Lincare.
valuation,
he testified
and StateMr.
Oxygen,
Inc.testifying
Competition
Zephyrhills
consisted ofexperience
Coast, Inc., and
In Sebring,
Lincare,at
Sunshine, Inc., Medicaid, Inc., and Homedco, Inc. competed with SRS. As will be discussed later in this
the
original trial that “We were using a package I believe it was just called Bank Source,
report, although these companies participated in the same markets as SRS, Mr. Smith did not believe that any
of these
companies offered
a significant,
threat to SRS. CPAs other business valuators
which
is nationally
marketed,
sold tocompetitive
various practitioners,
As of the valuation
date, (July
the Company
hadPage
approximately
50 employees.
overall
throughout
the country”
18, 2001,
50, line 24).
The actualResponsibility
name of thisforsoftware
management was shared between Mr. Smith and Ms. Lori Daniels. Their duties included day-to-day
operations,
marketing,
that whatever
be done
was accomplished.
They also
package
is training,
Valusource
andand
notensuring
Bank Source.
Mr.needed
Jonestowas
unfamiliar
with the computer
shared the responsibilities for managing the Plant City facility, which was both a retail and billing operation.
product
thatother
wasthree
being
used
his everyday
practice.
Each of the
stores
had ainmanager
responsible
for the store’s operations. The Company had four
marketing representatives whose primary responsibilities were to maintain existing referral sources and
establish new ones. SRS also had a delivery manager, who was responsible for coordinating drivers and the
delivery of products to patients. Additional employees included customer service representatives, drivers,
Mr.
Jonesreceivable
also testified
considered
this and
to be
state of the art software. However,
accounts
clerks, that
officehe
staff,
warehouse staff,
a dispatcher.
the
software producer suggested that this package was not to be blindly used, and
As part of our analysis, we inspected the former SRS retail locations, now operated by Lincare. All of the SRS
locations are
located
main roadways
near major local
and regional
centers
and numerous
doctors’
assumed
that
the on
practitioner
understood
enough
aboutmedical
business
valuation
to make
the
offices. This served as a constant reminder to doctors that SRS was close by. In addition, this enabled SRS
to
deliver services
such as setting
up a
oxygen
in a doctor’s
officecannot
or a hospital,
in order
to send
a patient home.
necessary
determinations
that
software
package
make
for the
practitioner.
This
Geographic local made it easier for SRS to respond rapidly to these needs. In addition, the demographics
of the area
surrounding
thebe
SRS
locations
the oxygen therapy
business.
for
would
include,
but not
limited
to,were
thefavorable
correct tomethodologies
that
apply This
to aallowed
particular
expansion of markets and market share based on an established presence in these areas. The following
valuation,
correct
inputs
to determine
paragraphsthe
discuss
the four
retail locations
operated discount
by SRS. rates, whether to use a weighted
average, a simple average or some other basis to reflect probable future earnings, and
- -2727 more.
An experienced
practitioner
also understand
limitations
that
this, through
or any,
The Zephyrhills
store was located
at 6500 would
Gall Boulevard.
This is one ofthe
the major
roadways
running
Zephyrhills along with Route 54, which Gall Boulevard intersects approximately a mile and a half from 6500
software
package
The
practitioner one
would
also
makeCenter,
certain
that
Gall Boulevard.
The has.
storefront
is approximately
quarter
of atest
milethe
fromsoftware
East PascotoMedical
which
is located at 7050 Gall Boulevard. Associated with the medical center are some office buildings that contain
the
mathematical calculations are correct.
approximately 20 different medical practices and laboratories. The medical center has a surgery center,
emergency room, therapies department, and out patient imaging department. There are additional doctors’
offices on Dougherty Road, which is just past the medical center, approximately one-half mile from the
Lincare
Approximately
three
quarters of aerror
mile down
Route
301 is Townview
Artsmethod
Center,
T&A
wasfacility.
unaware
of a major
calculation
in the
discounted
futureMedical
earnings
which appears to contain approximately eight medical practices. Across US Route 301 from the medial center
is Spanish Trails
living
trailer home,
a trailer
park. every
We observed
additional
office buildings
and
(discussed
latersenior
in this
report),
blindly
printed
schedule
thatmedical
the software
package
trailer parks on Route 301, within one to two miles of the SRS location.
had to offer, even if inappropriate for the ABC valuation, and used inappropriate valuation
Plant City is approximately 17 miles southeast of Zephyrhills on Route 39. The Plant City facility is located
methodologies
in reaching
its finalonconclusion.
in the Village at Watson
Lake mini-mall
South Alexander Street. Alexander Street intersects Route 92 in
Plant City. Alexander Street is a four lane roadway running north and south. South Florida Baptist Hospital
is on North Alexander Street . The Village at Walden Lake contains a restaurant, hair and tanning salon, a
realtor, photography business, and a Lincare facility under the name of Smith. The Watson Clinic is located
Another
major problem with the T&A assignment is that this firm lacked independence.
within one-half mile of the facility. Florida Baptist Hospital is approximately two miles north of the SRS
location.
Furthermore,
because of the valuation incompetence, the lack of independence became
In Lakeland,
theas
former
store is located
at 1100
Lakeland Hills Boulevard.
Lakeland
Hills Boulevard
more
obvious
T&ASRS
conducted
several
simultaneous
assignments,
causing
it to mix
contains Lakeland Regional Medical Center. The street is lined predominantly with medical office buildings,
centers, clinics,
andviolate
health care
aid facilities
from practice.
the 1100 through
blocks,
where
the medical
center
assignments
and
proper
appraisal
T&A 1700
allowed
itself
to (1)
help plan
the
is. The Watson Clinic is located on the 1500 block of Lakeland Hills Boulevard. The Lakeland facilities are
ESOP
transaction,
(2)
value
theRespiratory
ESOP transaction,
(3) assist
in the
still operating
under the
name
Smith
Services andand
the trucks
also carry
the forecasts
Smith name.that
The were
area
is significantly more commercialized than either Zephyrhills or Plant City.
required by the Bank of Jacksonville to demonstrate that ABC could pay for the financing.
The Sebring location is approximately one-half mile from the Highland Regional Medical Center. It is located
inconsistently
used
These
three
assignments
became medical
so intertwined
that across
data the
was
on Route
27 South.
There is a professional
building diagonally
street
that appears to have
two or three medical practices in it. This is a somewhat less densely populated area than the areas the other
between
the assignments. Foe example, the forecast for the Bank of Jacksonville has
stores are located in.
different figures in it than the forecast that was used in the Discounted Future Earnings
ECONOMY/INDUSTRY INFORMATION
method in the valuation report. Furthermore, T&A represented ABC in some of its
(This section has been omitted)
engagements and should have represented the ABC ESOP (trustees) in the valuation.
This is a clear conflict of interest.
FINANCIAL ANALYSIS
(Part of this section has been omitted)
EXCESS ASSETS: From our analysis of SRS’ financial statements, it appears that SRS has
assets.problem
Excess assets,
sometimes
referred
as non-operating
are assets
Anexcess
underlying
that exists
throughout
theto initial
T&A reportassets,
and updates
is that
thataa
business owns, that are not necessary for the operations of the business.
valuation was never performed as of the date of the transaction with the ESOP, which is
SRS had two categories of assets that are considered to be excess, current assets, and fixed
the
most At
important
datedate,
thatSRS’
should
havesheet
beenindicates
used tothat
value
the ABC had
stock.
The initial
assets.
the valuation
balance
the Company
$1,136,933
of
current assets
of current
liabilities.
This does30,
not1993.
include However,
the $550,000
accounts
valuation
date and
had $9,977
an effective
date
of November
theofinitial
and
receivable sold to Lincare. The reason for this is that SRS’ financial statements are prepared on
a cash basis,valuations
which does not
includeup
accounts
receivable.
this intoonly
consideration,
had
subsequent
leading
to the
ESOP Taking
transaction
utilized SRS
financial
current assets of $1,686,933. Subtracting SRS’ current liabilities from this figure results in the
information
October
31, 1993.
Even the
March 15,
1994 update
did not use any
calculation through
of SRS’ working
capital
of $1,676,956
($1,686,933
- $9,977
= $1,676,956).
additional information other than distributions to the shareholders. T&A never considered
the impact on the valuation of more than four months of economic and industry changes,
- -2828 nor
impact
on ABC of removing
more than
million
of cash
from
the company
Tothe
check
the reasonableness
of this position,
we $1.5
reviewed
Robert
Morris
Associates’
Annualas
Statement Studies for working capital industry norms for durable medical equipment providers. For
1995, RMA reported that median working capital, as a percentage of sales, was 7 percent.
Applying this to SRS’ revenues for the 12 months ended February 28, 1995 results in the following
calculation of working capital:
distributions.
The balance of this report will be specifically referenced to the T&A report.
Revenues
$ 5,930,480
TA 160 RMA Working Capital as a Percent of Revenues
7%
Required Working Capital
$
415,134
Page
160 isthat
theSRS
cover
to current
the valuation
report
that was issued by T&A. The date
This TA
indicates
hadpage
excess
assets of
$1,261,822.
of this report is March 7, 1994. The report is addressed to the Board of Directors and
Lincare and SRS allocated $550,000 of the purchase price to accounts receivable. Lincare
Trustees
but T&A
was and
only$35,000
retained
by ABC.current
The liabilities
engagement
letter
was with
assumedof
noABC,
other current
assets,
of accrued
were not
recorded
as
of February 28, 1995. This results in working capital of $515,000. This represents 8.68 percent
ABC
andrevenues
not the trustees.
were Although
no changes
made
to the
themedian,
engagement
letter
and
of SRS’
in the latestThere
12 months.
slightly
above
this figure
is still
within industry
norms.should
As a result,
have determined
that SRS has
current
assets
of
therefore,
the report
not bewe
addressed
to the trustees.
Theexcess
trustees
never
became
$1,136,933. This figure represents all of SRS’ current assets other than the accounts receivable.
the client even though they should have. T&A should have been familiar with the ESOP
SRS owned certain vehicles that we believe were non-operating assets. These vehicles were as
rules
about who it should represent.
follows:
1992 Mercedes
$ 125,603
1992 Mercedes
61,158
1989 Jaguar
58,332
1993 Jeep
17,176
According to the report, T&A valued ABC as of November 30, 1993. However, in reaching
its conclusion, T&A included information in this report that assumed that an ESOP
transaction had taken place. At November 30, no such transaction took place. That
causes this valuation to be hypothetical, although it is not labeled as such. We will
$ 262,269
reiterate this point as we review the valuation schedules that are attached to the report.
In our opinion, these vehicles were not necessary for the operation of SRS. They are luxury
automobiles that represented perquisites to Mr. Smith. In addition, Mr. Smith retained these
The
standard
known
as fair As
market
value,
takes
into consideration
thatare
which
vehicles
after of
thevalue,
asset sale
to Lincare.
a result,
we have
determined
these vehicles
non-is
operating assets. Their value has been estimated to be approximately $200,000.
“known or knowable” as of the valuation date. The purpose of the T&A report was to
VALUATION
OFthe
SMITH
SERVICES,
INC.
establish the fair market
value of
ABCRESPIRATORY
stock to determine
the “adequate
consideration”
toAs
beindicated
paid by the
ESOP the
for valuation
these shares.
At the valuation
date,
30 1993,
previously,
of a closely-held
company
can November
be accomplished
usingthere
the
three approaches to value. One might ask why the transaction that transpired could not be used
was
no ESOP. Using the proposed ESOP transaction to value ABC is circular logic. The
as the best indication of fair market value? Our analysis indicates that the price that was paid by
Lincare, Inc.
represents
value that was
fair market
value
of SRS. the correct
appraiser
must
value thea company
as itgreater
exists than
at thethe
appraisal
date
to establish
price
toactual
be paid
for the stock.
the
transaction,
thecertain
value net
may
change
as a
In the
transaction
that tookAfter
place,
Lincare
purchased
assets
of SRS
at result
a priceof
of $15,035,000. According to the allocation included in the Asset Purchase Agreement dated
how
the9,transaction
is consummated.
March
1995, the following
was purchased:
- -2929 Frequently, appraisersAccounts
are requested
to perform some
preliminary
valuation calculations
receivable
$
550,000
for the purpose of assisting
a client in a decision. For example,
Inventory
40,000 in this instance ABC was
contemplating the implementation
Fixed assets of an ESOP.
A 712,000
preliminary valuation would be
requested by management
of ABC to help them determine
Covenants
100,000if it would make economic
sense. What appearsGoodwill/customer
to have happened
ABC needed some preliminary
list here is that
13,633,000
numbers as of November 30, 1993, and T&A was engaged in December 1993 to assist in
Total
$ 15,035,000
this process. At the time, the October 1993 figures were the most recent figures available.
Thewas
priceconfirmed
paid is greater
thanJones
the fairinmarket
value of the
assets purchased.
the definition
This
by Mr.
his deposition
(January
24, 2005, Since
beginning
at page
of fair market value is based on “the most probable price,” a review of other factors brought to our
attention
56,
line23).in this matter, make us believe that the most probable price is lower than this amount.
In addition, we believe that Lincare had special motivations in consummating this deal, that would
cause the definition of fair market value to be violated.
Q.
Okay. Thank you. What I don't understand -- maybe you can explain
In the deposition transcript of Steve Nagel, a principal of Steven Richard Associates, the business
it --bywhy
the to
valuation
as sale
of November
30th,statements
'93, whenare
the
second
broker engaged
Mr. is
Smith
assist in the
of SRS, several
made
that assist
paragraph
says,
“The
information
utilized
to
perform
the
valuation
us in substantiating our position. Mr. Nagel’s responses are relevant in that they reflect the
includes
tax returns
and financial
statements
of ABC
Jail Company,
knowledge and
expectations
of the seller.
In the course
of Mr. Nagel’s
deposition,
he asserts that
Lincare overpaid
SRS, supporting
his opinion
with you
several
pieces
of information. Other than
Inc.for
through
October 31,
'93.” Can
explain
that?
Lincare, Mr. Nagel indicated there were four offers made to purchase SRS. The companies and
their offers
as follows:
A. are
Well,
they wanted us to -- “they” being the trustees, wanted us to do
the valuation in the latter part of '93 based on the information that the
Medical at that point in time.
$ 11 million
companyHome
had available
Now, they would not
have the full year-end information available to us until sometime into
Abey Home Healthcare
12 million
'94, so they wanted us to proceed with the information that they had
11 million
availableHomedco
at that time.
Q.
Continuem Care
Undisclosed
Well, but by March 7, 1994, you certainly had the financial information
through November 30th, 1993, did you not?
Mr. Nagel was then asked about the first Lincare offer of $13.5 million for SRS. This was an all
cash offer and Mr. Nagel thought after presenting the offer to Mr. Smith “...our deal was done.” Mr.
A. opinion
I don't
know if inthey
provided
that to us or not. We -- we had been
Nagel’s
is explained
the had
ensuing
dialogue.
given the October number, certainly.
“I felt that no one would turn that down and we just felt it was – at the time we believed it to be the
highest
LincareI mean,
had ever
paid for
company.
Inmy
fact,goodness,
we could almost
thatafter
it was the
Q.price Well,
March
7,a'94
is about,
threeassure
months
highest price they
ever paid
Mr. Nagel
wasthe
then
asked, “thefinancial
highest price
in dollar
October
31, for
'93.a company.”
Did you ever
ask for
November
data,
amount or theMr.
highest
price
compared
to
profits?”
To
this,
Mr.
Nagel
responded,
Jones?
It’s the highest price compared to gross revenues. Lincare’s never – they pay
A.between
I don't
if we
asked
for the
We ended
up
1.75remember
and 1.2 times
gross
revenue
andNovember
that’s just –data.
we thought
that was
getting some preliminary December information, which they -- they
outstanding.
being the company also indicated that there had not been any major
changes between their operations -- between the October 31st and
December matters.
- -3030 Q.That offer
Well,weI'm
trying
to tounderstand.
It’shitobvious
well,he
it threw
seems
tookjust
to Mr.
Smith,
Ben, and it never
his desk–before
it
obvious
-- istelling
it true
that
never
a full
using
back at
us and I’m
you
theyou
truth.
This issued
thing never
hitreport
his desk.
He financial
wouldn’t
th
even look
it. ofHeNovember
wouldn’t talk
dataatas
30to
,us.
'93? Is that true?
A.Q.
A.
Q.
Q.A.
A.
Did he
say--why
was turning30th
it down?
Well,
the
thehe
November
information wouldn't have been -Yes.
would not have been available November 30th.
Why?
Well,
youthat
issued
the
report
onthat
March
My question
is,
Two again,
provisions
we told
him
about,
most 7th,
of his'94.
employees
would
be
th
anytime,
March
7th,for
'94two
orofthereafter,
through
March
, '94,
fired andas
he of
had
no tenant
his properties.
So after
that 15
point
we
did
ever
full report
using
financial
data
of players
November
let you
Lincare
sit issue
out on aa fence
and I took
that
offer to all
the as
other
and
they '93?
all said let Lincare buy it. That went on for about a month and we
30th,
never had – we probably had some contact, but most of the contact with
Lincare
wasbecause
coming inwe
theused
front the
door.
They were
us, what’s going
We
did not
October
31stcalling
information.
on?
Finally, the last player who hadn’t given up was Continuem Care.
Continuem
Caretokept
fooling
fooling around.
was getting
Although T&A was
engaged
value
ABCaround,
as of November
30, Lincare
1993, they
never did. In
nervous. They thought they were going to lose the deal. And we went back
fact, Mr. Jonesto testified
he never
for shot.
the data
as ofYou’re
the valuation
them and that
said, make
– giveasked
it one best
Go ahead.
still way date,
off the mark. We never told them what the other offers were. We just said,
November 30, 1993.
data
a valuation
thereallis the
no excuse
you’re While
way offappraisers
the mark. use
With
thenear
suggestion
that date,
they keep
employees
in thethat
billing
center
and take
the leases
property
and
not to at least ask
for the data
would
impact
theall
report.
T&Aon
didthe
not
request
sufficient
it did. I mean, I had really nothing to – well, I guess it had a lot to do with
relevant data tome.
allow
them to
I pushed
it. perform their assignment properly.
Q.
You persuaded Lincare?
A.
I held their
to the fire because
theyused
thought
they werethe
going
to lose Most
T&A makes reference
to hand
the information
that they
to perform
valuation.
this deal in their own backyard and it would look very, very bad for a public
business valuation
treatises
have document checklists that can be used to assist in the
company
to do that.
gathering
theSmith’s
required
information
perform
proper valuation.
Practitioners
It is clearofMr.
advisors
thoughttothis
was a atremendous
deal, andIn itthe
exceeded
their
expectations.
The offer
was Guide
not rejected
by Mr. Smith
becauseThird
of theEdition,
price. According
to Mr.
Publishing
Company
(PPC)
to Business
Valuations,
May 1993,
the
Nagel, the offer was rejected by Mr. Smith because most of SRS’ employees would be fired, and
he would
not have a tenant for two of his properties. It was Mr. Nagel who obtained the higher
authors
state:
offer from Lincare, along with the accommodation of Mr. Smith’s concerns. He did this by letting
Lincare “sit out on a fence” and by telling Lincare that they were “way off the mark,” even though
it was by far the best offer he had received for SRS. What allowed Mr. Nagel to do this was a non115.14 Collect Data Appropriate for the Valuation Methods Used. In
financial concern on the part of Lincare, namely that the deal was in Lincare’s “own backyard” and
order to establish a value for a company, a consultant must generally gather
losing it would be embarrassing to Lincare. From Mr. Nagel’s statements, it appears that Mr. Smith
great
deal ofthe
information
about
its industry,
the economy
in and
wouldahave
accepted
$13.5 million
dollarthe
offercompany,
if his two conditions
regarding
his employees
which
the
company
operates,
and
other
comparative
companies.
In
order
tenancy had been met.
to be useful, the information must be timely, accurate, and comparable to
In fact,
the dialogue
comesagainst
back towhich
this issue:
similar
companies
comparisons will be made. This information
is usually gathered during the early stages of field work.
Q.
All right. Did Mr. Smith ever tell you what changed his mind regarding
deciding
to sell
his business?
He kept
turningwill
youvary
down
andengagement
later he115.15 The
specific
types
of information
needed
from
to engagement and are primarily based on the valuation methods that are
appropriate for a particular project. The data gathering process usually
- -3131 involves
an key
analysis
of that
historical
information,
interviews
with
A.
The
issue was
as soonfinancial
as we locked
the employees
in place and
companynomanagement,
extensive
research
comparative
companies,
one was to be and
terminated
is when
he saidonthat’s
worth all the
money in
theand
world
to me and
that’sand
exactly
whatprice
he said,
it’s Financial
worth all the
money in
economic
industry
trends,
market
data.
information
the be
world,
these people
having a before
job.
must often
adjusted
and analyzed
it can be used in the valuation
process. Comprehensive data gathering checklists and questionnaires are
Again,presented
according in
to Mr.
Mr.Aids
Smith’s
issues in
were
not related
to price,
but other non-price
the Nagel,
Practice
sections
Volume
2 of the
Guide.
factors.
Nagel further
explains the
of Lincare
by stating:
InMr.
addition
to collecting
the actions
appropriate
data,
the authors of the Guide to Business
Valuations
advise buying
the reader
to: Earnings drive the price of their stock. Ben had
A. also They’re
earnings.
a lot of earnings for the size of business that he had. And whether they
paid 15 million dollars or 12 million dollars or 13 million dollars, at that time
it didn’t matter.
They got
rid of a competitor
and they got the
best – andA
115.19 Document
All Work
Performed
and Conclusions
Reached.
theyshould
got people
there that
that are betterfor
thaneach
any people
that
consultant
prepare
a they
set don’t
of –workpapers
valuation
they have, so they took everything into – I’d like to say we had a lot to do
engagement.
The workpapers should include not only the completed work
with getting 15 million dollars for this company.
programs, but also all data, calculations, and key assumptions made by the
engagement
team,
as wellthat
as Lincare’s
all conclusions
reached.
This further
highlights
his beliefs
motivation
was beyond financial, and that Mr.
Smith’s reasons for rejecting the first Lincare offer were unrelated to the purchase price.
This
was the
only
Mr. Jones
that hevalue
had for
in T&A’s
Mr.publication
Nagel’s comments
raise
thetreatise
issue ofthat
whether
Lincarewas
paidsure
fair market
SRS, orlibrary
paid
fair the
market
value for
synergistic
and In
public
reasons.
discussed
earlier in from
this
atabove
the time
valuation
was
performed.
fact,image
Mr. Jones
usedAsthe
report checklist
report, fair market value is established between a willing buyer and willing seller, neither party being
this
publication,
butand
noboth
others.
We
will discuss
the report
checklist
report.
under
compulsion
having
reasonable
knowledge
of the
relevant later
facts.inItthis
appears
from
the comments of Mr. Nagel that he believed that Lincare was under compulsion, and that he could
exploit that compulsion to the advantage of Ben Smith.
TA 161
This brings about the possibility of a buyer’s premium. A buyer’s premium is concerned with
elements of investment value. According to Pratt, investment value is defined
The narrative
is aapproximately
11 pages
beginning
TA 161. Besides
the fact that
..... asreport
value to
particular investor
based on
individualatinvestment
requirements,
as distinguished
the concept
of is
market
value, which
is impersonal
and report
there is little
substance infrom
the narrative,
there
no connection
between
the narrative
detached.
and the schedules that are attached to it.
The report lacks explanation, analysis,
As Pratt states, investment value is different for different buyers. There are many factors that can
references
and almost
else that
would capacity,
permit the
reader oftorisk,
gain
proper
influence investment
valueanything
such as estimates
of earning
perceptions
tax astatutes,
and synergies.
understanding of the basis for the appraiser’s valuation. Furthermore, there is a lack of
Stated differently,
investment value
of aexplanations,
closely-held company
is the
value this
to a particular
buyer,
discussion
of keytheassumptions
and
and as
such,
report cannot
as compared to the population of willing buyers, as is the case in fair market value. This value
replicated.
The narrative
alsowhen
is contradictory
throughout,
which
will be pointed
we
definition would
be applicable,
an investor might
have specific
investment
criteria out
that as
must
be fulfilled in an acquisition.
proceed.
An appraiser will frequently use this standard of value when he or she represents a buyer who
wants to know, “How much is the business worth to me?” The fact that the buyer is specific about
The
paragraph
onhim
thisorpage
is incorrect.
The valuation
was done
as ofas
November
thefirst
business
value to
her changes
the standard
of value that
to investment
value,
opposed
to fair market value, which may be the value to everyone else.
30, 1993, was to assist management in determining, as part of the implementation of an
- -3232 ESOP,
ABC of
and
the ESOP
should
consummate
transactions
with Mr. Morris
Underhow
suchmuch
a definition
investment
value,
certain
elements can
be quantifiedfor
numerically
in an
income stream, and differences between fair market value and investment value can be calculated.
and
for newly issued shares. T&A states:
Others, like Lincare’s desire not to let other major competitors into its “backyard” cannot be
calculated from an income stream. Typical market data does not allow us to calculate such a
premium.
The purpose of this study was to arrive at a value to be used by the ESOP
trustees
for the
ABC
Company,
Inc. Employee
However,
one study
has establishment
provided us with of
an the
insight
into Jail
this type
of a premium
by comparing the
multiples
of earnings
before
interest
and taximmediately
(“EBIT”) paid following
by financialthe
buyers
and strategic
buyers.
Stock
Ownership
Plan,
whereby
acquisition
of the
The study
consisted
of
a
poll
of
35
professional
investment
bankers,
lenders,
and
the
managing
stock, the ESOP would own more than a fifty percent interest of all
partners
of buyout firms,
and covered
outstanding
corporate
stock. the manufacturing, retail, communications, services, and
healthcare industries, in particular.
As discussed above, hard data is difficult to obtain for such a survey. Accordingly, the study is
basedthe
on the
respondents
industry based
on theiritexperiences
in both
deals
Since
ESOP
did not “feel
existfor
atthe
November
30, 1993,
would have
beenproprietary
more accurate
and auction settings. At times, their answers were categorized as a broad interpretation of the
todiversity
state that
the apurpose
the 12
valuation
to assistobtained
the ESOP
trustees,
the 1993,
ESOP
within
sector.” of
Table
presentswas
the multiples
by the
survey once
for 1989,
and 1995, and calculates the premium that strategic buyers are paying over financial buyers.
was formed, in establishing the adequate consideration that must be paid by the ABC
ESOP for the shares in ABC as of the transaction
TABLE 12date. It should also have stated that this
TRENDS IN ACQUISITION MULTIPLES
report may have to be updated
to get closer to the actual transaction date.
1989
1993
1995
BuyersT&A references Revenue
7.76
6.11
At the bottomStrategic
of this page,
Ruling
59-60 and7.24
indicates that this
Financial
7.41
5.40 (not all6.50
Revenue Ruling
“setsBuyers
forth in some detail the
following factors
inclusive), which
generally arePremium
believed to be fundamental 4.72%
enough to 13.15%
the valuation11.38%
of a closely held
Source:
Lea
February
20,report
1995, p.1
corporate stock
thatJennifer
analysis
ofReed,
eachBuyouts,
is required.”
The
then proceeds to list ten
factors.
these
ten
dothe
notpremium
all come
59-60.
In Mr.
As can However,
be seen in the
data
in factors
Table 12,
for from
1995 Revenue
was 11.38Ruling
percent.
To apply
a
buyer’s premium to the sale of SRS, the premium is applied to Lincare’s initial offer of $13.5 million.
Jones’
deposition,
asked the
24, to
2004,
beginning
at page
82,
The justification
for he
thiswas
is two-fold.
First,following
Lincare’s (January
offer appears
already
have included
some
elements
line
14): of investment value, as it was significantly greater than the other offers for SRS. Second,
Mr. Smith’s reasons for not accepting the offer were unrelated to the purchase price, but rather
were related to the non-financial terms of the agreement.
Q. applied
Andthis
you’ve
got ten
items attributed
to Revenue
59-60, correct?
We have
premium
to Lincare’s
$13.5 million
offer to testRuling
to our hypothesis.
The results
are presented in Table 13.
A.
There’s ten items listed there, yes.
Q.
And my question is, whereTABLE
do you13get this ninth and tenth item if it's
not in Revenue
Ruling 59-60?
APPLICATION
OF A BUYER’S PREMIUM
A.
Initial
Lincare from other materials that we consider
$ 13,500,000
Well,Offer
fromFrom
-- probably
when we
evaluate
company
are
relevant
Times
One a
Plus
Strategicbecause
PremiumI think those are -- these
x
1.1138
facts. 59-60 is -- Revenue Ruling 59-60 is a guideline stipulated by
Price
with Buyers Premium
the IRS.
$ 15,036,300
- -3333 Q.
I agree.
I'm Price
just asking you where you got these other
two points,
Final
Purchase
$ 15,035,000
item 9 and 10, since it's not in Revenue Ruling 59-60. Can you tell
Difference
$ items?
1,300
me what authoritative source you used for those two
This strongly
supports
theofassertion
thatI'm
Lincare
a strategic
buyer
in its acquisition
of SRS,
A.
Off
the top
my head,
not --was
I don't
recall an
authoritative
source
and the assertions made by Mr. Nagel in his deposition. To verify this against other known data,
such as an IRS Revenue Ruling.
we relied on the deposition of Mr. Deutsch, Lincare’s national acquisition program manager. Mr.
Deutsch indicated that Lincare’s acquisitions typically occur at 3.5 to 4.0 times free cash flow for
Q. 12Well,
giveBased
me any
authoritative
source
--.cash flow for the trailing 12 months of
the trailing
months.
on Lincare’s
estimate
of free
$3.5 million, the price to free cash flow multiple paid for SRS using a value of $13,500,000 was
A.
Well, the
3.86 ($13,500,000
÷ $ --.
3,500,000 = 3.8571 or 3.86 rounded). Based on this data and the
information presented in Mr. Nagel’s deposition, we conclude that the fair market value of the
operating
of Smith
Q. business
Doesn’t
have Respiratory
to be IRS. Services was $13,500,000 at March 9, 1995, based on
the actual market transaction that was consummated.
A.
-- the judgment of the -- the valuator when performing a valuation
In order to test the conclusion reached in the market approach, we then applied an income
analysis.
approach methodology in our analysis. To implement the income approach, we have selected the
discounted future benefits method.
Once again, despite Mr. Jones’ claim of having substantial experience, he was unfamiliar
The discounted future benefits method is one of the most theoretically correct methods of
appraisal.
It isRuling
premised
on the
concept
that value is ruling
based in
onthe
the profession.
present valueItof
with Revenue
59-60,
which
is a cornerstone
is all
thefuture
most
benefits that flow to an owner of a property. These future benefits can consist of current income
widely
cited revenue
ruling
byproperty,
business
possibly
the most
cited
distributions,
appreciation
in the
or aappraisers,
combination and
of both.
The formula
for thewidely
discounted
future benefits
method isvaluation.
as follows: What makes these responses even worse is that Mr.
document
in business
Jones did not know where hen=ttook the ninth and tenth factors from. To give the response
En
+
TVt
that it was the judgement n=1
of the(1valuator,
further
+ i)n
(1 + i)t supports the lack of professional
competence
applied in this assignment. The deposition was approximately 11 years later,
Where
E did not
= know,
Forecasted
stream.
and he still
without benefit
additional
prompting in subsequent questions, that these
n
=
Year in which the benefit stream is achieved.
TV
=
Terminal value, which is the estimated value of the benefit stream after the
i
=
Required
ratethe
of Department
return.
two additional
factors
came from
of Labor Regulations relating to ESOPs.
T&A held itself out as forecast
having substantial
experience in ESOP valuations. Throughout Mr.
period.
t
=
of stabilization.
Jones’ deposition,
heYear
kept
referring to the subjective judgment of the appraiser to
The formula appears
muchofmore
complicated than
it is. In essence,
thisappraisal
valuation method
requires
compensate
for his lack
documentation
or knowledge
of the
literature.
This
a forecast to be made of future benefits, going out far enough into the future until an assumed
was
one more
instance
where
thisbeing
took appraised.
place.
stabilization
occurs
for the
property
In this instance, the benefit stream being
discounted is cash flow.
In 163
order to apply this methodology, we began the analysis with a forecast of expected future
TA
operating cash flows for SRS. Table 14 presents the forecasted income statement for SRS for the
years ended March 9, 1996 through 2000.
At the top of this page, the T&A report states:
- -3434 -34TABLE
14
We have relied heavily in our valuation
known operating results and the
TABLE upon
14
FORECASTED
INCOME
STATEMENT
AND
CASH
FLOW
FORECASTED
STATEMENT
AND
CASHAdditionally,
FLOW
financial condition
of ABCINCOME
for the prior
five fiscal
years.
we have
FOR
THE
YEARS
ENDED
MARCH
9,
FOR
THE
YEARS
ENDED
MARCH
9,
analyzed projections as prepared by management for future years. We
1996
1997
1998
1999
believe that this is the most
of valuing
the stock 2000
of a
1996satisfactory
1997 method
1998
1999
2000
closely
held corporation such as ABC.
1
Net
Net Sales
Sales1
2
Less:
Less: Cost
Cost of
of Sales
Sales2
$
$ 6,500,000
6,500,000
916,500
916,500
$
$ 7,345,000
7,345,000
1,035,645
1,035,645
$
$ 8,299,850
8,299,850
1,170,279
1,170,279
$
$ 9,378,830
9,378,830
1,322,415
1,322,415
$
$ 10,504,290
10,504,290
1,481,105
1,481,105
2,723,500
3,077,555
3,477,637
3,929,730
4,401,297
Equals: Net Operating Income
$
$ 2,860,000
2,860,000
1,144,000
1,144,000
$
$ 3,231,800
3,231,800
1,292,720
1,292,720
$
$ 3,651,934
3,651,934 $
$ 4,126,685
4,126,685
1,460,774
1,650,674
1,460,774
1,650,674
$
$ 4,621,888
4,621,888
1,848,755
1,848,755
NET
NET INCOME
INCOME
$
$ 1,716,000
1,716,000
$
$ 1,939,080
1,939,080
$
$ 2,191,160
2,191,160
$
$ 2,773,133
2,773,133
However,
T&AProfit
ultimately used $$valuation
methods
in $its7,129,571
final analysis
that are
inconsistent
Equals:
5,583,500
$
Equals: Gross
Gross Profit
5,583,500 $
$ 6,309,355
6,309,355 $
7,129,571 $
$ 8,056,415
8,056,415
$ 9,023,185
9,023,185
Less: Operating Expenses33
Expenses
3,477,637
3,929,730
4,401,297
withLess:
thisOperating
statement.
This will be2,723,500
pointed out3,077,555
as we review
the schedules
at the
back of its
Equals: Net 4Operating Income
report.
Less: Taxes
Taxes4
Less:
$
$ 2,476,011
2,476,011
Beginning
on thisforpage,
the12T&A
report
begins
to on
address
thepro10
items
fromin this
Revenue
1.
Revenues
the trailing
months
in 1995
are based
the Lincare
forma
included
report
1.
Revenues for the trailing 12 months in 1995 are based on the Lincare pro forma included in this report
as
2.
Revenues
are
thereafter
to
compound
annual
growth
for
as Exhibit
Exhibit
2.the
Revenues
are grown
grown
thereafter
to generate
generate a
a
compound
annual
growth rate
rate
for the
the
Ruling 59-60
and
Department
of Labor
Regulations.
Each
of
these
sections
is woefully
entire
forecast
period
of
12.7
percent.
This
is
the
approximate
rate
of
growth
projected
for
entire forecast period of 12.7 percent. This is the approximate rate of growth projected for the
the
industry,
as
discussed.
industry,
as previously
previouslyits
discussed.
inadequate
to accomplish
intended purpose. In the History and Nature of the Business
2.
Cost
forecasted
as
percent
for
year
in
period.
This
is
2.
Cost of
ofissales
sales
islittle
forecasted
as 14.1
14.1 to
percent
ofasales
sales
for each
each
yearunderstand
in the
the forecast
forecastthe
period.
Thisand
is
section
there
veryis
information
allowof
reader
to truly
history
based
based on
on the
the historical
historical average
average for
for the
the period
period analyzed.
analyzed.
nature of ABC. In fact, this entire narrative section only takes up one half of one page.
3.
3.
The
The historic
historic average
average operating
operating expenses
expenses for
for the
the period
period ended
ended May
May 30,
30, 1991
1991 through
through May
May 30,
30, 1994
1994
and
latest
months
ended
31,
was
45.1
sales.
For
items such
as the
form ofof
entity,
the1994,
state
The valuation
omits
important
and the
the report
latest twelve
twelve
months
ended December
December
31, 1994
1994
waslegal
45.1 percent
percent
of the
sales.
For fiscal
fiscal
1994,
operating
operating expenses
expenses were
were 41.9
41.9 percent
percent of
of sales,
sales, which
which we
we used
used in
in each
each year
year of
of the
the forecast
forecast period.
period.
of incorporation,
information
about
company
management,
competition,
information
about
The
fiscal
figure
was
over
based
downward
in
The most
most recent
recent
fiscal year’s
year’s
figure
was selected
selected
over the
the average,
average,
based on
on the
the
downward trend
trend
in
operating expenses as a percentage of sales during the historic period analyzed.
operating expenses as a percentage of sales during the historic period analyzed.
key employees,
sensitivity to seasonal or cyclical factors, and strengths and weaknesses.
4.
4.
have assumed
assumed a
a combined
combined federal
federal and
and state
state tax
tax rate
rate of
of 40
40 percent.
percent.
We
We have
Using the
the forecasted
forecasted income
income statements
statements presented
presented in
in Table
Table 14,
14, combined
combined with
with an
an analysis
analysis of
of the
the balance
balance
Using
The
small
amount of
information
that
is included
in the
report
includes
the ownership
of the
sheet of SRS, we have prepared a forecast of the net cash flow for the years ended March 9, 1996 through
sheet of SRS, we have prepared a forecast of the net cash flow for the years ended March 9, 1996 through
2000. This
This appears
appears
in Table
Table
15.
2000.
in
15.
corporation
including
the proposed
transaction, which as of November 30, 1993 should not
TABLE
15
be considered in the valuation of ABC. The
process
TABLE
15 of valuing ABC was to determine what
FORECASTED
FORECASTED NET
NET CASH
CASH FLOW
FLOW
FOR
ENDED
MARCH
the value should be for a transaction.
Including
information
FOR THE
THE YEARS
YEARS
ENDED
MARCH 9,
9,about the transaction makes
this valuation hypothetical. Hypothetical
valuations
are defined
as those
that are
contrary
1996
1997
1998
1999
2000
1996
1997
1998
1999
2000
to fact.
nothing
Labor Regulations
permits
hypothetical
Net There
Income is
(Table
14) in the Department
$ 1,716,000 of
$ 1,939,080
$ 2,191,160 $that
2,476,011
$ 2,773,133
Net Income (Table1 14)
Add: Depreciation1
$ 1,716,000 $ 1,939,080 $ 2,191,160 $ 2,476,011 $ 2,773,133
548,422
743,589
964,128 1,213,337 1,492,451
Add: Depreciation
548,422ESOP
743,589
964,128
1,213,337
1,492,451
appraisals
to be performed for an
actual
transaction.
This
is one more
instance
Gross
$2,264,422
$2,682,669
$3,155,288
$3,689,348
$4,265,584
Gross Cash
Cash Flow
Flow
$2,264,422
$2,682,669
$3,155,288
$3,689,348
$4,265,584
2
2
Less:
Capital
Expenditures
1,209,000
1,366,170
1,543,772
Less:
Capital
Expenditures
1,209,000Either
1,366,170
1,543,772
1,744,462
1,953,798
where
T&A
mixes
up its assignments.
this report
is for1,744,462
planning 1,953,798
purposes to
Less:
Less: Increase
Increase in
in Net
Net
Working
Capital
66,839
75,529
demonstrate
what would happen after43,506
the ESOP59,150
transaction
takes place,
or it is a78,782
valuation
Working Capital
43,506
59,150
66,839
75,529
78,782
NET
CASH
FLOW
1,011,916
$
$
$
$
of ABC
the purpose of $$meeting
adequate
consideration
requirements
NETstock
CASHfor
FLOW
1,011,916the
$ 1,257,349
1,257,349
$ 1,544,677
1,544,677
$ 1,869,357
1,869,357
$ 2,233,004
2,233,004in an
1.
Depreciation
based
on
factors:
First,
fixed
actual
transaction.
same
be used the
forexisting
both purposes.
1.
Depreciation is
isThe
based
on two
tworeport
factors:cannot
First, depreciating
depreciating
the
existing
fixed assets
assets as
as of
of February
February 28,
28,
1995
1995 of
of $1,878,538
$1,878,538 over
over a
a remaining
remaining useful
useful life
life of
of five
five years,
years, and
and second,
second, depreciating
depreciating future
future fixed
fixed
asset
additions
over
a
useful
life
of
seven
years.
asset additions over a useful life of seven years.
-35-- 35
Not
should
the history
nature
the
business
section
theonreport
the
2. onlyCapital
expenditures
areand
calculated
as of
18.6
percent
of sales.
This is of
based
capitalprovide
expenditures
as a percentage of sales in fiscal 1994. The calculation is as follows:
reader with an explanation of information about the company, but some of the items
Net Fixed
Assets
at May
31, 1995 be used by the appraiser$ to
1,771,669
discussed in this
section
should
ultimately
support some of the
Less: Net Fixed
at May
1994valuation process.
subjective judgment
that Assets
enters
into31,the
(For
1,214,949)
example,
in the
1994
Depreciation
developmentPlus:
of the
discount
rate,Expense
the lack of depth of management, or375,715
having inadequate
Fixed be
Asset
$ 932,435
management,1994
would
a Additions
risk factor that should be considered.
Since there is no
by 1994 Sales
$ 5,018,896
information inDivided
this section
to discuss the strengths and weaknesses
of management, it
1994 Fixed
as a Percent
Sales any adjustment to a discount
18.6%rate relating
would be impossible
forAssets
the appraiser
toofsupport
Our review
prior
capital
expenditures
15.9 percent
and 19.3topercent,
for 1992 and
to this item.
Laterofin
theyears’
report,
T&A
assignsrevealed
a significant
risk factor
the continuity
of
1993, respectively.
We felt that the 1994 capital expenditures was reasonable under the
management,
which is totally unsupported.
circumstances.
3.
The increase in working capital is based on the median for medical equipment rental and leasing
companies with three to five million dollars in sales, which was 7 percent.
Revenue Ruling 59-60 in Section 4, Paragraph .02 states the following:
Therefore, we have used this figure times the increase in sales to estimate increases in working
capital for each year in the projection period.
The history of a corporate enterprise will show its past stability or instability,
Once the cash flow has been forecast, the selection of a proper discount rate becomes necessary. Since the
its growth or lack of growth, the diversity or lack of diversity of its operations,
benefit stream being estimated will not occur until some time in the future, the future benefits must be
and other
needed
an opinion
of therate
degree
ofpercent
risk involved
discounted
to theirfacts
present
value. to
In form
this instance,
a discount
of 19.2
has beenindeemed
the (see
business.
For
enterprise
which changed
its form
of organization
applicable
section of
thisan
report
entitled "Discount
and Capitalization
Rates").
This results but
in the value
estimate
of SRSon
being
as closely
follows: similar operations of its predecessor, the
carried
thecalculated
same or
history of the former enterprise should be considered. The detail to be
Forecasted
x approach
19.2% Present
=
Present
Value
considered should
increase with
to the required
date
of appraisal,
Year
Cash
Flow
Value
Factors
Future
Cash
since recent events are of greatest help in predicting the future; but aFlow
study
of gross
and
net
income,
and
of
dividends
covering
a
long
prior
period,
1996
$ 1,011,916
0.8389
$
848,896 is
highly desirable. The history to be studied should include, but need not be
1997
1,257,349
0.7038
884,922
limited
to, the nature
of the business,
its products or services,
its
operating
and investment
sales
1998
1,544,677 assets, capital
0.5904 structure, plant facilities,
911,977
records and management, all of which should be considered as of the
1999
1,869,357
0.4953
925,893
date of the appraisal, with due regard for recent significant changes.
2000 of the past
2,233,004
0.4155
Events
that are unlikely
to recur in the future 927,813
should be
discounted,
since21,636,450
value has a close relation
(Emphasis
TV
0.4155to future expectancy.
8,989,945
added).
TOTAL
$ 13,489,446
TA
164
The
terminal value (TV) is calculated as follows:
Terminal Cash Flow
Discount Rate - Growth (.192 - .06)
= $ 2,856,011
=
.132 and Industry Outlook.
The next section addressed in the T&A report is the Economic
Once
Capitalizing $ 2,856,011 @ 13.2%
= $ 21,636,450
again, this section
lacks substance. Furthermore,
it is irrelevant to ABC. There are three
paragraphs regarding the economy dealing with slow economic growth, deficit reduction
- -3636 and
health
carethelegislation.
is alsobyno
mention
about
andincome
business
In this
instance,
terminal valueThere
is determined
growing
the last
year'sconsumer
forecasted net
by a
stabilized growth rate. Net income is then converted to cash flow as follows:
confidence and speculation about interest rates, but none of this is discussed with respect
to ABC or usersTerminal
of its services.
Value Net Income
$ 2,939,521
Plus: Depreciation1
2,000,000
1
Capitalof
Expenditures
2,000,000
The industry dataLess:
consists
two paragraphs,
but also lacks sufficient
information to assist
2
Less: Increaseainprospective
Working Capital
an appraiser in determining
growth rate or industry risk.83,509
Here also, by taking
TERMINAL
VALUE CASH
FLOW
2,856,011
a shortcut approach
to performing
the valuation,
T&A missed the$intent
of Revenue Ruling
59-60,
when
it states
Section
4, Paragraph
.02: in the terminal year.
1.
Depreciation
andincapital
expenditures
are set equal
2.
The increase in working capital is calculated as the increase in 2000, times one plus the long-term
growth rate of 6 percent.
A sound
of a closely
held stock
must
consider
current
The benefit
streamappraisal
used in the calculation
of the terminal
value is
the stabilized
benefit
stream and
expected to
prospective
economic
conditions
asstabilized
of the date
appraisal,
both
the
be achieved
by SRS after
the forecast
period. The
streamof
is then
capitalized,
andindiscounted
to
its present
value economy
at the appraisal
(Discount
rates,
capitalization
rates
and a the
discussion
of growth rates
national
anddate.
in the
industry
or industries
with
which
corporation
can beisfound
in the
report
section entitled
"Discount
andcompany
Capitalization
Rates").
allied.
It is
important
to know
that the
is more
or less successful
than its competitors in the same industry, or that it is maintaining a stable
Adding the terminal value to the present value of the anticipated interim benefit stream results in the present
position
with
respect
to competitors.
Equal
or even greater
value of
the future
benefits
of SRS
to be $13,496,690,
or $13,500,000
rounded.significance may
attach to the ability of the industry with which the company is allied to
Another
reasonableness
check
was performed
based on competition
the deposition which
transcript
of not
Howard
Deutsch,
compete
with other
industries.
Prospective
has
been
Executive
Vice President
and General
Counsel
of Lincare.
he states in
hisexample,
deposition, high
Mr. Deutsch
a factor
in prior years
should
be given
carefulAs
attention.
For
managed "the acquisition function for the company nationwide." The following excerpt from his deposition
profits
dueoftohow
theLincare
novelty
of its product
and the lack
of competition
often lead
gives an
overview
analyzes
potential acquisitions,
including
SRS.
to increasing competition. The public’s appraisal of the future prospects of
Q.
Okay.industries
Could youortell
what criteriawithin
was used
by Lincaremay
for the
of
competitive
ofme
competitors
an industry
be purpose
indicated
establishing
this
$13,500,000
value?
by price trends in the markets for commodities and for securities. The loss
A.
When we value businesses, we typically look at a number of elements, some
of the manager
of a so-called
may have
a depressing
financial related,
others not“one-man”
specifically business
financial related.
We look
at the sales
effect upon
the
value
of
the
stock
of
such
business,
particularly
if there
isata
revenue. We look at the earnings on a historical basis of the business.
We look
the earnings
of what we
believe of
to be
a pro forma basis
acquisition. We
lack of trained
personnel
capable
succeeding
to theafter
management
oflook
the
at
the
geographic
area
that
the
business
serves.
We
look
at
the
product
mix
that
enterprise. In valuing the stock of this type of business, therefore, the effect
business has in terms of its respiratory and nonrespiratory components. We look at
of the loss
of the manager on the future expectancy of the business, and the
the scope of their business in terms of geography and referral sources. Those would
absencebe
ofthe
management-succession
are pertinent factors to be
principal criteria that we look potentialities
at.
taken into consideration. On the other hand, there may be factors which
Q.
is there
rule ofthe
thumb
that
to earnings
for the purpose
of getting
offset,
inWell,
whole
or ina part,
loss
ofyou
theapply
manager’s
services.
For instance,
some preliminary feeling as to what a company would be worth to Lincare in
the nature of the business and of its assets may be such that they will not be
connection with an acquisition?
impaired
the And
lossthose
of criteria
the manger.
Furthermore,
the loss
be
A.
It’sby
flexible.
determine whether
or not our interest
levelmay
is higher
adequately
covered
by valuation
life insurance,
or competent
management
be
or lower
and our
level is higher
or lower with
respect to a might
particular
business.
If
it’s
got
a
better
geographic
situation
for
us,
if
there
are
more
synergies,
employed on the basis of the consideration paid for the former manager’s
a higher or
respiratory
mix, those would
be conditions
would put
the value
services.if it’sThese,
other offsetting
factors,
if foundwhich
to exist,
should
be
at the higher end of the spectrum. If those situations either singularly or in
carefullycombination
weighed against
the
loss
of
the
manager’s
services
in
valuing
the
are less desirable compared to what we’re looking for, then the
stock of business
the enterprise.
– then a particular business is at the lower end of the spectrum.
Mr. Deutsch further describes the process and the interest Lincare had in SRS:
- -3737 During Mr.
deposition,
he was
questioned
about
information
that he says
he learned
A. Jones’
Well,
as I said earlier,
we look
at the financial
performance
both historically
and what
it would be on a go-forward basis. And we then look at other elements to determine,
during his management
interview,
ininterest
particular
the end
company’s
expansion
into
you know, whether
or not our
level is about
at the higher
of the spectrum
or the
lower end
the spectrum.
In thisMr.
particular
case,
because of
the locations
because leader,
projects in Australia
andofEngland.
Since
Jones
described
ABC
as an industry
of the respiratory content, because of the reputation that the company had in the
it was at the
endinofterms
the spectrum.
questions werecommunity
asked regarding
its higher
ranking
of other private prison companies.
To
Thehe
keyresponded
element of this(January
statement is
thePage
reasons
for line
Lincare’s
this,
24,
90,
5): interest in SRS: good locations, high respiratory
therapy content, and good company reputation.
Mr. Deutsch indicates that Mr. Byrnes put together a pro forma income statement based on what he believed
I don’t
recallatus
a ranking
ofmonths
one, two,
three, four.
LincareA.
would expect
to occur
the having
SRS locations
in the 12
after acquisition
by Lincare. Mr. Deutsch
then used this pro forma to derive a value for SRS. Mr. Deutsch describes the valuation:
When heA.was asked
produce
hisisworkpapers
support
therange
management
interview,
The onlytothing
I can tell
that if you lookthat
across
the broad
of acquisitions
we’ve done, that based on a pro forma basis, the cash flow and reconciling that with
his answer washistorical
(January
24, Pageand
90,looking
line 5):
performance,
at it at our operating center level, not at the
A.
Q.
corporate level on a consolidated basis, but at that center level, businesses typically
tend to fall at about the three and a half to four times cash flow basis depending
upon various
and-intangible
higher
and some
Well,
I’m not
I don’tfactors,
havesome
notes
from
that lower.
discussion when
management
said
that described
their -- they
leader,
I think
other
And some of them
you’ve
herewere
earlieratoday.
Andbut
you’ve
alsothe
indicated
information
our file
that
they
arerespiratory
in a leadership
that because contained
of the mix of in
product,
theinfers
particular
area
where
– Smith
Respiratory
was industry.
operating, the reputation of the company, using the higher end of
position
in the
the spectrum to the extent that the rule of thumb has applicability at all would have
been what was – would have been Lincare’s approach in this situation.
A.
I don’tMr.
have
specific
recall
as to whatin
thehis
prodeposition
forma, if any,
was done
for this
Once again,
when
Jones
was
questioned
about
the economic
and
reflected. So I don’t know what the multiple is in this particular case. But based on
of the business
and itswere
size and
its location, Ithat
thinkhe
it’s considered
a fair statement
to overall
industry sectionthe
ofquality
his report,
his answers
generalities
the
say that this is at the very high end of the spectrum.
economy, but not once was he able to get specific. In fact, at one point he answered a
Although Mr. Deutsch did not recall the exact pro forma in his deposition, we have been provided a copy of
question
followsas(January
24,
6): indicated that Lincare expected $6.5 million
it and it isas
presented
Exhibit 2 to
thisPage
report.103,
The line
pro forma
in revenues, earnings before interest, tax depreciation and amortization (“EBITDA”) of $3.75 million, and free
cash flow of $3.5 million. Free cash flow is defined as EBITDA less capital expenditures. Dividing the
purchase price of $15,035,000 by $3,500,000 results in a multiple of price to free cash flow of 4.30. Following
A.
I think one of the factors that was good for the company, again, I
Mr Deutsch’s testimony, if we divide $13,500,000 by free cash flow of $3,500,000, the result is a multiple of
recollection,
-- were
sentencing
guidelines
were
3.86. This is very
much in linewas
with the
rangesome
of 3.5 stricter
to 4.0 times
cash flow testified
to bythat
Mr. Deutsch.
coming into play during this time period. Now, whether or not that’s
This confirms the
reasonableness
of establishing
fair market
value of
the operating
assets
of SRS
relating
to the economy
in the
general,
I can’t
speak,
but I’m
sure
thatat $13.5
million.
there is obviously some studies out there how the economy effects
crime.
VALUATION OF THE TANGIBLE ASSETS
The next
in our
analysis
to value
tangiblestudies,
assets ofdo
SRS
to on
be how
used the
in the
allocation of the
Q. step But
you
don’t ishave
anythe
of those
you,
economy
purchase price.effects
As previously
discussed,
Lincare
and
SRS
negotiated
a
transaction
that
included an
crime in your workpapers, do you?
allocation of the price to different classes of assets. In this instance, we are accepting the allocation of the
tangible assets as being reasonable. This results in the tangible assets being valued as follows:
A.
Not in my workpapers, no.
Accounts receivable
$
550,000
Once again, Mr. Jones attempts
to make up for the fact that40,000
his workpapers were deficient
Inventory
and that the T&A report does not address pertinent data that should have been included
- -3838 therein. When he was asked
and deficit reduction would
Fixedwhether
assets health care legislation
712,000
be positive or negative factors for ABC’s valuation he responded (January 24, Page 105,
Total
line 1):
$ 1,302,000
VALUATION OF THE IDENTIFIABLE INTANGIBLE ASSETS
Before undertaking the valuation of the identifiable intangible assets, a short discussion about intangible
Generally speaking, I would say that those factors in itself would not
assetsA.
is in order.
necessarily a large impact one way or the other.
INTANGIBLE ASSETS: Assets can take one of two basic forms, tangible and intangible. Tangible assets are
easily identified because they can be seen and touched. They can take the form of money, or assets
in monetary
terms,
such as accounts
Tangible
assets can
alsoas
be Concepts,
fixed assets, such
Indenominated
a discussion
of industry
players,
the T&Areceivable.
report lists
companies
such
Inc.,
as land, buildings, vehicles, or computers. Many times tangible assets are needed to obtain the value of an
Esmor,
Inc.,
Wackenhut
Corporation
and value
Prison
Ltd. Despite
intangible
asset.
For example, aCorrections
delivery business
that has intangible
fromSystems,
its name or trademark
needs
vehicles to make deliveries.
mentioning these competitors, T&A used no information from these companies’ public
Accounting theory defines intangible assets as “assets that do not have physical substance, that grant rights
filings
or annual reports to support its opinions throughout the report. Mr. Jones was
and privileges to a business owner, and that are inseparable from the business enterprise.” Theory defines
intangible assets
as this
having
future
benefits whose
determination
and timing
are difficult
determine.
questioned
about
and
responded
as follows
(January
24, Page
128,toline
11): One
notable treatise on the subject defines intangible assets as “all the elements of a business enterprise that
exist in addition to monetary and tangible assets.” In essence, an intangible asset is an asset that cannot be
seen or touched, gives the business owner rights and privileges, cannot be separated from the business
enterprise,
exists inWhat
addition
the tangible and
monetary
assets
of a business.
Q. andOkay.
I'mtowondering
about
is where
in your
work papers, if any,
do you analyze these companies in the same industry that you've just
According to Pratt, for an intangible asset to exist in an economic sense, it needs to have certain
characteristics:named to analyze their growth rates, their strengths and weaknesses
1.
2.
3.
A.
4.
Q.5.
6.
Q.
of one company versus another in terms of you developing your
It must be of
subject
to specificvalue
identification
and recognizable
valuation
fair market
of ABC?
Did you dodescription.
that?
It must be subject to legal existence and protection.
It must be subject to the right of private ownership, and this private ownership must
Well,
we -- we thought about it, considered it and decided that that
be legally transferable.
was
not
thebebest
to useorin
valuing the
business.
There
must
someapproach
tangible evidence
manifestation
of the
intangible asset (e.g.
a contract or a license or a registration document).
It must Ihave
been created
or answer,
have comebut
intothat
existence
an identifiable
time or as
Okay.
appreciate
your
reallyat wasn't
my question?
a result of an identifiable event.
It must be subject to being destroyed or to a termination of existence at an
Where
in your
work
papers,
any,
do youevent.
analyze these companies
identifiable
time or
as the
result ofifan
identifiable
in the same industry that you've just named to analyze their growth
In addition, Pratt
lists three
criteria
that an intangible
asset must have
order company
to have value:
strengths
and weaknesses
of inone
versus
rates,
their
1.
A.2.
3.
another in developing your valuation of the fair market value of ABC?
It must generate some measurable amount of economic benefit to the owner; this
economic benefit could be in the form of an income increment or cost decrement.
I don't
know that
there's
documentation
our work
papers
thatnet-This economic
benefit
mayany
be measured
in any ofinseveral
ways,
including
income
or net cash
etc. although we thought about it and discussed
that
specifically
goflow,
to that,
mustmanagement
enhance the value
of other
assets with which it is associated, the other
it Itwith
team,
et cetera.
assets may include tangible personal property and tangible real estate.
The distinction
to beonly
drawndid
fromT&A
these ignore
two sets the
of criteria
legal existence
the economic
Once
again, not
mainis between
industrytheplayers,
whichandwould
be an
value of an intangible asset. This is to say that an asset may have a legal existence and may be of no value
to
its owners.
example
wouldinbe
a copyrighted
that is claims
never used.
the trademark
essential
part An
of the
analysis
valuing
ABC, trademark
but Mr. Jones
that Although
this information
was
legally exists, it does not have economic value.
considered, but there was no documentation in the workpapers. The workpapers did not
contain any level of documentation to meet the sufficient relevant data standard. Once
- -3939 again,
Mr.assets
Jones
relying
ondifferent
his statement
of have
discussing
it with management
as
Intangible
canis
take
on many
forms and can
unique properties.
As Pratt points out,
intangible assets have been categorized into several discrete categories to allow for easy identification. He
justification
not using
this information.
presents thefor
following
categorization
of intangibleWhile
assets:there is no doubt that an appraiser will ask
management
questions,
it is up to the appraiser to perform his or her own analysis, and
1.
Technology-related (e.g., engineering drawings).
2.
Customer-related
(e.g.,
customer
lists).
where necessary,
due diligence
to test
the information
that management is providing. That
3.
Contract-related (e.g., favorable supplies contracts).
4.
processing
(e.g., computer
software).is hired.
is one of many Data
reasons
why related
an independent
appraiser
5.
Human capital-related (e.g., trained and assembled workforce).
6.
Marketing-related (e.g., leasehold interests).
7.
Location-related (e.g., leasehold improvements).
The T&A8.reportGoodwill-related
contained too
little
information
about the economy
(e.g.,
going
concern value).
and industry, and the
little
bit of information
that was
included
in the report
was
irrelevant
to the are
valuation
ABC.
Intellectual
property is another
classification
of intangible
assets.
Intellectual
properties
intangibleofassets
“created by human intellectual and/or inspirational activity”. These assets are set apart from other intangible
assets by their special legal recognition and protection.
TA
165
Pratt
classifies intellectual properties as either creative or innovative. Creative intellectual property can be
protected by copyrighting the property, while innovative property can be protected through patents. The
special rights given to intellectual properties are given through the protection of copyright and patent laws.
The
valuation
properties
carried
out under
similar methods
as those
used and
in valuing
other
On
this
pageofofintellectual
the T&A
report,isan
attempt
to discuss
the Book
Value
Financial
types of intangible assets.
Condition of ABC takes place. T&A indicates which balance sheets it used in its analysis
INTANGIBLE ASSET VALUATION APPROACHES: The approaches to the valuation of intangible assets
are states:
similar to the approaches used to value a business enterprise: market, asset based, and income. Each
and
of these approaches is discussed briefly below.
THE MARKET APPROACH: The market approach, also referred to as the sales comparison approach,
valueand
isidentifying
generally
defined
as assets
the total
net
value
of thethat
Corporation’s
entailsBook
researching
similar
intangible
to the
subject
intangible
have been transacted
assets
on
a
(sic)
historical
cost
basis
of
accounting,
less
total
liabilities.
in the marketplace. These transactions are then used as guidelines in developing the value ofThe
the subject
asset.
intangible
Corporation’s
book value is indicated in the summary of the valuation
methods, however, this value indication is seldom considered definitive in
THE ASSET BASED APPROACH: The asset based or cost approach attempts to ascertain the value of the
nature.
asset by
determining its cost. Cost typically can have several definitions. The most common definitions of
cost are, reproduction cost, the cost to reproduce an exact copy of the asset; replacement cost, the cost to
purchase an identical asset, or the cost to replace the functionality or utility of the asset; creation cost, the
Despite
this tostatement,
Schedule
XXI allocates
to bookorvalue
as an
a method
original cost
create the asset;
and recreation
cost, whatsome
it wouldweight
cost to recreate,
duplicate
existing
asset. In many circumstances, the definition of cost also includes the concept of obsolescence, or
ofdeterioration
appraisal. inBook
value
is not an appropriate
method.
is merely anofaccounting
concept
value.
Obsolescence
can result from
physicalIt deterioration
the asset, functional
obsolescence, technical obsolescence or economic obsolescence. Although not all intangible assets suffer
that
should not have been used in the valuation of ABC.
from obsolescence, the identification of obsolescence is important to the cost approach.
THE INCOME APPROACH: As in the case of the valuation of the business enterprise, the income approach
for
intangible
asset valuation
theofpresent
theincluded
future benefits
that
will accrue
the owner
When
questioned
why thedetermines
definition
book value
valueofis
in the
report,
andtowhat
T&A
of the asset. This is generally accomplished by either capitalizing a single period income stream or
discounting
a series
income streams,
based on
multi-period
forecast.
to of
express
to the reader
ofathe
valuation,
Mr. Jones responded (January
was
attempting
24,
Page 109, line
16):
IDENTIFIABLE
INTANGIBLE
ASSETS: In this appraisal, several intangible assets could be separately
identified and valued. These assets include the following:
A.
!
Trademark
That there's this
concept
of -- of book value which is not necessarily
!
Patient records
-- and that term!is a lotCovenant
in a lot of
circles, accounting circles, you know,
not-to-compete
investment circles, et cetera, that is not necessarily indicative of being
the fair market value of an entity.
-40- 40 -
Q. otherRight.
Although
intangible assets could be identified as existing in SRS, namely trained employee workforce,
procedure manuals, etc., they could not be separately valued. Therefore, these assets are valued under the
residual
in the next
of thissaying
report. in that paragraph.
A.methodThat's
whatsection
we were
THE INCOME APPROACH: To value the identifiable intangible assets and the goodwill of SRS, we have
used theknowing
income approach.
implement
income approach,
we haveof
used
the residual
flow
Despite
that bookTovalue
is notthenecessarily
indicative
being
the faircash
market
methodology. The residual method allocates the cash flows of the business to its component assets. This
includes
tangible T&A
and identifiable
assets.
This valuation
is accomplished
assets whose
values
value
of both
an entity,
include intangible
this method
in the
and for
assigned
weight
to itarein
known by calculating returns to those assets and subtracting the returns from the forecasted cash flows of
the business.
The cash
flow of a business is the product of combining all of the assets of the business in their
reaching
its final
conclusion.
productive capacities to generate returns to the shareholders. The cash flow that remains after returns to all
of the identified assets are subtracted is the cash flow attributable to the unidentified intangible assets.
InWe
thestarted
last paragraph
of this
section,
the T&A
states
“When
stock
of a
by analyzing the
returns
being generated
byreport
the tangible
assets
of the valuing
business.the
Since
we have
previously determined that excess assets existed in SRS at the valuation date, returns to these assets have
closely
held
corporation,
we believe
the
book
value
the Corporation’s
stock
not been
computed,
as this analysis
focuses
on adjusted
the operating
assets
of theofbusiness.
At the valuation
date,is
the tangible operating assets have been valued in addendum 3.4 to the asset purchase and sale agreement
important
in determining
theaddendum
actual current
market
value.”
When
Jones
was
between Lincare
and SRS. The
has been fair
attached
as Exhibit
3 to this
report.Mr.
As per
Exhibit
3,
the value of the
tangible
assets atabout
the valuation
date was as follows:
questioned
in his
deposition
this statement,
he answered (January 24, Page 110,
line 24):
Accounts Receivable
$
Inventory
A.
550,000
40,000
It's one ofFixed
the factors
of the many important
Assets we consider, yes. It's one 712,000
factors.
Total
$ 1,302,000
To compute
from these
assets,
we have developed
of returns
for each, and
applied them
to the
Once
again,returns
Mr. Jones’
lack
of understanding
of rates
business
valuation
principles
becomes
asset values. The starting point to estimate returns on these assets is the prime rate that banks charged at
the valuation
date. According
to the Federal
Reserve
Board,
average prime
rate59-60
for all U.S.
commercial
apparent.
When
he was asked
to show
where
in the
Revenue
Ruling
its states
that
banks was 9 percent on March 9, 1995. The prime rate represents the rate of interest banks charge their best
adjusted
book
value
is important
determining the fair market value of a company such
customers
on the
most secure
types of in
loans.
asFor
ABC,
his response
Paragraph
theforRevenue
his justification.
this analysis,
we haveindicated
added a premium
to the 4-C
primeofrate
each of theRuling
differentas
classes
of assets to
arrive at the following rates of return:
When he was further asked where in Paragraph 4-C, he read from this paragraph as
follows (January 24, Page 111, line 24):
A.
Asset Class
Return
After-Tax
Return
Accounts Receivable
11%
6.6%
Sorry. “In computing the book value per share of stock, assets of the
Inventory
investment
type should be revalued on 12%
the basis of7.2%
their market price
and the
book
value adjusted accordingly.”
Fixed
Assets
14%
8.4%
Accounts receivable are the most liquid of the three asset classes, making them less risky than the inventory
The
problem
Jones’
is that
the assets
ABC the
arereceivables
operatingbecause
assetsit and
or fixed
assets.with
YetMr.
banks
would response
still charge SRS
a premium
to lendofagainst
still
presents risk to the bank. The inventory is less liquid than the accounts receivable and thus presents more
not
assets of the investment type. A simple reading of Revenue Ruling 59-60 makes it
risk to the bank. Therefore, we have added an additional one percent premium to the inventory rate. The
fixedobvious
assets ofthat
the business
are evenRuling
less liquid
than the inventory,
and present
a greatertype
risk toassets
a bank that
very
the Revenue
distinguishes
between
investment
and
operating type assets. An investment asset is one that a company would invest in such
as marketable securities, excess real estate, etc. An operating asset is one that is used
-
-4141 -41-41-
considering lending against the fixed assets of a business. As such, we have added an additional 2 percent
inis
business
operations
tofixed
permit
theof
services
goods,
and
is
considering
lending
against
assets
a
As
such,
added
an
additional
2
isthe
considering
lending
against the
the
fixed
assets
of company
a business.
business. to
Asperform
such, we
we have
have
added or
an sells
additional
2 percent
percent
over and above the return to inventory.
over
over and
and above
above the
the return
return to
to inventory.
inventory.
therefore, earn a return based on its day to day business operations. When Mr. Jones was
All of the returns calculated are pre-tax returns. Since our objective is to allocate after-tax cash flow to these
All of the returns calculated are pre-tax returns. Since our objective is to allocate after-tax cash flow to these
assets, wethe
need
taxtoeffect
returns
to multiplied
put them on
after-tax
basis.
To accomplish
this,
we or
have
assumed
tax to
rate
be 40the
percent
and
thean
pre-tax
returns
by one
minus the tax
rate,
60
assumed
the
tax
rate
to
be
40
percent
and
multiplied
the
pre-tax
returns
by
one
minus
the
tax
rate,
or
60
assumed
the
tax
rate
to
be
40
percent
and
multiplied
the
pre-tax
returns
by
one
minus
the
tax
rate,
or
60
valuation,
response
(January
24,
112,
line
18):
percent (1 his
- 40%
= 60%). was
It should
be noted
thatPage
the returns
calculated
here are minimum returns. The
percent
(1
40%
=
60%).
It
should
be
noted
that
the
returns
calculated
here
are
minimum
returns.
The
percent
(1
40%
=
60%).
It
should
be
noted
that
the
returns
calculated
here
are
minimum
returns.
The
premise used here is that companies would require a rate of return equal to the cost to finance the asset. In
premise
used
is
companies
would
require a
rate
of
equal
to
cost to
the
In
premise
used here
here
is that
that
companies
would
ratewould
of return
return
equal
to the
the
to finance
finance
the asset.
asset.
In
fact,
companies
want
to make
profits on
theirrequire
assetsaand
want
to earn
an cost
incremental
return
over and
fact,
companies
want
to
make
profits
on
their
assets
and
would
want
to
earn
an
incremental
return
over
and
fact,
companies
want
to
make
profits
on
their
assets
and
would
want
to
earn
an
incremental
return
over
and
above their financing cost.
above
their
Well, cost.
I would consider all of the assets to be investments of the
above A.
their financing
financing
cost.
All of thewe
returns
calculated
are
pre-tax
Since
is tobasis.
after-tax
cashthis,
flowwe
to these
assets,
need
to tax
effect
the
returns
to put
them our
on objective
an after-tax
accomplish
have
questioned
about
what
assets
onreturns.
the
balance
are
ofallocate
theTo
investment
type
this
assets, we need
to tax
effect
the returns
to put
them on sheet
an after-tax
basis.
To
accomplish this,
weinhave
company.
To calculate the
cash flow that is allocable to each asset, the value of the asset is multiplied by the after-tax
To
the
that
is
to
asset, the value of the asset is multiplied by the after-tax
To calculate
calculate
the cash
cash flow
flow
that
is allocable
allocable
to each
each
return.
The calculations
are
presented
in Table
16.asset, the value of the asset is multiplied by the after-tax
return.
The
calculations
are
presented
in
Table
16.
return. The calculations are presented in Table 16.
Q.
A.
Well, it says assets of the investment type should be revalued. Are
TABLE
you saying that that's referring
to 16
all assets?
TABLE
16
TABLE 16
CALCULATION OF RETURNS
TO TANGIBLE ASSETS
CALCULATION
CALCULATION OF
OF RETURNS
RETURNS TO
TO TANGIBLE
TANGIBLE ASSETS
ASSETS
Well, all assets are invested in by the company. They have to make
investment in all their assets.
After-Tax
After-Tax
After-Tax
Asset
Value
Rate
of Return
Return
Asset
Value
Rate
Return
Asset
Value
Rate of
of Return
Return
Return
Accounts
Receivable
$
550,000
6.6%
$
36,600
However,
upon Receivable
further questioning, he gave
the following answers
(January 24,
Page 113,
Accounts
$
6.6%
$
Accounts Receivable
$ 550,000
550,000
6.6%
$ 36,600
36,600
40,000
7.2%
2,880
line 14):Inventory
Inventory
40,000
7.2%
2,880
Inventory
40,000
7.2%
2,880
Fixed Assets
712,000
8.4%
59,808
Fixed
712,000
8.4%
59,808
Fixed Assets
Assets
712,000
8.4%
59,808
Once the
from the
tangiblewhat
assets
have been
determined,
we can
these returns
Q. returns
Okay.
That's
you're
telling
me. What
issubtract
the difference,
if from
any,the cash
Once
returns from
tangible
assets
have
been
we
can
these
returns
from
cash
Onceofthe
the
fromtothe
the
tangible
assets
have
been determined,
determined,
we
can subtract
subtract
these
returns
from the
the
cash
flow
thereturns
business
obtain
the
cash
flow
allocable
to
all
of
the
intangible
assets.
This
is
shown
in Table
between
an
investment
type
asset
and
an
operating
asset
of
a
flow
of
the
business
to
obtain
the
cash
flow
allocable
to
all
of
the
intangible
assets.
This
is
shown
in
Table
flow
of
the
business
to
obtain
the
cash
flow
allocable
to
all
of
the
intangible
assets.
This
is
shown
in
Table
17.
17.
company?
17.
TABLE 17
TABLE
17
TABLE
17 one that
A.
Well, an operating
asset
would
be
used in the -- as by
CASH FLOWS
FROM
INTANGIBLE
ASSETS
CASH
FLOWS
FROM
INTANGIBLE
ASSETS
CASH FLOWS FROM INTANGIBLE ASSETS
definition the operations of the -- of the day-to-day operations of the
1996
1997
1998
1999
2000
business.
1996
1997
1998
1999
2000
Cash Flow (Table 15)
Cash Q.
Flow (Table
So 15)
for
$ 1,011,916
$ 1,257,349
$ 1,544,677
$ 1,869,357
$ 2,233,004
example -- $go1,011,916
ahead. $ 1,257,349 $ 1,544,677 $ 1,869,357 $ 2,233,004
Less Returns On:
Less
Returns
On:
Accounts
16)
36,300
36,300
A. Receivable(Table
And the investment
type
would be 36,300
generally --36,300
generally speaking,
on 36,300
Accounts
Receivable(Table
16)
36,300
36,300
36,300
36,300
36,300
Inventory (Table 16)
2,880
2,880
2,880
2,880
2,880
that
is
held
for
investment
purposes
only.
Inventory
(Table
16)
2,880
2,880
2,880
2,880
2,880
Fixed Assets (Table 16)
59,808
59,808
59,808
59,808
59,808
59,808
59,808
59,808
59,808
59,808
Cash Flows
Q. From
Okay. So in the situation with ABC Jail Company, Inc., obviously the
Cash
Flows
From
Intangible Assets
$ operating
912,928 $ asset,
1,158,361
1,445,689
$ 1,770,369
$ 2,134,016
prisons would be an
not $$$an
investment
type asset.
Intangible Assets
Assets
$ 912,928
912,928 $
$ 1,158,361
1,158,361
1,445,689
$ 1,770,369
1,770,369
$ 2,134,016
2,134,016
Intangible
$
1,445,689
$
$
A.
The prisons would be used in operations, yes.
TRADEMARK
TRADEMARK
TRADEMARK
A trademark, or trade name as it is sometimes referred to, is one of the most common types of intangible
A trademark,
trademark,
or trade
trade
name
as itit is
is sometimes
sometimes
referred to,
to, is
is
onedifference
of the
the most
most between
common types
types
of intangible
intangible
A
or
as
referred
one
of
common
of
The
significance
of name
Mr.
nottheunderstanding
the
an investment
assets.
The trademark
is theJones
name that
company
is recognized
by
in the
market
place. This
is
the reason
assets.
The
trademark
is
the
name
that
the
company
is
recognized
by
in
the
market
place.
This
is
the
reason
assets.
The have
trademark
the namethey
that are
the company
is recognized
by in
thereferral
market sources.
place. This
is the reason
trademarks
value,isbecause
recognized
by customers
and
Typically
in an
trademarks
have
value,
because
they
are
recognized
by
customers
and
referral
sources.
Typically
in an
an
type
asset and
an
operating
asset
is
critical
error
in applying
the
spirit
Ruling
trademarks
have
value,
they
by customers
andthe
referral
sources.
Typically
in
acquisition,
the
use
of
thebecause
trademark
byare
thearecognized
seller
is prohibited
to protect
value
of of
theRevenue
assets
purchased
acquisition,
the
use
of
the
trademark
by
the
seller
is
prohibited
to
protect
the
value
of
the
assets
purchased
acquisition,
the use of the trademark by the seller is prohibited to protect the value of the assets purchased
by the buyer.
59-60.
In section 5 of this very important Revenue Ruling, it states the following:
by the buyer.
- -4242 The valuation
a trademark
based
on the present
value of
a stream of royalties that would be paid for the
Sec. 5.of Weight
toisBe
Accorded
Various
Factors.
the trademark.
Royalty
rates
for
such
purposes
are
typically
defined
as a percentage of
of sales.
To
use ofThe
valuation of closely held corporate stock entails
the consideration
all
obtain the actual rates, one must observe similar transactions in the marketplace.
relevant factors as stated in section 4. Depending upon the circumstances
each case,
factors
may
weight
than
others
because
A few in
companies
keep certain
databases
of royalty
ratecarry
data. more
For the
purposes
of this
assignment,
we of
used the
database
ASU Consulting
and Trademark
LicensingTo
Associates.
These databases were searched for
theofnature
of the company’s
business.
illustrate:
companies in the medical equipment and respiratory therapy industries and related fields. The searches did
not identify any transaction that would be appropriate to the valuation of SRS’ trademark.
1.
Earnings may be the most important criterion of value in some cases
whereas
asset
will atreceive
primary
consideration
in others.
In leads
Our research and
discussions
withvalue
individuals
ASU Consulting
and
Trademark Licensing
Associates
general,
will between
accord one
primary
consideration
earnings
us to believe that
royalty the
ratesappraiser
typically range
percent
and 10 percentto
across
markets and
industries. Considering
the low stocks
level of technology
involved
in SRS,
as products
well as the company’s
strength
when valuing
of companies
which
sell
or services
to and
reputation, we have selected a royalty rate of 4 percent.
the public; conversely, in the investment or holding type of company,
appraiserhas
may
accordlong
theterm
greatest
assets
underlying
Estimating thatthe
the trademark
a relatively
holdingweight
period, to
wethe
have
calculated
the cash flow for
beSRS
valued.
a 25 year life. the
The security
strength oftothe
name becomes more and more apparent when the historic sales
growth is examined. Table 18 reflects our calculation.
2.
The value of the stock of a closely held investment or real estate
holding company, whetherTABLE
or not18
family owned, is closely related to
CASH
FLOW
ALLOCABLE
TO TRADEMARK
the value of the assets underlying the
stock. For companies of this
type the appraiser should determine the fair values of the assets of
Year
Sales
Rate
Flow and the cost
the company.
Operating
expenses
of such a Cash
company
of liquidating
it, if$any,
merit consideration
when appraising
the relative
1996
6,500,000
4.0%
$ 260,000
values of the stock and the underlying assets. The market values of
1997
7,345,000
293,800
the underlying
assets
give due 4.0%
weight to potential
earnings and
dividends
of
the
particular
items
of
property
underlying
1998
8,299,850
4.0%
331,994 the stock,
capitalized at rates deemed proper by the investing public at the date
1999
9,378,831
375,153
of appraisal.
A current
appraisal4.0%
by the investing
public should be
superior
to the 10,504,290
retrospective opinion
2000
4.0% of an individual.
420,172 For these
reasons, adjusted net worth should be accorded greater weight in
2001
11,134,548
4.0%
445,382
valuing the stock of a closely held investment or real estate holding
company,
or not family4.0%
owned, than472,105
any of the other
2002 whether
11,802,620
customary
yardsticks
of appraisal,
such as earnings
and dividend
2003
12,510,778
4.0%
500,431
paying capacity.
2004
13,261,424
4.0%
530,457
14,057,110
562,284consideration in the
Based on the above2005
quote, earnings
would be4.0%
the most important
2006
14,900,536
596,021
valuation of ABC. Despite
this,
the T&A report4.0%
places a significant
amount of weight on
2007heavily15,794,569
4.0%
631,783
methodologies that rely
on adjusted book
value and/or book
value. While it would
2008
16,742,243
4.0%
669,690
2009
17,746,777
4.0%
709,871
2010
18,811,584
4.0%
752,463
2011
19,940,279
4.0%
797,611
2012
21,136,696
4.0%
845,468
2008 these
16,742,243
4.0% have been
669,690
be appropriate to consider
methods, they should
eliminated based on the
2009
17,746,777
4.0%
709,871
nature of ABC’s business.
Furthermore,
the manner
in which the
various methodologies
were applied, even those that should not have been used in the valuation of ABC, was
incorrect.
- -4343 In calculating the adjusted book value, theTABLE
only adjustment
made to the balance sheet was
18
CASH FLOW ALLOCABLE TO TRADEMARK
a write up of the real estate values to fair market value based on appraisals performed by
an outside real estate
appraiser.Sales
No other assets
were
Year
Rateor liabilities
Cash
Flowdiscussed regarding
any potential adjustments.
2013
Furthermore,
T&A
failed to take
into consideration any
22,404,897
4.0%
896,196
intangible assets that2014
may need
to be reflected to
properly adjust
the balance sheet to fair
23,749,191
4.0%
949,968
market value. Nowhere
report, does T&A
discuss the1,006,966
fact that it is determining
2015 in its25,174,143
4.0%
26,684,591
adjusted book value 2016
with only the
tangible assets4.0%
and liabilities.1,067,384
When asked where in the
28,285,667
4.0%
1,131,427
literature Mr. Jones 2017
could point
to for support of
the adjusted
book value not including
4.0%
1,199,312
intangible assets, his2018
response29,982,807
was (January 24,
Page 126, line
20):
2019
A.
31,781,775
4.0%
1,271,271
2020
33,688,682
I can't specifically
say that I have a4.0%
source to cite1,347,547
you off the top of my
head.
Once the cash flow has been forecast, the selection of a proper discount rate becomes necessary. Since the
cash flow stream being estimated will not occur until some time in the future, the future cash flow must be
discounted to its present value.
At the bottom of this page, the T&A report discusses the Earning Capacity of ABC. T&A
The SRS trademark
is well
established
in its local
markets.
The Company
had an excellent
reputation
for
discusses
annualized
revenues
growing
from
$4.7 million
to approximately
$13.7
million.
service and integrity. As Mr. Smith has said, he did not spend money on advertising, but let SRS’ reputation
build
by word
of mouth,
satisfied
patientbeyond
to doctor,this.
and from
doctor
to doctor.they
These
events
have gone
However,
there
is no from
further
analysis
In this
section,
also
indicate
that
a long way in strengthening the trademark of SRS in its marketplaces. SRS had the predominant market
position
in eachof
of its
andcorporation
continually maintained
position
with most
diligentimportant
marketing
“Net
earnings
anmarkets
ongoing
are, in and
ourupgraded
opinion,itsone
of the
efforts. These positive qualities provide value to a trademark and reduce the risk associated with it. As a
factors
in determining
fair market
result, available
we have selected
a 20 percentthe
discount
rate. value of a closely held corporation’s stock.”
The
Thisreport
resultscontinues
in the value with:
estimate of the trademark being calculated as follows:
Forecasted
20% Present
Present Value
place
WeYear
believe the potential
in theFactors
stock of a=corporation
Cash Flowinvestors
x
Value
Futurewould
Cash Flow
more emphasis on the most recent years’ earnings when valuing the
1996
$ 260,000
0.8333
$ 216,658
corporation. Therefore, when using the net earnings method in determining
293,800
204,015
the 1997
fair market value
of ABC’s stock,0.6944
we have weighted the most
recent
years’
net earnings331,994
more heavily than0.5787
the prior years’ earnings. 192,125
1998
1999
375,153
0.4823
180,936
2000
420,172
0.4019
168,867
2001
445,382
0.3349
149,158
2002
472,105
0.2791
131,764
2003
500,431
0.2326
116,400
2004
530,457
0.1938
102,803
Reading the T&A report, thus far, leaves the reader with the feeling that adjusted book
value is very important, but so are earnings. T&A contradicts itself by stating that these
methods are both very important in this assignment. ABC was an operating company, and
as such earning capacity is much more important that its assets and liabilities.
-44-- 44
As a general rule, most Forecasted
appraisers are much
more
concerned with cash
flowValue
than they are
20%
Present
Present
Year
Cash Flow
x
Value Factors
=
Future Cash Flow
2005
562,284
0.1615
90,809
2006
596,021
0.1346
80,224
2007
631,783
0.1122
70,886
2008
669,690
0.0935
62,616
2009
709,871
0.0779
55,299
2010
752,463
0.0649
48,835
2011
797,611
0.0541
43,151
2012
845,468
0.0451
38,131
2013
896,196
0.0376
33,697
2015
1,006,966
0.0261
26,282
earnings. Although Revenue Ruling 59-60 discusses earning capacity, the interpretation
in the appraisal industry is that this does not necessarily mean net earnings. In a growing
company, cash flow is much more important than earnings since many profitable
companies go out of business because they do not have the necessary cash flow to fund
their growth. No consideration is made in this valuation as to how ABC would fund the
extraordinary growth that was being projected for the company.
TA 166
Continuing2014
the discussion949,968
about Earning Capacity,
0.0313 T&A indicates that: 29,734
We2016
made adjustments
for excess compensation
of officers over what
would
1,067,384
0.0217
23,162
be a “normalized amount.” This amount has been determined for what has
2017
1,131,427
0.0181to pay unrelated third parties
20,479 for
been
calculated as
the amount necessary
the 2018
management 1,199,312
of the Corporation. 0.0151
18,110
2019
1,271,271
0.0126
16,018
2020
1,347,547
0.0105
14,149
However, there is no explanation in the report as to how this information was derived, nor
is there any documentation in the T&A workpapers. When asked about the workpapers,
Mr. Jones TOTAL
responded (January 24, Page 138, line 2):
$ 2,134,308
The indicated fair market value of SRS’ trademark is $2,134,308, or $2,134,000 rounded.
A.
I don't recall a specific work paper in our file about that; however, we did
discuss with them what the appropriate level of compensation would be for
PATIENT RECORDS
someone to provide the services that -- that was being provided by the
shareholders.
One of the important intangible assets of a business like SRS, are the patient records or customer list. These
records are important to a potential purchaser because it is this very patient base that generates immediate
cash flow
company.
Q. to theOkay.
Where in you work -- I’m sorry, I don’t want to cut you off.
This type of asset is generally valued by reviewing the expected life of the patient relationship, and applying
I was
just
saying the
thatcash
based
on would
our discussions
them and
some A.
factor to Well,
the sales
in order
to estimate
flow that
be expected to with
be generated
from our
this
general
knowledge
businesses
that
we've worked
withdetermine
throughthe
-- over
the
relationship. Before
applying
factors toofthe
cash flow of the
company,
we must first
cash flow
available from -thethroughout
patient records
andyears
the remaining
assets.
This is calculated
in Tableper
19. stockholder
the
that we
concluded
that 200,000
would be indicative of what they would have to go out and hire somebody to
do their jobs.
Q.
Okay. Show me in your work papers where you documented that
conversation and your general knowledge of the business?
- 45 -
-45-
A.
I don't believe it's in our work TABLE
papers.
19
Cash Flow (Table 15)
CASH FLOWS AVAILABLE TO PATIENT RECORDS
1996
1997
1998
1999
2000
2001
$ 1,011,916
$ 1,257,349
$ 1,544,677
$ 1,869,357
$ 2,233,003
$ 2,366,983
2002
1
$ 2,509,002
Once again, Mr. Jones attempted to respond in general terms regarding T&A’s or his
Less Returns On:
Accounts Receivable (Table 16)
Inventory (Table 16)
Trademark (Table 18)
36,300
36,300
36,300
36,300
36,300
36,300
knowledge about management
compensation,
but
he fails36,300
to demonstrate
that
any analysis
2,880
2,880
2,880
2,880
2,880
2,880
2,880
59,808
59,808
59,808
59,808
59,808
59,808
59,808
or research was performed260,000
including293,800
what other
individuals
field were
A
331,994
375,153 in the
420,172
445,382earning.
472,105
Cash Flow to
All Intangible
$200,000
per
officer figure appears to be pulled out of the air and remains unsupported.
Assets Other Than Trademarks
$ 652,928
$ 864,561
$ 1,113,695
$ 1,395,216
$ 1,713,843
$ 1,822,613
$ 1,937,909
There is no discussion in the report as to management’s jobs duties, the hours worked, or
Using the same survivorship factors as the Valuation Group, the survivorship rates for the life of the patient relationships are as follows:
the experience required to perform the particular function of each officer. Therefore, there
Survivorship %
is no basis upon which to estimateYear
reasonable
compensation.
1
83.88
This adjustment is
supposed to be well supported, and in 2this instance,
it is totally unsupported. T&A lacks
62.43
3
sufficient relevant data to support this item.
47.22
4
34.57
5
23.13
The next section of the report is a discussion
of the
Dividend Paying Capacity. Despite
6
12.32
indicating that distributions have been7 made to 1.87
permit the shareholders to pay their
Therefore, projected
cash flows
fromstate
the existing
patient base
are estimated
Table
respective
federal
and
income
taxes,
therein is
no20.quantification of the amounts that
were paid. Rather than properly addressing the dividend paying capacity, the T&A report
states:
Considering the nature of the industry and its potential growth as well as the
Corporation’s size and method of operation, it does not appear the
Corporation’s dividend paying capacity is greatly in excess of the current rate
of dividends being paid. The Corporation will retain substantially all its equity
in order to support anticipated growth, debt service requirements and
operations. As a closely held entity, the Corporation does not have the
access to equity markets which are available to publicly held corporations to
finance anticipated growth.
This statement has no analysis associated with it in the report or in the workpapers from
which T&A was able to reach the conclusion that it wrote in its report. In his deposition, Mr.
Jones stated (January 24, Page 142, line 5):
2
- -4646 We knew that they were
Cashgoing
Flow to be needing capital to expand -- to finance
Survivorship
Cash Flow to
the
the expansion of theirtooperations,
so they were probably
going to be
Year
Residual
Rate
Patient
Records
retaining as much as they could in order to finance those growth operations
and to -- 1996
and to service
the existing
debt that they
had prior to the
$ 652,928
.8388
$ 547,676
transaction.
1997
864,561
.6243
539,745
1998
1,113,695
.4722
525,887
1999
1,395,216
.3457
482,326
2000
1,713,843
.2313
396,412
2001
1,822,613
.1232
224,546
2002
1,937,909
.0187
36,236
The ironic part about Mr. Jones’ statement is that T&A assisted management in producing
a forecast for the Bank of Jacksonville. In that forecast, however, there was no provision
for capital expenditures, which indicates that the projected cash flow would be significantly
overstated. The possibility of ABC continuing its operations without capital expenditures
is impossible. Therefore, while net cash flow is sometimes considered to be dividend
After calculating the cash flow attributable to the patient records, the next step is to discount these amounts
paying
capacity, T&A never calculated the net cash flow that would be available after a
to their present values to determine an estimate of the value of the patient records. In our opinion, the least
risky ofreinvestment
the identified intangible
assets
areprovided
the patientfor
records,
as they
are As
actual
physical
documents.
proper
of its cash
was
to grow
ABC.
a result,
the
dividend
Possessing these documents allows a buyer to continue servicing the existing patients. The remaining life
of thesecapacity
records can
and has while
been estimated.
addition,
buyers was
such as
Lincare from
and other
companies
paying
section,
includedInin
the report,
omitted
thelarge
analysis.
in the industry have their own experiences with how long a patient will remain with the company. As these
patients are currently availing themselves of SRS’s services, they are generating cash flows and will generate
a material and predictable portion of SRS’ cash flows over the following months and years. This makes the
The
section
of the
discusses
Goodwill
and Intangible
Value.
Once
again,
T&A
risknext
of receiving
these
cashreport
flows low.
Therefore,
we have applied
a 14 percent
discount
rate to
the patient
records. This results in an estimate of value as calculated in Table 21.
demonstrates that it did not have the professional competence to undertake the
TABLE 21 has many definitions, and for valuation
assignment. In this section, T&A states “...goodwill
CASH FLOWS ALLOCABLE TO PATIENT RECORDS
purposes is sometimes considered to be value in excess of book value.” This statement
Cash Flow
to
Present Goodwill
Value
Presenta value in excess
is absolutely incorrect in a business
valuation
context.
is never
Year
Patient Records
Factors
Value
of book value. Goodwill is a value in excess of the net tangible and identifiable intangible
1996 is an accounting
$ 547,676
0.8782
480,421
assets. Book value
concept that does
not reflect$ the
fair market value of
1997
539,745between the0.7695
the assets and liabilities.
The difference
tangible assets415,334
and liabilities and the
525,887
0.6750
354,973
total value of the1998
company would be
the intangible value,
not all of which
is attributable to
1999
482,326
0.5921
285,585
2000
396,412
0.5194
205,896
2001
224,546
0.4556
102,303
2002
36,239
0.3996
14,481
goodwill. T&A also states that “Goodwill in the context of Rev. Ruling 59-60, whether
positive or negative, is determined by the overall valuation of the Corporation’s equity in
relation to its book value.” The very mention of negative goodwill must be questioned. A
company either has goodwill or does not have goodwill. If it has goodwill, frequently the
Total Present Value
$ 1,858,995
role of the appraiser is to determine if that goodwill has value. The value cannot be less
Therefore, based on our analysis, the value of the patient records is estimated to be $1,858,995, or
than
zero. There is no such valuation concept as negative goodwill.
$1,859,000 rounded.
- -4747 TA
167
COVENANT
NOT-TO-COMPETE
A covenant not-to-compete (non-compete agreement) is an intangible asset based on a contractual
agreement. Typically, the seller of a business, the covenantor, agrees not-to-compete with the buyer of the
Atbusiness,
the top the
of covenantee,
this page, inthere
is a discussion about Comparable Stock Values. Despite
a defined industry or market for a specific period of time, in a geographically
defined area.
A non-compete
agreement
value
the buyer
to the degree
that
it protects
the assets
identifying
its procedure
to develop
a has
group
of to
public
corporations
that
could
be used
in this
(tangible and intangible) from loss of value by restricting competitive actions of the seller. From an economic
perspective,
the value of a T&A
non-compete
dependent
severalMr.
factors,
including
the ability of
part
of the assignment,
did notagreement
do what itissaid
it did.onWhen
Jones
was questioned
the seller to compete, the derivation of the non-compete agreement, and the losses the company would suffer
if the the
sellerprocedures
competed. and analysis, the following discussion took place (January 24, Page
about
149,
line
12): where the seller has the ability to compete, the relevant question becomes, what impact would
In the
instance
competition from the seller have on the business? The answer to this question depends on a myriad of
factors. Chief among them are: 1) the seller being in possession of relationships that could redirect business
from the company to a new company established or invested into by the seller, and 2) the seller having either
Q. knowledge
Okay.or Now,
can to
you
point
again
in your
work services
papers,toExhibit
sufficient
technology
allow
him out
or her
to bring
competitive
market. 368, where
you have the detailed criteria that you use to identify the comparable
The single most
important source
in determining
the value
of a covenant
companies
anddocument
detail what
you use
to perform
anynot-to-compete
analysis onis the
the
agreement in which
the
covenant
is
made.
For
this
reason,
we
have
performed
a
detailed
review
of
the
asset
companies that were located?
purchase agreement between Lincare, SRS, and Ben W. Smith, dated March 9, 1995 (the “agreement”). The
following discussion highlights items in the agreement that impact the value of the covenant not-to-compete.
A.
Your question again is with respect to our work paper?
Q.
Yes. I want you to go to your work papers, Exhibit 368, and show me where,
Article 1.1(b) defines business as it applies to the agreement:
“Business” shall mean the entire business of Company [SRS], including, but not limited to,
if anywhere, you have your criteria that you used to identify the comparable
the business of marketing, advertising, selling, leasing, renting, distributing or otherwise
companies
andequipment,
detail what
usedtherapy
perform
any and
analysis
of those
providing
oxygen, oxygen
aerosolyou
inhalation
equipment
respiratory
companies.
medications,
nasal continuous positive airway pressure devices, infant monitoring equipment
and services, home sleep studies and related therapy equipment, and other respiratory
durable medical equipment, products, supplies and services to customers in
A.therapyI and
don't
think we have a work -- work paper that is in detailed format that
their homes or other alternative site care facilities.
outlines the -- the criteria, I think you referred to --
Article 1.1(f) defines territory as:
Q.
Right?
[T]he State of Florida and a radius of one hundred fifty (150) miles from any of Company’s
current operating centers, regardless of which states such radius may include.
A.
-- that at the end of the page there's a handwritten conclusion that
we're
not going
to use
-- this
methodology.
So states:
I don't believe
Section 3.4 of the
agreement
pertains
to thethese
allocation
of the
purchase price and
there's a work paper to that effect.
The parties agree to allocate the Purchase Price among the Assets as set forth in Addendum
3.4. The values assigned to the Assets as set forth Addendum 3.4 were separately
Q.established
Okay.
in –party
on page
167
of Exhibit
307 that
by So
the even
partiesthough
in good you
faith have
and each
agrees
to report
the transaction
you say
inRevenue
our search,
contemplated
by this“Entities
Agreementobtained
to the Internal
Service as while
requiredhaving
by Sectionmany
1060
of the Internal
Revenue
in accordance
with Addendum
subject
to the
approval
just stop
right there.
You can't3.4,
really
even
point
me of
to
similarities”
-- Code
Lincare’s
Company’s
independent
auditors.
anyandentities
obtained
in your
search, is that right, from your work
papers?
An important statement in this section is the discussion of the values being “separately established by the
parties in good faith.” This indicates that the parties discussed each of the values and negotiated them
A. including
Well,the
we
considered
some Addendum
of the other
entities
that were
in the
separately,
covenant
not-to-compete.
3.4 has
been attached
to this report
as Exhibit
3.
industry.
Article 8.2 contains a no solicitation clause which states:
Q.
Okay. But you didn't put a work paper in about why you decided that
you could not use them as a comparable company. Is that what
you're telling me?
a)
A.a)
a)
-48-48- 48
-48--
From and after the Closing, neither Company nor the Shareholder [Ben W. Smith]
From
Closing, neither
the Shareholder [Ben W. Smith]
We
didand
notafter
putthe
together
a workCompany
paper. nor
From
and
after
the
Closing, neither
Company
nor the Shareholder [Ben W. Smith]
shall:
shall:
shall:
i)
directly
or
hire,
offer
hire,
away,
other
directly
or indirectly,
indirectly,
hire,
offer to
todata
hire, or
or entice
entice
away, or
or in
in any
any
other
This is one morei)i) instance
where
sufficient
relevant
not obtained
the
appraiser.
directly
or indirectly,
hire,
offer
to hire, was
or
entice
away,
or inby
any
other
manner
persuade
or
attempt
to
persuade,
any
officer,
employee
or
agent
manner persuade or attempt to persuade, any officer, employee or agent of
of
manner (including,
persuade or
attempt
to persuade,
any officer,
employee
or or
agent
of
Lincare
but
not
limited
to,
any
former
officer,
employee
agent
Lincare
(including,
but
not
limited
to,
any
former
officer,
employee
or
agent
Besides the fact that Lincare
T&A
mislead
the
reader
its
by
stating
thatorit agent
did
certain
(including,
but
not
limitedofto,
anyreport
former
officer,
employee
of
Company),
or
in
any
manner
persuade
or
attempt
to
persuade,
any
of Company), or in any manner persuade or attempt to persuade, any
of Company),
or in
any
manner
persuade or attempt
to persuade,
any
officer,
employee
or
agent
Lincare
but
officer,
employee
ornothing
agent of
of contained
Lincare (including
(including
but not
not limited
limitedtoto,
to,
any
procedures that it did not
do,officer,
there was
in theto,,,workpapers
support
that
officer,
employee
or agent
of
Lincare
(including
but
not limited
to,
any
former
employee
or
agent
of
Company)
discontinue
his
or
former officer, employee or agent of Company) to discontinue his or her
her
former
officer,
employee
agent
of Company)
to discontinue
his or her
relationship
with
Lincare.
It
and
prohibitions
there was even a proper
attempt
to
apply or
the
market
approach
thethe
valuation
of ABC.
relationship
with
Lincare.
It is
is understood
understood
and agreed
agreedinthat
that
the
prohibitions
relationship
with
Lincare.8.2
It is(i)understood
and
agreed
that
the
prohibitions
contained
in
this
Section
shall
apply
to
all
current
and
future
officers,
contained in this Section 8.2 (i) shall apply to all current and future officers,
contained
thisagents
Section 8.2
(i) shall
apply
to all
current
officers,
employees
and
Lincare
(including,
but
to,
any
former
Fair market value comes
from in
the
market
approach
is and
the future
most
employees
andmarket.
agents of
of The
Lincare
(including,
but not
not limited
limited
to,
any fundamental
former
employees
and
agents
of
Lincare
(including,
but
not
limited
to,
any
former
officer,
officer, employee
employee or
or agent
agent of
of Company),
Company), whether
whether or
or not
not any
any such
such person
person is
is
officer,
employee
or
agent
of
Company),
whether
or
not
any
such
person
is
approach to valuationthen
in acurrently
fair market
value
analysis.
an
employee
or
then
currently
an officer,
officer,
employee
or agent
agent of
of Lincare
Lincare or
or whether
whether any
any such
such
then
currently
an
officer,
employee
or
agent
of
Lincare
or
whether
any
such
prohibited
prohibited activity
activity is
is in
in connection
connection with
with employment,
employment, an
an offer
offer of
of employment
employment
prohibited
activity
is inor
connection
with
employment,
an offer of employment
or
other
action
within
outside
the
Territory;
or
or other action within or outside the Territory; or
or other action within or outside the Territory; or
The T&A reportii)statesdirectly
“Entitiesindirectly
obtained in our
search,
while having
many
similarities
tend
ii)
directly or
or indirectly solicit,
solicit, divert
divert or
or take
take away,
away, or
or attempt
attempt to
to solicit,
solicit, divert
divert or
or
ii)
directly
or indirectly
solicit, divert orhad
takeenjoyed
away, ororattempt
to solicit,
divert
or
take
away
any
business
to
date
takeheld
awayin
any
business Company
Company
hadturn
enjoyed
or solicited
solicited
prior
to the
the
date traded
to be much more widely
ownership
which
in
indicates
theprior
stock
being
take away
any
business
Company
had
enjoyed
or
solicited
prior
to the
the
hereof
or
which
Lincare
may
enjoy
or
solicit
in
the
Territory
after
date
hereof or which Lincare may enjoy or solicit in the Territory after the date
hereof or which Lincare may enjoy or solicit in the Territory after the date
hereof.
publicly would have substantial
minority interests discounts applied.” Besides there being
hereof.
hereof.
b)
is
understood
the
hereto
itit shall
breach
no search,
eitherby
desire
to that
specifically
this
b) this It
Itstatement
is expressly
expressly demonstrates
understood and
and agreed
agreed
byT&A’s
the parties
parties
hereto
that
shall be
be a
aeliminate
breach
b)
It is expressly
understood
and
agreed bytothe
parties
hereto
that
it member
shall be aofbreach
hereof
for
Company
or
the
Shareholder
assist
in
any
way
any
hereof for Company or the Shareholder to assist in any way any member of his
his or
or
hereof
for Company
or the
to assistof
in the
anyperson,
way
anyfirm,
member ofThere
his or
any
associate,
or
methodology orher
complete
lack
ofShareholder
understanding
methodology.
heritsfamily,
family,
any business
business
associate,
or any
any other
other
person,
firm, corporation,
corporation, is no
her family, joint
any venture,
businessassociation,
associate,trust
or or
anyother
other
person,
firm,incorporation,
partnership,
entity,
to
engage
any
activity
partnership, joint venture, association, trust or other entity, to engage in any activity
question that awhich
publicly
traded
stock
is generally
more
than
a activity
closely held
partnership,
joint venture,
association,
trust or
other widely
entity, to held
engage
in any
which is
is prohibited
prohibited by
by this
this Section
Section 8.2.
8.2.
which is prohibited by this Section 8.2.
stock;
that is
the nature
of thethesecurity.
To use this employees
as an excuse acquired
for not using
this data
Notice
Notice that
that this
this article
article deals
deals with
with the existing
existing customers
customers and
and employees being
being acquired at
at the
the time
time of
of the
the
Notice
that
this
article
deals
with
the
existing
customers
and
employees
being
acquired
at
the
time
of itthe
agreement.
This
article
acts
as
protection
for
Lincare
with
respect
to
the
customers
and
human
capital
agreement.
This
articlelogic.
acts as In
protection
for Lincare
with respect
to thefrom
customers
and human
capital
it is
is
toacquiring.
value
ABC
defies
fact,
minority
values
are
used
the
public
market
on
a
agreement. This article acts as protection for Lincare with respect to the customers and human capital it is
acquiring.
acquiring.
regular
basis in the valuation process. There are numerous studies that measure the
Article
Article 9
9 is
is the
the covenant
not-to-compete and
and is
is presented
presented in
in its
its entirety.
entirety.
Article 9premiums
is the covenant
not-to-compete
is presented
its entirety.
control
paid
above the and
minority
pricein that
could have been used had this
9.1
Covenant.
9.1
Covenant.
9.1 been
Covenant.
methodology
properly considered. Based on Mr. Jones’ testimony, we believe that
a)
In
a)
In consideration
consideration of
of the
the purchase
purchase by
by Lincare
Lincare of
of the
the Assets
Assets and
and the
the Business
Business
no one at T&A had
knowledge
as
to
the
proper
application
of
a) sufficient
In consideration
of theand
purchase
by
Lincare
of
the Assetsand
andthis
the method,
Business which
pursuant
to
the
terms
conditions
of
this
Agreement,
for
pursuant to the terms and conditions of this Agreement, and for other
other good
good
pursuant
to the terms
and conditions
of this Agreement,
and for other(each
good
and
valuable
consideration,
the
Company
and
Shareholder,
and
valuable
consideration,
the
Company
and
Shareholder,
(each
such
as the
is the reason why it was
from
consideration.
In aand
niche
industry, as
andeliminated
valuable
consideration,
theas Company
Shareholder,
(each
hereinafter
referred
to
individually
a
“Covenantor”
and
collectively
hereinafter referred to individually as a “Covenantor” and collectively as the
the
hereinafter referred
to individually
a “Covenantor”
asand
the
“Covenantors”)
hereby
represent, as
warrant,
covenant and
andcollectively
agree, jointly
jointly
“Covenantors”)
hereby
represent,
warrant,
covenant
and
agree,
and player.
one in which ABC operated
within,
the most
likely
purchaser
would
anfor
industry
“Covenantors”)
hereby
represent,
warrant,
covenant
andbe
agree,
jointly
and
severally,
that
commencing
on
the
date
hereof
and
continuing
a
period
severally, that commencing on the date hereof and continuing for a period
severally,
commencing
the date
hereof
and continuing
a period
of
fivehappened
(5)that
years
thereafter,
none
of
the
Covenantors
will, for
directly
or
In fact, that is exactly what
severalon
years
later.
Therefore,
the
best
companies
of
five
(5)
years
thereafter,
none
of
the
Covenantors
will,
directly
or
of five (5)engage
years inthereafter,
none
of the Covenantors
will,
directly
or
indirectly,
the
business
of
marketing,
advertising,
selling,
leasing,
indirectly, engage in the business of marketing, advertising, selling, leasing,
indirectly,
engage
in
the
business
of
marketing,
advertising,
selling,
leasing,
renting,
distributing,
or
otherwise
providing
oxygen,
oxygen
equipment,
to be considered in renting,
the application
the market
approach
the potential
distributing, of
or otherwise
providing
oxygen,would
oxygen be
equipment,
renting, inhalation
distributing,
or otherwise
providing
oxygen, oxygen
equipment,
aerosol
therapy
equipment
and
respiratory
medications,
nasal
aerosol inhalation therapy equipment and respiratory medications, nasal
aerosol inhalation
therapy
equipment
and respiratory
medications,
nasal
continuous
positive
airway
pressure
devices,
infant
monitoring
equipment
purchasers of this company.
Eliminating
this
methodology
and
ignoring
the
industry
continuous positive airway pressure devices, infant monitoring equipment
continuous
positive
airway
pressure
devices,
infant
monitoring
equipment
and
services,
home
sleep
studies
and
related
therapy
equipment,
or
any
and services, home sleep studies and related therapy equipment, or any
andwere,
services,
home
sleep
and
related
therapy equipment,
or any
players, as few as there
was
negligent
on the
part
of
T&A.
other
respiratory
therapy
orstudies
durable
medical
equipment,
products, supplies
supplies
other
respiratory
therapy
or
durable
medical
equipment,
products,
other
respiratory
therapy
or
durable
medical
equipment,
products,
supplies
and services
services to
to customers
customers in
in their
their homes
homes or
or other
other alternative
alternative site
site care
care
and
and services
tothe
customers
in their homes or other alternative site care
facilities
within
Territory.
facilities within the Territory.
facilities within the Territory.
Despite indicating
thatWithout
a search
ofthe
entities
was
conducted,
did
do this.
b)
limiting
generality
of the
the
provisions of
ofT&A
Section
9.1not
(a) hereof,
hereof,
this When
b)
Without limiting
the generality
of
provisions
Section
9.1
(a)
this
b)
Without limiting
the generality
ofbe
theconstrued
provisionssoofthat
Section
9.1 (a) hereof,
this
Covenant
Not-to-compete
shall
Covenantors
shall
also
Not-to-compete
shall
be construed
so that
Covenantors
shall
also
asked about this,
Mr. Covenant
Jones stated
in his deposition
(January
24,
Page
169,
line
9):
Covenant Not-to-compete shall be construed so that Covenantors shall also
- 49
-49-A.
We -- we
with management
entities that
aredirector,
in the
bediscussed
in breach hereof
if any of them other
is an employee,
officer,
shareholder,
trustee,
agent, principal
or partner
or a consultant
business.
We -- weinvestor,
got some
information
about
those of,
businesses
--.
or advisor to or for, or a subcontractor or manager for, a person, firm,
corporation, partnership, joint venture, association, trust or other entity
Q.
Okay. which is engaged in such business in the Territory, or if any of them
receives any compensation or remuneration from or owns, directly or
A.
-- and did
a preliminary
review.stock or shares or has a beneficial or other
indirectly,
any outstanding
financial interest in the stock or assets of any such person, firm, corporation,
partnership, joint venture, association, trust or other entity engaged in such
When specifically asked
whether
not Mr.Notwithstanding
Jones did an
independent
search
business
in the or
Territory.
anything
to the contrary
contained in this Section 9.1 (b), no Covenantor shall be deemed to be in
comparable companies
he answered
(January
24, Pagesolely
170,by
line
3): of owning an
breach
of this Covenant
Not-to-compete
reason
interest of less than one percent (1%) of the shares of any company traded
on a national securities exchange or in the over the counter market.
A.
for
Well,
weItasked
them for the names of the others in the industry. And
c)
is expressly understood and agreed by Covenantors that it shall be a
some ofbreach
the articles
we previously
referred
to to
some
of this Covenant
Not-to-compete
for to
anyreferred
Covenantor
assistof
in the
any
other entities
that
were
in -- any
in the
similar
business
--.other person, firm,
way any
family
member,
business
associate,
or any
In essence, T&A
corporation, partnership, joint venture, association, trust or other entity, to
engage in any activity which a Covenantor is prohibited from engaging in by
this Covenant
Not-to-compete.
inaccurately
portrayed
in its report the attempt to apply the market
approach.
eighth factor of Revenue Ruling 59-60 states the following:
9.2 TheRemedies.
Covenantors agree that the remedy at law for any breach of obligation under this
Covenant Not-to-compete will be inadequate and that in addition to any other rights
Section and
2031(b)
of the Code states, in effect, that in valuing unlisted
remedies to which it may be entitled hereunder, at law or in equity, Lincare shall
securities
value
of stock
or and
securities
of corporations
engaged
in fees
the
be the
entitled
to injunctive
relief,
reimbursement
for all reasonable
attorneys’
same or and
a similar
line of business
which
are listed
onenforcement
an exchange
should
be
other expenses
incurred in
connection
with the
hereof.
It is the
intention
of Covenantors
and Lincare
Covenant
Not-to-compete
be fully
taken into
consideration
along
with that
all this
other
factors.
An important
enforceable in accordance with its terms and that the provisions hereof be
consideration is that the corporations to be used for comparisons have
interpreted so as to be enforceable to the maximum extent permitted by applicable
capital stocks
arethat
actively
traded
thefrom
public.
In accordance
law. Towhich
the extent
any obligation
to by
refrain
competing
within an area with
for a
section period
2031(b)
of
the
Code,
stocks
listed
on
an
exchange
areinvalid
to be
of time as provided in this Covenant Not-to-compete is held
or
unenforceable,
it shall,iftosufficient
the extent comparable
that it is invalidcompanies
or unenforceable,
be deemed
considered
first. However,
whose
stocks
void
initio.
The remaining
obligations
imposed
by the
provisions of this
Covenant
are listed
onaban
exchange
cannot
be found,
other
comparable
companies
Not-to-compete shall be fully enforceable as if such invalid or unenforceable
which have
stockshad
actively
traded
on the
over-the-counter
market
may
provisions
not been
included
herein
and shall be construed
to also
the extent
be used.possible,
The essential
factor
is
that
whether
the
stocks
are
sold
on
such that the purpose of this Covenant Not-to-compete, as intended an
by
Covenantors
and Lincare, can
be achieved
in a lawful
exchange
or over-the-counter
there
is evidence
of manner.
an active, free public
market for the stock as of the valuation date. In selecting corporations for
comparative purposes, care should be taken to use only comparable
companies.
Although
only
restrictive
requirement as to comparable
•
The covenant
is forthe
a term
of five
years.
corporations
specified
in
the
statute
is
that
theiraslines
of business be the
•
The covenant covers what the agreement defines
“business”.
•
covenant
to the geographic
region definedmust
in the be
agreement
“territory”.
same
orThe
similar,
yet relates
it is obvious
that consideration
given as
to the
other
•
Prohibits
partaking
in
the
“business”
in
the
“territory”
for
the
five
year
period.
relevant factors in order that the most valid comparison possible will be
•
The covenant defines remedies for Lincare if the covenant is violated.
obtained. For illustration, a corporation having one or more issues of
preferred
stock,
bonds
or debentures
in addition
to its
shouldability to
The valuation
of the
covenant
not-to-compete
is highly
dependent
on common
the impact stock
of the seller’s
compete
the considered
marketplace with
the directly
buyer. Therefore,
in order
estimate
theonly
potential
impact of SRS
notinbe
to be
comparable
to to
one
having
common
competing
with
Lincare,
after
the
sale,
we
have
performed
a
lost
sales
analysis.
stock outstanding. In like manner, a company with a declining business and
decreasing markets is not comparable to one with a record of current
progress and market expansion.
The key elements of the covenant not-to-compete are as follows:
- -5050 The
market
approach
is considered
the best
indication
of fair market
value since
this
A lost
sales analysis
entails
estimating theto
potential
losses
to the covenantee
from competition
from the
covenantor. The analysis is used as part of a residual method valuation of a non-compete. As part of a
type
of value
comes
fromthe
the
market.
While
determining
good
comparable
companies
residual
method
of valuation,
lost
sales analysis
determines
the cash
flow that
is allocable to
the covenantis
not-to-compete. The cash flow is then valued directly in the residual valuation analysis.
at times difficult, that is never a reason to dismiss the approach without attempting its
Lost sales analysis can be used to value the subject business’ cash flow for the period of the covenant, first
application.
In fact, the standards of all appraisal organizations tell the appraiser to
assuming the covenant is in place and then a second time without the covenant. The difference in the values
assuming the covenant is in place and then a second time without the covenant. The difference in the values
in these two
is the
value of the non-compete
agreement.
consider
all scenarios
applicable
approaches
and methods
for any valuation that is performed. To
Regardless
howI considered
it is to be used,itthere
several
stepsisinvolved
in preparing
sales analysis.
The
merely
say of
that
and are
I ruled
it out
not in the
spirit ofa lost
appraisal
standards.
first step is to prepare a forecast of the company’s income statement and cash flow assuming the covenant
is
place, and the
is not intoviolation
of the
agreement.
This procedures.
has previously been done to value
Theinappraiser
hascovenantor
an obligation
properly
apply
valuation
the entire operating enterprise.
The next step is to ascertain what level of sales would be lost if the covenant was not in place. The impact
Since
is so
closely
tied toand
thecash
spirit
Revenue
Ruling 59-60
and the
of thean
lostESOP
sales onvaluation
the company’s
income
statement
flowof
must
then be analyzed
and forecasted.
Determining the likely level of lost sales is a highly intricate process that typically involves in-depth discussions
Department
of Labor
Regulations,
omission
of the
market
in thisinfashion
with management
of the acquiring
company.
The closest
information
weapproach
have to interviews
this case was
are
the depositions of the Lincare officials and of Mr. Smith. Based on our review of the various deposition
the depositions of the Lincare officials and of Mr. Smith. Based on our review of the various deposition
negligent.
Even in Mr. Jones’ deposition he admitted that a possible comparable would be
transcripts provided to us, we determined that the possible range of lost sales would be between 1 and 25
percent.facilities
Our analyses
follows24,
in Tables
through
“rehab”
(January
Page22171,
line27.
12), but they were not identified in his report
rule that is applied to these scenarios is that we have not reduced sales in any one year by more
orAingeneral
his workpapers.
than 10 percent. This has been done to reflect that transferring revenues to a new entity would take Mr. Smith
time to accomplish.
AtEach
theof bottom
ofhas
this
page,assumptions
the T&Aregarding
reportto includes
boilerplate
aboutand
valuation
these tables
the same
cost of sales,
operating expenses
income
taxes. They are:
methodologies. It starts off by indicating “There are four general methods of valuation to
1.
Cost of sales is forecasted at 14.1 percent of sales based on the historic cost of sales.
2.
Operating expenses are forecasted as 41.9 percent of sales.
be considered in any valuation assignment, they are the asset, income, market data and
2.
Operating expenses are forecasted as 41.9 percent of sales.
cost
methodologies.”
When asked in his deposition, Mr. Jones could not point to a an
3.
We have
assumed
combined federal
state
tax rate
of 40 percent.
authoritative
source
that adiscusses
theseand
four
general
methods
of valuation. The valuation
Table 22 presents
the that
forecasted
statements
SRS for the years
ended March
9, 1996 through
2000
literature
indicates
thereincome
are only
three of
approaches
to business
valuation.
They
are
assuming a one percent loss of revenues due to competition from Mr. Smith.
the market approach, the income approach and the asset based approach. The asset
TABLE 22
based approach, formerlySRS’
had FORECASTED
been known as
the cost
approach, but the terminology was
INCOME
STATEMENTS
ASSUMING A 1 PERCENT LOSS IN REVENUES
changed a number of years ago. T&A refers to methods, however the appraisal literature
1996
1997
1998
1999
2000
$ 6,435,000
$ 7,271,550
$ 8,216,852
$ 9,285,042
$ 10,399,247
calls these approaches. Methods exist within the approaches. Despite the incorrect
Net Sales1
terminology,
there are not four general
(approaches),
three. It1,466,294
appears
Less: Cost of Sales
907,335methods
1,025,289
1,158,576 but only
1,309,191
Equals:
Profit lifted boilerplate
$ 5,527,665
$ 6,246,261 without
$ 7,058,275
$ 7,975,851
$ 8,932,953
that
T&AGross
merely
from somewhere
verifying
or understanding
Less: Operating Expenses
whether or not it was correct.
Less: Taxes
2,696,265
3,046,779
3,442,861
3,890,433
4,357,285
$ 2,831,400
1,132,560
$ 3,199,482
1,279,793
$ 3,615,415
1,446,166
$ 4,085,419
1,634,167
$ 4,575,669
1,830,268
NET
INCOME
$ 1,698,840
1,919,689
$ 2,169,249
$ 2,451,251
The
cost
approach is predominately
used in$the
valuation
of intangible
assets in$ a2,745,401
business
Note: Figures may be off due to rounding.
valuation setting. It is sometimes known as the cost to create approach, which is the
- -5151 recreation
of ain business
from scratch.
It is certainly
not one of
the used
approaches
to
1.
Sales
1996 haveasset
been multiplied
by 99 percent
of the $6,500,000
figure
in the noncompetition forecast analysis ($6,500,000 x .99 = $ 6,435,000). Thereafter sales have been grown
valuing an
entire
business.
This wouldforecast
not only
be impractical, it would also be cost
at the
rates used
in the non-competition
analysis.
prohibitive
for most businesses as every asset would have to have analysis performed
The next analysis assumes a 5 percent loss of sales from seller-based competition and is presented in Table
23. it to recreate it from scratch.
about
Once again, at the
TABLE 23
SRS’ FORECASTED INCOME STATEMENTS
ASSUMING
5 PERCENT
LOSS OF REVENUES
bottom
of this Apage,
in a discussion
of the asset
approaches, T&A
indicates “Book value represents1996
the accounting
of the business.
According
1997net equity
1998
1999
2000 to
1
generally
accounting$ principles
book
value is composed
historic
Net Salesaccepted
6,175,000 (GAAP),
$ 6,977,750
$ 7,884,858
$ 8,909,889of $the
9,979,076
Less: Cost of Sales
870,675
983,863
1,111,765
1,256,294
1,407,050
cost of assets minus liabilities, and is therefore not considered a measure of value.”
Equals: Gross Profit
$ 5,304,325 $ 5,993,887 $ 6,773,093 $ 7,653,595 $ 8,572,026
Despite
this comment, T&A nevertheless
used book value as one of the methods to value
ABC.
Less: Taxes
TANET
168
INCOME
2,587,325
2,923,677
3,303,755
3,733,243
4,181,233
$ 2,717,000
1,086,800
$ 3,070,210
1,228,084
$ 3,469,337
1,387,735
$ 3,920,351
1,568,140
$ 4,390,793
1,756,317
$ 1,630,200
$ 1,842,126
$ 2,081,602
$ 2,352,211
$ 2,634,476
Continuing
in inthe
same
asbyabove,
T&A
“Conversely,
book
1.
Sales
1996
have paragraph
been estimated
multiplying
theindicates
estimated 1996
sales in theadjusted
non-competition
scenario by 95 percent ($6,500,000 x 95% = $6,175,000). Sales thereafter are grown at the same
value represents
the fair market of the tangible assets and liabilities of the business. For
rates used in the non-competition scenario.
operating businesses, this is considered a good measure of the bare minimum bench mark
The next analysis assumes that 10 percent of sales were lost due to seller competition. This analysis is
presented
in adjusted
Table 24. book value method if properly performed should include intangible
price.” The
24 is being valued. At the end of the
assets, otherwise only a portion of theTABLE
company
discussion of the asset ASSUMING
approach Athe
T&A report
discusses
liquidation value. In fact, it
10 PERCENT
LOSS
OF REVENUES
states “This value is most often1996
used when1997
the business
current earnings
1998has no 1999
2000 or
prospects
only did$ T&A
use this
method, they
used it $incorrectly.
Net Sales1thereof.” However,$not
5,850,000
6,610,500
$ 7,469,865
$ 8,440,947
9,453,861
Less: Cost of Sales
932,081
1,053,251
1,332,994
have no appropriate
application 1,190,174
in a valuation
further
Once
again, using methods that824,850
Equals: Gross negligence
Profit
$ 5,025,150
$ 6,416,614 $ 7,250,774 $ 8,120,867
demonstrates
in the
valuation $of5,678,420
ABC.
2,451,150
2,769,800
3,129,873
3,536,757
3,961,168
$ 2,574,000
$ 2,908,620
$ 3,286,741
$ 3,714,017
$ 4,159,699
NET INCOME
$ 1,544,400
$ 1,745,172
$ 1,972,044
$ 2,228,410
$ 2,495,819
The
next
section discussed in this
report is 1,163,448
the income 1,314,696
approach. T&A
indicates:
Less:
Taxes
1,029,600
1,485,607
1,663,880
The most
common
techniques
Note: Figures
may be
off due to rounding.
under this methodology are : (sic) the
Price/Earnings Ratio Analysis, the Discounted Future Earnings, the
Capitalization of Excess Earnings, Capitalization of Earnings, the Dividend
Payout Ratio and a multiple of Gross Receipts.
- -5252 Once
again,
no valuation
treatise
that would
support1996
all of
these
methods
under
1.
Salesthere
in 1996ishave
been estimated
by multiplying
the estimated
sales
in the
non-competition
scenario by 90 percent ($6,500,000 x 90% = $5,850,000). Sales thereafter are grown at the rates
the income
A price/earnings
usedapproach.
in the non-competition
scenario. analysis, a multiple of gross receipts and using a
dividend
payout ratio are all market approach applications, not income approach
The next analysis assumes that 15 percent of sales are lost due to seller competition. This analysis is
presented in TableThis
25. is one more instance where T&A demonstrates its lack of knowledge
methodologies.
25
of business valuation. Even its report TABLE
boilerplate
is incorrect. To further support our
A 15 PERCENT
LOSS OF REVENUES
position, when asked inASSUMING
his deposition
about price/earnings
ratios and multiple of gross
receipts being part of the market approach
as1997
opposed to 1998
the income approach,
Mr.
Jones
1996
1999
2000
1
stated
(January
24, Page 178,$ line
12): $ 6,279,975 $ 7,096,372 $ 8,018,900 $ 8,981,168
Net Sales
5,850,000
Less: Cost of Sales
A.
I would say
questions.
824,850
885,476
1,000,588
1,130,665
1,266,345
5,025,150 $ 5,394,499 $ 6,095,783 $ 6,888,235 $ 7,714,823
that$that
– that is2,631,310
in the wrong
paragraph,
if that’s your
2,451,150
2,973,380
3,359,919
3,763,109
Less: Taxes
$ 2,574,000
1,029,600
$ 2,763,189
1,105,276
$ 3,122,404
1,248,961
$ 3,528,316
1,411,326
$ 3,951,714
1,580,686
NET INCOME
$ 1,544,400
$ 1,657,913
$ 1,873,442
$ 2,116,990
$ 2,371,028
When asked about the multiple of gross receipts, he stated (January 24. Page 178, line
25):
1.
1996 have
beenwith
estimated
by multiplying
estimated
1996 That
sales in
non-competition
A.Sales in
I would
agree
you on
the grossthereceipts
part.
is,the
again,
in
scenarios by 90 percent ($6,500,000 x 90% = $5,850,000). 1997 Sales are then grown by 13
the wrong paragraph.
percent, the rate of growth from the non-competition scenario. The result is then multiplied by 95
percent, to reflect the further 5 percent decrease in sales ($5,850,000 x 1.13 = $6,610,500 x 95% =
$6,279,975). Sales thereafter are grown at the rates of growth used in the non-competition scenario.
At the bottom of this page is a discussion about the cost method.
As previously
The next analysis presented assumes 20 percent of the sales volume of the former SRS locations is lost due
mentioned,
this method is applied to particular assets. The description included in this
to seller competition. This analysis is presented in Table 26.
business valuation report would be correct if it were being applied to a particular asset such
as a piece of
TABLE 26
SRS’
FORECASTED
INCOME
STATEMENTS
equipment. Functional, economic,
and
physical depreciation
ASSUMING A 20 PERCENT LOSS OF REVENUES
are the types
of depreciation that are considered by a machinery and equipment or real estate appraiser.
1996
1997
1998
1999
2000
Net Sales1
$ 5,850,000
$ 5,949,450
$ 6,722,879
$ 7,596,853
1,071,156
$ 8,508,475
1,199,695
$ 5,025,150
2,451,150
$ 5,110,578
2,492,820
$ 5,774,953
2,816,886
$ 6,525,696
3,183,081
$ 7,308,780
3,565,051
Less: Taxes
$ 2,574,000
1,029,600
$ 2,617,758
1,047,103
$ 2,958,067
1,183,227
$ 3,342,615
1,337,046
$ 3,743,729
1,497,492
NET INCOME
$ 1,544,400
$ 1,570,655
$ 1,774,840
$ 2,005,569
$ 2,246,237
If this method were being applied to value specific tangible assets, it would be correct, as
stated.
However,
context in838,872
the T&A report.
Less: Cost
of Salesit is totally out of
824,850
947,926
- -5353 TA
1. 169 Sales in 1996 have been estimated by multiplying the estimated 1996 sales in the non-competition
This
scenarios by 90 percent ($6,500,000 x 90% = $5,850,000). 1997 sales are then grown by 13 percent,
the rate of growth from the non-competition scenario. The result is then multiplied by 95 percent, to
reflect a further 10 percent decrease in sales ($5,850,000 x 1.13 = $6,610,500 x 90% = $5,949,450).
page
lists all of the methods that were used in this valuation, many of which are
Sales thereafter are grown at the rates of growth used in the non-competition scenario.
inappropriate for the valuation of ABC. Book value, adjusted book value and liquidation
The last analysis we present in our lost sales sensitivity analysis assumes that 25 percent of revenues at the
former
SRS no
locations
due
to seller competition.
This analysis
is presented
below in
Table 27.
value
have
placeisinlostthe
valuation
of ABC. Single
period
capitalization
models
such as
TABLE 27
the capitalization of earnings or the capitalization
of earnings before interest were
incorrectly applied. TheASSUMING
capitalization
of excessLOSS
earnings
is also incorrectly applied. The
A 25 PERCENT
OF REVENUES
discounted future earnings methods
were
applied
totally
1996
1997inconsistently
1998
1999and are
2000
unsupported.
Each of these $methods
be discussed
in our report
as we$ 8,083,051
reach the
Net Sales1
5,850,000 will
$ 5,949,450
$ 6,386,735
$ 7,217,010
Less: Cost of Sales
900,530
1,017,598
1,139,710
appropriate
schedule at the back824,850
of the T&A838,872
report.
$ 5,025,150
2,451,150
$ 5,110,578
2,492,820
$ 5,486,205
2,676,042
$ 6,199,412
3,023,927
$ 6,943,341
3,386,798
Less: Taxes
$ 2,574,000
1,029,600
$ 2,617,758
1,047,103
$ 2,810,163
1,124,065
$ 3,175,484
1,270,194
$ 3,556,543
1,422,617
TA 170
In NET
theINCOME
discussion of the capitalization
excess earnings
method,
T&A states
“The
$ 1,544,400 of
$ 1,570,655
$ 1,686,098
$ 1,905,291
$ 2,133,926
capitalization
of excess
method is the most widely used valuation technique.”
Note: Figures may
be off dueearnings
to rounding.
This
in thehave
T&A
report
is inaccurate.
While
this method
wasinwidely
used, it was
1. statement
Sales in 1996
been
estimated
by multiplying
the estimated
1996 sales
the non-competition
scenarios by 90 percent ($6,500,000 x 90% = $5,850,000). 1997 sales are then grown by 13 percent,
certainlythenot
most
widely
used method
of The
valuation.
Inmultiplied
fact, this
rate the
of growth
from
the non-competition
scenario.
result is then
by 90method
percent, tois
reflect a further 10 percent decrease in sales ($5,850,000 x 1.13 = $6,610,500 x 90% = $5,949,450).
predominately
used for small businesses and professional practices, hardly applicable to
Sales in 1998 are grown by 13 percent, as in the non-competition scenario, and then multiplied by 95
percent
to as
reflect
a further
percenttestified
decrease in
($5,949,450
x 1.13 = $6,722,875.50
x 95%
a business such
ABC.
Mr.5Jones
inrevenues
his deposition
(January
24, Page 195,
line
= $6,386,734.58, $6,386,735 rounded).
12) that “I’ve seen it in small and large businesses.” However, not only did T&A apply this
Having presented these analyses, the lost income calculated under each scenario is summarized in Table 28.
method incorrectly, it used the method despite the language that appears in Revenue
TABLE 28
Ruling 68-609 regarding this method.
SUMMARY OF LOST INCOME
FROM SELLER COMPETITION
Lost
RevenueRevenue
Ruling 68-609 is 1996
the outgrowth
of Appellate
Review Memorandum
34, C.B.2, 31
1997
1998
1999
2000
(1920). It was originally promulgated due to prohibition and the lost intangible value that
1 Percent
17,160
19,391
21,912
24,760
27,731
10 Percent
171,600
193,908
219,116
247,601
277,313
5 Percent
85,800
96,964and breweries.
109,558
123,801 also 138,657
would have
to be measured
for distilleries
Known
as the formula
approach,
Ruling
68-609 states
“The ‘formula’
not be used if
15Revenue
Percent
171,600
281,167
317,718 approach
359,022should402,104
20 Percent
171,600
368,425
416,320
470,442
526,895
there is better
evidence available
from368,425
which the value
of intangibles
can be
determined.”
25 Percent
171,600
505,062
570,721
639,207
The revenue ruling states “accordingly, the ‘formula’ approach may be used for determining
the fair market value of intangible assets of a business only if there is no better basis
- -5454 therefore
Despite
the the
fact
that
eventhe
the
originator
revenue
As can be available.”
seen in Table 28,
the greater
loss
of sales,
greater
the lossof
of this
income,
and as aruling
result, says
loss
of cash flow. The question that needs to be answered after an analysis like this is, what is the most likely loss
it of
should
not
used,
individuals
use it and
misuse
it order
on atoregular
basis.
revenue
thatbe
would
result
from the competition
of the
seller? In
answer this
question, we reviewed
numerous documents relating to this matter. We have highlighted that which we consider to be most relevant
to our analysis.
The
description in the T&A report, item number three, of the capitalization of excess
The deposition of John Byrnes provided us with a significant amount of relevant information. Mr. Byrnes is,
and was at
the time deviates
of the SRS from
acquisition,
Chief Operating
Officer of Lincare.
From his
is clear
earnings
method
the calculation
performed
on Schedule
IXdeposition,
on pageitTA
191.
that he is highly experienced in the respiratory therapy business as an industry insider.
The write up discusses the fact that a return on the adjusted book value should be taken
On page 4 of his deposition, Mr. Byrnes explained his involvement in the acquisition of SRS by Lincare. Mr.
Byrnes
indicated that he calculation
reviewed a “book”
from Mr.
business
brokers,
then attended
a meeting
but
the mathematical
included
inSmith’s
the report
is based
onand
a return
on book
value.
with the brokers, Ben Smith and Lori Daniels. Mr. Byrnes indicated the reason he went to the meeting was
Mr.
Jones
questioned
about the
thisbusiness
computation
theisSacks
trial.
Mr. Jones
was asked
“...to
see if was
Lori was
capable of running
herself.”at
This
significant
because
it demonstrates
that
Lincare believed Ms. Daniels to be a key individual in the operations of SRS.
and answered the following (Trial Transcript, Page 91, line 7):
When asked if he knew of SRS and Mr. Smith prior to their meeting in December 1994, he said “...we knew
who they were and we knew that they’re at four locations and were a good competitor.”
Q.
Tell the Court what net book value is.
Later Mr. Byrnes was asked “Why were you concerned about whether or not Ms. Daniels would be able to
run the company after the acquisition?” His response was “Because the feeling I got was that Mr. Smith
wasn’tA.
coming Net
in thebook
acquisition.”
Mr.the
Byrnes
was asked “Did
Lincare
have
an of
interest
in having Mr. Smith
value is
stockholders
equity,
if you
will,
the company’s
continue on with
the
business
in
some
capacity,
if
you
recall.”
Mr.
Byrnes’
reply
was
“No”,
“wevalue
did not have
balance sheet based on what amount of money is the asset
an interest.” This is a very clear statement that Lincare’s interest was in Lori Daniels and not in Ben Smith.
minus the liabilities.
Mr. Byrnes was asked what Ms. Daniels’s role has been from the acquisition forward. His response was “Her
Q.area manager.
And is the
value
toopened
the stockholder
title is an
Shenet
runsbook
the four
Smithequivalent
locations. We
up an Arcadiaequity?
office. She also runs
up through Ocala and Gainesville for us now. She has several locations that report to her.” Clearly Ms.
Daniels has shown the capabilities, not only to effectively run what was SRS, but also the ability to take on
A.
Yes.
these new locations, as well.
Andtheissource
that ofareferrals
commonly
usedrevenues
number
forcompany,
determining
excess
When Q.
asked about
that generate
for his
Mr. Byrnes
indicated that
half come from earnings?
doctors and half come from hospitals. Mr. Byrnes was asked how these referral relationships
were maintained. He replied, “In Smith's case, we continued to do exactly the same things that they were
doing. They had four or five sales reps who called on hospitals, the doctors, the nursing agencies, who were
Yes.
willing A.
to service
their indigent patients who provided a high level of service.” Mr. Byrnes was then asked, “Did
you attempt to ascertain as part of the due diligence who had been responsible for generating the doctors,
hospitals
referrals thataccepted?
Smith Respiratory had?”
Q. and nurse
Is it generally
Mr. Byrnes responded that Lincare had ascertained that information and “that it was the sales people who
A.in theYeah,
yes. Mr. Byrnes was then asked “Did you have any reason to believe that the
brought
business.”
relationships that existed with the doctors, nurses, and hospitals had been of long standing, namely initiated
and started by Mr. Smith himself?” Mr. Byrnes responded “There’s probably some in Plant City. But for the
other locations outside of Plant City, I think it was the salespeople he hired.” Mr. Byrnes was then asked a
series of questions regarding the percentage of business SRS derived from each of its locations. His
Inresponse
this instance,
T&A
violates proper valuation practice. Mr. Jones testified that using book
indicated
the following:
value as part of the excess earnings calculation is generally accepted. This is an incorrect
Plant City
25%
Sebring
15%
statement. The use of adjusted book value is generally accepted.
Lakeland
40%
Step 2 in PPC’s Guide to Business Valuations states “Determine the value of the
company’s net tangible assets.” This publication then continues “the model for the excess
- -5555 earnings method computes the
company’s equity value 80%
based on the ‘appraised’ value of
Total
tangible
assets, plus an additional amount for intangible assets.”
In regard to the Lakeland store, Mr. Byrnes was asked “did you attempt to ascertain or did you ascertain the
role that Mr. Smith individually had in initially establishing and having continuity in terms of the referral
relationship?”
At Mr. Jones’ deposition on January 24, 2005, he was asked about this method being
Mr. Byrnes answered “It was Judy Clark that got the business there.” Mr. Byrnes was asked how he was
aware of this
he small
responded
“because when
opened in Lakeland,
I was the
managerby
there
[For
applicable
toand
only
businesses
and he
professional
practices.
Hecenter
responded
stating
Lincare].” Mr. Byrnes further commented that he “...knew who was out calling on the docs.”
that it is also applicable to larger businesses. According to Guide to Business Valuations,
From all of these questions and answers, it is clear that Mr. Byrnes is well versed in the local markets where
inSRS
section
720.26,
entitled
Limitation
the Method,
operated,
and how
the Company
wasof
generating
its referrals. Mr. Byrnes’ concerns were about the
abilities of Lori Daniels, as discussed above. Mr. Byrnes was later asked what his determination of Ms.
Daniels’s abilities to run the locations was. He responded “I thought she could.” When asked why, Mr. Byrnes
said, “She knew what was going on. She knew where the business was coming from. She knew what was
The excess earnings method is often criticized because it applies primarily
going on in all four markets. And I just felt confident that she was on top of the business.”
to smaller businesses. It generally is not suited to larger or more complex
businesses
because
of its
mechanical
nature.who was specifically asked about the nonAnother
deposition that
was helpful
was
that of Mr. Deutsch,
compete agreement and how the value was derived. He responded as follows:
A. T&A
As demonstrates
you know, we’ve its
been
on of
a fairly
active acquisition
programby
fornot
a number
Once again,
lack
professional
competence
being of
aware of
years. From the beginning of 1991 through today, we’ve closed more than 70
the valuation literature.
acquisitions.
TA 171
In a very short
Working with our independent auditors, we have determined that during 1995, we
were basically allocating $50,000 per shareholder to the covenant. Because of the
size of this transaction, which was – the business was larger than the normal
business in the industry and larger than our normal acquisition, we felt it appropriate
to increase that from 50,000 to 100,000 in terms of allocation of the purchase price
to the covenant.
it was a standard
calculation
adjusted
for the size T&A
of thetells
section
entitled So
Conclusion
on Valuation
Factors
Discussed,
business that we arrived at working with our outside auditors.
the
reader that it placed more emphasis on certain methods than others. However, there is
Although one could construe this statement as indicating that Lincare applies a blind rule of thumb to the
of purchase
a non-compete,
do T&A
not believe
that is the are
case.also
As Mr.
Deutsch indicated,
noallocation
justification
as to price
whyfor
this
was done. we
The
workpapers
nonexistent
in that
his company is very experienced in acquiring other companies. Their method of allocating to a non-compete
regard.
problematic
reader,
particularly
since the
various auditors.
methodologies
is based This
on thisis
experience,
and asfor
he the
mentioned,
from
working with Lincare’s
independent
At some
point in this process, Lincare, with its outside accountants’ assistance, determined this to be an appropriate
reflected
theshould
T&A report
in such
a wide
of values.
measure.inThis
also be resulted
held up against
Lincare’s
taxdisparity
and accounting
incentives. An allocation of
purchase price to a non-compete agreement can be amortized over the life of the agreement. Goodwill on
the other hand, is amortizable for financial statement purposes over 40 years. In prior years, goodwill was
not next
at all deductible
for income
tax purposes.
Now, it can beDiscount.
amortized over
15 years.
The
paragraph
discusses
the Marketability
Once
again, T&A relies on
In addition, Lincare
is required by law,that
to submit
financial
statements with
to theother
Securities
and that
Exchange
management
for representations
thereitswere
discussions
entities
were
Commission because of its status as a publicly traded company. These financial statements must fairly
represent the
condition
of the company
and have
been audited
company’s
accountant,
interested
in financial
acquiring
an interest
in ABC.
However,
therebyistheno
analysisoutside
included
in the
KPMG Peat Marwick. In recording the allocation of purchase price, the company has a duty to fairly report
report
orshareholders,
in the T&A workpapers.
When
questioned
abouttothis
in his deposition,
Jones
it to its
and the independent
accountant
has opined
its fairness.
Given theseMr.
facts
and
circumstances, we do not believe that Lincare’s methodology is without merit.
indicated that there were two offers, one before the valuation date and one after the
The third Lincare deponent was Robert G. Abood, whose deposition pointed out two issues relevant to our
valuation
date.
market value
is suppose
to be
based
on what is known or
analysis. The
first Since
issue is fair
the importance
of Lori Daniels
to Lincare
in the
transaction.
knowable as of the valuation date, using subsequent information in the consideration of the
fair market value of ABC is incorrect. There also would need to be due diligence
- 56
-56-performed
such
offers
if they
wereorto
be
used, Employment
rather than
merely with
relying on
Q. regarding
Now, in that
regard,
is that
instrument
Ms.
Daniels’s
Agreement
Lincare pursuant to the terms of the agreement? Because I don’t know why, but I
management’swas
representations.
states did
thatnot
“...because
of the
‘put option’ on
of the impressionT&A
that also
Ms. Daniels
have a written
Employment
Agreement with Smith Respiratory.
stock held by an
ESOP, the lack of marketability appears to be substantially mitigated.”
A.
The problem
No. This is an Employment Agreement between Ms. Daniels and Lincare as a
condition
precedent to is
closing
with
this statement
that the
as acquisition.
of November 30, 1993, there was no ESOP.
Themeans
key is that
heratemployment
agreement
Lincare
a precondition
to the acquisition.
Lincare
This
that
the valuation
date,with
there
was was
no ESOP
and therefore,
there was
nowas
put
concerned with locking her into the deal from the very beginning.
option.
The second issue is over the negotiation of the individual asset values.
Q.
And did Mr. Gonzales or anyone on behalf of Mr. Smith make any suggestion as to
Even if T&A wanted
toallocation
consider
the be
putor option,
an employee
census
should
have been
what the
should
was the allocation
something
that was
the product
of Lincare?
reviewedA.to determine
any potential repurchase liability on behalf of the company. T&A’s
I do not believe anyone representing the seller or the seller himself made any
as to any
what such
the allocation
should
believe analysis
the processrelating
was we to the
workpapers didsuggestions
not include
census,
or be.
any I other
presented our good faith estimate of what the allocation should be and it was
by the seller
afterno
their
review.
marketability ofaccepted
these shares.
While
marketability
discount has been considered in the
The importance
of this response
neither Mr. Smith
nor his
on the allocation
valuation
calculations,
thereisisthat
inadequate
support
forrepresentatives
this position.commented
Using letters
of intent
of the asset values. This issue will be taken up again later in this report.
which Mr. Jones did not see, and considering only a unilateral offer that was rejected,
The fourth and final Lincare official deposed in this matter was Phillip Phenis. Mr. Phenis is Lincare’s
either
by ABC
or by was
the deposed
possibleforacquirer,
would
make poormore
justification
to support
the
controller.
Mr. Phenis
the purposes
of understanding
about Lincare’s
acquisition
process, and how Lincare values individual assets, particularly covenants not-to-compete.
marketability
of ABC.
Mr. Phenis established that Lincare does have a written policy as to how it allocates purchase prices. In
establishing this, he stated:
The last section on this page discusses Previous ABC Stock Transactions. T&A indicates:
We have – using the term “protocol” or methodologies as to how we – how we come up with
the end product of a purchase price allocation. That is, from the inception of the early – late
1990, ‘91 and ‘92 when we started acquiring businesses with our outside auditors, KPMG
Management
hasdeveloped
indicated
there has not been any recent transaction
Peat Marwick, we
thatthat
methodology.
involving the Corporation’s stock. The most recent transaction was in 1991
And it’s
applied overredeemed
that entire span
of our
acquisition
program
with very minor
when
thebeen
Corporation
a less
than
five percent
shareholder
no
adjustments, very few in form and very few in substance. It’s primarily the same
longer
employed
methodologies
fromby
thethe
timeCorporation.
I started with the company in 1993.
The important points in this statement are that the methodology has been developed with Lincare’s outside
Since
1991
was
only
two years
prior
tobeen
the valuation
thisvery
may
have
been relevant to
auditor,
KPMG
Peat
Marwick
,and that
it has
applied overdate,
time with
little
modification.
atMr.
least
test the value of ABC. Ignoring a stock transaction involving the company’s own
Phenis goes on further to discuss how covenants are valued, and what the trend has been over time.
stock violates the seventh factor that Revenue Ruling 59-60 suggests be considered.
A.
Revenue
And the covenant, which is the second item – ready to go to the next one? – if
in an
asset andthis
stock
Rulingyou’re
59-60
discusses
aspurchase,
follows: in each of those transactions, there is
normally – with an asset purchase, there is one or more persons that are the
influential persons in that business.
Sales of Instock
ofpurchase,
a closely
held corporation
should that
be are
carefully
investigated
a stock
certainly
there are shareholders
oftentimes
participants
in thewhether
business they
in ourrepresent
industry, and
they are the at
significant
influencing
persons
to determine
transactions
arm’s length.
Forced
or
involved
in
the
business.
distress sales do not ordinarily reflect fair market value nor do isolated sales
in small amounts necessarily control as the measure of value. This is
especially true in the valuation of a controlling interest in a corporation.
- -5757 Since, inWe
the
case
of closely
held
stocks,
no prevailing
market
prices
value
covenant
based on
the same
methodology,
the number
of persons
that are
are
th
involved
amount.
And thean
amount
in the case
March 9 ofIt1995
was
available,
there times
is no an
basis
for making
adjustment
forofblockage.
follows,
$100,000
for
the
significant
person
involved
in
the
Smith
Respiratory
acquisition.
therefore, that such stocks should be valued upon a consideration of all the
evidenceThe
affecting
the fair market value. The size of the block of stock itself
methodology of using a number of persons involved times a dollar amount has
is a relevant
to 1994
be considered.
Although
it is istrue
a minority
been infactor
place for
through today. The
only variation
that that
the dollar
amount
that
have assigned
to each of
thoseissignificant
persons
in the
business
has
interest in
anwe
unlisted
corporation’s
stock
more difficult
to sell
than
a similar
changed.
It’s
continued
to
slide
on
a
downward
scale.
block of listed stock, it is equally true that control of a corporation, either
actual orInin1994,
effect,
representing as it does an added element of value, may
we were valuing – when we were developing purchase price allocations, we
justify a were
higher
value
for a specific
block–of
stock.
looking
at businesses
and saying
and
we were buying from a different pool
of sellers.
Since the nature
a case,
closely
held
business
is isthat
there are
generally
very
few transactions
In of
this
I don’t
think
Mr. Smith
a doctor.
But in
‘94, we were
buying
many
physician-owned practices. And you would often be buying for more than one
in the company’s
own and
stock,
using
the assistance
of internal
transactions,
person,
there’s
a – there’s
12 shareholders.
We were
valuing thoseparticularly
in that time close
frame from 50 to $100,000 per person.
enough to the valuation
date, would be extremely helpful in testing a valuation conclusion.
Through
the middle
of ‘95, value
then wemay
started
change
the valuation
more in theinterest
Recognizing that
a minority
interest
notto be
reflective
of a to
controlling
value, it can
$25,000 per person; in 1996, more in the 10,000, where today and for the last 12 to
18
months, we’ve be
beenused
valuingtoeach
covenant
based on the numberofof persons
at
nevertheless
test
the reasonableness
the appraiser’s
$5,000 per person.
conclusion. There is no analysis included in the T&A workpapers, but this transaction is
Q.
Since that is truly the focus of our litigation, let me address that for a few moments.
outright dismissed
A.
Sure.as not being useful. To take this one step further, upon review of the
T&A workpapers,
did notnumber
see any
agreements
the buyout
ofused,
this shareholder.
Q.
Thewe
$100,000
or $50,000
number,regarding
or whatever number
may be
where
does that number come from?
This would
in the valuation
A. be a
It normal
is purelydocument
an estimaterequested
based on management’s
abilityprocess.
to estimate what this
covenant is valued to us internally.
There
TA
176are two factors in this statement. First, that the dollar amount assigned to each shareholder has
decreased through time. This indicates that Lincare has seen what it believes to be trends in the value of noncompete agreements, and has adjusted its valuations accordingly. This further supports the notion that
Lincare’s allocation is not arbitrary. Second, the value of the covenant is Lincare’s perception. This indicates
that as an active
participant
market
Lincare
does not
that the owning
individual
is highlyfrom
valuable
Beginning
at this
stagein this
of the
T&A
report
arebelieve
schedules
that were
printed
the
to the success of the business.
ValuSource computer program. T&A attached every schedule that the computer program
A review of the deposition transcript of Ben Smith also provides us with important information regarding the
was
capable
of generating,
or not
applicable
the valuation
of Smith
ABC.wasSome
covenant
not-to-compete.
From whether
reviewing Mr.
Smith’s
deposition to
transcript,
we feel Mr.
very
knowledgeable about his business and his industry. It appears that Mr. Smith has good marketing skills and
schedules
had computational
errors,
but since
failed to
calculations
for
is a very effective
teacher. These are
both important
skillsT&A
in developing
andreview
growingthe
a successful
business
in this industry. In addition, Mr. Smith describes the importance of his employees and the level of service
reasonableness,
and since T&A was unfamiliar with the workings of the software, these
provided to customers in the success of SRS. The deposition covers topics from opening new locations,
competition,
and key
employees,
and The
referral
development.
schedules
were
also
includedtoinmarketing
the report.
erroneous
calculations also were included
Smithfinal
was asked
about of
andvalue.
discussed
decided
to open
new locations.
factors
appeared
inMr.
T&A’s
indication
Wehow
willSRS
point
these
out when
we get Key
to the
appropriate
to be a geographic area with an elderly population, and a sufficient potential referral base. In answering a
question about how the actual decision process went, Mr. Smith said:
schedules.
We’d take all my marketing people and I would think I’d see an area I thought would be good.
I would visit it myself or I would have some kind of contact. And I would send all those
marketing reps into the area, and they would talk with doctors about who they were using or
- -5858 When Mr.
Jones
wasdoing
asked
in his
workpapers
whether
how
they were
or how
theydeposition
could be, youabout
know, his
handled
better by a and
company.
If wethere is
saw there was potential, then we would go there and open a facility.
a narrative explaining his analysis and conclusions, based on all of the schedules that were
Mr. Smith was
asked
openedhe
thestated
Sebring(January
location. He
responded:
produced
as part
ofwhy
thehereport,
25,
2005 page 8, line 14):
A.
A.
Despite this
Smith Respiratory continued to expand yearly looking for places that we thought we
had potential business. And I had looked at purchasing a company down there one
time and
didn’t.
And then I including
thought it would
a good opportunity
for Smith
to
don't
recall
a narrative
-- orbe
included
in our work
papers;
expand.
I
however, there are various calculations within our work papers.
So I expanded down there because I thought there would be some additional
business, which, in that business, as always, you look for an older population of
statement,
produced
thatthere.
include any analysis
people that no
had workpapers
some problems.were
That’s
why we moved
that is
covered by a narrative in the report.
Mr. Smith later discussed how Zephyrhills differed in respect to why it was opened.
TA 177
A.
No sir. We did that a little bit different than that. We had some doctors in Plant City
that also covered Zephyrhills. And so they were looking for some additional people.
They wanted better coverage up there. So that helped make – There’s more than
just one reason you would decide to go there, but that was one of the major reasons
to look at Zephyrhills.
This schedule includes the historic balance sheet comparison that is merely input into the
And, again, it’s an older population of people, which is what we were. We were
computer software
from the
company’s
financial
statements.
is no discussion in the
government,
Medicare
– you needed
older
people – olderThere
sick people.
T&A
report
the schedule.
There
are Employees
no T&A workpapers
that
an analysis
of
Training
is aabout
very important
part of SRS’
business.
who typically are
notreflect
highly skilled
when they
began their employment at SRS must be trained to deliver a high level of service to SRS’ patients. SRS’
this
schedule. Revenue Ruling 59-60 states the following:
employees were trained in how to educate patients in using oxygen and other equipment. Mr. Smith
discussed the training of these individuals in-depth.
A.
Itsheets
would beshould
delivered
the patient’spreferably
home, and they
would
educate
the patient in
Balance
betoobtained,
in the
form
of comparative
how the doctor prescribed the oxygen for him, and how the equipment worked.
annual statements for two or more years immediately preceding the date of
appraisal,
together
balancethat
sheet
at the
end in
ofyour
theoperation
month preceding
Q.
Okay.
Would with
this bea someone
had been
trained
to do this?
that
if corporate
accounting will permit. Any balance sheet descriptions
A. date,
Yes,
sir.
Q. areThis
be someone outand
of thebalance
labor poolsheet
–
that
notwouldn’t
self-explanatory,
items comprehending
A.
No.
diverse assets or liabilities, should be clarified in essential detail by
supporting
schedules.
Q.
– insupplemental
Tampa or Lakeland,
would it? These statements usually will disclose
toA.the appraiser
(1) liquid position (ratio of current assets to current
No.
liabilities); (2) gross and net book value of principal classes of fixed assets:
Q.working
Thiscapital:
would be(4)
someone
that you
would recognize
havingstructure;
the degreeand
of skill
long-term
indebtedness;
(5) as
capital
(6)
(3)
necessary to –
net
also should
beatgiven
to any to
assets
noteverybody
essential
to
A. worth.
WeConsideration
had constant education
programs
the company
educate
that
the operation
of the business,
such
investments
securities,
realphase
estate,
came onboard.
They all had
to goas
through
a trainingin
period
or a training
to
do
anything
that
was
related
to
our
company,
whether
it
would
be
install
a
bedside
etc. In general, such nonoperating assets will command a lower rate of
commode
or a walker.
And we
were governed
by the
commissions,cases
which said
return than
do the
operating
assets,
although
injoint
exceptional
the
that we were doing it in a proper safe manner for the patient.
reverse may be true. In computing the book value per share of stock, assets
ofQ.the investment
type should
They were skilled
people? be revalued on the basis of their market price
and
bookyouvalue
accordingly.
Comparison
theyoucompany’s
A. the Well,
know,adjusted
you don’t hire
them skilled. You
hire them andof
then,
know, train
to doover
the job.
So youyears
weren’tmay
respiratory
therapists
you know,
physical
balance them
sheets
several
reveal,
amongor,other
facts,
such
therapists or nurses, no, sir.
developments as the acquisition of additional production facilities or
subsidiary companies, improvement in financial position, and details as to
- -5959 -59Q.
Was
a
between
truck
driver
the
who
actually
recapitalization
other changes
in the
structure
of the
Q.
Was there
thereand
a difference
difference
between the
the
truckcapital
driver and
and
the person
person
whocorporation.
actually took
took
the
tank
to
the
patient?
the
tank
to
the
patient?
If the corporation has more than one class of stock outstanding, the charter
A.
No.
No. of incorporation should be examined to ascertain the explicit
orA.certificate
rights
privileges
of the
stock
issues
including:
(1) voting
Q.
Would
that
that
was
by
–
he’d
know
how
Q. and
Would
that person
person
thatvarious
was trained
trained
by you
you
– of
of course,
course,
he’d already
already
knowpowers,
how to
to
drive
a
truck,
but,
obviously,
that
person
be
trained
by
you,
then,
to
take
the
tank
(2) preference
as
to
dividends,
and
(3)
preference
as
to
assets
in
the
drive a truck, but, obviously, that person be trained by you, then, to take theevent
tank
inside
inside and
and help
help the
the patient?
patient?
of liquidation.
A.
A.
Yes,
Yes, sir.
sir. Me
Me or
or my
my staff
staff trained
trained them.
them. Ninety
Ninety percent
percent of
of them
them II have
have trained
trained myself.
myself.
Q.
Q.
Was
Was there
there some
some sort
sort of
of formalized
formalized training
training you
you gave
gave them?
them? In
In other
other words,
words, did
did you
you
have
some
sort
of
brochure
you
followed
or
was
it
just
based
on
your
experience
have some sort of brochure you followed or was it just based on your experience in
in
the
business?
the discussion
business? in Revenue Ruling 59-60, T&A failed to analyze this balance
Despite the clear
A.
Well,
A.
Well, initially
initially when
when we
we first
first did
did it,
it, itit was,
was, you
you know,
know, based
based around
around our
our experience
experience the
the
way
–
but
when
we
became
JCO
certified
or
joint
commissioned,
we
sheet. Mr. Jones
in his
deposition
whatorthe
reason
was thatthen
cash,
reflected in
waywas
– butasked
when we
became
JCO certified
joint
commissioned,
then
we had
had
protocol
protocol that
that you
you had
had to
to follow,
follow, and
and itit was
was a
a written
written procedure.
procedure. We
We had
had a
a policy
policy and
and
manual
that
we
–
Lori
Daniels,
matter
of
fact,
wrote
our
policy
and
the December procedure
1991
financial
statements
as
$961,000,
was
considerably
higher
procedure manual that we – Lori Daniels, matter of fact, wrote our policy
andthan any
procedure
manual
that
joint
commissions
came
in
and
inspected
us
and
said,
yes,
procedure manual that joint commissions came in and inspected us and said, yes,
we’re
proper
with
the
precautions
that
other year in the
fivefollowing
years presented.
Without
workpapers,
heeverything
could only
we’re
following
proper procedure
procedure
with all
allproper
the safety
safety
precautions and
and
everything
thatrespond
should
be
done
to
maintain
the
health
and
safety
for
the
patients
with
the
equipment.
should be done to maintain the health and safety for the patients with the equipment.
as follows (January 25, 2005, Page 9, line 3):
The
The quality
quality of
of the
the services
services provided
provided by
by SRS
SRS differentiated
differentiated the
the Company
Company from
from its
its competition.
competition. In
In discussing
discussing
the
quality
of
the
services
provided
compared
to
its
competition,
Mr.
Smith
felt
that
SRS
was
superior
the quality of the services provided compared to its competition, Mr. Smith felt that SRS was superior in
in all
all
respects.
respects.
A.
A.
A.
I don't recall a specific reason for that.
Not
Not a
a chance.
chance.
Q.
Is
of
you
provided
Q. pressed
Is this
this because
because
of the
the better
better
training
youanalysis
provided your
your
people?
When being
as to whether
ortraining
not any
waspeople?
done to determine why cash
A.
A.
was so high in
9, line 19):
Q.
A.Q.
A.
A.
Q.
II think
think itit was
was better
better training
training and
and just
just simply
simply the
the way
way we
we maintained,
maintained, you
you know,
know, our
our
equipment.
And
there
was
just
never
a
question
just
from
the
physicians
and
this period,And
thethere
questions
and answers
asthe
follows
(January
equipment.
was just never
a question were
just from
physicians
and the
the25,
patients
patients themselves
themselves and
and the
the referrals
referrals from
from social
social services
services workers
workers at
at hospitals,
hospitals,
nurses
nurses at
at hospitals.
hospitals. Your
Your patients
patients and
and word-of-mouth
word-of-mouth back
back to
to the
the physicians
physicians is
is what
what
built
Smith
Respiratory
Services.
built Smith Respiratory Services.
Page
And that’s what I was going to ask you. Is it this quality of services that you – to
And that’s what I was going to ask you. Is it this quality of services that you – to
Well,
we
obviously
looked
atsuccess
the trends
andRespiratory
the relationships
between
which
of
Services
which you
you attribute
attribute the
the obvious
obvious success
of Smith
Smith Respiratory
Services in
in these
these
areas?
the
assets.
Also,
the
-the
current
liabilities
went
up
a
significant
areas?
II think
gave
best
out
yes,
must
pretty
think we
weduring
gave the
thethat
bestsame
out there,
there,
yes, sir.
sir.
Lincare
must think
think we
weagave
gave
pretty good,
good,
amount
period
of Lincare
time, effectively
borrowing.
too,
too, because
because they
they still
still carry
carry our
our name
name in
in several
several of
of the
the locations.
locations. Even
Even though
though they
they
bought
my
company
they
still
have
my
name
on
it.
bought my company they still have my name on it.
That wasn't my question. My question is, did you determine why cash
Mr.
of
relating
competition
companies
in
business.
wasaa series
so high
in December
1991,
and iffrom
so,other
is there
an analysis
of that
Mr. Smith
Smith answers
answers
series
of questions
questions
relating to
to
competition
from
other
companies
in the
the oxygen
oxygen
business.
Through
his
responses,
he
indicated
that
he
did
not
believe
any
of
the
independent
companies
in
his
Through his responses,
indicated
that he did not believe any of the independent companies in his industry
industry
in your he
work
papers?
offered
offered any
any significant
significant competition
competition to
to SRS.
SRS. Mr.
Mr. Smith
Smith described
described SRS’
SRS’ competitive
competitive advantage
advantage as
as taking
taking care
care
of
patients.
of patients.
A.
What
There would not be a specific analysis for that individual line item in
so
you
got
paper.based
soour
youwork
got business
business
based around
around what
what your
your ability
ability –
– the
the physician,
physician, he
he wanted
wanted his
his
And
And
patients
patients taken
taken care
care of.
of. II mean,
mean, that’s
that’s what
what he
he was
was looking
looking for.
for. So
So whoever
whoever gave
gave the
the best
best
care
to
his
patients
is,
you
know,
who
he’s
normally
going
to
use.
And
so
it
care to his patients is, you know, who he’s normally going to use. And so it was
was a
a
combination
of
things,
and
years.
We
didn’t
took
us,
is the ItItfact
little-to-no
became
obvious
review
of the
T&A
things,
and itit was
was
years.
Weworkpapers
didn’t do
do itit overnight.
overnight.
took that
us, you
you
combination
of a
a lot
lotinof
of our
know,
know, 13
13 years
years to
to build
build that
that business.
business.
analysis was done by T&A in performing this valuation. This was little more than an
In
In addition
addition to
to providing
providing high
high quality
quality service
service to
to patients,
patients, Mr.
Mr. Smith
Smith believed
believed itit was
was crucial
crucial to
to market
market these
these
exercise
ofpotential
inputting
numbers
a computer
system
that they
were unfamiliar
with,
and
services
referral
sources.into
When
asked, Mr.
Mr. Smith
Smith
discussed
the importance
importance
of marketing
marketing
and the
the
services to
to
potential
referral
sources.
When
asked,
discussed
the
of
and
marketing staff to SRS.
marketing staff to SRS.
seeing
what the result was that came out. It appears that they then massaged the
-60- 60 -
weightings
methodologies,
if inappropriate
to do so,
to derive
a value that
A. of different
My marketing
people met witheven
me, not
just – We had a meeting
every
week. There
is no question about it. But it was daily that my marketing people would get on their
had already been
through
thein scenarios
were
performed
radiodetermined
or they had mobile
phones
their car, thatthat
I talked
to them
constantlyprior
about,to being
know, this position, you need to do this. You need to do this. You need to do
hired to performyou
the
valuation assignment.
this hospital.
Regarding
So my marketing people were in constant contact with me every day. My marketing
people
backbone Mr.
and center
of this
whole
thing. why
So didaccounts
I spend the payable-trade
majority
the sameis the
schedule,
Jones
was
asked
of my time with my marketing people? There is no question about that.
increased so substantially over the other years. His response was (January 25, Page 12,
line 13):
A.
Q.
A.
I’m just simply talking about going outside and making sure everything got done. But
my marketing people, that’s the backbone of all this company. And if you’ll check
with Rotech and Bill Kennedy – and that’s what I did when I went to work for Rotech.
I trained the marketing people. That was my job with them, is to hire and train
marketing people and then to expand my philosophy of how to do business
Again,
I – that
number
came from their audited financial statements
throughout
the Rotech
system.
that we used to input – we didn’t enquire specifically about that one
How many marketing people did you meet with when you would meet weekly?
account.
Whatever number we had. So what was it? Five maybe.
Q. reasons
That’swhy
whatappraisers
I’m asking. I create
don’t know.
One of the
a comparative spreadsheet with multiple years
A.
Yes, sir.
is to examine the trends that took place.
Q.
This allows the appraiser to question
Would that include Lori Daniels or was she in addition to the marketing people that
management about
that
you’reitems
referring
to?may be considered to be inconsistent or an aberration. T&A
A.
Lori was a business director. That was her title. But it was not unusual for me to
blindly accepted
theLori.
financial
performing
any analysis.
schedule
send
If I hadstatements
a big luncheonwithout
somewhere,
if I had a special
deal goingThis
on with
a doctor, would I send Lori into one of the doctor’s offices with the marketing person?
also lists non-operating
assets,
but,for
once
is no
documentation
Yes. That wasn’t
unusual
her toagain,
do that.there
It wasn’t
unusual
for me to go to in
onethe T&A
workpapers formyself.
this item. Mr. Jones stated (January 25, Page 15, line 11):
The key to referrals is developing relationships with doctors, nurses, social workers, and certain hospital
personnel. Mr. Smith was asked about how significant referral sources were developed. His response to that
question
A. was: Not a specific workpaper, again. Just based on the information they
A.
had provided from their financial statements, that’s what we were told
How you develop it was, it’s a combination of a lot of things, but a lot of it depends
it on
was.
was property
held
when you
firstfor
did expansion.
what you said you were going to do back in
your Itreputation
1981, when Smith Respiratory first started. You had to do what you said you were
going to do.
TA 178
And one of the things that helped us more than anything is, we went out and we said,
“We will have equipment in a patient’s home within the hour.” And so it was a
that you built over years of doing exactly what you said you were going
Schedule III isreputation
a Summary
Historic Income Statement Comparison that contains
to do and taking care of patients better than anybody else could take care of it. And
that reputation
rested, in
honest
to God,
Ben Smith,
because
it was Smith
mislabeled columns.
The dates
the first
twowith
columns
indicate
December
1989 and
Respiratory.
December 1990, when the time periods actually reflected February 1989 and 1990. There
Referral development was discussed further with Mr. Smith.
is no footnote or discussion that allows the reader to know that ABC changed its fiscal year
Q.
When you – your sales personnel would call on a physician or a hospital, did you
A.
That was their job. So anything that they did – They might do a talk for a nursing
from February to
December,
and as ina referral
result,development
there is a gap
inpoint?
the five year period covered
regard
them as engaging
at that
by these financial
statements.
service.
They might go to a nursing service and put on a demonstration. They
- -6161 -61-61would
take a
driver with
them and
they
would
do, you
know, a
demonstration of
how
would
a
with
and
they
would
you
a
of
how
would take
take
a driver
driver would
with them
them
and
they
would do,
do,
you know,
know,
a demonstration
demonstration
of
how
oxygen
equipment
work,
or
if
a
nursing
service,
you
know,
wasn’t
sure
where
oxygen
equipment
would
work,
or
if
a
nursing
service,
you
know,
wasn’t
sure
where
oxygen
equipment
wouldhow
work,
or if a nursing
service,
youmarketing
know, wasn’t
sure
where
the
low
air
loss
mattress
it
worked,
we
would
use
our
people
to
go
put
the
low
air
loss
mattress
how
it
worked,
we
would
use
our
marketing
people
to
go
the
low
air
loss
mattress
how
it
worked,
we
would
use
our
marketing
people
to
go put
put
on
a
demonstration
for
a
nursing
service.
on
on a
a demonstration
demonstration for
for a
a nursing
nursing service.
service.
TA 179
This is continuation of Schedule III reflecting the Adjusted Summary Income Statement
Mr.
Mr. Smith
Smith clearly
clearly believed
believed that
that marketing
marketing was
was the
the key
key to
to his
his business,
business, as
as he
he said:
said:
Mr. Smith clearly believed that marketing was the key to his business, as he said:
Comparison.
As discussed previously, T&A made adjustments to officers’ compensation.
Everything
Everything that
that you
you do
do is
is a
a marketing.
marketing. Anything
Anything that
that you
you do
do good
good is
is going
going to
to be
be considered
considered
Everything
that
youSo
do everything
is a marketing.
Anything
that you do
good
is going
to bethat
considered
This schedule
reflects
of compensation.
There
is no
a
tool.
that
did
making
sure
a marketing
marketing
tool.the
Soadjusted
everythinglevel
that we
we
did is
is geared
geared around
around
making
surejustification
that we
we get
get for the
a marketing tool. So everything that we did is geared around making sure that we get
referrals.
referrals.
referrals.
adjustment
to officers’ salaries and there are no workpapers to support any such level
of
The
discussion
moved
on
to
the
subject
of
key
personnel.
One
of
the
key
individuals
at
SRS
was
Lori
The discussion
discussion moved
moved
on to
to the
the there
subjectisof
ofno
keyanalysis
personnel.
One
of the
the key
key
individuals
at SRS
SRS was
was that
Lori
The
on
subject
key
personnel.
One
of
at
Lori
compensation.
Furthermore,
inresponded:
the report,
orindividuals
in the workpapers,
Daniels.
When
asked
to
describe
her
role
at
SRS,
Mr.
Smith
Daniels.
When
asked
to
describe
her
role
at
SRS,
Mr.
Smith
responded:
Daniels. When asked to describe her role at SRS, Mr. Smith responded:
explains A.the fact
that
thestarted
adjusted
net
income
increases
from
$442,000
torun
almost
$4.8
Lori
Daniels
to
work
for
me
in
Lakeland
for
$5
an
hour
as
a
person
to
the
A.
Lori Daniels
Daniels started
started to
to work
work for
for me
me in
in Lakeland
Lakeland for
for $5
$5 an
an hour
hour as
as a
a person
person to
to run
run the
the
A.
Lori
Lakeland
store.
And
from
there
she
developed
and
was
trained
and
aggressive
Lakeland
store.
And from
from
thereis
she
developed
and about
was trained
trained
and aggressive
aggressive
million over thisLakeland
five year
period.
There
nodeveloped
discussion
the trend
in earnings or
store.
And
there
she
and
was
and
about,
and
she
ended
up
being
the
director
for
the
business.
She
ran
the
about, and
and she
she ended
ended up
up being
being the
the director
director for
for the
the business.
business. She
She ran
ran the
the
about,
businesses
just
like
I
would
have
done
from
years
and
years
of
training.
impactbusinesses
would bejust
of like
thisII would
type of
growth
on
the
net
income
of
ABC.
What
appears
businesses
just
like
would
have
done
from
years
and
years
of
training.
have done from years and years of training.
what the
good
is.
this
regional
manager
for
to be extremelyHow
unusual,
and
yet just
it iswas
notpromoted
discussed
in theto
the workpapers,
How
good she
she
is. She
She
just
was
promoted
this week
week
to report
regionalor
manager
for Lincare.
Lincare. is the
How
good
she
is. She
justother
was than
promoted
this week
to Florida.
regional manager
for all
Lincare.
She
has
the
highest
job,
the
CEO,
here
in
She
covers
of
the
She has
has the
the highest
highest job,
job, other
other than
than the
the CEO,
CEO, here
here in
in Florida.
Florida. She
She covers
covers all
all of
of the
the
She
fact that from 1992
tooperations
1993, revenues
are is
approximately
$350,000
different,
and
Florida
for
them,
which
their
largest,
by
far,
dollar
volume
dollarwise
in
Florida
operations
for
them,
which
is
their
largest,
by
far,
dollar
volume
dollarwise
in yet the
Florida
operations
for
them,
which
is
their
largest,
by
far,
dollar
volume
dollarwise
in
their
company.
So
how
good
is
she?
That’s
how
good
she
is.
their company.
company. So
So how
how good
good is
is she?
she? That’s
That’s how
how good
good she
she is.
is.
their
profitability almost
doubled.
Operating
expenses
dropped
from
$7,892,000
to $5,683,000
Q.
A.
A.
What were her duties with SRS, Smith Respiratory Services?
Yes, sir.
sir. Well,
Well, she
she started
started out,
out, like
like II said,
said, as
as a
a customer
customer service
service person,
person, and
and then,
then,
Yes,
you
know,
from
there,
for
different
jobs,
in
charge
of
billing.
And
just
finally,
her
title
you
know,
from
there,
for
different
jobs,
in
charge
of
billing.
And
just
finally,
her
title
lackyou
of know,
analysis
regarding
this
schedule.
fromherself
there,whatever
for different
jobs,
in charge
of billing.
And
just finally, her title
–
I
let
her
call
she
wanted
to
–
was
director
of
business.
–
I
let
her
call
herself
whatever
she
wanted
to
–
was
director
of
business.
– I let her call herself whatever she wanted to – was director of business.
Q.
What were
wereas
hertoduties
duties
with
SRS, Smith
Smith
Respiratory
Services?
Q.
What
her
with
SRS,
Respiratory
Services?
without any
what
caused
these
expenses
to service
drop so
significantly.
A. discussion
Yes, sir.
Well,
she
started
out, like
I said,
as a customer
person,
and then, There
is clearly a
TA 180
This
Q.
Q.
Q.
A.
A.
A.
Was
that
her
title
as
of
December
of
1994?
Was that
that her
her title
title as
as of
of December
December of
of 1994?
1994?
Was
Yes,
sir.
Yes,
sir.
Yes, sir.
st
Okay.
And
what
were
her
duties
as
of
December
31
1994?
Okay. And
And what
what were
were her
her duties
duties as
as of
of December
December 31
31stst,,, 1994?
1994?
Okay.
She
had,
you
know,
combination
of
everything,
to
make
sure that
–
you
know,
same
She
had,
you
know,
combination
of
everything,
to
make
that
–
you
know,
same
She
had, the
you
know,
combination
of everything,
to
make sure
sure
that
–marketing
youfigures
know,people
same
reflects
adjustments
made
to
the
historical
financial
to arrive at
as
I
would
do.
The
drivers
did
what
they
were
supposed
to,
the
as
I
would
do.
The
drivers
did
what
they
were
supposed
to,
the
marketing
people
as
I
would
do.
The
drivers
did
what
they
were
supposed
to,
the
marketing
people
did
what
they
were
supposed
to,
billing,
that
we
collected
our
money.
did what
were
supposed to,
that
we
our
money.
what they
theyIn
were
to, billing,
billing,
thatsalaries
we collected
collected
our adjusted
money.
netdidincome.
thissupposed
instance,
officers’
were
anywhere from
Q.
Q.
Q.
A.
A.
A.
schedule
the adjusted
She met with – Every time we had a marketing meeting, she was part of that. If I had
a
meeting
with
drivers,
she
part
of
If
II had
a
with
drivers,
she
was
a
meeting
with
drivers,
she was
was
part send
of that.
that.
If to
had
aI meeting
meeting
with
drivers,
she
was
part
of
that.
Many
a
times
II would
her
–
if
couldn’t
go
to
run
one
of
the
part
of
that.
Many
a
times
would
send
her
to
–
if
I
couldn’t
go
to
run
one
of
the
compensation operations
specialist,
Mr.
Jones,
admitted
in
his
deposition
that
he
was
run
one
of
the not an
part
of that.that
Many
a
times
I
would
send
her
to
–
if
I
couldn’t
go
to
I
had
problems,
I
would
send
her
to
Sebring
or
send
her
to
Lakeland
operations
that
I
had
problems,
I
would
send
her
to
Sebring
or
send
her
to
Lakeland
operations
that
I
had
problems,
I
would
send
her
to
Sebring
or
send
her
to
Lakeland
or
send
her
tovocational
Zephyrhills to
handle
a
situation that,
know,
time
to
or
her
handle
a
you
know,
didn’t
have
time
employment expert
nor
25, you
Page
25,III didn’t
lineshave
14 and
16). Mr.
or send
send
herato
to Zephyrhills
Zephyrhills to
toexpert
handle (January
a situation
situation that,
that,
you
know,
didn’t
have
time to
to
get
to.
get
to.
get to.
She
met
–
Every
time
had
a
meeting,
she
part
of
that.
If
had
She
met
with
– drivers,
Everyfor
time
we
had
a marketing
marketing
she was
was
part
ofhis
that.
If II was
had
$519,000 to almost
$3with
million
awe
single
year.
about
expertise
as a
a
meeting
with
she
was
part
of that. When
If Imeeting,
had aasked
meeting
with
drivers,
she
Jones was questioned about the level of compensation that was estimated in light of the
So
So she
she did
did the
the same
same kind
kind of
of things
things that
that II would
would have
have done
done if
if II couldn’t
couldn’t get
get to
to them,
them,
Soshe
shewas
did the
same
kind Iofwanted
things done.
that I would
have
done
if I couldn’t
to would
them,
what
Like
CEO
would
do,17):
thatget
they
or
a
part
of what
extraordinary level
ofwas
profitability
of ABC
(January
25,any
Page
26,
line
or
a
or she
she was
a part
part of
of what II wanted
wanted done.
done. Like
Like any
any CEO
CEO would
would do,
do, that
that they
they would
would
Q.
A.
pass down
down to
to a
a president
president or someone
someone under them
them to do
do things that,
that, you know,
know,
pass
pass down
todone.
a president or
or someone under
under them to
to do things
things that, you
you know,
needed
to
be
needed
needed to
to be
be done.
done.
Okay.
My––only
question
isthings
it looks
officers
are doingshe
a good
So did
did she
she
One of
of
the biggest
biggest
things
she like
ever the
did for
for
Smith Respiratory,
Respiratory,
she
wrote
So
One
the
she
ever
did
Smith
wrote
So
did
she
–
One
of
the
biggest
things
she
ever
did
for
Smith
Respiratory,
she
wrote
job
by
increasing
adjusted
net
income,
but
you
don’t
increase
any
a
manual
–
policies
and
procedures
manual
which
was
for
joint
commissions
when
a
manual
–
policies
and
procedures
manual
which
was
for
joint
commissions
when
a
manual
–
policies
and
procedures
manual
which
was
for
joint
commissions
when
we
decided
that
we
needed
to
be
joint
commissioned.
Lori
actually
gathered
the
officers
salary,
do needed
you? to
we
that
we decided
decided
that we
we
needed
to be
be joint
joint commissioned.
commissioned. Lori
Lori actually
actually gathered
gathered the
the
information and
and put
put this policy
policy and
and procedure
procedure manual
manual together
together that
that II would
would have
have had
had
information
information
and puttothis
this
policy
and
procedure
manual
together
thatjob.
I would
have
had
to
spend
$25,000
get
done.
She
did
it
for
me
in
addition
to
her
She
did
it
on
to
$25,000
to
done.
did
for
her
She
did
on
to spend
spend
$25,000
to get
get again,
done. She
She
did itit assuming
for me
me in
in addition
addition
toyou
her job.
job.
Shepay
did ititthe
on
We
didn’t,
because,
it was
whatto
would
unrelated – an unrelated individual to come in and do their job.
- -6262 -62andthe
what
She
weekends
at
times.
So
did
do?
This does not the
reflect
whatand
happens
real
world.
When
officers
are did
doing an
the
weekends
and
at night
night in
and other
other
times.
So what
did she
she
do? She
did
everything.
everything.
everything.
extraordinary job, there is generally a bonus that is tied to some level of profitability. To
Q.
Q.
Did
Did she
she have
have any
any responsibilities
responsibilities concerning
concerning the
the referral
referral development?
development?
expect the
officers
to work for $600,000 when they are generating $4.8 million of net
A.
Absolutely.
A.
Absolutely.
income, Q.
more than
that of the year before, does not make sense.
What double
were those?
Q.
A.
A.
What
those?if we had a marketing – If one of the marketing people needed her
Again,were
you know,
Again,
you
know,
if we
a marketing
– If go
onefrom
of the
needed
her
to help support them
inhad
some
way, did Lori
themarketing
office intopeople
physicians’
offices
to
help
support
them
in
some
way,
did
Lori
go
from
the
office
into
physicians’
offices
and take care of whatever needed to be done? Yes.
and
take care
whatever
to be done?
Yes.
It should also be
noted
thatofT&A
usesneeded
a marginal
tax rate
34 percent to adjust the expense
Q.
What was –
adjustments
inwas
this
schedule.
Elsewhere in the report, T&A uses different tax rates.
Q. made
What
– her
A.
That wasn’t
major – That was not her major job, no.
A.
A.
That
That wasn’t
wasn’t her
her major
major –
– That
That was
was not
not her
her major
major job,
job, no.
no.
This is one more inconsistency in the T&A report.
Q.
Q.
A.
A.
What was her major job?
What
was
job? part would have just been one of the 10 other things that
All
of it.
Buther
themajor
marketing
All
of
it.
But
the
marketing
part would
just been one
of the
10 she
otherwas
things
she did. Her job was to make
sure have
that everything
there
– that
partthat
of
she
did.
Her
job
was
to
make
sure
that
everything
there
–
that
she
was
partthat
of
everything
that
went
on.
Somebody
that
you
can
count
on
if
you’re
not
there,
There are no workpapers
for the non-operating asset. There are also no workpapers
to
everything that went on. Somebody that you can count on if you’re not there, that
you
know
is
going
to
do
everything
that
you
would
do,
and
make
sure
that
if
you
did
you knowor
is income
going to do
everything
that
younon-operating
would do, and make
sureThe
that ifnon-operating
you did
discuss any expenses
that
relate or
to
the
asset.
go
go on
on vacation
vacation or
or you
you did
did go
go skiing
skiing or you
you did
did something,
something, that
that you
you knew
knew itit was
was going
going
to
get
done
right.
to
get
done
right.
asset was eventually described as real estate, which indicates, at a minimum, that there
Mr. Smith felt that there were several key people at SRS in addition to Ms. Daniels, as indicated in the
Mr. Smith
felt estate
that there
were and
several
key people
at SRS in addition
Ms. Daniels,
as indicatedIfinnonthe
must
be real
taxes
some
costs associated
with toholding
the property.
following
discussion.
following
following discussion.
discussion.
operating assets are removed from the balance sheet, non-operating expenses should be
Q.
Q.
removed from
A.
A.
Who
Who did
did you
you regard
regard as
as the
the management
management personnel
personnel of
of Smith
Smith Respiratory
Respiratory Services
Services
in
December
of
‘94,
other
than
yourself,
obviously?
the
incomeof statement.
This would
not be a necessary expense
in
December
‘94, other than yourself,
obviously?
The
The key
key people?
people?
in the
normal course of operations by its very definition. However, T&A ignored this item.
TA 182
Q.
Q.
A.
A.
Yeah.
Yeah.
Key people at that point was Lori Daniels, all of my marketing people. Judy Clark
Key people
at that point
Lori Daniels,
alltremendous
of my marketing
people. Judy Clark
was
really important.
Nowas
question.
She had
–
was really important. No question. She had tremendous –
Q.
Q.
A.
A.
She is one of those four or five marketing people?
She
oneJanie
of those
four
or five marketing
people?
Yes. isAnd
Wey;
tremendously
important.
Yes. And Janie Wey; tremendously important.
Q.
Another one of the marketing people?
ScheduleQ. IV isAnother
an Historic
Flow Comparison, comparing the owners’
one of theSimple
marketingCash
people?
A.
Caroline Hanken; tremendously important. My other marketing person, Kathy
discretionary
cash
flow
over thewas
fivefairly
years
input
intoMy
theas
computer
system.
Once
again,
A.
Caroline
important.
other
marketing
person,
Elston,
atHanken;
that timetremendously
new.
Wasn’t near
effective,
because
she Kathy
didn’t
Elston,
Elston, at
at that
that time
time was
was fairly
fairly new.
new. Wasn’t
Wasn’t near
near as
as effective,
effective, because
because she
she didn’t
didn’t
have the
time
under her belt. She had
really tough territory.
there is no narrative
ortime
workpaper
thataa indicates
T&A used this information.
have the
under her analysis
belt. She had
really toughwhy
territory.
God.
Then,
my
supervisor
of
Johnie
my
By using owners’
cash
a knowledgeable
reader
this report
God.discretionary
Then, you
you know,
know,
myflow,
supervisor
of my
my drivers
drivers was
was
JohnieofGoodson,
Goodson,
my would
brother, a young lady by the name of Brenda Harrell, which ran my billing department
brother, a young
lady by the name of Brenda Harrell, which ran my billing department
Jacobi.
assume that ABC
is Cindy
a very
small mom and pop type of company. However, Mr. Jones
for
for me,
me, Cindy
Jacobi.
indicates
(Januarytranscript,
25, Page
line 4)
it used
-- cash
flow
analysis of
used
for
From the deposition
it is32,
apparent
that“I’ve
SRS’seen
success
is derived
from the
collaboration
several
From
the deposition
transcript,
it is apparent
that SRS’
success is derived
the collaboration
of several
key
individuals.
As Mr.
Smith stated,
the marketing
representatives
are thefrom
“backbone”
of the Company.
It
key
individuals.
As
Mr.
Smith
stated,
the
marketing
representatives
are
the
“backbone”
of
the
Company.
It
small
as wellthat
asMs.
large
businesses.”
T&A to
may
have used
thisworked
levelinofallincome
past,
also appears
Daniels
was very important
the business,
as she
facets of in
thethe
business
also
appears
that Ms.interchangeable
Daniels was very
important
to theIt business,
as she
all facets
the business
and was
essentially
with
Mr. Smith.
appears that
Mr. worked
Smith’sinskills
lay inof
marketing
and
and
was
essentially
interchangeable
with
Mr.
Smith.
It
appears
that
Mr.
Smith’s
skills
lay
in
marketing
and
but
owner’s
discretionary
cash
flow
is
used
for
the
mom
and
pop
business.
Also
known
training. Mr. Smith said that he performed over 90 percent of the training of all employees. This developed
training.
Smith
said that making
he performed
over 90 percent
the training of all employees. This developed
the skills Mr.
of the
employees,
them proficient
at their of
jobs.
asthe
sellers’
flow,
PPC at
Guide
to Business Valuations describes this
skills ofdiscretionary
the employees, cash
making
themthe
proficient
their jobs.
In addition
to
the Lincare executives and Ben Smith depositions, we also searched for other authoritative
method
as to
follows:
In addition
the Lincare executives and Ben Smith depositions, we also searched for other authoritative
sources to assist in the valuation of the covenant not-to-compete. The value of non-compete agreements in
sources to assist in the valuation of the covenant not-to-compete. The value of non-compete agreements in
- -6363 215.22and
Sellers’
Cash
Flow.ofThis
method
can
be a
good way
the purchase
sale of aDiscretionary
company has been
the subject
numerous
court
cases
involving
the Internal
Revenue
Servicea(“IRS”)
taxpayers. According
to Neil C.
Kelly,as
ASA,
CFA, the IRSice
maintains
to value
small,and
owner-managed
business,
such
a single-store
creama theory
called shop.
the “massThe
asset”
rule. Prior
to tax reform,
that certain
intangible assets
method
assumes
thatthis
a theory
buyerheld
would
be purchasing
bothwere
a “nondepreciable as a matter of law, because such intangible properties are part of a single mass asset, which, in
business and a job. Sellers’ discretionary cash flow is defined as the
the aggregate, has no determinable useful life and is either inextricably linked to goodwill or self regenerating.”
company’s
pretax
earnings plus
owners’
and benefits,
According
to Mr. Kelly,
for a non-compete
agreement
to compensation
not fall under the mass
asset rule, interest
it must have the
following
components:
expense,
and noncash expenses, less the amount of any expected capital
expenditures. To determine the company’s value, the consultant would
1.
A recital to the effect that it is the intent of the parties that the Covenant not-tomultiply
sellers’
discretionary cash flow by a value multiple derived from sales
compete is separate and distinct from any goodwill the seller may be selling.
in the market. The value indicated by this method generally represents the
2.
subject covenant
is not merely for
the purpose of protecting
purchaseis
value
ofThat
thethe
business
to a prospective
owner/manager.
Thisthe
method
goodwill.
discussed in Section 725.
3.
That the Covenant has an independent basis-value.
4.
That the Covenant was expressly bargained for – separate and distinct from the
Despite Mr. Jones’ representation that he has seen this method used for large businesses,
it is clear that the
authors
ofseller.
the Guide to Business Valuations think otherwise. In fact, the
goodwill
of the
Guide to5.Business
Valuations is consistent with other publications in the field. This is one
That a specific monetary sum is being paid for the Covenant.
more instance where a clear lack of professional competence becomes obvious.
6.
That the Covenant is for a specified period of time - which goes to the permissible
amortized period.
Covenant is
to compete
key individual
fromaddback
competing in
with
the method
Another 7.
error inThat
thistheschedule
the factrestrains
that thea owner’s
salary
this
purchaser, and if same is not accomplished, that the purchaser will suffer an
assumes a single
owner.
For because
ABC, there
were
threeability
officers.
Therefore,
the amount
economic
detriment
of the key
person’s
and competitive
activities.
assumes
added back
Because
thegrantor
computer
8. is an
Thatincorrect
even in theamount.
event of the
death of the
of thesoftware
Covenant, program
such will not
entitle the purchaser to depreciate or recover the cost of such Covenant over a
that this would period
only be
used
inthe
anterm
appropriate
situation, it adds back 100 percent of the
shorter
than
of such a Covenant.
compensation
assuming
that there would only be a single owner. Once again, T&A did not
9.
The amount the purchaser is paying for the Covenant not-to-compete is depreciable
over
thesoftware
life of the Covenant
regardless
of whether
the purchaser makes payments
know how to use
the
to produce
a credible
calculation.
for such Covenant over a period shorter than the life of the Covenant.
TA 183
10.
A recital to the effect that the value allocated to the Covenant has economic reality
or substance.
In addition, guidance can be found in the four tests that the courts have historically applied to non-compete
agreements in determining whether it could be amortized for federal income taxes. The four tests were
This
schedule
is an Historic
Statement
Flows.
is noasanalysis
summarized
in Forward
Communications
Corp.ofv. Cash
U.S., 78-2
USTCThere
Para. 9542,
follows: in the report
nor in the
is a schedule
that
merely
put intofrom
thethe
report.
There
is no
1. workpapers.
Whether theItcompensation
paid for
the is
covenant
is severable
price paid
for
the acquired goodwill.
discussion as to why net operating cash flow was so inconsistent increasing from $355,000
Whether either party to the contract is attempting to repudiate an amount knowingly
in 1990 2.to $932,000
in 1991 and then dropping again to $364,000, before rising to
fixed by both the buyer and seller as allocable to the covenant.
$609,000. This type of inconsistency reflects risk relating to the cash flows, and yet there
3.
is no mention
Whether there is proof that both parties actually intended, when they signed the sale
agreement, that
some
portion
of the
beworkpapers
assigned to theabout
covenant.
anywhere
in the
T&A
report
orprice
in its
the risk associated
with this 4.result.Whether the covenant is economically real and meaningful.
- -6464 -64-64The
first
test was
effectively established
in
Marsh &
McLennan, Inc.
v.
Commissioner, 51
T.C.
The
first
was
established
in
&
Inc.
v.
51
T.C.
The(1968).
first test
test
wasoneffectively
effectively
established
in Marsh
Marsh
& McLennan,
McLennan,
Inc.
v. Commissioner,
Commissioner,
51
T.C.
56
aff’d
other
grounds,
420
F.2d
667
(3d
Cir.
1969).
In
this
case,
the
court
looked
56
(1968).
aff’d
on
other
grounds,
420
F.2d
667
(3d
Cir.
1969).
In
this
case,
the
court
looked
56
(1968).
aff’d
on
other
grounds,
420
F.2d
667
(3d
Cir.
1969).
In
this
case,
the
court
looked
at
whether
the
compensation paid
for the
covenant is
separable
from
the price
for
goodwill.
at
whether
the
paid
the
separable
from
price
for
at
whether
the compensation
compensation
paid for
for
the covenant
covenant is
is
separable
from the
thethe
price
for goodwill.
goodwill.
Where
goodwill
and
the
covenant
not-to-compete
are
closely
related,
benefits
of
the
Where
goodwill
and
the
covenant
not-to-compete
are
closely
related,
the
benefits
of
the
Where
goodwill
and
the
covenant
not-to-compete
are
closely
related,
the
benefits
of
the
elimination
of
competition
may
be
permanent
or
of
indefinite
duration
and,
hence,
the
value
Scheduleelimination
V
contains
a
very
limited
ratio
analysis,
with
more
zero’s
on
this
page
than
of
competition
may
be
permanent
or
of
indefinite
duration
and,
hence,
the
value
elimination
of
competition
may
be
permanent
or
of
indefinite
duration
and,
hence,
the
value
of
the
covenant
is
not
exhaustible
or
a
wasting
asset
to
be
amortized
over
a
limited
period.
of
the
covenant
is
not
exhaustible
or
a
wasting
asset
to
be
amortized
over
a
limited
period.
of the covenant is not exhaustible or a wasting asset to be amortized over a limited period.
TA 184
any
other numbers. There is no industry data, as no comparison was made to any industry
In
In Commissioner
Commissioner v.
v. Danielson,
Danielson, 378
378 F.
F. 2d
2d 771
771 (3d.
(3d. Cir.)
Cir.) cert.
cert. Denied
Denied 389
389 US
US 358
358 (1967),
(1967), the
the
In
Commissioner
v. reasons
Danielson,
378aF.was
2d attempting
771
(3d. Cir.)
cert.
389
US 358
(1967),
the
information.
ofat
ratio
analysis
notDenied
only
look
at the
trends
courts
looked
whether
either
party
to
repudiate
an
amount
knowingly
fixed
courtsOne
looked
atthe
whether
either for
party
was
attempting
to is
repudiate
an to
amount
knowingly
fixed of the
courts
looked
at whether
party wasthe
attempting
to repudiate
an of
amount
fixed
by
both
as allocable
to either
the covenant,
calculable
tax benefit
whichknowingly
may fairly
be
by
to
the
the
tax
of
be
by both
both as
as allocable
allocable
to
the
covenant,
the calculable
calculable
tax benefit
benefit
of which
which may
may
fairly
be
subject company,
but
also
to
be covenant,
able
to compare
the
subject
company
to itsfairly
industry
peer
assumed
assumed to
to have
have been
been a
a factor
factor in
in determining
determining the
the final
final price.
price.
assumed to have been a factor in determining the final price.
group. This
is oneCandy
manner
inCommissioner,
which to determine
or not the
thecovenant
subjectplayed
company is
In Annabelle
Co. v.
the courtswhether
looked at whether
better
In
Annabelle
Candy
Co.
In
Annabelle
Candy
Co. v.
v. Commissioner,
Commissioner, the
the courts
courts looked
looked at
at whether
whether the
the covenant
covenant played
played
a
real
part
in
the
negotiations.
a
real
part
in
the
negotiations.
ora worse
its peer group. It assists the appraiser in supporting subjective
real part than
in the negotiations.
Although
the
valuation
of
is
not
concerned
with
or
not the
value
Although
valuation
of a
a non-compete
non-compete
agreement
is
not
concerned
with whether
whether
or
value is
is
judgments
involving
discount
rates, agreement
capitalization
rates
and multiples.
Although the
the
valuation
non-compete
agreement
is in
notthe
concerned
whether
or not
not the
the
is
amortizable,
these
testsof
doaprovide
meaningful
guidance
valuation with
process.
In reviewing
Mr.value
Kelly’s
amortizable,
these
tests
meaningful
amortizable,
these
tests do
do provide
provide
meaningful guidance
guidance in
in the
the valuation
valuation process.
process. In
In reviewing
reviewing Mr.
Mr. Kelly’s
Kelly’s
points,
we
have
determined
the
following:
points,
we
have
determined
the
following:
points, we have determined the following:
1.
Based
on the
the asset
asset
purchase
agreement,
the workpapers
parties intended
for
the covenant
covenant
not-to-compete
to
There
is Based
no analysis
in thepurchase
T&A report
or in the
discussing
or analyzing
the fact
1.
on
agreement,
the
parties
intended
for the
not-to-compete
to
1.
Based
on the
asset purchase
agreement,
the parties
intended for the covenant not-to-compete to
have value
value
separate
and distinct
distinct
from the
the value
value
of goodwill.
goodwill.
have
separate
and
from
of
have
value
separate
and
distinct
from
the
value
of
goodwill.
that the current ratio (defined as the current assets divided by the current liabilities) is well
2.
It appears that Mr. Smith was skilled in his business and would have the ability to compete with
2.
It
appears
that
Mr.
Smith
was
skilled
in
business
and
would
have
the
ability
to
with
2.
It
appears
thatdoes
Mr.indicate
Smith
wasthat
skilled
in his
his
and
would
have
theprovide.
ability
to compete
compete
with
below
1.0.
ThisThis
might
ABC
could
have
aMr.
difficult
time
meeting
its current
Lincare.
not
indicate
what
level
of business
competition
Smith
might
Lincare.
Lincare. This
This does
does not
not indicate
indicate what
what level
level of
of competition
competition Mr.
Mr. Smith
Smith might
might provide.
provide.
financial
obligations
as they
due.have
Once
again, basis
this is
a risk
elementinthat
is not
3.
Based
on our review,
the become
covenant does
independent
value
as presented
Addendum
3.
3.
Based
Based on
on our
our review,
review, the
the covenant
covenant does
does have
have independent
independent basis
basis value
value as
as presented
presented in
in Addendum
Addendum
3.4 to
to the
the agreement.
agreement.
3.4
discussed
but merely appears on a schedule that is included in the valuation. By
3.4at
to all,
the agreement.
4.
The
agreement
clearly lays
lays out
the
allocation
of purchase
purchase
price.
A series
series
ofschedules,
documents dated
dated
including
thisagreement
type of schedule
thethe
report,
as well
as many
of the
otherof
T&A
4.
The
clearly
allocation
of
price.
A
4.
The
agreement
clearly laysinout
out
the
allocation
of purchase
price.
A series
of documents
documents dated
between March
March 1
1 and
and March
March 9,
9, 1995,
1995, between
between Robert
Robert G.
G. Abood,
Abood, a
a member
member of
of Lincare’s
Lincare’s acquisition
acquisition
between
between
1 andCorporate
March 9, 1995,
Robert
G.attorney,
Abood, aLarry
member
of Lincare’s
acquisition
group
andMarch
Associate
Counsel,
and Mr.
Mr.
Smith’s
Gonzales,
indicates
that
effectively
has
provided
a report
tobetween
potential
users
of this
report,
whether
it the
be
group
group and
and Associate
Associate Corporate
Corporate Counsel,
Counsel, and
and Mr. Smith’s
Smith’s attorney,
attorney, Larry
Larry Gonzales,
Gonzales, indicates
indicates that
that the
the
asset purchase
purchase agreement
agreement and
and lease
lease had
had been
been negotiated,
negotiated, as
as well
well as
as the
the value
value of
of the
the accounts
accounts
asset
asset purchase
agreement
and
lease
had
been
negotiated,
well as
the
value
of theand
accounts
receivable.
In fact,
fact,
Mr.the
Smith
appears
to
have
been
personally
involved
in
this
negotiation.
In a
aT&A
fax
management,
trustees
or
prison
guards
that
becomeasinvolved
part
ofin
the
ESOP,
receivable.
In
Mr.
Smith
appears
to
have
been
personally
this
negotiation.
In
fax
receivable.dated
In fact,
Mr. Smith
appears
to have
been
personally
involved
in this negotiation.
a fax
transmittal
March
1, 1995,
1995,
from Rick
Rick
Glass
of Steven
Steven
Richards
& Associates,
Associates,
Inc. to
to Mr.
Mr. In
Abood,
transmittal
dated
March
1,
from
Glass
of
Richards
&
Inc.
Abood,
transmittal
dated
March
1,
1995,
from
Rick
Glass
of
Steven
Richards
&
Associates,
Inc.
to
Mr.
Abood,
effectively
is requiring
the reader
to figure
out
why“Ben
thisbelieves
information
is in the
report,
as well
regarding
the accounts
accounts
receivable,
Mr. Glass
Glass
writes
“Ben
believes
a fair
fair resolution
resolution
would
be additional
additional
regarding
receivable,
Mr.
writes
a
would
regarding the
the accounts
receivable,
Mr. Glass
writes
“Benas
believes
a fair billing
resolution
would be
be28,
additional
consideration
of
$332,516.
The
excess
over
$600,000
of
stopping
on
February
1995.”
of
The
$600,000
of
billing
February
28,
consideration
of $332,516.
$332,516.
The excess
excess
over
$600,000
asthis
of stopping
stopping
billing
onback
February
28, 1995.”
1995.”
as what consideration
its relevance
is. Nowhere
in theover
report
doesas
schedule
tieon
to any
of the
Although there is no indication that Mr. Smith or his representatives expressly bargained for the value
Although
there
is
no
that
Mr.
Smith
or
expressly bargained
for
value
decisionsof
that
are
made
throughout
the
valuation
process. Furthermore,
it would
have
Although
there
isnot-to-compete,
no indication
indication
that
Mr.
Smith
or his
his representatives
representatives
bargained
for the
the asset
value
the covenant
they
did
negotiate
the terms of theexpressly
deal, as well
as particular
of
of the
the covenant
covenant not-to-compete,
not-to-compete, they
they did
did negotiate
negotiate the
the terms
terms of
of the
the deal,
deal, as
as well
well as
as particular
particular asset
asset
values.
From
this,
weof
must
conclude
that Mr.
Mr.
Smith
and
histhem
advisors
implicitly
approved of
of
the value
value
values.
we
that
implicitly
approved
the
been easier
to From
readthis,
if all
theconclude
lines with
all Smith
zerosand
onhis
were
eliminated.
Since
the
values.
From
this,
we must
must
conclude
that Mr.
Smith
and
his advisors
advisors
implicitly
approved of
the value
of the
the covenant not-to-compete.
not-to-compete.
of
of the covenant
computer generated this information, it was included because it was there.
5.
5.
5.
The agreement
agreement clearly states
states that $100,000
$100,000 is being
being paid for
for the covenant
The
The agreement clearly
clearly states that
that $100,000 is
is being paid
paid for the
the covenant not-to-compete.
not-to-compete.
6.
The covenant is for a period of five years after which it expires.
7.
7.
7.
The covenant
covenant does
does constrain Mr.
Mr. Smith from
from competing and
and the same
same stated in
in 2 above
above holds here,
here,
The
Thewell.
covenant does constrain
constrain Mr. Smith
Smith from competing
competing and the
the same stated
stated in 2
2 above holds
holds here,
as
as
as well.
well.
6.
6. 185 The
The covenant
covenant is
is for
for a
a period
period of
of five
five years
years after
after which
which itit expires.
expires.
TA
This
Size
Statement
usethein
8. is a
WeCommon
are unaware
unaware
of the
theIncome
impact the
the
death of
of Mr.
Mr. Comparison,
Smith would
would have
haveindicating
on Lincare’s
Lincare’strends
ability to
to for
recover
recover
the
8.
We
are
of
impact
death
Smith
on
ability
8.
We
are
unaware
of
the
impact
the
death
of
Mr.
Smith
would
have
on
Lincare’s
ability
to
recover
the
cost
over
a
shorter
period
of
time.
cost
over
a
shorter
period
of
time.
comparing
the period
industry.
costABC
over ato
shorter
of time.However, there is no industry data included on this
9.
The
value
of the
is
depreciable
over
the
lifezeros
of the
covenant
even
though
payments
for
the
9.
The
value
covenant
is
over
the
even
though
for
schedule.
arecovenant
numerous
lines that
on them
because
the software
9.
The There
value of
of the
the
covenant
is depreciable
depreciable
overhave
the life
life of
of the
the covenant
covenant
even
though payments
payments
for the
the
covenant
were made
over a
shorter period.
covenant
covenant were
were made
made over
over a
a shorter
shorter period.
period.
generated them. There is no discussion in the report, nor do the workpapers show why net
-65- 65 -
income
is
volatile,
reflecting
a low
ofcovenant
0.57 percent
to a high of 20.67 percent. The
10.
Noso
recital
of the economic
reality
of the
was found.
discussion
schedule
nonexistent
in the report
and
is no
mention
of the
In reviewingof
thethis
four tests
put forthis
in Forward
Communications
Corp. v.
U.S.,there
we found
the following
in regard
to the agreement.
relevance
of this schedule.
1.
The compensation paid is separable from goodwill, as it was expressly laid out in the agreement.
have found
no evidence
thatshould
Mr. Smith
repudiated
or attempted
repudiatecertain
the allocation
the
A 2.
simpleWe
review
of this
schedule
have
caused
T&A to to
question
line to
items
covenant offered by Lincare.
that were in the financial statements. For example, relating back to the question discussed
3.
Both parties clearly intended an allocation to be made to the covenant not-to-compete, as it is
earlier about
excess
cash
inagreement.
1991, the common size balance sheet comparison indicates
expressly
laid out
in the
that
and equivalents
were
6.30 skills
percent
total assets
in 1991,
while
in all of
other
4. cashBased
on Mr. Smith’s
apparent
and of
abilities,
he appears
to have
an ability
to the
compete.
However, this is in no way an indication of the level of competition he could provide. Therefore, the
years it was
roughly
3 percentreal
or less.
Had T&A reviewed the information that its computer
covenant
is economically
and meaningful.
program
generated, T&A would have realized that it should have asked more appropriate
Of particular importance, is whether the covenant was at issue in the negotiation process. This relates to the
economic reality
of the covenantInstead,
and its economic
significance.
According
to Kelly, the following
are factors
questions
of management.
T&A tries
to hide behind
management
as if they
would
which are important in determining the economic reality of a non-compete agreement.
understand all of these schedules.
a.
TA 186 b.
c.
The presence of a grantor of the covenant not-to-compete having business expertise
evidencing a formidable capability to compete;
grantor’s ownership of technology and machinery necessary to compete;
grantor’s possession of sufficient economic resources to compete;
This schedule
is
part
of Schedule
entitled
Historic
Adjusted
d.
legal
enforceability
of the V,
covenant
for the
term of the
particularIncome
covenant Account
under stateGrowth.
law;
It shows the year-to-year percentage change in the income statement line items. The first
e.
grantor’s legal capacity to compete;
line indicates
total
revenue changing by 75.56 percent growth in 1990 followed by three
f.
covenantyears.
having sufficient
scope to
assuredate,
non-competition
without
overreaching;
significantly
declining
By the most
recent
the growth
in revenue
is only 2.64
too advanced
agewhat
of grantor;
percent, g.
a rate not
much
lower than
is used in the forecast of future operations of ABC.
h. is no
good
health of grantor;
Since there
discussion
of this trend in the report or in the workpapers, nor is there a
discussion
trend in
rates to
thegrantor’s
forecast
that
was performed,
a
i. comparing
payments this
for covenant
thatgrowth
are not pro-rata
to the
stock
ownership
in the
seller;
reader cannot possibly come to a determination as to the reasonableness of the
j.
purchaser’s policing of the covenant not-to-compete;
information presented in this report. Other line items have also changed significantly in this
structuring payments under the covenant to occur over time and to cease upon
report. k.
With no
discussion or use of this data, this becomes an irrelevant schedule.
breach of such covenant;
However, it should have been a very relevant schedule in performing the analysis of ABC.
l.
vigorous negotiations over the covenant and negotiations over its value should be
recited in the agreement;
m.
a detailed, specific, and carefully drafted covenant not-to-compete;
n.
independent appraisal of the value of the covenant not-to-compete;
- -6666 TA 187 o.
some degree of reasonableness in the percentage of the considerations allocated
to the covenant and other items.
The importance of the covenant not-to-compete having economic substance was further delineated by a
Schedule
VI is a schedule that would relate to a preferred stock valuation. ABC had no
Bureau of National Affairs' paper on the subject published in 1992. The paper stated:
preferred shares, and therefore, there are zero’s on this schedule. T&A included this
is the
product ofthe
bona
fide bargaining
rather
than a sham.
reality
irrelevantcovenant
schedule
because
software
program
generated
it. The
It is economic
irrelevant
to the ABC
theory is primarily concerned with business realities which would cause reasonable persons,
concerned
with their
economic
future,intothe
bargain
for the covenant not-to-compete.
valuationgenuinely
and should
not have
been
included
report.
TA 188
Among the facts to be considered are whether the seller could actually compete with the
purchaser. Where the seller is, objectively, likely to be a competitor.
The paper states that courts have also looked at the actual contract negotiations to determine if the parties'
intentions were for the covenant not-to-compete to have value.
This partInofaddition,
Schedule
VI relates
to the
determination
of discount
andreflect
capitalization
the amount
allocated
to the
may not
economic rates,
reality. The taxpayer has the burden of proving that he is entitled to the deduction. Welch
a very important
schedule that relates to the various income approach calculations
v. Helvering, 290 U.S. 111 (1933). Courts have frequently found that covenants have no
or, T&A
at least,
substantially
less
than the purchaser
to them. The
includedvalue
in the
report.
There
isvalue
no discussion
aboutattributes
these figures,
andsame
there is no
factors as above have been considered for this purpose. Further, courts have looked at the
actual contract
negotiations
to determine
if the parties
intended theany
covenant
have any
documentation
included
in the T&A
workpapers
that supports
of thetofigures
used. In
value. For example, if the parties agreed to pay a certain amount for the assets of the seller
andofthe
purchase
priceare
is not
altered when
covenant
not-to-compete
is later
fact, many
these
figures
generated
byathe
computer
software.
Mr.added,
Jonesthe
could not
covenant has no or minimal value.
explain how these figures were derived. Using the information that is most commonly used
in The
theruling
industry
determine
discount
rate, we the
performed
review of agreement
information
in the
statesto
that
the relevantafactors
for determining
value of a a
non-compete
include:
public domain.
The
20-year
Bond
on November
26,
1993, the
date most
1) Whether
in the
absenceTreasury
of the covenant
therate
covenantor
would desire
to compete
with the
covenantee; 2) the ability of the covenantor to compete effectively with the covenantee in the
recently activity
available
prior to the valuation date, was 6.47 percent, and not 6 percent as
in question; and 3) the feasibility, in view of the activity and market in question, of
by the covenantor
within thean
time
and area
specified
in the is
covenant.
reflectedeffective
in thecompetition
T&A report.
To this figure,
equity
risk
premium
added, most
Based on the
issues presented
by Kelly inAssociates’
regard to the mass
assetBonds,
rule, theBills
covenant
a distinguishable
commonly
obtained
from Ibbotson
Stocks,
andisInflation
Annual
asset that can be valued separately from goodwill. Further, the covenant in the Lincare-SRS deal appears
to pass the four
testsinstance,
from Forward
Corporation
U.S. been
Tests two
and three
particular
Yearbook.
In this
theCommunication
1993 yearbook
would v.have
available
atare
theofvaluation
importance here. The importance of test two is that after Lincare proposed the allocation to the covenant, Mr.
SmithThe
and his
advisor
didpremium
not attemptreflected
to repudiateinorthis
negotiate
it, although
they percent,
did negotiate
other
risk
publication
is 7.3
theseveral
difference
date.
equity
items in the agreement. As a result, we believe the covenant is economically real. Test three is significant
between
theallocation
total returns
on common
stocks
(12.4
percent) and the income returns on
because the
to the covenant
is clearly
made in
the agreement.
long-term
government
bonds
(5.1executives,
percent).we learned that Lincare has developed a methodology
From the deposition
of various
Lincare
for allocating a portion of the acquisition price to covenants with the assistance of its outside accountant,
KPMG Peat Marwick. In addition, we know that Lincare is a major player in the industry and has been
undergoing a major acquisition program. Therefore, Lincare’s actions appear to be reflective of market
The
next item that should be included in the build-up is a small company stock premium,
conditions.
which, once again, would be obtained from Stocks, Bonds, Bills and Inflation. In this
As Mr. Deutsch states, “Lincare’s interest in SRS was due to its good locations, respiratory therapy control
and
good this
reputation.”
According
to Mr.
he did
believe that
Mr. Smithsmall
held many
of the referral
instance,
would have
been
5.2Byrnes,
percent,
thenot
difference
between
company
stocks
relationships personally. In fact, Mr. Byrnes knew first hand that in Lakeland, Judy Clarke was generating
(17.6 percent) and large company stocks (12.4 percent). Next, a specific company risk
premium would be considered, which could be positive or negative, depending on all of the
- -6767 analysis
performed
relating
tothat
theMr.
appraisal
Clearly
smaller
than
the referrals.
Mr. Byrnes
believed
Smith maysubject.
have originally
heldABC
some was
of themuch
relationships
in Plant
City. This puts Mr. Smith’s control of the referral base at less than 25 percent.
even the small companies in the public market, it had less depth in management, its net
As we know from Mr. Smith, additional relationships were developed by the marketing representative in that
income
was somewhat volatile on a common size basis, and its cash flow was somewhat
territory. It was also the marketing person’s responsibility to maintain existing relationships. In addition, from
Mr. Smith’s
deposition, we understand
that the
marketing
are critical
to the all
success
of SRS.
erratic.
Management’s
forecast was
also
pretty people
aggressive.
Given
of these
factors, it
We alsothat
learned
from
Mr. of
Smith
he was
responsible
for over 90This
percent
of the
training
of these
appears
some
level
riskthat
should
have
been assessed.
means
that
the minimum
individuals, as well as the other employees of the Company. Mr. Smith has imparted a great deal of his
knowledge
andwould
expertise
on these
individuals.
It appears
this has occurred to a large extent with Ms. Daniels,
discount
rate
have
been
calculated
as follows:
who did everything Mr. Smith did for the Company.
Ms. Daniels’s talents were recognized by Lincare, who ensured she was part of the acquisition, by making
an employment agreement
with her,
a prerequisite to the acquisition closing.
According to Mr. Byrnes,
Treasury
Rate
6.47%
Lincare’s interest was always in Ms. Daniels, and Lincare had no interest in retaining the services of Mr. Smith.
We believe Mr. ByrnesEquity
to be credible
on this issue because Lincare did not offer
Mr. Smith an employment
Risk Premium
7.30%
contract prior to the closing of the acquisition.
Small Company Risk Premium
5.20%
If Lincare felt that Mr. Smith was essential to the business because he held many personal relationships, then
it would be a prudent business decision to bring Mr. Smith along with the acquisition, and lock him into an
Specific Company Risk Premium
?
employment contract for a period of time that allows for a transfer of these relationships. In this type of a
situation, a buyer needs to ensure the transferability of what it is purchasing. Relationships take time to
Discount Rate
18.97%
develop. They cannot be transferred overnight.
An employment contract is typically used to retain the services of the seller as an employee of the acquirer
for a specified period of time. Typical time periods range from six months to two years. During the term of
the employment contract, the business seller assists the buyer in the transitioning of the business. Prudence
dictates
thatto
such
an agreement
should
be in place
beforerisk
closing,
as was would
the agreement
Lori
If one
were
assume
that the
specific
company
premium
fall in awith
3 to
5 Daniels.
percent
Yet Lincare had no interest in such an arrangement with Mr. Smith. From this position, one can reasonably
infer that
did notrate
believe
that Mr. Smith
was important
to theapproximately
successful transition
range,
theLincare
discount
determined
would
have been
22 oftothe
24customers
percent,
and referral sources to Lincare.
which would also been applicable to net cash flow. The computer program incorrectly
Using all of this information, we have determined that Mr. Smith would be able to provide a minimal loss of
calculated
discount
rate acquired
on future
earnings
the discount
rate
is actually
related to
business toathe
SRS locations
by Lincare.
Mr.when
Smith created
a company
of highly
skilled individuals
and significantly reduced SRS’ reliance on himself. In addition, Lori Daniels, the person who was most crucial
cash
flow.
In order
tohas
apply
discount
to earnings
instead
of cash
to the
deal taking
place
beenatied
up in anrate
employment
contract
by Lincare.
As aflow,
result,an
weadjustment
believe that
only a small portion of the sales could be diverted if SRS continued to compete with Lincare. Therefore, we
is have
generally
tothe
reflect
a differential
between
netdivert
cash
flow
and net earnings of
selectednecessary
10 percent as
percentage
of sales that
SRS could
from
Lincare.
the
company.
a 3ofto106percent,
percent
betweenthat
these
discount
rates is seen
Based
on a lost Typically
sales analysis
wespread
have determined
the lost
income attributable
to thein
covenant not-to-compete is as follows:
practice.
The authors of the Guide to Business Valuations indicate “...many experienced
practitioners feel that this difference most typically ranges from 3% to 6%.” What they also
1996
1997
1998
1999
2000
$ 171,600
$ 193,908
$ 219,116
$ 247,601
$ 277,313
indicate is that judgment is necessary to determine the correct increment. They state that
“The higher the expected growth rate of the company, the higher the increment.” This is
The estimated cash flows attributable to the lost income, calculated in a manner similar to that which we
because
growth
lowers the payout ratio (more cash must be retained in the
calculatedhigher
previously,
is as follows:
company to support the growth).
1996
1997
1998
1999
2000
- -6868 Schedule VI of the
T&A report$ indicates
that
expected$ 149,365
growth is approximately
9 percent.
$ 22,471
88,164
$ 116,897
$ 185,730
With
this type
of growth
rate,
you
at least
range,expenditures,
or 6 percent,
The major
difference
between
the lost
netwould
incomeexpect
and the cash
flow isthe
the upper
level of capital
whichto
far outpaces depreciation expense. These items were treated in a consistent manner when the valuation of
beSRS
thewas
differential
in the discount
be applied
tocompany
earnings.
Therefore,
previously performed.
However,rate
sinceto
management
of the
can change
the leveladding
of capital6
expenditures, we believe that it would be more prudent to discount the lost earnings, rather than cash flow,
percent
to the range would indicate a discount rate in the 28 to 30 percent range, rather
in valuing the covenant.
than the 20 percent reflected in the T&A report. While we are not opining on what the
The value of the covenant not-to-compete is the present value of the lost income to the buyer. Using a
discount
rate of 24rate
percent,
this equates
to the value
the covenant
beingthe
$578,766,
or $579,000suggests
rounded.
correct
discount
should
have been
in theofABC
valuation,
documentation
The discount rate used is based on a discount rate applicable to cash flow of 18 percent, with a six percent
premium
duepercent
to the increased
risk of
cash flow.
that
the 20
rate used
byearnings
T&A isover
wrong.
The higher rate would reduce the value
estimates
by approximately
Once
again,
because
the
lackassociated
of documentation
The covenant
not-to-compete is one
a lessthird.
predictable
asset
and has
severalof
risk
factors
with it. In
reviewing Kelly’s factors pertaining to the economic reality of the covenant, we find the following:
by T&A, it is impossible to know how T&A supports the rates that were included in this
1.
Mr. Smith has the expertise necessary to compete. Mr. Smith has proven to be quite knowledgeable
schedule.
about his business, and by all accounts has been very successful.
2.
The
Mr. Smith has the financial resources necessary to compete. Given the low cost of doing business
and
Mr. Smithis
reasonably
has the economic
to compete.
growth Mr.
rateSmith’s
usedfinancial
by T&Aassets,
of 9 percent
also problematic.
The capacity
difference
between a
3.
Mr.
Smith
notcapitalization
advanced in agerate
nor isishelong
of diminished
health that would
keep him
from
competing.
discount
rate
andis a
term sustainable
growth.
Most
finance
text
4.
Very littlethat
of the
price
was
structured
over
time.
Only $500,000
was not
at of
closing
and
books
indicate
a purchase
company
can
hardly
grow
into
perpetuity,
beyond
thepaid
rate
inflation
this was for accounts receivable. Several of Kelly’s factors also serve to reduce the risk associated
and population
growth. More often than not, this rate is in the 3 to 5 percent range.
with the covenant.
Valuation
theory
discusses
that
thetoreason
an appraiserThis
willreduces
use athediscounting
model
5.
The
covenant
has sufficient
scope
insure non-competition.
risks associated
with
violation of the covenant.
versus a capitalization model will depend upon the stability of the income stream that is
6.
There is no technology or machinery that Mr. Smith owns that would enable him to compete. In
being
discounted
or capitalized. The theory that appears in valuation treatises is that one
uses a
addition, SRS is a marketing-based business, and individuals other than Mr. Smith are in control of
many
of the relationships.
discounting
model when growth is uncertain, or less stable, and a capitalization
As a result
of the
thesefuture
factors,income
we havestream
selected will
an 18
discountpredictable
rate for the covenant
model
when
bepercent
somewhat
and at not-to-compete.
a stable level.
It was increased by six percent to reflect the earnings premium. It should be noted that this rate does not
reflect the level of competition that could be put forth by Mr. Smith, but only the risk associated with Mr. Smith
competing.
As a test for reasonableness of the amount allocated to the covenant not-to-compete, we examined
Using
both available
models ininthe
thepublic
same
reportAsis asomewhat
because
thecurrent
same
information
domain.
result of thecontradictory
respiratory therapy
industry’s
consolidation mode, we have reviewed the Securities and Exchange Commission’s filings of publicly-traded
income
stream
beproduct
stableand
and
unstable
at the
same
time.industry,
Despite
this,some
T&Ainsight
used
companies
in the cannot
respiratory
medical
equipment
sales
and rental
to gain
into their acquisition practices and how they allocate purchase price to intangible assets, and non-compete
both
models. The problem with using a 9 percent growth rate in the capitalization model
agreements, in particular.
is that this would indicate that ABC is expected to grow at such an extraordinary pace, that
We reviewed the 1995 10-K filings for Apria Healthcare Group, American Home Patient, Inc., Complete
Management,
Inc., Interwest
Home
Lincare,
Pediatric
of America,
Inc.,means
and Rotech
the
company would
outpace
theMedical,
Gross Inc.,
National
Product
ofServices
the world.
This also
that
Medical Corp. From these documents, we attempted to isolate information relating to how they allocated the
purchase
prices
of their acquisitions.
Although
all of these
companies
discuss
their
in one form
ABC
would
be growing
faster than
the prison
population.
This
does
notacquisition
make sense.
The
or another, only Lincare and Pediatric Services of America (“PSA”) provided enough detail to be meaningful
use
of analysis.
this growth
rateweisanalyzed
one more
instance
T&A 1995,
demonstrates
its filings.
lack of
to our
As a result,
Lincare’s
10-Ks forwhere
1993 through
and PSA’s 1995
professional competence.
- -6969 -69In the
notes
to its consolidated
financial
statements,
Lincare
discloses
purchase
price of
its acquisitions
T&A
also
added
a 5 percent
excess
earnings
premium
intothe
computer
system,
which
In the
notes
to its consolidated
financial
statements,
Lincare
discloses
thethe
purchase
price of
its acquisitions
for the year and the allocation of the total purchase. Lincare divides the allocation between current assets,
for the year and the allocation of the total purchase. Lincare divides the allocation between current assets,
fixed
assets, identified
intangibles,
and goodwill.
Tableto29intangible
presents this
data forare
1993
through
1995.
Table
recognized
excess
earnings,
attributable
assets,
more
risky
than
the
fixed assets,that
identified
intangibles,
and goodwill.
Table 29 presents this
data for 1993
through
1995.
Table
30 presents each item as a percentage of the year’s total acquisition purchase price.
30 presents each item as a percentage of the year’s total acquisition purchase price.
total earnings stream of the company.
Since there is no discussion, analysis or
TABLE 29to determine why T&A chose 5 percent.
workpapers to support this amount, it is difficult
TABLE 29
A 5 percent excess
BREAKDOWN OF LINCARE HOLDINGS, INC.’S
TOTAL ACQUISITIONS
BY YEAR
earnings premium
seems very low
given the large
TOTAL ACQUISITIONS
BY YEAR
1995 - 1993
1995 - 1993
amount of tangible
assets owned by ABC. This figure is most likely incorrect.
1995
1994
1993
Average
1995
1994
1993
Average
Current
Assetson this schedule is a$108,097
$ 2,915for management
$ 1,704 continuity.
$ 6,358As
Also
included
percent premium
Current
Assets
$ 8,097
$ 2,915
$ 1,704
$ 6,358
Property and
Equipmentthere is no discussion
4,731 in the narrative
4,024
2,828 nor is there
3,861an
previously
discussed,
of the report,
Property and
Equipment
4,731
4,024
2,828
3,861
Intangible
12,056
11,613
7,277
analysis
in Assets
the T&A workpapers, discussing
management.
Therefore,
there10,315
is no
Intangible
Assets
12,056
11,613
7,277
10,315
Goodwill
43,000 that T&A
14,195
34,415
justification
for this figure. Based46,050
on the adjustment
made to officers’
Goodwill
46,050
43,000
14,195
34,415
$ 70,934
$ 61,552
$ 26,004
$ 54,949
compensation, it would seem that$ ABC
and
70,934could replace
$ 61,552management
$ 26,004pretty easily
$ 54,949
inexpensively, which would reduce the risk rather than increase the risk relating to
TABLE 30
TABLE 30
TOTAL ACQUISITIONS BY YEAR
TOTAL ACQUISITIONS BY YEAR
AS A PERCENTAGE OF TOTAL ACQUISITIONS
AS A PERCENTAGE OF TOTAL ACQUISITIONS
- 1993
Overall, none of the figures on this page 1995
are supported.
There was no industry data in the
1995 - 1993
management.
common size financial statements, nor the financial ratio schedules that were reflected
1995
1994
1993
Average
at a medianAverage
and high
earlier in the report. Despite this, there1995
is an industry 1994
return on equity1993
Current Assets
11.4%
4.7%
Current Assets
11.4%
4.7%
Property and Equipment
6.7%
6.5%
Property and Equipment
6.7%
6.5%
industry data, why couldn’t it get other data? With that said,
Intangible Assets
17.0%
18.9%
Intangible Assets
17.0%
18.9%
workpapers for these industry numbers. This could mean
Goodwill
64.9%
69.9%
Goodwill
64.9%
69.9%
generated them or they were made 100.0%
up by the appraiser.
100.0%
100.0%
100.0%
6.6%
6.6%
10.9%
10.9%
there is no
28.0%
28.0%
that either
54.6%
54.6%
100.0%
100.0%
11.6%
11.6%
7.0%
7.0%
support in the
18.8%
18.8%
the computer
62.6%
62.6%
100.0%
100.0%
level of 10 percent and 15 percent, respectively, used in the report. If T&A could get this
Our recollection of how this computer program worked, was that the excess earnings
From Table 29, it is clearly seen that the largest component of the acquisition costs for each year was
From Table
is clearly seen
that the
largest
component
the acquisition
costs for each
year was
premium
in 29,
theitsoftware
package
was
byoftaking
between
goodwill, followed
by identified
intangibles.
Ofcalculated
particular importance
tothe
this differential
analysis is the
allocationthe
to
goodwill, followed by identified intangibles. Of particular importance to this analysis is the allocation to
identifiable intangible assets. Lincare, as we will show later in this report, typically only identifies patient
identifiable intangible
assets.
Lincare,(15%-10%=5%).
as we will show laterThe
in this
report,
only identifies
median
high rates
of return
on typically
thethat
schedule
in intangible
thepatient
T&A
records and
and non-compete
agreements.
Therefore, we have made
theitem
assumption
the identified
records and non-compete agreements. Therefore, we have made the assumption that the identified intangible
assets line in Table 30 contains only these two types of assets. As can be seen in the data, these assets
assetsthat
line is
in Table
contains only these
two types of
As can
in the data,between
these assets
report
called30quantitative
risk premium
ofassets.
4 percent,
is be
theseen
differential
the
represented 17, 18.9, and 28 percent of the total purchase prices in 1995, 1994, and 1993, respectively.
represented 17, 18.9, and 28 percent of the total purchase prices in 1995, 1994, and 1993, respectively.
median industry return on equity and the long term Treasury Bond rate of 6 percent.
As a major player in this industry, Lincare’s economic decisions are reflective of market conditions. Total
As a major player in this industry, Lincare’s economic decisions are reflective of market conditions. Total
acquisition
purchase
price forfigures
1995 was $70,934,000.
This unsupported
represented the accumulation
20 separate
and
These
were
calculated
on the
inputs intoof
computer
acquisition
purchase
price for 1995 wasbased
$70,934,000.
This represented the accumulation
of the
20 separate
and
distinct transactions. Each of these was negotiated with an arm’s-length (non-related) party. Most of these
distinct transactions. Each of these was negotiated with an arm’s-length (non-related) party. Most of these
- -7070 program.
understanding
how
the
computer
generated
its figures
is negligence
onwas
the
businessesNot
were
much smaller than
SRS,
as total
revenues
for the acquired
companies,
excluding SRS,
$38.4 million, or an average of approximately $2 million. In 1993, Lincare acquired 15 companies with
part
of T&A.
They
areor responsible
for the
toolsLincare
that they
use.24 companies with $35 million in
revenues
of $18
million
$1.2 million each.
In 1994,
acquired
revenue, or $1.46 million each. As a result, the data taken from Lincare’s 10-Ks provide us with a guide from
the marketplace for the combined values of a non-compete agreement and a customer list. This guide
that onofa combined
basis,
these
shouldrate
constitute
17.0
to 18.8 percent
the purchase a
price,
Atindicates
the bottom
this page,
there
is assets
a blended
of 8.1
percent,
whichofrepresents
rate
based on Lincare’s 1995 acquisitions and the three-year weighted average, respectively.
used for earnings before interest and taxes. There is also a return on net assets of 10
On October 3, 1994, PSA bought Oxygen Specialties, Inc. (“OSI”) for $4.9 million. OI was a medical
equipment
company
located in New
Orleans.
According
to PSA’s
10-K,These
$200,000
of the purchase
price
percent,
which
is generated
from
the industry
return
onForm
equity.
computer
generated
was paid for the non-compete agreement. This represents approximately 4.1 percent of the purchase price.
figures
are unsupported
bytheT&A.
askednot-to-compete
a series ofand
questions
T&A
In our valuation,
we determined
value ofWhen
the covenant
the patient about
records how
(customer
list) to be $2,450,000, and the covenant to be $579,000. Based on a total value of $13,500,000, the total of
supports
these
items,
in Mr.ofJones’
were
as amounts
follows:
the covenant
plusvarious
the patient
recordsvarious
amountsanswers
to 18.06 percent
the total,deposition
and the covenant
alone
to 4.3 percent of the total. This demonstrates the reasonableness of our calculations.
A.
OF THE COVENANT NOT-TO-COMPETE
There isALLOCATION
not
a specific
workpaper that addresses that rate (January
BETWEEN SRS AND BEN SMITH, INDIVIDUALLY
25, Page 50, line 17).
In addition to the issue of the economic reality of the covenant, the allocation of the covenant is significant in
determining
common
practiceworkpapers.
in asset purchases
is for
thewould
non-compete
agreement to
A. personal
Again,goodwill.
not onAthese
specific
And
that
have been
name the selling company, and its shareholders, as being subject to the non-compete. This is exactly the
developed through our reference material if you will, to look at various
case in the sale of assets to Lincare. The agreement was between Lincare as the purchaser and SRS and
rates
of returns
for investors
over
a period
time. Again,
various
Ben W. Smith as
the sellers.
The issue
becomes one
of allocating
the of
non-compete
between
the company,
sources
were
sited
-not
sited,
but
referred
to
for
rates
of
return
for
which results in corporate goodwill, and Ben Smith, resulting in personal goodwill.
hypothetical investors. (January 25, Page 50, line 23).
Smith Respiratory Services developed an excellent reputation for the services it provided to clients. This
reputation is, in large part, the corporation’s, and not Mr. Smith’s. Mr. Smith has done an excellent job, over
A. in training
Therepersonnel,
is not a separate
in ourand
filetransferring
(Januaryhis
25,importance
Page 51,to other
the years,
teaching hisworkpaper
marketing people,
lines
10).
members of the company. Earlier in the business’ formation, there can be no doubt that Ben Smith was SRS.
However, over the years there has been a clear transition to other members of the company. In fact, it was
Lori Daniels,
and
Ben Smith,
who Lincare
insisted(January
sign an employment
A.
No not
specific
workpaper
in there.
25, Page contract
51, linewith
17).the firm as a
prerequisite to a deal.
A. theThere’s
notSmith
a specific
reference
10 percent
our toworkpapers
Recognizing
fact that Mr.
is no longer
required to to
provide
a personalin
service
the patients, referral
sources and others,
we do 25,
not see
there
being
economic reason to allocate any of the covenant not-to(January
Page
52,
lineany
12).
compete to Mr. Smith personally. We further believe that the deposition transcripts reviewed and cited
throughout our report justify our position.
The same theme took place over and over
again during Mr. Jones’ deposition. T&A did
SUMMARY
not
have
any workpapers
support Services
many ofasthe
figures
that was
were
included in
the
report.
The
fair market
value of Smithto
Respiratory
of March
9, 1995
$13,500,000.
The
allocation
of the purchase price of the Company as of the same date is as follows:
When
questioned about these rates and when the report drafts were reviewed with ABC
representatives, Mr. Jones indicated (January 25, Page 53, line 18):
A.
Well, there’s not a specific formula. But again, based on our
discussions and when we reviewed the reports, drafts of the reports
with them and we went over the various factors that we considered in
developing our -- our rates, we discussed with then -- “them” being the
trustees, that -- that these were appropriates rates that they believe
were achievable.
- -7171 It is inconceivable
toReceivable
think that anyone, including the trustees, could
have had enough
Accounts
$
550,000
knowledge ofInventory
business valuation to determine the reasonableness of these
40,000 rates in light
of the unsupported
information that was presented to them. In this instance,
Fixed Assets
712,000 the trustees
Trademark
probably relied
on the professionals who they were hiring, assumed 2,134,000
that they understood
Patient
Records
1,859,000 reasonable.
what they were
doing,
and that rates in the 15 to 20 percent range seemed
- SRS
579,000
Clearly, the Covenant
rates areNot-to-compete
unsupported,
undocumented and illogical when
considering the
Covenant Not-to-compete
- Ben
W. Smith
appropriate components
that should
have
gone into the development of the 0discount rate.
Goodwill
7,626,000
Fair Market Value
$ 13,500,000
One other point
relating to this schedule is the fact that T&A says that
the business growth
Buyers Premium
1,535,000
will be 15 percent, while the industry is growing at 6 percent. This means that ABC will
Price Paid by Lincare Holdings, Inc.
$ 15,035,000
grow at a rate approximately 250 percent greater than the industry. This would require
The to
equitable
distribution
of Smith
RespiratoryMr.
Services,
Inc.had
as ofindicated
March 9, 1995
$16,900,000,
ABC
take over
manyvalue
of its
competitors.
Jones
thatwas
there
were no
consisting of the following:
comparables because these other companies were much larger than ABC. If that were the
Price Paid by Lincare Holdings, Inc.
case, how could
growth expectations be justified?
Retained Assets
$ 15,035,000
1,900,000
Total
$ 16,935,000
Rounded
$ 16,900,000
When asked in his deposition about whether the discount rate derived on TA 188 in
Schedule VI applied to earnings or cash flow, Mr. Jones answered (January 25, Page 67,
line 21):
DISCOUNT AND CAPITALIZATION RATES
Section
Ruling 59-60
states:
A.6 of Revenue
They would
be applied
to earnings, but in our analysis we assumed
that earnings and cash flows were approximately the same so we
In the application of certain fundamental valuation factors, such as earnings and dividends,
applied toit capitalize
to both, the
I believe,
our analyses.
it is necessary
averagein
orsome
currentofresults
at some appropriate rate. A
determination of the proper capitalization rate presents one of the most difficult problems in
valuation.
This response illustrates a lack of professional competence. Any experienced appraiser
In the text of Revenue Ruling 68-609, capitalization rates of 15 to 20 percent were mentioned as an example.
knows
that in a are
growing
company,
cashthat
flow
generally
less
Many appraisers
under the
misconception
the will
capitalization
ratebe
must
staythan
withinearnings,
this range. primarily
In reality,
the capitalization rate must be consistent with the rate of return currently needed to attract capital to the type
because
of the amount of money needed to reinvest into the company to meet the growth
of investment in question.
expectations. In this instance, the T&A report reflects business growth of 15 percent, an
There are various methods of determining discount and capitalization rates. Using the build up method of
determining these
rates resultsrate
in the
extraordinarily
impossible
tofollowing:
achieve into perpetuity. Despite this, T&A indicates that
cash flow
and earnings would be the same. That is not possible. To make
a broad
Appraisal Date Long-Term Treasury Bond Yield
6.991
assumption
that Premium
the discount
rate
be applied to both earnings
in a
2
Equity Risk
-- Stocks
overcan
Bonds
+ and cash
7.00flow
company that is growing in this fashion, is not only incorrect, but it demonstrates a total
- -7272 lack of Average
understanding
of what these rates represent. T&A uses the
= same rates
13.99to apply
Market Return
to tangible assets, intangible assets, capitalization models and discounting models, all of
3
which should
be Premium
differentfor
rates
too,
Benchmark
Size of return because of the risk profile.
+ Therefore,
4.00this
violatesAdjustments
proper appraisal
practice.
for Other Risk
Factors
+
1.204
Discount Rate for Net Cash Flow
=
19.19
=
19.20
TA 189Discount for Rate for Net Cash Flow (Rounded)
CAPITALIZATION RATE
Schedule VII reflects the adjusted book value and liquidation value methods as applied in
Discount Rate for Cash Flow
19.20
the T&A
report. Once again, there is no discussion, other than the
fact that
the fixed
Growth Rate
6.00
assets Capitalization
were beingRate
increased
by $29,911,000 based on the appraised
value. An
=
13.20
for Cash Flow
adjustment was made to remove the intangibles from the balance sheet and yet there is
no1.discussion
the report
as to why this item was removed. Furthermore,
there is
no
Federal in
Reserve
Board, http://www.bog.fbr.fed.us/releases1H15/data/b/temzoy.txt
for a 20-year
U.S.
Treasury Bond for March 9, 1995.
discussion about the non-operating assets that are reflected as part of this methodology.
2.
Stocks, Bonds, Bills and Inflation 1995 Yearbook, Ibbotson Associates, difference between the total
returns on common stocks and long-term government bonds from 1926 to 1994.
Despite
this
schedule calculating what is purported to be liquidation value, the liquidation
3.
Stocks, Bonds, Bills and Inflation 1995 Yearbook, Ibbotson Associates, difference between the total
returns
on small
company
stocks
large company
stocks. This is illogical. However, both
book value.
value is the
exact
same
value as
theand
adjusted
based on the analysis
throughout
theeven
report.if appropriate, they
of4.these Appraiser’s
methods judgment
were inappropriate
for the discussed
ABC valuation,
and
A capitalization
rate has been derived from a discount rate, which has been calculated above. The
were
applied incorrectly.
components of the discount rate include a safe rate which indicates the fact that any investor would receive,
at a bare minimum, an equivalent rate for a safe investment. In this particular instance, United States
Treasury Bonds are used as an indication of a safe rate.
The first problem with the adjusted book value method as presented, is the fact that there
An equity risk premium is added to the safe rate which represents the premium that common stockholders
is received
no discussion
that
mentions
this method
only
includes
the This
tangible
assets
and
in the public
marketplace
overthat
investors
in long-term
government
bonds.
indicates
that since
equity securities are considered to be more risky by the investor, a higher rate of return has been required
liabilities
of ABC. Any intangible value that may exist pertaining to ABC is not reflected in
over the period of time indicated in the calculation of this premium.
this schedule. Therefore, the methodology does not capture the full value of ABC,
Additional premia have been added to reflect size differentials relating to SRS. An adjustment has also been
made for other
factors.
In this instance,
percent has been
added to reflect level
discussed
assuming
thatrisk
it has
intangible
value.1.2Reconciling
a methodology,
that of
isrisk.
not As
inclusive
of
throughout this report, SRS is in a competitive industry with many players. SRS is also smaller than the
observed
by Ibbotson
Associates,
Inc. in developing
marketing
premium utilized
The
allcompanies
components
of value,
to other
methodologies
that the
would
be inclusive
of theabove.
intangible
size differential is an additional risk element to SRS.
value does not allow a proper comparison of values in determining a final conclusion. This
Summing all of these items results in the derivation of a discount rate. The mathematical formula to
is distinguish
like comparing
and
betweenapples
a discount
rateoranges.
and a capitalization rate is the subtraction of the present value of longterm sustainable growth from the discount rate. The present value of the long-term sustainable growth has
been included at a rate of 6 percent for SRS. This rate has been determined based on the trend in industry
rates of growth and overall long-term economic growth.
The liquidation value methodology, as applied by T&A, ignores costs of liquidation and the
time value of liquidation, and the schedule omits any reduction in value of the assets
- -7373 and/or
liabilities
liquidation.
It assumes
thattransaction
100 percent
of SRS
the adjusted
In addition,
supportfor
fororderly
this discount
rate is gained
from the actual
between
and Lincare.book
We
earlier established the fair market value of SRS to be $13,500,000 as of March 9, 1995. (See the section of
value
would
be“Valuation
receivedofupon
of theseInc.).
assets.
practice,
this does
notfree
happen
this report
titled
Smithliquidation
Respiratory Services,
UsingIn
Lincare’s
estimate
of pre-tax
cash
flow of $3,500,000 presented in Exhibit 3 to this report, we can calculate the pre-tax capitalization rate implied
forin
many of the asset categories. If it were to happen, it could potentially take a
the transaction as follows:
extraordinary amount of time to receive full value, in which case liquidity would suffer
Estimated Free Cash Flow
terribly and there would be a discount for lack of marketability.
Fair Market Value
$ 3,500,000
÷
Pre-Tax Capitalization Rate (Rounded)
13,500,000
26.0%
Revenue Ruling 59-60 suggests that earnings be considered for an operating company as
an investor would look to the earnings or cash flow of the business in order to measure its
To convert a capitalization rate to a discount rate, the long-term rate of growth needs to be added to the
capitalization
In this
instance, the
calculationhe
is:acknowledged that the non-operating assets
value. In Mr. rate.
Jones’
deposition
testimony,
consisted of land held for
investment.
ThisRate
item has been on
the books for a number of
Pre-Tax
Capitalization
26.0%
years, and yet, there was
no adjustment
for the fair market value
Long-Term
Growth Rate
6.0% for this asset. We can
only assume that over aPre-Tax
number
of years
Discount
Ratethe value of this asset
32.0% would have increased.
There are no workpapers indicating that this asset was appraised or that T&A specifically
To convert
a pre-tax discount
an after-tax rate,
theof
pre-tax
discountHere
rate isalso,
multiplied
by one minus
the
asked
any questions
aboutrate
thetoappraised
value
this asset.
sufficient
relevant
assumed tax rate. In this instance, we have assumed the combined federal and state tax rate to be 40
percent.
data
was The
not calculation
obtained.of the after-tax discount rate is as follows:
TA 190
Pre-Tax Discount Rate
1 - Corporate Tax Rate @ 40%
After-Tax Discount Rate
32.00%
x .60
19.20%
Although Schedule VIII is labeled Capitalization of Earnings, it is actually a capitalization
of owners’ cash flow. We have previously commented about the use of owners’ cash flow
being inappropriate, so we will not repeat that discussion here. However, in deriving
owners’ cash flow, the schedule starts with the adjusted net income, which is derived from
Schedule III (TA 170) and then adds the depreciation expense and subtracts owners’
perquisites. However, the amount of owner perquisites is unexplained. Typically, owners’
compensation and perquisites would be removed from the adjusted net income. The line
that is labeled Owners Perk’s contains different figures than officers’ salary on Schedule
III. Therefore, some additional adjustment has been made without explanation. Once
again, there are no workpapers in the T&A file that would indicate what these numbers
consist of. Therefore, not only does the reader not know why these numbers are being
subtracted, it is impossible to recreate what they consist of.
- -7474 The computer program
also
a line to CPA/ABV,
subtract dividends
in deriving
GARY
R.had
TRUGMAN
MCBA, ASA,
MVS owners’ cash flow,
but there are zeros on that line. Mr. Jones testified that distributions were made in the
Gary R. Trugman is a Certified Public Accountant licensed in the states of New Jersey, New York
past.
Therefore,
shouldinhave
beenValuation
figures by
included
on thisInstitute
schedule.
and Florida.
He isthere
Accredited
Business
the American
of CPAs and is a
Master Certified Business Appraiser as designated by The Institute of Business Appraisers Inc.
He is also an Accredited Senior Appraiser in Business Valuation by the American Society of
Appraisers. Gary is regularly court appointed and has served as an expert witness in Federal court
The
problem
with
this schedule
is that
the T&A
weighted
thematrimonial
cash flow matters,
amounts
andnext
state
courts in
several
jurisdictions,
testifying
on report
business
valuation,
business and economic damages and other types of litigation matters.
by putting the most weight on the most recent period. Conceptually while this would not
is currently
on theonly
American
Institute
of result
CPAs’ of
ABV
Committeethe
andprobable
he is a
beGary
a problem,
it would
be correct
if the
theExaminations
weighting represents
former member of the AICPAs Subcommittee Working with the Judiciary, ABV Credentials
Committee,
Executive
Committee
of owners’
the Management
Consulting
Services Division,
and the
future
earnings
(or in this
schedule,
cash flow)
for the company.
Reviewing
the
Business Valuation and Appraisal Subcommittee. He is currently Chairman of the Florida Institute
1989
through
1993 Forensic
cash flows
reflect aand
substantial
growth over
thisand
fivewas
year
period.
The
of CPAs’
Litigation,
Accounting
Valuation Services
Section
formerly
on the
New Jersey Society of CPAs’ Litigation Services Committee, Business Valuation Subcommittee
owners’
cash flows
from
$1,087,000 to $2,024,000, to $3,725,000, to $4,714,000
(past-chairman)
andincrease
Matrimonial
Committee.
toGary
$6,250,000,
in the
most
recent
period. Committee,
Yet, the T&A
uses
a weighted
average of
is Chairman
of the
Ethics
and Discipline
andreport
formerly
served
on the Qualifications
Review
Committee
and isup
thewith
former
Regional Governor
the Mid-Atlantic
Region of The
Institute
these
amounts
to come
a weighted
average of
cash
flow of $4,428,000.
Clearly,
with
of Business Appraisers Inc. He has received a “Fellow” Award from The Institute of Business
Appraisers
for his
many
of volunteer
in the
profession.
Gary
has
also received
an
the historicalInc.
trend
that
is years
indicated
in thiswork
report,
and
assuming
the
same
15 percent
AICPA “Hall of Fame” Award for his service to the accounting profession in assisting in the
accreditation
in business
process. the
Garylikelihood
formerly of
served
on the
Business
Valuation
growth
rate reflected
in anvaluation
earlier schedule,
probable
future
earnings
being
Education Subcommittee and the International Board of Examiners of the American Society of
$4,428,000
highlyadoubtful.
This weighted
average
would
significantly understate
Appraisers.would
He is be
currently
faculty member
of the National
Judicial
College.
the
earnings
stream
thaton
would
be representative
of the
future
for ABC.
weentitled
are not
Gary
lectures
nationally
business
valuation topics.
He is
the author
of a While
textbook
Understanding Business Valuation: A Practical Guide to Valuing Small to Medium-Sized
commenting
as to whether or not the figures are correct, the result in Schedule VIII is
Businesses, published by the American Institute of CPAs. He has also developed numerous
educational
courses,
butT&A
not limited
inconsistent with
the including
rest of the
report.to, a six day business valuation educational series
and a seminar entitled "Understanding Business Valuation for the Practice of Law" for the Institute
of Continuing Legal Education. Gary also serves as an editorial advisor for The Journal of
Accountancy, The CPA Expert, and formerly for National Litigation Consultants’ Review and the
ToCPA
compound
problem
further,
earningsgroups
on this
schedule
Litigation the
Service
Counselor.
Hethe
has weighted
lectured inaverage
front of numerous
and
has beenis
published in The Journal of Accountancy, FairShare and The CPA Litigation Service Counselor.
divided by a capitalization rate of 11 percent. While this capitalization rate is derived in
Gary was born in New York and received his undergraduate degree from The Bernard M. Baruch
Schedule
(TA
it notofonly
a 9the
percent
long term
perpetual
growthStates
of the
College ofVI
the
City188),
University
Newassumes
York. He was
first business
appraiser
in the United
to earn a but
Masters
Valuationindicates
Sciences from
His Masters
Thesis
topic was
company
the in
schedule
that Lindenwood
it should beCollege.
an historic
earnings
capitalization
"Equitable Distribution Value of Closely Held Businesses and Professional Practices". Gary's
appraisal
also includes
various
courses
offeredtobycash
The Institute
of Business
Appraisers,
rate.
This education
capitalization
rate should
not
be applied
flow. Earnings
and
cash flow
the American Society of Appraisers, the American Institute of CPAs and others. He has taught
federal
income
taxationcapitalization
at Centenary College,
financialfor
statement
analysisdiscussed
in the masters
degree
would
have
different
rates applied
the reasons
previously.
program at Lindenwood College, and several topics at the AICPA. National Tax School in
Here
too, T&AIllinois.
violates
appraisal
practice
therefore,
breaches
itsthe
professional
Champaign,
Heproper
is a member
of The
Instituteand
of Business
Appraisers
Inc.,
American
Society of Appraisers, the American Institute of Certified Public Accountants, the Florida Institute
obligation
to Public
the client.
of Certified
Accountants, the New Jersey Society of Certified Public Accountants and the
New York State Society of Certified Public Accountants.
Gary can be reached at [email protected].
- 75 When
asked
in his deposition
about
the title
of the
schedule
Capitalization
of Earnings
Linda
B. Trugman
CPA/ABV,
MCBA,
ASA,
MBA
is the Vice
President of
Trugman
Valuation
Associates,
Inc.,
a
firm
specializing
in
business
valuation
and
litigation
support
being an inaccurate heading for the methodology, Mr. Jones stated (January 25, Page
74,
services. Linda is a Certified Public Accountant licensed in the states of Florida and New
lineJersey.
7):
She is designated as Accredited in Business Valuation by the American Institute
of CPAs, a Master Certified Business Appraiser by The Institute of Business Appraisers
and an Accredited Senior Appraiser by The American Society of Appraisers. Linda is a
member
theincorrectly
Qualifications
Review
A. of Its
stated,
yes.Committee of The Institute of Business Appraisers,
and formerly served on the International Board of Examiners of the American Society of
Appraisers. She is currently serving as International Vice President of the American
When
questioned
in his deposition
aboutChair
using
results
as a predictor
ofof
future
Society
of Appraisers
as well as Past
ofthe
thehistoric
Business
Valuation
Committee
that
organization.
Linda responded
formerly served
as chair
of the25,American
operations,
Mr. Jones
as follows
(January
Page 82,Society
line 16):of Appraisers
Business Valuation Education Committee. Linda is a Fellow and former Governor of The
Institute of Business Appraisers. She formerly served as Chair of the FICPA’s Relations
with Q.
the Florida
Bar Committee,
on the
steeringhistory
committee
of thetoValuation,
Litigation
Do you
expect thatand
– the
five-year
of ABC
be a good
and Forensic
Accounting
Section
of
the
FICPA.
Linda
currently
serves
as
Secretary
of the
predictor of future operations of ABC?
ASA Educational Foundation.
A.
I believe it was as good as the – is more indicative of what was likely
Linda is the former editor of the ABV e-Alert, a publication of the AICPA’s Business
to happen. It was an indicator of value, yes, but I think we weighted
Valuation Committee. She formerly served as editor of Business Appraisal Practice, the
pro –ofthe
cash
flows more
the
professionalthe
journal
Thediscounted
Institute of future
Business
Appraisers.,
andheavily
served than
on the
editorial
historic
method.
board of BV Q&A published by Business Valuation Resources. Linda formerly served on
the Business Valuation and the Business Valuation/Forensic and Litigation Services
Q.
Well, is it representatives
of the
futureserves
or not?
sureboard
I
Executive
Committees
of the AICPA. She
currently
on I’m
the not
editorial
of
understand
–
you
said,
“I
believe”
–
“I
believe
it
was
as
good
as
the
–
Financial Valuation and Litigation Expert published by Valuation Products, LLC. In
is more
indicative
of whatinto
was
to happen.”
don’t understand
November 2009,
Linda
was inducted
thelikely
AICPA’s
BusinessI Valuation
Hall of Fame.
your answer. My questions I thought was pretty simple. Did you
expect
the five-year
history
of ABC
to be a the
good
predictor
of future
Linda teaches
business
valuation
courses
throughout
country
for The
Institute of
operations the
of ABC?
Business Appraisers,
AICPA, various state societies of CPAs, and the American
Society of Appraisers. She also lectures nationwide. She has served as faculty for the
National
Linda is a co-author of the first, second and third editions of
A. Judicial
It was College.
a predictor.
Financial Valuation Applications and Models, published by Wiley Finance, has authored
several self-study courses and has served as a technical reviewers on all four editions of
the AICPA’s Understanding Business Valuation: A Practical Guide to Valuing Small to
Medium
Sized
Businesses
as to
well
Theit would
Lawyer's
Valuation
Clearly,
even
Mr. Jones
refused
sayasthat
be Business
a good predictor
of Handbook
the future
authored by Shannon Pratt and published by the American Bar Association. She is also
operations.
merelyGuide
said “Ittowas
a predictor.”
When
questioned
and
the editor He
of BVR’s
Business
Valuation
Issues
in Estateabout
and the
Gift results
Tax, 2010
theedition.
trend in terms of earnings, Mr. Jones indicated the following (January 25, Page 83, line
19):Linda can be reached at [email protected].
Q.
Assuming that ABC is going to be able to take advantage of the
growth that you’ve indicated in your report, i.e., 15 percent long-term
business growth, do you believe that the earnings of ABC will go up,
go down or remain flat?

Florida Personal Goodwill

Transcription

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