Several years ago, when BCG Valuations was celebrating its 10th anniversary, and its founder his 40th year as a business appraiser, our staff spoke with Jim about the industry and how it has changed during his career.
Q: How has the business valuation profession changed in the last 40 years?
A: That’s a tough question. I suppose one of the biggest changes is the increasing application of the income approach, which we barely touched on in the 70s. On a related note, back then, we almost always reflected a controlling interest by applying a control premium and/or deriving multiples from transaction comparables (now known as “guideline transactions”). Today, in applying the income approach, it’s routine to adjust cash flows to a controlling interest basis, rather than apply a control premium. Another change is the development and adoption of USPAP (the Uniform Standards of Professional Appraisal Practice). Before 1990, there were continual references to “generally accepted valuation standards,” although, the fact is there were none. USPAP did not come into being until after the savings and loan crisis. As a result, there are now standards by which we must all abide. Finally, the number of qualified credentialed competitors has proliferated over the past 20 to 30 years, moving forward from the “old days” of attorneys and accountants preparing valuations on a part-time, ad hoc basis. An aftershock of the increase in business valuation professionals is that fees in certain segments of the industry have been deeply reduced.
Q: What about changes in the last 10 years?
A: One that comes to mind is the passage of the Pension Protection Act of 2006, which added teeth to earlier code sections dealing with valuation understatements. Since its passage, business appraisers, for the first time, have been subject to monetary sanctions (generally equal to the lesser of 10% of the underpayment amount or 125% of the engagement fee). Also, with the advent of fair value accounting, the use of option pricing models is now widespread.
Q: What was the oddest/most unique business model you’ve seen in your valuation practice?
A: I guess it was back in the 80s, a divorcing spouse was running a cash-based jewelry business for wealthy area residents from a number of downtown safe deposit boxes at local banks. An odd business model, but quite lucrative for obvious reasons.
Q: What was the toughest challenge you faced in your career?
A: Actually, I can think of two. The first was working through a deluge of gift tax valuations between 2011 and October 15, 2013. Processing those hundreds of appraisals was a formidable task, but it was also an opportunity to test our mettle. In the end, it was very gratifying to have met the challenge on a timely basis. The other was figuring out the complexities and ramifications of Chapter 14 (Code Sections 2701-2704) when they were issued back in the 4th quarter of 1990.
Q: What practical advice can you share with an attorney/client?
A: Often, a practical solution in estate planning for the owners of a closely held company is to create two classes of stock—voting and non-voting. All too often, a disproportionately large number of non-voting shares is issued or suggested by the professional advisors. A top heavy, non-voting to voting ratio, however, can create considerable uncertainty because, sooner or later, the share(s) in that very small voting class need to be valued. Then, it becomes a contest of figuring out “how many angels can dance on the head of the valuation pin.” It’s much better to keep the ratio more proximate, especially in the case of an operating company organized as a corporation. A more balanced capital structure will help reduce the uncertainty in an already highly uncertain estate planning process.
Q: And to a business-owner client?
A: If you’re hesitant about relinquishing control but want to reduce the size of your estate, talk to your attorney about recapitalizing with voting and non-voting shares, through which you can retain control of the enterprise with a smaller sliver of the overall equity.
Q: What would help an attorney gain a better understanding of valuations?
A: Having a working knowledge of USPAP and how it affects the development and reporting of a business valuation is a solid place to start. But USPAP also embraces real estate, machinery and equipment and personal property appraisals—we expand on this on our third blog post.