News & Articles

The Market Approach: A Touchstone in Valuation

Posted on Mon, Apr 19, 2021

The market approach, whereby appraisers use comparable "guideline companies" to help them estimate the value of a private business, has become a long-standing valuation touchstone.

Two primary valuation methods are categorized under the market approach:

1. Guideline public company method. Here, appraisers identify companies with stock (or partnership interests) that are actively traded in the public markets, such as the AMEX or NYSE. Then they calculate key financial variables, using the stock price and a variety of pricing multiples such as price-to-revenue, price-to-net income and price-to-book.

Financial variables may be calculated for a variety of time periods, such as next year's forecasted performance, the preceding 12 months, or an average of the last five years. The appropriate pricing multiple depends on case specifics and is a matter of the appraiser's professional judgment.

The subject company's fair market value equals the pricing multiple times the subject company's financial variable (for example, revenues, net income or book value). Because the guideline public company method is based on individual stock prices, under certain circumstances it generates a minority, marketable basis of value.

2. Merger and acquisition (M&A) method. For guideline transactions under this method, appraisers analyze sales of entire public or private businesses. So this technique typically generates a controlling, marketable basis of value.

Because private businesses aren't required to disclose sales to the SEC, finding out their details can be difficult. Fortunately, appraisers have access to several proprietary databases (such as DealStats, Done Deals and BIZCOMPS) that they can use to identify and analyze private deals.

Once appraisers have identified a relevant sample of potential guideline transactions, they calculate pricing multiples relative to key financial variables. Fair market value is a function of the pricing multiple and the subject company's financial metric (say, last year's revenues or book value).

Deciding Which Way to Go

The availability of transaction data is a key determinant of whether an appraiser uses the market approach. Pure players (companies that focus on a single target market or offer a limited menu of products) may be hard to come by in the public markets -- especially in industries dominated by conglomerates. And some industries lack a meaningful sample of M&A transactions, particularly those involving small niche participants.

In general, the guideline public company method makes more sense if the subject company is large enough to consider going public and when valuing a minority interest in a going concern business. Using this method to value a controlling interest may require subjective adjustments for control.

Conversely, the M&A method is generally more appropriate when valuing controlling interests. But, with proper adjustments and analyses, it can be used to value minority interests.

Other disadvantages of the M&A method are:

  • Transaction databases provide limited information about guideline companies.

  • Details provided are unverified.

  • The sales price may include buyer-specific synergies and undisclosed terms (such as installment sales, employment contracts and noncompete agreements).

Avoiding Mistakes

One common valuation mistake that may occur under the market approach is failing to adjust the financial statements of the subject company or the guideline companies to ensure accurate comparisons.

For example, nonrecurring items and discontinued operations may need to be eliminated. Or, for comparative purposes, appraisers may need to rectify accounting inconsistencies, say, for depreciation or inventory methods. Ideally, appraisers make these adjustments before selecting guideline companies and computing pricing multiples.

Inconsistent terminology may also lead to problems. Slight differences in the ways databases or appraisers define terms such as "cash flow" or "earnings" can trigger significant valuation differences. It's imperative to understand how each database defines variables as well as what's included (or excluded) in the selling price.

An Accurate and Defensible Valuation

The market approach has intuitive appeal: The value of an investment should be comparable to similar investments in the marketplace. But finding a reliable sample of comparable transactions isn't as easy as it appears, especially for small niche players. An experienced valuation pro knows the tricks to applying the market approach to derive accurate and defensible valuations. EHTC has a team dedicated to provide the appropriate valuation method to you.

About EHTC

EHTC is a dedicated, full-service CPA firm in West Michigan that focuses on helping clients to achieve their full potential through comprehensive accounting, finance and tax services. We are a local firm with large firm resources, using a team approach to proactive client service that helps our clients gain a competitive advantage through our ability to develop strategies and present realistic solutions that build value.

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Tags: Valuation, Mergers and Acquisition (M&A)

Know Your OSHA Obligations if COVID-19 Strikes Your Business

Posted on Wed, Apr 14, 2021

Not all employers are bound by the recordkeeping and reporting requirements established by the Occupational Safety and Health Administration (OSHA). Generally, an employer must have more than 10 employees to be subject to those legal obligations, unless OSHA specifically instructs you otherwise.

Your company also must be in an industry that's considered hazardous, such as manufacturing, construction, utilities, agriculture and wholesale trades. Examples of non-hazardous industries include retail, financial services, and real estate. OSHA classifies industries using the Census Bureau's North American Industrial Classification codes. If you're uncertain about your status regarding OSHA, contact the agency.

Reporting requirements can vary by each business establishment — defined as "a single location where business is conducted or where services or industrial operations are performed." That means if you have multiple locations with varied functions, it's possible that one location is subject to OSHA recordkeeping (maintaining an OSHA log) and reporting requirements, and another isn't.

OSHA "General Duties Clause"

Beyond administrative requirements, all employers large enough to be subject to regulations specific in the Occupational Safety and Health Act (regardless of industry) are covered by the law's "general duties clause." This clause specifies that employers must give employees a place to work "free from recognized hazards that are causing or likely to cause death or serious physical harm."

Also, 28 states have their own laws and regulations governing occupational health that might be more stringent than OSHA's. Perhaps you operate in one of them.

If you're subject to OSHA's recordkeeping and reporting requirements, how does COVID-19 fit into that picture? According to OSHA, the following conditions must be met before you are required to record an employee COVID-19 case:

  • Most basic: The employee's ailment is, indeed, proven to be COVID-19,

  • The case "involves one or more of the general recording criteria" laid out in OSHA regulations, including, for example, that the condition can't be remedied with basic first aid procedures, and

  • The disease was contracted in conjunction with the employee's work.

Determining What's "Work-Related"

OSHA concedes that "in many instances, it remains difficult to determine whether a COVID-19 illness is work-related, especially when an employee has experienced potential exposure both in and out of the workplace." With that challenge in mind, OSHA has laid out some "enforcement guidance" for its investigators to determine violations applicable to COVID-19 cases.

Here are three highlights included in that guidance:

  1. A discussion of the reasonableness of the employer's investigation into work-relatedness. "Employers, especially small [ones], should not be expected to undertake extensive medical inquiries, given employee privacy concerns."

  2. An examination of the evidence available to the employer. Employers shouldn't be penalized for good-faith determinations when limited evidence was at hand to draw an accurate conclusion about whether a COVID-19 case was work-related.

  3. A look at how available evidence is interpreted.

The OSHA enforcement guidance offers several illustrations of evidence that is likely to lead to a reasonable conclusion that a COVID-19 case was work-related. One example is when several employees who work closely together all come down with COVID-19 and there's no alternative explanation. Another involves the employee whose job duties "include having frequent, close exposure to the general public in a locality with ongoing community transmission."

Recordable vs. Reportable

As with other workplace-related illnesses and injuries, a work-related COVID-19 case may be "recordable" (and thus logged), but not "reportable" — that is, promptly reported to OSHA. To be recordable, an illness or injury must be too serious to be remedied with basic first aid and involves time away from work. COVID-19 cases often fit that description.

To be reportable, the case either involves in-patient hospitalization or, in the ultimate example, death. However, that standard isn't as clear-cut as it might appear with COVID-19. That's because to meet the "reportable" standard, the hospitalization must occur within 24 hours of the incident. In the COVID-19 case, the incident is exposure to the SARS-CoV-2 virus that leads to the disease. It's unlikely that someone who is exposed to the virus one day would be hospitalized within 24 hours.

You'd also need to know that the employee was hospitalized and that the COVID-19 case was work-related. Knowing both promptly may be improbable. However, as soon as you do determine that the case was work-related, you've got 24 hours to report it to OSHA.

When an employee dies of a confirmed COVID-19 case, and the death occurs within 30 days of exposure to the virus, you have an eight-hour window to report it to OSHA from the time you know "both that the employee has died, and that the cause of death was a work-related case of COVID-19," according to a Q&A provided by agency.

A Little Perspective

OSHA's enforcement guidance — and common sense — indicate that proper recording and reporting take a back seat to a basic concern for employee health. "In all events," the guidance states, "it is important as a matter of worker health and safety, as well as public health, for an employer to examine COVID-19 cases among workers and respond appropriately to protect workers, regardless of whether a case is ultimately determined to be work-related."
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Tags: OSHA, Business Owner, COVID-19

Team Member Spotlight: Maddie Boerema

Posted on Mon, Apr 12, 2021
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Tags: Taxes, Team Member, Transaction Advisory Services, Financial Due Diligence

Goodwill: Personal or Business -- and Why Does It Matter?

Posted on Thu, Apr 08, 2021

You can't touch goodwill, but it's one of the most valuable assets for many businesses. Commonly associated with professional service firms, goodwill can also exist among manufacturers, retailers, contractors and other types of businesses. Valuing intangible assets, including goodwill, requires the use of a business valuation professional to get it done right.

Getting a Handle on Goodwill

The International Glossary of Business Valuation Terms defines goodwill as:

That intangible asset arising as a result of name, reputation, customer loyalty, location, products, and similar factors not separately identified.

Goodwill (or "blue sky" as it's also known) is often thought of as the difference between a business's fair market value and the value of its net identifiable tangible and intangible assets. Business owners and attorneys may need to gauge the value of goodwill -- and its underlying components -- in mergers and acquisitions, divorce cases, shareholder disputes, and various tax scenarios.

Different Types of Goodwill

If you talk with business owners or professional practitioners, many will tell you that their companies could not survive without them. That may be a bit of an exaggeration, but they do have a point. Traditionally, goodwill has been broken down into two components:

Business (or entity) goodwill. This belongs strictly to the entity itself. Business goodwill may arise from many sources, including the company's name, phone number, location, and special attributes, such as special menu items or recipes at a restaurant.

Personal (or professional) goodwill. This type of goodwill is directly attributable to an individual's characteristics or attributes. It includes not only the owner's skills, knowledge and reputation but also his or her contacts and relationships.

Personal goodwill can be further bifurcated into pure personal goodwill and transferable goodwill. Pure personal goodwill cannot be transferred to the entity or anyone else under any circumstance. These are often true personal relationships:

  • "We want John to testify in this case because we know what type of a witness he is. No one else will do."
  • "Wayne has developed the cultural relationship and ties necessary to gain the trust of a particular customer. Therefore, only Wayne is able to buy and sell the product to him."

If a business is sold, the buyer won't pay for pure personal goodwill, because it's something that will literally walk out the door with the seller.

Transferable goodwill is goodwill that is personal in nature, but might be transferred to the entity or to another individual with proper planning and adequate time. These could be personal relationships or specialized knowledge that could be transferred through training or development of other people. It could also include contact lists that have been developed over a period of time or customer (or vendor) relationships that can be transferred given effort and time.

Splitting Up Goodwill

So, how personal is your goodwill? Dividing goodwill among its three components -- business, pure personal and transferable personal goodwill -- requires professional judgment and careful consideration of the facts at hand. Valuators may perform different analyses to divvy up goodwill that include:

Evaluate comparable transactions. Search for similar business sales in proprietary transaction databases. Theoretically, these deals should not include any pure personal goodwill, because no rational buyer would pay for an asset that walks out the door with the seller. But beware, a comparable business could rely more (or less) on pure personal goodwill than the subject company.

For example, an accounting firm in an urban market with 10 partners and 100 employees would be more likely to possess business or transferable personal goodwill than a three-partner firm that operates in a small, rural market and employs just a receptionist and one bookkeeper. Clients of the smaller firm may be attracted solely to an individual practitioner and his or her reputation. Clients of a mid-sized urban firm might be attracted to the firm's location, name recognition and diversified staff of professionals, however.

Consider conditions of sale. Some databases also list the details of employment, consulting or noncompete agreements between the buyer and seller as a condition of sale. The value similar businesses assign to these agreements can be used as a basis to estimate transferable personal goodwill. But, beware, these agreements might be based on gut instinct or driven by tax strategies, rather than market value.

Estimate the cost of an orderly transition. Some personal goodwill can be transferred to new owners through an orderly transition. The selling owner can remain for some period of time with the business to maintain a presence, introduce the new owner, and facilitate a rapport-building program with the employees, customers, and suppliers. The estimated costs of the selling owner's compensation plus other direct expenses during the transition can be used as an estimated value of personal goodwill.

Even in an orderly transition, some customers may be lost, so it's also important to consider the expected loss of revenue. Some customers simply can't be transitioned over to the new owner, no matter how hard the buyer and seller try. Beware however, that some customer loss may be due to operational changes made by the new owner, so it can be argued that the revenue lost from these changes is not related to personal goodwill.

Bottom Line

Knowing how to differentiate and value the components of goodwill is important if you're buying or selling a business -- or if you face litigation that involves the value of a business interest, such as a marital dissolution or shareholder dispute. Splitting goodwill may seem like splitting hairs, but it should be done in logical way by a valuation expert who understands all of the interconnections and implications.

About EHTC

EHTC is a dedicated, full-service CPA firm in West Michigan that focuses on helping clients to achieve their full potential through comprehensive accounting, finance and tax services. We are a local firm with large firm resources, using a team approach to proactive client service that helps our clients gain a competitive advantage through our ability to develop strategies and present realistic solutions that build value.

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Tags: Valuation, Business Valuation, Goodwill

PPP Application Deadline Extended in New Law

Posted on Tue, Apr 06, 2021

On March 30, 2021, President Biden signed legislation to extend the application period of the popular Paycheck Protection Program (PPP) through May 31, 2021. This followed a bipartisan 92-7 vote in the U.S. Senate to pass the Paycheck Protection Program Extension Act of 2021.

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Tags: Deadlines, Paycheck Protection Program, PPP

The Evolution of the Employee Retention Credit

Posted on Fri, Mar 26, 2021

The pandemic has adversely affected many sectors of the U.S. economy, causing widespread job losses. At the start of the national emergency, Congress created a novel tax break — the Employee Retention Credit (ERC) — to entice employers to retain employees. But three different laws have created and changed the credit, which has led to significant confusion. Here's a summary of how the ERC has evolved over the last year from the CARES Act to the American Rescue Plan Act (ARPA).

New Tax Break under the CARES Act

The CARES Act, which was enacted in March 2020, introduced the ERC for employers that kept workers on their payrolls. It was designed to help curb layoffs during the COVID-19 pandemic.

Under the CARES Act, the tax credit amount equaled 50% of qualified employee wages paid by an eligible employer in an applicable 2020 calendar quarter. It was subject to an overall wage cap of $10,000 per eligible employee per year. Originally, the ERC only covered wages paid between March 13, 2020, and December 31, 2020.

Changes under the CAA

In December 2020, the Consolidated Appropriations Act (CAA) extended and greatly enhanced the ERC. Specifically, the CAA extended the covered wage period to include the first two calendar quarters of 2021, ending on June 30, 2021.

In addition, for the first two quarters of 2021 ending on June 30, the CAA:

  • Increased the overall covered wage ceiling to 70% of qualified wages paid during the applicable quarter (versus 50% under the original CARES Act rules), and

  • Increased the per-employee covered wage ceiling to $10,000 of qualified wages paid during the applicable quarter (versus a $10,000 annual ceiling under the original rules).

Important: For the first two quarters of 2021 ending on June 30, 2021, these changes effectively increase the maximum per-employee credit from $5,000 (50% x $10,000 of qualified wages) to $14,000 (70% x $10,000 of qualified wages x 2 quarters).

For the first two quarters of 2021 ending on June 30, the CAA included a liberalized employer eligibility rule based on a required more-than-20% decline in gross receipts, compared to the corresponding 2019 quarter (versus a required more-than-50% decline under the original CARES Act rules).

For the first two quarters of 2021 ending on June 30, the CAA also stipulated that for employers with 500 or more employees (versus 100 or more under the original rules), the ERC can only be claimed for qualified wages paid to employees who are unable to work due to a suspension of the employer's business or a lack of business. This change will allow more medium-sized employers to claim the credit in 2021.

In a retroactive change, the CAA stipulated that the ERC can be claimed for qualified wages paid with proceeds from Paycheck Protection Program (PPP) loans that aren't forgiven. This retroactive change goes back to the day the CARES Act was signed.  

Another Extension and Expansion under the ARPA

The ARPA was enacted on March 11, 2021. The new law extends 1) the ERC from June 30, 2021, until December 31, 2021, and 2) the rate of the credit at 70% for this time period. Qualified wages are generally limited to $10,000 per employee per calendar quarter in 2021. So, the maximum ERC amount available is generally $7,000 per employee per calendar quarter or $28,000 per employee in 2021.

Employers who got a PPP loan in 2020 can still claim the ERC. But, when calculating the credit, the same wages can't be used both for seeking PPP loan forgiveness or satisfying conditions of other COVID-relief programs, such as the restaurant revitalization grants enacted as part of the ARPA. (See "Important Rules and Restrictions for 2021" below.)

Need Help?

The ERC provides struggling employers with a valuable tax break when they need it most. Contact your EHTC Tax Advisor to help you understand the rules and maximize your credit in 2020 and 2021.

Important Rules and Restrictions for 2021

A qualified employer is eligible for the Employee Retention Credit (ERC) if it experiences a significant decline in gross receipts or a full or partial suspension of business due to a governmental order. For 2021, small employers (with up to 500 full-time employees) can claim the credit without regard to whether the employees for whom the credit is claimed actually perform services. But, except as discussed below, large employers (with more than 500 full-time employees) can only claim the credit with respect to employees that don't perform services. 

An eligible employer can claim the refundable ERC against "applicable employment taxes" equal to 70% of the qualified wages it pays to employees in the third and fourth quarters of 2021.

Under the American Rescue Plan Act (ARPA), beginning in the third quarter of 2021, the following modifications will apply to the ERC:

  • Applicable employment taxes are the employer's share of Medicare (equal to 1.45% of the wages) and the amount of the tax under the Railroad Retirement Tax Act payroll tax that's attributable to the employer's Medicare tax rate. For the first and second quarters of 2021, "applicable employment taxes" are defined as the employer's share of Social Security tax (equal to 6.2% of the wages) and the amount of the tax under the Railroad Retirement Tax Act payroll tax that was attributable to the employer's Social Security tax rate.

  • So-called "recovery startup businesses" are qualified employers. A recovery startup business is generally a business that began operating after February 15, 2020, and meets certain gross receipts requirements. A recovery startup business will be eligible for an increased maximum credit of $50,000 per quarter, even if the business hasn't experienced a significant decline in gross receipts or been subject to a full or partial suspension under a government order.

  • A "severely financially distressed" employer who has suffered a decline in quarterly gross receipts of 90% or more compared to the same calendar quarter in 2019 will be able to treat all wages (up to the $10,000 limitation) paid during those quarters as qualified wages. This rule will allow a large employer (with over 500 employees) under severe financial distress to treat those wages as qualified wages regardless of whether its employees actually provide services.

  • The statute of limitations for assessments relating to the ERC won't expire until five years after the date that the original return claiming the credit is filed or treated as filed.

Contact your EHTC Tax Advisor for more information.

 

About EHTC

EHTC is a dedicated, full-service CPA firm in West Michigan that focuses on helping clients to achieve their full potential through comprehensive accounting, finance and tax services. We are a local firm with large firm resources, using a team approach to proactive client service that helps our clients gain a competitive advantage through our ability to develop strategies and present realistic solutions that build value.

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Tags: Employers, Business Owner, cares act, ERC

How the Current Tax Law Affects Charitable Giving from IRAs

Posted on Mon, Mar 22, 2021

For charitable donors, the Tax Cuts and Jobs Act (TCJA) provided some tax breaks and took away others. Here's what charity-minded individuals need to know.

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Tags: Charitable Donations, Charitable Contributions, IRA, Standard Deductions

IRS Extends the Tax Filing and Paying Deadline for Individuals

Posted on Fri, Mar 19, 2021

The IRS has announced that the federal income tax filing deadline for individuals for the 2020 tax year is extended from April 15, 2021, until Monday, May 17, 2021.

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Tags: Individual Taxes, IRS, Tax Deadline

EHTC Welcomes Christi Clark as the Human Resources Manager

Posted on Mon, Mar 15, 2021
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Tags: Human Resources, EHTC, Team Member

When Should You Take Social Security Benefits?

Posted on Thu, Mar 04, 2021

If you're nearing retirement, you've likely paid into the Social Security system your entire career. It's only fitting that you finally cash in on the Social Security benefits that are rightfully yours. But when should you start receiving benefits — at the first available date, at the latest date or somewhere between those dates?

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Tags: Retirement, Social Security