Ag Case Study - Conducting a Business Valuation for Success Planning

November 25, 2019

GC NICHE: Agriculture

TYPE OF INDUSTRY: Agriculture

GC TEAM MEMBER(S) INVOLVED: Marty Fox, CPA/ABV, CVA

SITUATION:

A non-client came to the firm for a business valuation as part of their succession planning process, which was completed with the help of a family business consultant. The multi-owner business (two families) included a second generation hoping to buy the business from the first generation of owners.

The business itself was comprised of multiple companies: a land holding company, a processing company, and a marketing and sales company. The initial plan was to gift and/or sell interests in the business to the second generation. The goal of the valuation was to help the family determine the best financial structure of the transfers.

We met with the parties involved, bringing them together in one room to discuss some of the family-controlled costs of the business and how they compared to the market value of similar costs. The sit-down allowed us to get the perspectives of both the controlling and minority owners.

Under the existing structure, the business compensated all the owners. Our first step was to adjust that compensation, so it was more in line with the market. The second generation felt that was fair, given that the older generation wasn’t doing a lot of heavy day-to-day lifting anymore, and the older generation felt the change was reasonable because they owned land and charged rent to the operating business.

CHALLENGES:

  • Getting all involved parties into one room. In this situation, we were able to do so and get perspectives on the business from the main and minority owners.
  • Developing reasonable market compensation for the owners. We wanted to consider the minority owners’ opinions: Did they feel like they were receiving a fair price?
  • Consolidating the value of the business into a meaningful package, including real estate values and operating business values.
  • Examining past industry trends as well as future projections.
  • Managing personalities and reading the room to make sure all parties feel heard.
  • Managing the needs and expectations of both active and inactive partners.

CONSIDERATIONS & TACTICS:

  • Build consensus. The parties might not start of the same mind, but through discussion it’s possible to get to a point where everyone is comfortable. If not, there is a risk that one or more parties might dispute the valuation.
  • Read personalities. Coming to a valuation involves emotions and motives, not just numbers.
  • Facilitate discussion. Real discussion and feedback are the keys to moving forward. We always make sure that all perspectives are heard and included in our analysis in order to temper the dominant voices and elevate the voices of those who are reluctant to speak up.
  • Maintain creative control. Keeping options on the table makes it easier to come up with creative solutions and parse out the business.
  • Understand trends. How is the business going? Is its success cyclical, or is there steady growth? How is the industry growing? We do a financial spread for five years and review it for aberrations. If inconsistencies are present, we discuss what caused them and whether they are likely to repeat themselves. What is the expectation for the future?

OTHER CONSIDERATIONS OR PERSPECTIVES:

  • Our analysis uncovered errors in the business tax returns. Depreciation on equipment purchases of nearly $1 million was not taken, potentially costing the business $300,000 in income taxes.
  • We recommended third-party vendors who could help them appraise real estate and equipment. We reviewed the appraisal reports and spoke with the client to ensure the appraisal didn’t double-count assets.
  • More and more business owners are looking for independent valuations to help them make decisions about buying or selling, structuring transfers to family members, and to monitor the value of the major asset in their portfolio… their business.

LIST THE STEP-BY-STEP PROCESS:

  • We allowed plenty of time for research, in-person fact-finding and discussion, and writing and reviewing the final report.
  • We acquired five years of financial statements and used them as the basis of our analysis. We studied trends, aberrations, and made note of questions.
  • We then went back to the client with our initial findings and asked for their feedback and to fill any gaps in knowledge.
  • We looked at the business objectively: What would it look like if an independent third party were in charge? How would that affect compensation and rent?
  • Once adjustments were made, we looked at the value based on risk factors (leverage, loss of key management, narrow scope of customers, small geographic area, economy, industry, etc.)
  • We evaluated risks to the income to determine an appropriate rate of return that a normal investor would require.
  • We used an income approach to determine the value of the business based on its return of cash flow to the owners. We also used a market approach by searching transactions of similar companies — known as “comps” — to provide a starting point. In the end, we valued the company based on cash flow.
  • We wrote the report, sent a draft for review, and then had a detailed review in person. Once everyone was good with the assumptions and conclusions of the report, we finalized the document.

FINAL RECOMMENDATION & OUTCOME:

The valuation gave the owners a fair, unbiased view of the business and allowed them to make changes without resorting to emotional decisions. They saw the valuation as an important part of the succession process and were able to come to an amicable consensus. As one of the parties said, “This is really helpful, and I don’t think we could have progressed any further without having this done.”

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Modesto, CA 95350

(209) 527-4220 (phone)
(209) 527-4247 (fax)

https://www.grimbleby-coleman.com/resources/articles/209

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