Opening Comments Welcome to our Fall 2009 issue of Valuation/Litigation Insights. Through this publication, our hope is to bring our friends in the business community original, internally prepared perspectives that are brief, meaningful and useful. With each article we identify our intended audience, allowing you to focus on what is relevant for your practice or business. Please let us know if there are any topics you would like to see addressed in future issues.
Market Non-Comparables When Market Comparables Are NotWellComparable [This article is intended for advisors who utilize business valuations]
I was recently asked by an attorney how do I know that the market comparables listed in a business valuation are really comparable. Her concern was that the business appraiser was intentionally picking guideline companies that would support a biased value.
The concern, for me, goes beyond intentional bias. The concern also includes unintentionally inappropriate comparisons. I once saw a privately held business with annual revenues of $15 million valued based on multiples obtained from multi-billion dollar publicly traded companies. The publicly traded companies selected merely had small divisions that indirectly related to the subject companys line of business. Were these companies comparable Hardly, but many readers of a valuation report would not know why comparables are not comparable.
The average user of a valuation report may not be able to identify whether companies used are a good comparable, but there is something the average user can consider. That is, are the multiples used a good match Often, they are not. Let me explain.
When comparable companies are identified, a value multiple is determined from them. This multiple is applied to the subject company and a value is concluded upon. For instance, an identified average multiple of 5.0 x EBITDA applied to a company with $200,000 in EBITDA calculates an unadjusted value of $1 million. The problem is that the average multiple may not be appropriate.
To use an exaggerated case, assume three comparable companies were identified. One had an EBITDA multiple of 4.95 : 1.00, another was at 5.00 : 1.00 and a third was at 5.05 : 1.00. Here, I think we would agree that the average of 5:00 is a reasonable multiple. Now here is an exaggeration, and again assume three companies. One had an EBITDA multiple of 9.00 : 1.00, another was at 5.00 : 1.00 and a third was at 1.00 : 1.00. Here, is the average of 5:00 a reasonable multiple or should the seller be selling at 9.0x EBITDA Should the buyer be buying at 1.0x EBITDA
Unfortunately, in reality the indentified multiples are not so clearly related or unrelated, so how is the user supposed to know if they are appropriate The answer consider the coefficient of variation. The coefficient of variation is a measure of dispersion around the average. Simply put, it is a statistical measure that considers whether or not numbers are related. The lower the coefficient of variation, the higher the relationship. Generally, a coefficient of variation of 0.50 or lower suggests a strong relationship.
You may not have the tools to calculate the coefficient of variation, but you can see whether or not it was considered by the appraiser. If not, question the relationship.
Jumpstart Your Audit Committee Serving the Need, Not Checking the Box [This article is for individuals associated with organizations having audit committees.]
Frequently, Audit Committees are thrown together more in a check the box response to a required procedure and less in a desire for strong corporate governance. As a result, Audit Committees often gather once a year only to hear an often routine report from the outside accountants. With the growing understanding of the importance of appropriate corporate governance, we thought our readers would appreciate knowing practical areas that Audit Committees should be considering:
Awareness the Audit Committee should be challenging their own awareness of:
Ethics and the opportunity for fraud within their own organization,
Fraud and fraud fighting procedures...procedures that may also uncover honest but costly mistakes,
Organizational controls, their appropriateness and their effectiveness, and
The organization's prior experience with the detection of errors and fraud and the organization's response to it.
Oversight - the Audit Committee should be taking an active role in directing
The monitoring of managements financial activities,
The guidance of the internal audit function,
The implementation of error/fraud prevention and detection programs, and
The reporting of such activities to the Board and/or ownership.
Self-Assessment the committee should ensure that it is functioning as an audit committee and not as a passive body of listeners to an outside auditors report. Tools such as self assessments, formal written surveys and feedback from management and auditors can help ensure that the Audit Committee is effective and engaged.
Ready for your revival The most important part of jumpstarting your committee is having everyone make a commitment to embrace changes for the good of your organization, changes that will protect and ensure the longevity of the entity. A first step can be finding an experienced facilitator who will lead the group into uncovering and addressing some key areas for improvement and who can assess the current committees knowledge and commitment to the points above. Effective retreats will study hypothetical ethical dilemmas and evaluate the committee members responses to them. They will also provide an overview of fraud and common methods used to commit it, summarize error and fraud prevention and detection techniques, identify specific industry risks and exercise brainstorming to address a response to the days findings. For more information on how to jumpstart your Audit Committee or how to develop a retreat customized to your organization contact me via phone or .
Disclaimer: These articles are intended for our friends in the legal, banking and professional services community and merely reflect our observations. These articles should not be construed as legal counsel. Contact an attorney whenever legal advice is needed.
