Anecdotally there is a lot of money on the sidelines obtaining small yields.  Will a market upturn start a reocurrence of the . . . → Read More: An Economic Turn Around Ahead?]]> As reported in the New York times there appears to be a historical pattern of total returns (dividends and gains) in the stock market.   Is the historical pattern about to repeat itself?

Anecdotally there is a lot of money on the sidelines obtaining small yields.  Will a market upturn start a reocurrence of the historical trend?

It is always dangerous to assume historical patterns will repeat themselves.  But perhaps the glass is really half full and not half empty!

The link below will connect you to the story.

http://www.nytimes.com/interactive/2012/01/06/business/Similar-Cycles-for-Stocks.html

Business owners often say, “There is no business to sell – if I leave it is worth nothing”. Many clients who have been referred for business valuations will make that statement within the first five minutes of contact. I generally tell them that the surest way . . . → Read More: Personal vs. Enterprise Goodwill In Domestic Relations]]> Originally published by the Ohio Domestic Relations Journal

Business owners often say, “There is no business to sell – if I leave it is worth nothing”. Many clients who have been referred for business valuations will make that statement within the first five minutes of contact. I generally tell them that the surest way to lose a valuation issue in court is to go in with the claim that the business is worth nothing. There are some exceptions. In one case the business was licensed by the state and though it operated as a corporation the license was in the name of the owner. The business could not be sold. Ex President Bill Clinton makes quite a bit of money speaking. The business is quite literally President Clinton. Even George W. Bush could not buy Clinton’s book of business. But most businesses, no matter how intrinsically tied to the individual owner can be, and are often, sold.

Another common claim by the prospective client to a business valuator is that due to his or her “special relationship” with the customers or clients they would not transfer to a new buyer. The issue the client is really addressing is the issue of goodwill. The easiest way to think of goodwill is to consider the purchase of a business where there are literally no tangible assets to sell, or very little in the way of tangible assets. Lawyers, accountants, doctors, dentists and other professionals who sell their practices are, for the most part, selling goodwill. That raises the first issue, just what is goodwill?

From an accounting viewpoint goodwill exists when the cost of the assets which are being purchased is less than the total purchase price. Accountants, being very particular that things need to balance, call this excess “intangible value”, often categorizing it as goodwill on a balance sheet.

By way of illustration, think of the purchase of an accounting practice. The Purchaser will take over the equipment, software, office, the lease, the telephone number and the clients that have made up the practice. The decision of whether or not the clients will remain with the purchaser or go elsewhere needs to be dealt with, and will be examined. Parties may agree that the “hard assets” are worth $10,000.00 and agree tentatively to a purchase price of $100,000.00. The purchase price that is in excess of the hard assets can be referred to as “intangible assets”. Before one rushes to call the entire $90,000.00 goodwill, the purchase agreement, which may include many of the following terms, must be examined.

1. The seller will use his or her best efforts to effectuate a transfer of the client base to the purchaser. There are several ways to accomplish this and they are not mutually exclusive.
2. The purchase price will be paid with a given percentage at closing with the remainder being paid over a period of years. While this will vary with the specific contract three to five years is a period often seen in the agreement.
3. The seller will be prohibited from practicing accounting, other than for the Purchaser, for a given number of years. Other clauses which are somewhat similar is that the Seller will not cause the client base to go to another accountant, employees of the Seller’s practice will not be solicited for other employment.

If one looks at the individual clauses in the contract, they might be called “covenants not to compete”. Does one really care what the contractual clauses are called? Isn’t it enough that there is an intangible value of the agreement? Often the tax structure of a purchase has a major impact on what the seller really receives and what the purchaser really pays. However, tax issues are not the subject of this article. It is difficult enough to come to grips with goodwill without worrying about taxes.

Many states, Ohio not being one of them, have differentiated goodwill in a domestic relations case into two components, personal goodwill and enterprise goodwill. In many of these states personal goodwill is considered to be a non marital asset, therefore not subject to division, while enterprise goodwill is considered to be a marital asset subject to division. An article Goodwill Hunting, published by BV Resources and recently updated, presents a state by state analysis of how goodwill is treated for marital purposes.

A good way to think of personal versus enterprise goodwill is to ask “What would happen to the business if the owner suddenly died or became ill and could no longer work or even speak to the clients?” The telephone could still ring, the office would be there, and the staff would remain. Suppose a new owner came in immediately so there would be no loss of continuity in terms of an owner to deal with clients. Suppose the name stayed the same. There are many professional practices that retain the name or names of the original owners long after they have retired or died. To the extent that the client base remained there would be, by definition, enterprise goodwill. The client base and income from them is more of a function of the business, as perceived by the clients, than the importance of the owner. Some of the client base may leave immediately or in a short time after finding another professional they prefer to do business with. This element could be classified as personal goodwill. With the Seller gone the clients go elsewhere. The line may get blurry on occasion, but overall this is the concept between differentiating between personal and enterprise goodwill. How does one separate personal from enterprise goodwill? There is currently at least one software program being marketed that separates personal goodwill from enterprise goodwill. The software allows the user to weight certain variables that make up either personal or enterprise goodwill and results in apportioning the goodwill between the two. The model utilizes the concept of objective information integrated with the subjective analysis of the valuator to differentiate personal and enterprise goodwill. While not embraced by all valuation analysts the model has been subjected to peer review and has been accepted by some courts, so on its face it should stand up to a Daubert challenge.

The issue of how much of the practice or business is goodwill is not addressed by the model. There are several methods that can be used to attempt to calculate goodwill. One data base that deals primarily with small businesses reports the purchase price for a combination of goodwill and fixed assets for many small businesses. Particularly in service industries or professional practices the amount of fixed assets are relatively small which would result in the goodwill portion being relatively large (or 100% of the price in some instances). In health care a publication and, now a computer data base, reports the portion of the sales price called goodwill by the parties involved, as well as other key financial data. One cautionary word is that calling something goodwill does not make it goodwill. Because of tax laws the purchaser and seller may agree to call something goodwill that is in reality a fixed asset, or alternatively lower the actual amount of goodwill being reported. There may be arguments regarding the precision of the measurement, but the methodology for calculating goodwill does exist. A common way of calculating goodwill is to utilize a method known as the “Excess Earnings” approach. Here the business is allowed a “reasonable” return on investment and allows a “normal” salary for the owner. After these allocations the residual earnings are capitalized and the result is referred to as goodwill. While the Excess Earnings approach is generally not held in high esteem among business valuation professionals for most cases, it is still a useful approach for small businesses.

So how does one can calculate goodwill? Theoretically it can be broken down into enterprise and personal goodwill. In domestic relations cases, should this really matter? Let’s look at an extreme case; a one person professional practice. These businesses are bought and sold all the time. The issue is not then does personal goodwill get sold, but how is it transferred?

One scenario might look something like the following. Seller knows he would like to retire and would like to sell his practice. Purchaser is a young professional who views the purchase of a practice very favorably to starting from scratch or working as an employee for another professional. Purchaser and seller reach an agreement on price. The price, however, is dependent on the revenue from the practice that remains with the purchaser. Such a clause, often referred to as an “earn out” clause motivates the seller to have the clients stay with the Purchaser. The first steps would be the creation of a “partnership” and an announcement to current and prospective clients that purchaser has joined seller in the practice. Seller agrees to stay on for a period of time. Whether or not seller will have duties other than shifting client loyalties will depend on the situation. In some instances purchaser might need someone to assist with the work requirements of the practice. In that case seller would be receiving a bona fide salary or consultant’s fee. This fee, assuming it is reasonable for the functions performed by seller, for work actually performed, other than assisting with the transfer of the client base, would be a salary component and not goodwill. A covenant not to compete to protect Purchaser from further competition by seller would not be unusual. Ideally the goal is to infuse Purchaser with all the persona of seller, so to the client base there appears a seamless transition. Seller is anointing purchaser as an heir apparent. At some point seller is not there every day. At some point he is no longer there at all. The transition or attempt at transition would then be complete. How much seller receives and purchaser pays is often dependent on how successful the transition is.

How hard is transition to accomplish? My own experience has been that the longer the transition period the more likely it will be possible to transfer personal goodwill. The second situation, which may appear counter intuitive originally, is where the seller has such a good relationship with the client that the client is willing to take seller’s advice to go with the purchaser. Over the years as the scope of my practice has narrowed and I began making referrals to other attorneys or accountants I found long time clients, who have entrusted me with many of their problems, seem perfectly willing to take my advice as to the proper person on a referral, whether it is an injury case, litigation case, complex business transaction, or just a tax return.

In domestic relations cases, a business owner may claim that it is “all me” or “without me there is no business”. Presidents are changed every four to eight years and manage to get by. Clients can learn to get by without the principal. The transfer mechanism takes more than changing the locks on the doors or handing the new owner the keys. But to head down a path wherein the non business owner receives nothing of substance for the personal goodwill, developed over the period of the marriage, makes no more sense than saying there should be no spousal support. Spousal support recognizes that income differentials may exist at the end of the marriage. Spousal support is really a sort of transition mechanism as the parties separate. Personal goodwill, which is developed over a lifetime work, seems not that dissimilar to the income that is received from the business.

A review of the state by state analysis leads one to the conclusion that separation of goodwill into a personal component, which is not divisible for domestic relations cases, and enterprise goodwill which is divisible for domestic relations cases, indicates that this distinction, with its results, is an idea whose time has come. Once again Ohio may be viewed as behind the curve. But, before Ohio gets on this particular train, one need look at the equitable result that domestic relations courts attempt to attain. Denying that personal goodwill is a marital asset that should be divided in some fashion seems more like a step backward in time to when businesses assets were not thought of as marital assets subject to division. Perhaps when the train stops, Ohio should just not get on. The reality is that situations are created during marriage that leads to financial differences. One of those financial differences may be the creation of personal goodwill which may be the most valuable asset in the marital estate. A second reality is that personal goodwill may not be subject to division. Perhaps the real problem is over-dependence on the concept that treats all assets as if they were fungible goods and insist on equal division.

Until the Supreme Court of Ohio deals with the issue, trial courts will not have any clear direction.

When investments behave in a fashion that . . . → Read More: The Next Bubble]]> If we have learned anything from the last few decades is there is always some hot new investment vehicle that is growing faster than other investments.  But we have also learned that bubbles always seem to burst.  Dot-com companies, real estate, commodities, and the stock market itself.

When investments behave in a fashion that seems too good to be true they probably are.  The ultimate admonition is that YOU NEVER WANT TO BE THE LAST MAN STANDING.

Basically most investments are priced based on an expected rate of return and the risk associated with the investment.  In general the higher the rate of return on the investment the greater is the risk.

When asked how the Federal Reserve had missed the real estate bubble then Ex-Chairman Alan Greenspan replied that real estate prices had never decreased so rapidly and so much in terms of value and the models did not incorporate such a possibility.  You may or may not believe the Fed’s model could not have considered such a possibility – but it is certainly clear that such a possibility was not simulated in the Fed’s various economic models.  While investment real estate was paying returns far in excess of other investments investors continued to invest – not considering that it was speculation instead of market fundamentals that was causing these investments to rise so rapidly.

Of course there are exceptions.  When my wife wanted to buy Google when it first came out our broker advised against it.  While an opportunity was lost the advice was sound.  Our investment philosophy was to shy away from speculative ventures.

No investment advisor can be right 100% of the time.  But one that promises growth far in excess of general market trends should be looked at with skepticism.  Many investment advisors will acknowledge their philosophy will not cause performance as good as the market in general during growth periods.  By the same token their clients anticipate their portfolios will not decrease as much as the market during down periods.

Growth and loss of money are usually not symmetrical to most investors.  They fear losing money much more than the satisfaction gained from making money.  One way to look at this is to think that a gain of 10% may cause satisfaction of 5 (on a scale of 1 to 10 – 10 being the highest) while a loss of 10% may cause dissatisfaction of minus 8.  Many investors would fit into a similar profile.

When using an investment advisor make certain he or she has an accurate picture of your tolerance for risk.

We overcome the problem by concentrating on teaching – in a way that is readily . . . → Read More: Expert Testimony – Getting Your Point Across]]> Expert witnesses often use techniques developed by and understood by people with graduate degrees in the field of expertise being discussed.  The problem is the level of sophistication of the judge or jury is well below the concepts used.

We overcome the problem by concentrating on teaching – in a way that is readily comprehended by our target audience.  We can talk to ourselves all day long.  We have one chance – and a brief attention span to convey your case to our target.  Our key phrase to ourselves is KISS – keep it simple stupid.

A number of years ago in a domestic relations case the opposing expert and I had a cordial professional relationship and . . . → Read More: Hidden Income – Can it be found?]]> Valuing a business is difficult enough even when all of the financial data is reliable.  Can anything be done when a significant amount of the businesses income comes in the form of cash?

A number of years ago in a domestic relations case the opposing expert and I had a cordial professional relationship and also tended to look at valuations in the same way.  The business was a hair dressing salon.  The first thing we both asked to see was the appointment book.  The reason was that there is usually a relationship between number of customers and revenues.  When we were told the owner tore out the pages of his appointment book each day warning bells went off.  Both experts agreed that the revenue of the business was understated.  Our only disagreement was how much.  With the specter of both experts coming up with a business value that could only be supported if real income was in excess of the stated income the case settled.

Often you can find hidden income the way the Internal Revenue finds it.  Does the lifestyle of the parties appear consistent with the income and other sources of spending (such as from savings or by accumulating debt)?
We can also look at the personal expenditures and see what is not there.  No expenditures for groceries, clothing, or entertainment when the parties have these items as part of their lifestyle can be used to shift the burden to the business owner to explain how these items are paid for.

Some cases are not so easily solved and in those instances we have a frank discussion with our client who is looking for the missing income as to the possible cost and probability of success in using more costly forensic accounting procedures.  We recognize that in litigation the cost to find missing income may not be worth the expense to the client.

If you are involved in a case where missing income is an issue we are pleased talk with you about options and costs before you commit to using our services.