Understanding and Using the Goodwill Valuation Report

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Understanding and Using the Goodwill Valuation Report

IRWA Chapter 12012 Fall Seminar October 23, 2012

William W. Thomsen, ASA, CFA, MBAThomsen LLC

www.thomsenllc.com

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Understanding and Using the Goodwill Valuation Report

• Agenda– When a Goodwill Valuation May be Needed– Elements of a Goodwill Loss Valuation– How Goodwill Relates to Other Elements of Value

and Compensation– Potential Areas of Controversy– Considerations When Reviewing a Goodwill Loss

Valuation Report

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When a Goodwill Valuation May be Needed

• Pre-Condemnation Planning• Agency Offer and Deposit• Negotiations• Trial/Litigation

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• Pre-Condemnation Planning– What site to acquire? Agency must identify and evaluate sites

before deciding– Appraisers may assist in this process– Preliminary analysis to test for potential goodwill exposure

• Businesses on site?• Shared facilities parking• Impact of partial takings• Inverse condemnation claim exposure

– Complications• Limited information may be available at this early stage• Goodwill exposure may be only one factor of many to consider

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• Agency Offer and Deposit– Before an Agency can condemn, it must make an

offer based on an appraisal– The appraisal used to make offer may also be used

to support the pre-condemnation deposit

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• Negotiations– An appraisal report (preliminary or formal) may be

used for mediation or settlement purposes– The appraisal expert may be brought in to explain

findings and opinions– Appraisal experts from opposing sides may be

brought in to discuss differences and commonalities – and to possibly arrive at a mutually agreeable value range

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• Trial/Litigation– The formal appraisal is performed in concert with

expert designation and exchange of reports– The expert is typically deposed after appraisal

exchange– The expert may testify in court to explain/defend

valuation (goodwill loss) opinions and to rebut other expert opinions

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Elements of a Goodwill Loss Valuation

• How California Statute Defines Loss of Goodwill and Compensation

• Calculating Loss of Goodwill• Implications for Valuation and Compensation

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• How California Statute Defines Loss of Goodwill and Compensation– California Code of Civil Procedure Section

1263.510 (b) defines goodwill as:• the benefits that accrue to a business as a result of its

location, reputation for dependability, skill or quality, and any other circumstances resulting in probable retention of old or acquisition of new patronage.

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• How California Statute Defines Loss of Goodwill and Compensation– Section 1263.510 (a) of the Code of Civil Procedure states:

• The owner of a business conducted on the property taken, or on the remainder if the property is part of a larger parcel, shall be compensated for loss of goodwill if the owner proves all of the following:

1) The loss is caused by the taking of the property or the injury to the remainder.2) The loss cannot reasonably be prevented by a relocation of the business or by

taking steps and adopting procedures that a reasonably prudent person would take and adopt in preserving the goodwill.

3) Compensation for the loss will not be included in payments under Section 7262 of the Government Code [No overlap with relocation benefits].

4) Compensation for the loss will not be duplicated in the compensation otherwise awarded to the owner.

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• Calculating Loss of Goodwill– Goodwill Before – Goodwill After (Mitigated) =

Goodwill Change (Loss), where:• Goodwill Before measures goodwill in the absence of

eminent domain,• Goodwill After (Mitigated) represents goodwill reduced

by condemnation and the costs of mitigation, and• Goodwill Change (Loss) is the difference in goodwill

between the “before” and “after” measurements.

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• Calculating Loss of Goodwill– Causes of goodwill loss:• Sales decline (lost patronage)• Increased costs (occupancy/rent, operational/logistic)• Lower growth• Higher risk

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• Implications for Valuation and Compensation– The loss of goodwill is limited by the amount of goodwill

computed in the “before” condition. Need to establish existence of goodwill (Sobke)

– Compensable goodwill loss must be attributable to the subject eminent domain action

– In order to be compensated, the business owner must demonstrate that reasonable efforts were made to preserve goodwill (mitigation is an essential element of the analysis)

– Avoidable betterment not included in loss– Compensation for loss of goodwill must not be included in

relocation payments or elsewhere (ex: real property award)

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How Goodwill Relates to Other Elements of Value and Compensation

• Components of Business Value• Goodwill Relationship to Other Components

of Value

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Components of Business En-terprise Value

Working Capital (Current Assets less Current Liabilities)

Tangible Assets (Cars and Trucks, Machinery and Equipment, Leasehold Improvements) -- Some Movable, Some Not

Other Identified Intangible Assets (e.g., Liquor License)

Goodwill

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• FASB ASC Topic 805 identifies the following intangible asset categories:– Technology-related (e.g., patents, software, databases, trade secrets);– Customer-related (e.g., customer lists and related relationships);– Marketing-related (e.g., trademarks and trade names);– Contract-related (e.g., licensing agreements, supply contracts); and– Artistic-related (e.g., pictures, photographs, literary works, a/v material).– Assembled workforce– Goodwill

• “Goodwill” under the eminent domain statute actually consists of various types of intangible assets– Understanding this asset composition can help understand how

condemnation may impact goodwill (facts and circumstances driven)

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• Components of Business Enterprise Value– Business Enterprise Value = Working Capital + Tangible

Assets + Identified Intangible Assets + Goodwill– Goodwill = Business Enterprise Value less Working

Capital, less Tangible Assets, Less Identified Intangible Assets (Residual Approach)

– Goodwill = Capitalized “Excess Earnings” Above Required Returns on Working Capital, Tangible Assets, and Identified Intangible Assets (Excess Earnings Approach)

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• Goodwill Relationship to Other Components of Value– For a given business enterprise value, a higher value of

working capital, tangible assets, or other identified intangible assets would imply a lower goodwill value

– Stated otherwise, higher working capital, tangible assets or other identified intangibles would necessitate a higher level of “excess earnings” to justify the same level of goodwill

– Thus, there may be a tradeoff between goodwill and other allocated components of value – and a possible tradeoff among award categories. “Efficiency” in tangible asset utilization rewarded in higher goodwill/intangible value

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• Goodwill Relationship to Real Estate– Value of real estate is typically reflected in the fair market rent

computed for the subject business – separating the potential award for real property value from goodwill value

– Other things equal, a higher fair market rent results in a lower economic earnings for the business, and hence lower goodwill.

– In most cases, real estate value is positively correlated with fair market rent. So, a higher real estate appraisal may imply a lower goodwill value

– However, all things not always equal. High fair market rent may reflect a superior location that supports higher sales, profits and business goodwill

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Potential Areas of Controversy

• Use of Projections and “Hypothetical” Calculations

• Project Attribution• Mitigation Assessment• Accounting for Economic Trends/Cycle

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• Use of Projections and “Hypothetical” Calculations– Need to value the actual business conducted on site, not

a hypothetical operation (Mesdaq, Coyne, S&M)– However, Aklilu decision seemed to turn “hypothetical vs

actual” logic on its head (“cost to create” seemed to presume existence of goodwill without quantitative proof)

– Any business valuation is necessarily forward-looking, and may not be reflective of past performance

– Key may be whether the analysis is sufficiently supported, or whether it would be considered “speculative”

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• Project Attribution– How has/will the project impact the business?– Other factors potentially contributing to company

trends – such as the economic climate, competition, changes in management and changes in the marketplace – need to be separated from project impacts

– Has the project affected the company indirectly by impacting customers or suppliers?

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• Mitigation Assessment– Relocation site search and assessment: has an adequate

effort been made?– Relocation assistance from the agency: how much benefit?

A data dump from the MLS may be of limited assistance– Have any betterments resulting from relocation been taken

into account?– Soft costs of relocation and reconfiguration – such as time

spent by management and potential impact on clients, suppliers and employees – should be considered

– Is it goodwill mitigation or “reestablishment cost?”

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Potential Areas of Controversy• Accounting for Economic/Industry Trends

– Decline in business performance – due to relocation or to economic and industry trends?

– Was business condemned at the trough of the economic cycle? If so, has an anticipated recovery been adequately factored into the valuation analysis? If, on the other hand, bad times were ahead at the value date, were those expectations reasonably reflected in the analysis?

– Has economic or industry risk been accounted for in the analysis to the extent considered appropriate?

– Do comparable company transactions used in the analysis reflect or have been adjusted to reflect current expectations?

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Considerations When Reviewing a Goodwill Loss Valuation Report

• General Considerations• Specific Considerations• Overall Considerations

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• General Considerations– Appraiser qualifications• Credentials and experience)

– Identification of assignment• Business to be valued, date of value, value definition

– Conformity to accepted professional standards• USPAP, ASA

– Use of accepted valuation methodologies• Explanation of why methods used or not used

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• General Considerations– Accuracy and adequate disclosure of relevant facts

and assumptions• Disclosure of hypothetical, critical or extraordinary

assumptions– Adequate support for assumptions– Appearance of objectivity/absence of obvious bias– Demonstrated understanding of company,

industry and economic factors

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• Specific Considerations– Adjustments to historical earnings/results

• Normalization, officer compensation, fair market rent, project-specific

– Use of market data• Selection of comparable companies, multiples, discount rate

– Mitigation considerations– “After” condition and project attribution/causation– “Temporary” vs. “permanent” impacts and

compensability considerations

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• Overall Considerations– Does the appraisal accurately reflect the facts and

circumstances?– Does the appraisal interpret relevant market

evidence and apply them to the facts using reasonable appraisal techniques?

– Does the appraisal bring together the facts and analysis to arrive at a credible conclusion?

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Questions?

William W. ThomsenThomsen [email protected]