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FROM: JUL-AUG 2009 ISSUE | BY ILONA KAUREMSZKY
Lauded as a techno-geek, a university drop-out transforms his parent’s garage into a makeshift office only to watch his corporate vision grow into a viable company. The new enterprise acquires silent investors, hires a team of employees, and expands the company’s operations all on “what if” scenarios. But the inexperienced owner hates balance sheets, and doesn’t know what a budget is. Creditors call. The bank loan doesn’t get approved. A business valuator is called in, but is it too late?
Jeannine Brooks, FCGA, president and CEO at the Canadian Institute of Chartered Business Valuators, says too often financially troubled companies didn’t think they were in trouble. “They think they are still viable. When a business valuator looks at their balance sheet they realize they don’t have any equity,” she says.
The federal Office of the Superintendent of Bankruptcy recently reported that insolvencies in March totalled 14,244, up 51 per cent from March 2008. And according to the Bank of Canada, when the rate of corporate bankruptcies are compared from this year’s first quarter to the same period in 2008, business bankruptcies were down 14 per cent – somewhat surprisingly.
Vince Siciliano, CIRP, CMC, CGA, partner, financial advisory services, Financial Recovery Services for BDO Dunwoody Ltd. suggests two things are happening in the current economic situation. “Companies are more mature today compared to the eighties’ recession when we saw more receiverships and liquidations. Restructuring is looked at harder these days. Our industry has evolved over time. The lenders, debtors, debtors’ lawyers, everybody has become more sophisticated and they are all looking for alternatives to liquidation.”
With fewer corporate bankruptcies on the books, the buzzword now is “restructuring” so the company can have a future.
“Financially stressed companies realize they have to get leaner, downsizing in many cases, and quite often they are going back to their core services in order to stay afloat,” explains Siciliano about the growing trend toward restructuring.
At first glance, the term ‘bankruptcy protection’ sounds like a dirty word, but as Brooks puts it, bankruptcy protection actually buys the company valuable time. “The creditors have to stay at bay.”
But for companies that have no option except to liquidate what is the role of the business valuator? Many industry insiders draw a line in the sand when it comes to assessing financially troubled companies. Across Canada, the role of the CBV is very specialized. As Marsha Stanley, CBV, CGA, and a partner with Meyers Norris Penny LLP in B.C. notes, “Often it is either the shareholder or the bank requesting that the company engage the services of a restructuring consultant. What I typically see is a company that is starting to feel the effects of troubling times or has been struggling for a while and the owner is tired and would like to get out. Of course the fact that the company is struggling results in reduced valuations.”
Her role, like so many CBV/CGAs stems in detecting warning signs and advising the client to seek assistance from a restructuring specialist, often a trustee in bankruptcy, to take steps to avoid having to seek bankruptcy protection.
In addition, valuators are keeping business executives of financially troubled companies busy by requesting access to all their books. “I want to take a look at all their spreadsheets and assets so that I can assess what path will be taken,” explains Tom McCallum, FCGA in Whitby, Ontario.
When Al Jones, once Revenue Canada’s chief valuator and a founding member of CICBV was assessing companies, the now retired FCBV/FCGA describes how valuators used a couple of methods in determining whether or not a business should seek bankruptcy protection.
“You needed to project the earnings, or lack of earnings, into the future, and show the owners just what is likely to happen – both the most positive projection and the most negative projection,” he says and adds, “The valuator would have to show the owners what could happen if results continue to fail. Depending on the timing and the projected poor results, the valuator would recommend for or against bankruptcy protection.”
As companies move forward in these unsettling times, business valuators are finding themselves more in demand. Over at the Bank of Montreal, senior director and group head of BMO’s business finance, Mark Shoniker CBV, CGA, says his role is often assessing the true nature of the expected future cash flows and their sufficiency to continue to meet debt obligations in the normal course as they come due.
“This is primary. In many cases, cash flows may still be positive, however as a result of an overly aggressive acquisition program or other such event, the balance sheet structure is no longer tenable,” he explains, noting when debt levels are too high, debt rollover issues may be prevalent due to capital liquidity issues in the market, requiring a “court sanctioned” process.
“Valuations are also required to provide a potential investor/capital provider with some idea of the hard back-stop for their funds. They may be putting in capital based on expected future enterprise values improving however there is still the desire to fully understand down-side risk.”
So then the concerns and challenges with valuing financially troubled companies escalate. Mike Cheevers, CBV and president of Wolrige Mahon Limited, a corporate trustee in bankruptcy, feels the biggest issue facing troubled companies in today’s market is the lack of regular credit facilities. “Credit has become very scarce even if assets are available to support debt,” he notes.
Shoniker says when considering the concerns CBVs need to keep in mind:
- The accuracy of information disclosure. “Are you receiving full information as to the severity of the problem or are there other issues ‘lurking in the bushes’ of which you are not being made aware?”
- Is the worst over? “This is the problem of ‘catching a falling knife.’ Are you properly judging the speed of decline?”
- Visibility of revenues/cash flows. “It’s very difficult in swooning markets to determine the resiliency of revenue streams. How badly will they be affected by possible recessionary or soft market conditions in the broader market?”
Vancouver-based Hugh G. Livingstone, CBV, CGA, explains a few more. “Numerous valuation approaches assume the business is a going concern. If the business is not considered a going concern perhaps a liquidation approach to value is more appropriate. Even for companies that are going concerns, the valuation of assets is now a major consideration. In some businesses rolling over debt is a normal part of their business. In a highly-leveraged business, replacement financing may not be available; or not at attractive rates. The ability to raise equity to finance operations is also far more difficult at this time. Growth businesses that require equity injections from time to time are finding this increasingly difficult to accomplish.”
Stanley finds one of the biggest challenges is when the owner views the company as having a higher value based on values that may have been present when the company was not troubled. For example, if a business was valued at $2 million a year ago it is difficult to accept that due to financial difficulties (lost contracts, declining sales, etc.) the value may be $.5 - $1 million lower. “Valuation methodologies determine value at a point in time and are based on future expectations for performance. It is not unusual that values can change significantly over a period of six months or a year if major factors change.”
For business valuators grappling with the valuation methodologies used to determine the fair market value of privately held businesses, strengths and weaknesses do exist. Brooks of the CICBV says the biggest strength is that CBVs have more than one method. “CBVs take six courses in the methods, and they know where to go. There are standards. It’s an estimate not an exact science.”
Stanley elaborates more on the art of valuation. “Valuation is an art not a science. The valuator’s role is to determine fair market value, which is defined as being the highest price available in an open and unrestricted market.”
She finds the first challenge among CBVs is that the valuator prepares a notional valuation and the value determined may be very different than the price in a real live deal. “The second challenge is that value is based on the estimated future operations/cash flow. Valuators will either use past results to estimate future operations or they may use future-oriented financial information (projections) prepared by the client.”
As with everything, risk is always there especially as it relates to the issue of good-will. Shoniker says, “Goodwill is ultimately representative of the business’s ability to generate an above average return on assets. If results are deteriorating, it is difficult to see how this value is not compromised. The difficulty is determining the extent, especially in a private company scenario. Ultimately you’ll use benchmarks from publicly traded companies, recent multiples for cash flow, original factors that gave rise to the goodwill, and how those factors have changed. However it is still a bit of a guessing game.”
“The risk associated with the valuation of goodwill is that it could be wrong. The greater part of the risk is how large an amount is placed on the goodwill, and the consequent effect on the balance sheet value of the assets. It is one thing to purchase another company, and in so doing, have an amount of “purchased” goodwill. It is quite another matter to place an amount of goodwill resulting from a valuation, which could be overstated,” advises Jones.
Furthermore, Livingstone describes the importance of the issue of goodwill. “Auditors may require an independent assessment of the goodwill value on the books and the related impairment testing. Many businesses do not have the technical ability to value the goodwill on their books. Even within the CBV community, the valuation of goodwill has become a specialty. If goodwill happens to be a significant asset relative to other assets on company’s financial statements, it is imperative that management discuss the possible impairment with a qualified professional. The sooner that conversation happens, the better.”
In conclusion, what is the current climate of valuation? It depends on who you talk to.
Shoniker explains how valuations are continuing to decrease for private companies. “They tend to lag public companies primarily due to market inefficiencies and owner expectations. There’s no real evidence of any uptick in private companies at this stage.”
Businesses being sold today are generally attracting lower multiples of EBITDA (earnings before interest, taxes, depreciation, and amortization) than they were a few years ago. “There is less financing available. In the past, cheap and plentiful financing drove up the price of deals, much in the same way as real estate transactions,” observes Livingstone.
For more companies there is a significant concern that the current economic environment makes it more challenging than ever to determine the estimated future operating results. “Valuations prepared on a notional basis may provide results that are significantly different than the price that may be negotiated in the open market,” cautions Stanley.
Other business valuators remain more positive. McCallum notes the current recession is affecting industries across the board with many choosing to restructure rather than go down the path of liquidity. “I have had clients recently who are not going bankrupt. They are insolvent so they have bankruptcy protection where you get a period of time to reorganize and need that time to restructure the business in an orderly basis. Your orderly rearrangement will be the downsizing.”
“I think that the current ‘climate’of valuation is very good. As a result of organizations such as the Canadian Institute of Chartered Business Valuators and the American Society of Appraisers, and of course their education programs, professional valuation expertise has greatly increased, since, for example, we went into capital gains taxation in 1971. The experiences of professional business valuators have grown over the years. As well, court cases dealing with valuation problems have guided the business valuation profession in what is expected by the legal system,” concludes Jones.
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