Deck 10: Analysis and Valuation of Privately Held Companies

Question 1

Both public and private firms always attempt to maximize earnings growth.

Answer 1

False

Question 2

Managers and owners in public companies are likely to have the same emotional attachment to their
businesses as those in private firms.

Answer 2

False

Question 3

It is easier to obtain the fair market value of private companies than for public companies because of the
absence of volatile stock markets.

Answer 3

False

Question 4

The purpose of adjusting the target's income statement is to provide an accurate estimate of the
current year's reported operating income or operating cash flow.

Question 5

The risk associated with an illiquid market for a specific stock is referred to as the liquidity or marketability risk.

Question 6

An increase in the target firm's reserves for doubtful accounts increases taxable income,while a
decrease reduces the firm's taxable income.

Question 7

For privately held firms,firm specific risk may include lack of product,industry,and geographic
diversification; limited management depth,volatile stock markets,and unionized workforces.

Question 8

Methodologies employed to value private firms are substantially different from those employed to value
public firms.

Question 9

Because of data limitations,valuation of private firms often requires more subjective adjustments than for
public firms.

Question 10

Shell corporations may have significant value to acquiring firms.

Question 11

If a buyer expects that the target firm's revenue has been overstated,the buyer can reconstruct revenue by examining usage levels of the key inputs required to produce the product or service.

Question 12

Asset valuation includes specific business risks but ignores any adjustment for liquidity risk.

Question 13

Private firms must file quarterly earnings reports with the Securities and Exchange Commission.

Question 14

Financial information for both public and private firms is equally reliable because their statements are audited by outside accounting firms to ensure that are developed in a manner consistent with GAAP.

Question 15

Private businesses may need to be valued to settle shareholder disputes,court cases,divorce,or the payment of gift or estate taxes.

Question 16

Private firms are likely to understate revenue and understate costs in order to minimize their tax liabilities.

Question 17

Revenue may be inflated by booking as revenue products shipped to resellers without adequately
adjusting for probable returns.

Question 18

Employee benefit levels in private firms are almost always mandated by state or federal law and
therefore cannot be changed.

Question 19

The availability and reliability of data for public companies tends to be much greater than for small private firms.

Question 20

Empirical evidence suggests that discounts have declined in recent years.

Question 21

Very few closely held businesses are family owned.

Question 22

Succession issues tend to be easier for small family owned firms than for large publicly traded firms.

Question 23

Restricted stock is often issued to employees of privately held firms as a significant portion of their total
compensation.Such stock is similar to other types of common stock except that its sale on the open market is prohibited for a period of time.

Question 24

The market model of corporate governance is readily applicable to privately held,family owned firms.

Question 25

Valuation of privately held businesses may involve substantial adjustment of the discount or capitalization
rate.

Question 26

Before selling a business,an owner may increase advertising expenses in order to inflate profits.

Question 27

In adjusting base year income,an appraiser must be aware of the implications of various accounting
methods for value.During periods of inflation,businesses frequently use the last-in,first out method to
value inventories.This approach results a reduction in the cost of sales and an increase in gross profits and taxable income.

Question 28

The primary purpose of the buyer adjusting the seller earnings is to provide an accurate estimate of the
current year's operating income or cash flow in the base year.

Question 29

A private corporation is a firm whose securities are not registered with state or federal authorities.

Question 30

The term capitalization refers to the conversion of a future income stream into a present value,and it is a
term often used by business appraisers when future income or cash flows are not expected to grow or to grow at a constant rate.

Question 31

The M&A market for employer firms tends to be concentrated among smaller firms,as firms in the United States with 99 or fewer employees account for 98% of all firms with employees.

Question 32

In many family owned firms,family influence is exercised by family members holding senior management positions,seats on the board of directors,and through holding super-voting stock (i.e.,stock with multiple voting rights).

Question 33

Privately owned businesses are often referred to as "closely held" since they are usually characterized by a small group of shareholders controlling operating and managerial policies of the firm.

Question 34

Membership or subscription businesses,such as health clubs and magazine publishers,may inflate revenue by booking the full value of muliyear contracts in the first year of the contract.

Question 35

Fair value is by necessity more subjective than the concept of fair market value,because it represents the
dollar value of a business based upon an appraisal of the tangible and intangible assets of the business.

Question 36

Firms that are family owned but not managed by family members are often well managed,as family shareholders with large equity stakes carefully monitor those charged with managing the business.

Question 37

Family owned businesses account for about 89% of all businesses in the U.S.

Question 38

Intangible assets such as customer lists,intellectual property,licenses,distributorships agreements,leases,
regulatory approvals,and employment contracts may offer significant sources of value.

Question 39

All family owned businesses are small.

Question 40

If the buyer believes that the seller has overstated revenue in a specific accounting period,the buyer can reconstruct revenue by examining usage levels,in the same accounting period,of the key inputs required to produce the product or service.

Question 41

It is rare that the owner or a family member is either an investor in or an owner of a vendor supplying products or services to the family owned firm.

Question 42

Shell corporations may be attractive for investors interested in capitalizing on the intangible value associated with the existing corporate shell.This could include name recognition; licenses,patents,and other forms of intellectual properties; and underutilized assets such as warehouse space and fully depreciated equipment with some economic life remaining.

Question 43

A family owned firm's board faces the sometimes daunting challenge of achieving the proper balance between monitoring and collaboration to minimize the emotionality and overlapping roles that often characterize such firms.

Question 44

Because of the need to satisfy both the demands of stockholders and regulatory agencies,public companies need to balance the desire to minimize taxes with the goal of achieving quarterly earnings levels consistent with investor expectations.Failure to do so frequently results in an immediate loss in the firm's market value.

Question 45

An investor in a small company generally has little difficulty in selling their shares because of the high demand for small businesses.

Question 46

If the cash flows of the firm are not expected to grow or are expected to grow at a constant rate indefinitely,the discount rate used by practitioners often is referred to as the capitalization rate.

Question 47

EBITDA has become an increasingly popular measure of value for privately held firms in recent years.

Question 48

It is generally easier to sell a minority interest than a majority interest in a business without loss of the value of the original investment.

Question 49

Shell corporations rarely have any value.

Question 50

Private investment in public entities (PIPES)is a commonly used method of financing reverse mergers.

Question 51

Despite the lack of public exchanges for privately held firms,Wall Street analysts have ample incentive to analyze such firms in search of emerging companies.

Question 52

Owners of private businesses attempting to minimize taxes may overstate their contribution to the firm by giving themselves or family members unusually low salaries,bonuses,and benefits.

Question 53

A sudden improvement in operating profits in the year in which the business is being offered for sale may suggest that both revenue and expenses had been overstated during the historical period.

Question 54

The control model of corporate governance may be more applicable where ownership tends to be highly diverse and the right to control the business is separate from ownership.

Question 55

The fair value concept is applied when no strong market exists for a business or it is not possible to identify the value of substantially similar firms.

Question 56

In many countries,family owned firms have been successful because of their shared interests and because investors place a higher value on short-term performance than on the long-term health of the business.

Question 57

Small firms may lack product,industry,and geographic diversification,which add to their specific business risk.

Question 58

A control premium is the additional premium a buyer is willing to pay for the right to direct the activities of a firm.

Question 59

Private companies are generally not subject to the same level of rigorous controls and reporting systems as are public companies.

Question 60

If the discount rate is assumed to be 8% and the current cash flow is $1.5 million and is expected to remain at that level in perpetuity,the implied valuation is $18.75 million.

Question 61

The discount rate may be estimated using all but the one of the following:

A) The capital asset pricing model
B) The share exchange ratio
C) The cost of capital
D) Return on total assets
E) Price-to-earnings ratio

Question 62

All of the following are true of reverse mergers except for.

A) May be used to take a private firm public
B) May represent an effective alternative to an IPO
C) Commonly use private equity placements for financing
D) Requires 2 years of audited financial statements to take a private firm public
E) A and B

Question 63

A business owner may overstate revenue and understate actual expenses when

A) The business is about to be sold
B) They are being audited by the IRS
C) They are trying to minimize tax liabilities
D) All of the above
E) None of the above

Question 64

There is widespread agreement over the magnitude of the liquidity discount.

Question 65

Studies show that control premiums vary widely across countries reflecting the efficacy of shareholder rights laws and how well such laws are enforced in each country.

Question 66

A pure control premium is the value the acquirer believes can be created by replacing the target firm's incompetent management,by changing the strategic direction of the target,by gaining a foothold in a market not currently served,or by achieving unrelated diversification.

Question 67

All of the following represent common sources of value in appraising private or publicly owned businesses except for

A) Intellectual property
B) Customer lists
C) Licenses
D) Contingent liabilities
E) Employment contracts

Question 68

Which of the following are often true about the challenges of valuing private firms?

A) There is a lack of analyses generated by sources outside of the company.
B) Financial reporting systems are often inadequate.
C) Management depth and experience is often limited.
D) Reported earnings are often understated to minimize taxes.
E) All of the above.

Question 69

Revenue Ruling 59-60 describes the general factors that the IRS and tax courts consider relevant in valuing private businesses.Of the following valuation methods,which do the IRS and tax courts view as the most important?

A) Discounted cash flow
B) Comparable company methods
C) Tangible book value
D) Replacement cost method
E) All of the above

Question 70

Studies of restricted stock sales since 1990 indicate a median liquidity discount of about 20 percent with several showing a decline to 13 percent after 1997 following the holding period change under Rule 144 from two years to one.

Question 71

Corporate shells have value because they enable the buyer to

A) Avoid the cost of going public
B) Exploit intangible value such as brand name
C) A and D only
D) Provide limited liability
E) A, B, and D only

Question 72

A business owner may overstate revenue by

A) Failing to deduct from revenue products returned by customers
B) Billing customers for products not ordered
C) Booking the entire value of a multiyear contract in the current year
D) Counting interest income as revenue
E) All of the above

Question 73

A minority discount is the reduction in the value of a minority investor's investment because minority owners have little influence in how the firm is managed.

Question 74

All of the following are often true of privately held firms except for

A) Financial data is often inaccurate and out of date
B) Internal controls are ineffective
C) Have limited access to capital markets and product distribution channels
D) Are more easily valued than public companies
E) Have limited ability to influence customers, suppliers, unions, and regulators

Question 75

Fair market value is

A) The cash or cash equivalent value that a willing buyer would pay or seller would accept for a business
B) The cash or cash equivalent value that a willing buyer would pay or seller would accept for a business, assuming each had access to all necessary information
C) The cash or cash equivalent value that a willing buyer would pay or seller would accept for a business, assuming each had access to all necessary information and that neither party is under duress.
D) The discounted value of free cash flow to the firm
E) The discounted value of free cash flow to equity investors.

Question 76

The most important element(s)in selecting a business valuation professional include which of the following: (Select only one)

A) Overall experience
B) Demonstrated ability in the industry in which the firm to valued competes
C) Degree of specialization
D) Number of professional degrees
E) A and B only

Question 77

Which of the following is not true of liquidity or marketability risk or discount?

A) It is measurable.
B) It is believed to have declined in recent years
C) The magnitude of the discount or risk is inversely related to the size of the investor's equity ownership in the business.
D) The magnitude of the discount or risk is directly related to the size of the investor's equity ownership in the business.
E) It is important to adjust the discount rate for liquidity risk.

Question 78

A corporate shell may have value because

A) It may enable the owner to avoid the costs of going public
B) The name is widely recognized
C) It could own the rights to various forms of intellectual property
D) All of the above
E) None of the above

Question 79

In valuing private businesses,the U.S.tax courts have historically supported the use of which valuation method for purposes of estate valuation?

A) Discounted cash flow
B) Comparable company method
C) Tangible book value method
D) A combination of a and c
E) All of the above

Question 80

Leveraged employee stock ownership plans are frequently used by owners of private businesses to

A) Hide assets
B) Motivate employees
C) Sell the firm to the employees
D) B and C
E) A, B, and C