DB #4 – Valuation Issues in Small Businesses
When valuating a company, there are many things one has to keep in mind in order to
perform a fair valuation. However, there are many issues that come into place when valuating a
company, especially for small businesses. According to the textbook, one of the reasons why it
could be difficult for an evaluator to gather all the resources to perform a formal appraisal is the
lack of high-quality financial statements, which might have been prepared by and outside
accountant (Hitchner, 2017, p. 853). This could make someone’s work more difficult, since the
statements will be most likely tax reporting-oriented, and not necessarily for stockholders to buy
into the company.
To illustrate and apply these issues discussed in the textbook, a family-owned company
called Delta Marine Construction, LLC (DMC), will be used as an example. This is a small
business located in a small town in Deltaville, Virginia, around the Chesapeake Bay area. This
construction company focuses in building and installing marine facilities such as docks, boat
ramps, boatlifts, and marinas (Delta Marine Construction). All information regarding this
company will be retrieve from their official website, or from personal experience of the author if
this thread, since the company is owned by author’s family.
As mentioned above, one main issue regarding valuating small businesses is the lack of
high-quality financial statements for future/prospective investors to look at. One of the many
reasons this happens is because small businesses frequently can not afford to have a full time
accountant if the owner is not one already, and typically they hire an outside
company/accountant to outsource their need to create financial statements to be able to report in
their taxes filing.
The majority of the time, if the company is private, the financial statements will not be
compliant with GAAP, and will most likely be biased. (Hitchenr, 2017, p, 854). DMC is a
company that functions with only two administrative staff members; the CEO, and an
administrative assistant, the rest of the employees are construction supervisors and workers. Both
the CEO and the administrative assistant are not trained in any financial or business education.
Instead, they have learned everything they know with the time working in the company. To be
able to properly report taxes, DMC has hired a local small business accountant firm to be able to
create their financial statements every reporting period. DMC has noticed that throughout the
current worldwide health crisis and recession, before the government released any financial aid,
the company’s owners have had to consider if they need to use personal funds to be able to pay
their employees and keep operations. In an interview from the Wall Street Journal (WSJ), Nina
Kaufman, a small business specialized lawyer from New York said that using personal funds is a
terrible idea because it is not sustainable to the company (Dagher et al., 2020).
This year, the owners of the company have decided to appraise DMC due to personal
matters. They have noticed that the personal that was hired to perform the valuation has had
troubles with being able to use the current financial information provided by the company. All
statements were focused in making sure all income and expenses were reported to make sure that
all taxes were paid, instead of making sure that the actual statements were organized and
understandable to potential investors. Hitchner says that in most cases, many adjustments are
usually made when the statements are cash-based and not accrual-based (2017, p. 854). This is
exactly what DMC had to go through during the valuation process.
The Bible teaches that Christians should honor the Lord with their wealth and the fruit of
their produce, so that He can blessed them with more (Proverbs 3:9-10, ESV, 2001). It is
important to understand that beyond being diligent and honest when it comes to creating
financial statements to report on taxes, Christians have a bigger calling on honoring the Lord
with what their companies do as well, making sure they are always putting Him first, so that
blessings may come from Him.
References
Dagher, V., Tergesen, A., Burton, A., & Carpenter, J. (2020, July 31). Help for small-business
owners: The money questions. WSJ. https://www.wsj.com/articles/help-for-small-
business-owners-the-money-questions-11596187815
Delta Marine Construction. Retrieved December 3, 2020, from
https://www.deltamarineconstruction.com/
English Standard Version. (2001). English Standard Version Bible Online. https://www.esv.org/
Hitchner, James R. (2017). Financial Valuation: Application and models (4th Edition). Published
by John Wiley & Sons, Inc., Hoboken, New Jersey.
Barbara,
What a controversial topic you have chosen to talk about in this discussion board. In my
opinion, reasonable compensation is definitely a concept that not only the United States faces,
but also the entire world as well. There are many factors that determine the fair amount of
compensation workers deserve; however, just like you said in your post, understanding what is
“ordinary” and what is “necessary” is the key to make sure workers get a reasonable
compensation. In addition to this, I think the last two concepts I mentioned are very subjective,
and depend on the interpretation of who is determining the definition of the concepts.
One of the topics you talked about was how in many times, business owners use their
business to avoid personal taxes. This is an unethical practice that unfortunately is very common
throughout this country. According to an article of the Wall Street Journal (WSJ), the reason why
business owners can avoid paying income taxes is because they can determine how much income
they want to report to the IRS, and that a 55% of the income is either not reported or misreported
(Saunders, 2020). You mentioned a very specific example in the company you chose as
example, on how they created program that was reported to be something else, but in reality,
internally it was used for something else that involved tax avoidance. It is sad when companies
make employee compensation-based benefits as a cover up for their unethical and illegal tax
avoidance practices.
In addition, even though I think that bonuses and other extra monetary benefit offer by
employers are a great incentive for employers to do better and be motivated, I do not call that
compensation. I think compensation is what an employee receives for his or her performance
according to what is expected from him or her. In the text we can see that Treas. Reg. 1.162-7(b)
(3) defines reasonable compensation as the “amount that would ordinarily be paid for like
services by like organizations in like circumstances” (Hitchner, 2017, p. 890). This means that
compensation is only, how we mentioned before, the ordinary and the necessary; even though it
could be reasonable, nothing extra counts towards compensation. I would like to add that I can
only imagine how companies, especially small businesses, are struggling right now during the
pandemic, on what is reasonable, what is fair, and what they can afford to compensate their
employees for their work during this season.
The word of God teaches us to pay what people deserve by telling us “do not withhold
good from those to whom it is due, when it is in your power to do it” (Proverbs 3:27, ESV,
2001). I believe that it is a Biblical principle to always make sure we properly compensate
people for what they do.
References
English Standard Version. (2001). English Standard Version Bible Online. https://www.esv.org/
Hitchner, James R. (2017). Financial Valuation: Application and models (4th Edition). Published
by John Wiley & Sons, Inc., Hoboken, New Jersey.
Saunders, L. (2020, October 9). It’s easier to avoid taxes when you own a business. Just ask
Donald Trump (and Joe Biden). WSJ. https://www.wsj.com/articles/its-easier-to-avoid-
taxes-when-you-own-a-business-just-ask-donald-trump-and-joe-biden-11602235806
Michael,
Let me start by saying that I agree with you on how divorce is very complicated and
hostile, especially when a husband and a wife are business partners. Even though I have not
experience divorce myself, I have seen close friends and family be in very uncomfortable
situations where, in some cases, a business is not a part of the negotiation and it is still difficult to
come into an agreement. I could not even imagine what it would be like for a couple that owns a
company together. In my opinion, their decision does not only affect them emotionally and
potentially financially, but it also affects everyone in the company and in their family. According
to Grey Grey & Grey Certified Public Account Advisors, marital dissolution is one of the top 10
reasons why businesses look for a valuation (Feilteau, 2017). I believe that in this topic, it is
important to thoroughly understand the standards of value that apply to the business that is being
appraised, so that each party in the ending marriage get an equitable division of the assets.
One of the more specific topics you talked about was how a 50/50 division of assets is
almost expected in a divorce; however, is it fair to think that way? Even though this controversial
topic differs in every state, especially in when it comes to court-cases like in the double dipping
concept you talked about. I agree with you in the fact that business should be appraised with an
asset or a market approach since it only counts what is present, and it does not make any
assumptions. I think it is also important to account for any future events that come as a
repercussion from past business partnerships or activities that involve both the husband and wife.
The majority of the time, divorces that involve a business are typically small businesses.
In this cases, these companies sometimes have a lack of high-quality financial statements that
make an appraiser’s job even more difficult (Hitchner, 2017). I actually talk about this in my
discussion board post. I would encourage you to read it. Additionally, another obstacle that
makes the valuation job even harder when it comes to divorces, is the lack of a well kept
inventory of assets. Some companies, specially private ones have a very poor inventory system
that is only good enough for tax reporting purposes. An article of the Wall Street Journal actually
advises individuals to always make sure they keep track of all assets and liabilities, like
collectibles and furniture, not just real state, and to make sure they have access to financial
information like tax returns and retirement plans (Dagher, 2015). As sad as the situation could
be, it would be easier for the couple to make sure they are honest with each other about what
each one owns and possess, to make sure they both get a fair amount of assets.
The Bible says that “A false balance is an abomination to the Lord, but a just weight is
his delight” (Proverbs 11:1, ESV, 2001). I believe this portion of the Bible applies to this topic
because, how I mentioned before, it is important to put feelings aside, and to always be honest
and truthful so that everyone gets a fair division of the assets when a divorce is taking place.
References
Dagher, V. (2015, May 15). Divorce and money: Six costly mistakes. WSJ.
https://www.wsj.com/articles/money-and-divorce-six-major-mistakes-to-avoid-
1431693937
Feilteau, R. (2017, February 9). Top 10 reasons for a business valuation. Gray Gray & Gray.
https://www.gggcpas.com/Top-10-Reasons-for-a-Business-Valuation
English Standard Version. (2001). English Standard Version Bible Online. https://www.esv.org/
Hitchner, James R. (2017). Financial Valuation: Application and models (4th Edition). Published
by John Wiley & Sons, Inc., Hoboken, New Jersey.
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