Transcript

 Welcome to the Life Unlimited Podcast with Larry Heller. You deserve complete financial advice so you can confidently live your life your way for life. Now, let’s get into this week’s podcast episode. 

Aric: Hello and welcome to Life Unlimited with Larry Heller from Heller Wealth Management. I’m Larry’s producer Aric, and I’m here to learn along with you, the audience. Larry, how are you? 

Larry: I’m doing terrific today, Aric, how are you? 

Aric: Oh, fantastic. I know that you’ve got a great guest on the show and you’ve given me the honor again of introducing him. Can I do that? Absolutely. Go ahead. All right, here we go. So, Karl H Janhsen is an experienced CPA, ABV with a career spanning over 30 years in public accounting.

He worked at Deloitte and Touche, LLP and several accounting firms as a partner where he oversaw audits and challenging clients and was involved in business valuation engagements in 1998. He [00:01:00] co-founded Covati & Janhsen CPAs, PC and Premier Business Appraisals Incorporated. Providing financial and tax advice to a diverse clientele with over 100 hours of training and business valuation techniques and theory.

Karl is a sought after expert in the field. Again, fantastic bio, Larry. What are you guys talking about as if I don’t know, a little bit of a hint of it. 

Larry: Yeah, so we’re gonna talk about, business valuations and what they are and why you need them and who you should work with. And maybe take a little bit of the, uh, demystify some of the, uh, the business valuations cause that, what’s Karl’s been doing for the good part of his career. So, Karl, thank you for for joining us. 

Karl: Oh, thank you very much for having me. I really appreciate the time. 

Larry: Well, let’s just jump right, right, jump right in. So, obviously everyone knows what accountant does in different audits tax, but how did you get started in the area [00:02:00] of business valuations?

Karl: Back in 1991, I worked for a small firm in Massapequa. And one of the engagements was to value the business for one of our major clients. And I worked with the managing partner as well as one of the senior partners in trying to develop an approach to. Coming up with the value of this client.

And it was an interesting project because there really wasn’t a lot of empirical data out there. This was prior to the internet. This was prior to a lot of databases that are available to us now as professionals. And it was more professional judgment and gut feel. And when we thought we provided a solid Valuation. When we presented it to the client as well as to the client’s advisors, a lot of questions arose as to, you know, where’d you come up with this rate? Or how did you assume that sales were going to grow? And how did you figure out what gross profit [00:03:00] margin should be? And there were a lot of things that, uh, you know, you think about and you think you have a solid foundation for, but when you start to apply market data to it, you realize that there might be some shortcomings to the data that you’re using.

And again, that was in 1991, and that’s really what intrigued me. This was an area where CPA started to focus on, in the mid nineties. The AICPA got involved with business valuations. And so I started to take the training and I started to develop a a network of attorneys and other accountants to help me, uh, start premier business appraisals.

Larry: Yeah. So you, you mentioned that one, you know, client that you started went there so why would you need a business valuation? I guess the one thing that comes to mind, I guess if you’re looking to sell your business, it’d be good to have a valuation. Um mm-hmm. Any other reasons why someone would go through a business valuation process?

Karl: Absolutely. It’s probably the most popular are divorce, unfortunately. We’ve seen an uptick [00:04:00] of. Divorce engagements since the start of the pandemic. A estate and gift planning people passing businesses from one generation to the next. Of course selling a business admitting a a new shareholder into a business will also require a business valuation.

A merger of two businesses could require a business valuation. Filling out an application for financing a mortgage application business might be one of your largest assets that you have on your balance sheet. Therefore, uh, we can be brought in for that purpose. Shareholders that are developing a shareholder agreement where, hey, if something were to happen to one or both of us, how do we value the business for buyout or for disability buyout?

So we’ve been brought into several different circumstances to help develop a, a business valuation. Even one most recent engagement was to develop a value for a group of intellectual property on, in [00:05:00] a business. Um, we used, uh, certain models that we’ve developed to provide a value of an intangible intellectual property on an international company.

Larry: Hmm. So I was just gonna ask you, without naming names or companies, is there a particular valuation that you can share with the audience that you found really interesting? 

Karl: Uh, sure. We’ve we’ve done many valuations of small businesses pizzerias, delicatessens restaurants. But we’ve also done interesting projects where, you know, a public company was acquiring a private company and they needed an allocation of a purchase price for booking the, the purchase of the company to their balance sheet.

But probably the most interesting was A biotechnology company in New Jersey that had developed a system of de delivering to the cell level chemotherapy. So it [00:06:00] actually leave healthy tissue alone, healthy cells alone, and bring. The medication right to the cell level so you weren’t destroying healthy tissue.

And when we were first asked to do it, we were doing it for a trust, a family trust that owned the shares and they were moving assets around and, company didn’t make money cuz of biotechnology. And it was early in its stages, but it did have revenue. And trying to find a comparable company to develop a.

A capitalization rate or to develop a a price earnings ratio is very difficult in that space. So we actually worked with another gentleman who actually wrote the book on such valuations and he provided me with a lot of guidance and a lot of Models to help support the valuation that was done for estate and gift planning purposes, and that valuation was actually accepted by the Internal Revenue Service.

So that was probably my most one of my most interesting and [00:07:00] challenging engagements that I’ve had. 

Larry: And that is very, very interesting. So, you, let’s fast forward. You originally said when you first started in 91, pre-internet, pre-computer programs for doing this. A lot of it was feel. So I guess now with all the types of computer programs and modeling you can do, it’s more science.

But I’m guessing there’s still some art that’s involved in these valuations, or is it just either. X amount of model valuations and you take an average of that, how do you kind of go about determining that? Or is it every industry is completely different? 

Karl: I would say that it still comes down to, it has to make sense. And we have to be able to educate our clients. To agree or or disagree with the value that we come up with. We wanna work with them so that they understand it and in. In the end that the valuation does make sense. You can disagree on certain inputs. [00:08:00] Client always knows the business better.

We educate ourselves along, you know, by speaking with the client about the business where it is in its cycle. You know, is it growing? Is it plateauing? Is it in decline? But also where is the industry and where do you fit into that industry? And the information that’s out there is much better now. When I first started, you had to go to the Wall Street Journal and get price earnings ratios for similar companies, and now you’re trying to, if you have a, a chip manufacturer or a component manufacturer of of, helicopter parts, let’s say.

And it’s a small business owned by one individual or two, two brothers. And now you’re trying to get similar companies to compare that business too. So you get a price earnings ratio, or you get capitalization or discount rates from the market. You know, you’re, you’re comparing an international company or a, a multi, multi-billion dollar company to a [00:09:00] small mom and pop shop.

And over the years, uh, Bis Comps is a very common database that we use. Deal Stats is another database that we use. Value Source is a third database that we use to help develop actual companies that have sold and we can compare our business based upon size, based upon profitability to those companies.

So now we can actually apply a market approach also Duffin Phelps, which was a company that produced a data from the stock market crash all the way till today. What’s a safe risk? What’s a, an equity risk? Premium? What’s a, uh, small company risk premium? All that data is now available so you can develop capitalization rates and discount rates that are specific to the company that you’re looking at based upon size.

Another company that took over for Duffin Phelps has actually taken that one step further and has developed, you know, [00:10:00] capitalization rates based upon company size, sales profitability, number of employees, history of, earnings before interest and taxes. So the data is so much more resilient, uh, so much more robust that you can feel more confident in the conclusion that you come to, but still, When you come to that conclusion, it has to make sense to your, your the attorney that you’re working for, or the accountant that you’re working for, even the ultimate client so that you can compare the risk of investing in that company to any other financial instrument.

You know, if you’re investing in a small business, there’s gonna be greater risk than if you take your money and put it into a CD, so the return on your money. For a small business has to be greater than the going rate for a CD. But then you take it a step further and say, well, small business risk is greater than a company that trades on Wall Street.

So what’s the return on a company in Wall Street? I have to at least be higher than that [00:11:00] also. That is what we do is we come up with reasonable rates, defensible rates. We’re hired to be an advocate for the value, not an advocate for The client or for the Internal Revenue Service, we wanna be able to support what our conclusion is to a, a trier of fact, or the Internal Revenue Service.

And that’s, that’s how we that’s how we approach every engagement. The number’s gotta be right. 

Larry: Right. And there’s, that’s interesting. And there could be so many different variables cuz I, I guess there’s so much data out there for certain industries. You may have a multiple of IDA or a multiple of sales, but mm-hmm.

You know, if one, if you have two. Companies and one company has 80% of their sales through one vendor. The risk there is a lot different than a company that’s got multiple vendors that they, they work with. So it’s not just so straightforward. Is that correct? 

Karl: That’s absolutely correct. And that’s actually one of the areas [00:12:00] that we’ve focused on, on a number of our engagements is that there’s really no empirical data out there That says I kind of call it the Walmart effect. If you’re 65% of your sales are to Walmart, Walmart pretty much predicts or tells you how much you’re gonna Sell the stuff to them for, really puts the company under a little bit of financial stress in order to raise prices or to increase profitability.

And that really holds the company back. So as you’re a hundred percent correct. If I’m a company and I’m selling a hundred, a million dollars worth of product and 65% of that’s going to Walmart, and I compare that to a company that’s, Same profitability, but they have no heavy concentration risk in their sales company that doesn’t have the concentration risk has gotta sell more for the company that does have this concentration risk.

There’s no Database. So you can look at that and say, that company that has the concentration risk is gonna sell at a 20%, [00:13:00] 30%, 50% de, dis, uh, discount from the company that doesn’t have the concentration risk. Uh, it’s an area we focus on. There are papers that have been written how to calculate a discount for concentration risk.

We’ve applied concentration risk in the past to, uh, valuations of those companies that do have that. And so far so good. You know, we’ve it hasn’t been challenged, but by not being challenged doesn’t mean it, it’s accepted either. So, that’s an area that we do focus on and we hope to develop something in that area to to be a market rate in the future.

Larry: Very interesting. So I guess anyone that’s bought a house understands when they get a real estate appraisal, they see the different values of homes. But I guess those are easy to kind of do, but you know, each home is different. So is a business appraisal kind of a similar approach as a real estate appraisal?

Karl: It is. We do have a cost approach, an income approach, and a market approach. The market approach [00:14:00] is most favored by the Internal Revenue Service, cuz now you’re actually using sales data for actual transactions. So that’s, that should be the best empirical data that you can use to value a business.

And like I said, there are many databases available today that help you develop a multiple of EBITDA or a multiple of sales. Or even gross profit or earnings before interest in taxes or sellers discretionary earnings. But you have to look at that data as well and say, okay, well is the data developed from geographically the same location?

There are some businesses that just seem to be reported in these databases that are. In the south, Florida, Tennessee, Kentucky. Can you really use that data compared to a company that’s selling in the Northeast? And sometimes yes, sometimes no. We just have to know what the data says to us and how it’s developed.

We also use income approaches. [00:15:00] We develop a model that shows us what the future cash flows of the business should be. We get the agreement of the client that those are in fact what they believe to be their, their budgets or their projections. And then we’ll develop a rate of return a discount rate in order to discount those future cash flows back to today’s dollars.

And that’s what you’re really investing in when you buy. Ford Motor Company or you’re buying anyone else Apple computer, you know, what are the dividends, what’s the cash flow that’s going to go to the, the common shareholders? Cuz that’s what you’re really doing is buying a, a future cash flow and what are the risks associated with that cash flow.

And that’s how we develop a value as of today. What am I willing to invest to get that rate of return and that cash flow? Hmm. And we take several different approaches. We really try to do at least three or four models. So it helps us kind of circle around a value that we can defend. Uh, I [00:16:00] think the reports that we review for attorneys before we go to court or, uh, for other valuation professionals.

Some do apply several approaches, but oftentimes you find just one approach and that’s simply dangerous because other approaches can help show weaknesses or strengths in the company that you’re valuing and it really helps you reconcile the values. You know, why would a, a multiple of revenue for this company indicate a higher value?

Than a a discount of future earnings of the cash flows to shareholders. And maybe that company is just not as profitable as another company that recently sold. And we did that for a doctor’s office just a few months ago, and we said, well, We’ve looked at similar size companies and they seem to be much more profitable than you are.

Why is that? And the answer was because the nurses did just didn’t wanna see more than six patients a day. And that held [00:17:00] down, they got paid the same, they just weren’t producing the same. So that held down profitability and that ultimately affected the value of the business that the doctor wanted to to sell to another group because he just was not as profitable. As as similarly sized companies. 

Larry: So this is all great information, especially for somebody that needs a business valuation. So how do you differ from other professionals in the field? 

Karl: I think, I don’t wanna say that others don’t care about their clients cuz I think we all care about our clients. I just wanna get it right and I take the extra time to get it right. I don’t use standard software to come up with a value where I just put the client’s data in and, market rates of assumptions that are very general. I like to understand the business. I like to understand what makes it tick, where it’s going and where it’s been, and how that affects value.

I, I don’t mind. Explaining the valuation [00:18:00] to a. Client. Unfortunately, sometimes the client thinks it’s worth much more because their blood, sweat, and tears and sacrifices have gone into that company. 

Larry: Doesn’t every business owner think it’s worth more money than anything? 

Karl: Well, we’ve had business owners come to us and say, I don’t think my company’s worth anything. We actually had that with a snack route distributor who said, I, you know, I’m the business. It’s not worth anything without me. And we said, well, based upon other companies that have sold somewhere in size, your business is probably worth about $80,000. And plus the cost of your van that you just purchased.

And he didn’t believe us, and I think he wound up selling it for $60,000 plus the cost of the van. And that was. That was found money for him. You know, he, it was certainly a help to his retirement plan. So you do have clients on each side. But the best clients are the ones that you can just talk to and explain why you’re, you’ve come up with the value that you have.

And I think that’s important that we [00:19:00] are a advocate for the value and not an advocate for, showing a higher value or a lower value. Because once you have to back that up with the math, it’s hard to justify some of the assumptions that you make. 

Larry: Hmm. So, so why don’t you let us audience know, so. When and why should somebody reach out to you? 

Karl: I think anyone who’s doing a personal financial plan that says, Hey, am I gonna retire on time? Am I gonna run outta money? The biggest assets that you have if you’re self-employed, is usually your house. You might have a building, you know, that your business runs out of, and that’s the business and too often, people don’t do the proper planning over time cuz they’re too busy servicing their clients and running the business. And I think it’s important to be realistic as to what the value of your business is and where the business is in its own cycle. You know, many people [00:20:00] developed products that are no longer.

Part of the American economy, and unfortunately, if your business is solely focused on that, your retirement asset isn’t going to be there for you. So I think a business valuation also forces you to take a look at the business and how you run it and what the next generation would be for the business. We’ve had

one company that has gone from, the grandfather to the current parents and now to the son, and you don’t see that really in America where a, a business lasts for three generations. Hmm. They’re still pretty much doing things the same way that they have done for years. Custom jewelry.

But now they produce their own molds and so they’re, they’re more profitable than the competition. But they’ve had clients for 60 years and that’s, that is certainly worth something. And you know, we’ve helped transfer that from generation to generation.

Larry: Yeah, We have one of those, we have one of those clients, they’ve been a round for a hundred years, [00:21:00] which is great. Pretty cool to say also three generations. Mm-hmm. So, that way you don’t see that. So when you see something you can say, oh, this has been around for a hundred years. Obviously you have to change over time, but that’s still pretty unique these days. 

Karl: Mm-hmm. Yep. Um, you know, when you’re negotiating with your partner about what the value of the business is and what’s gonna happen, if one of us, passes and what’s the agreement going to call for? Let’s get insurance. Well, we don’t know how much the business is worth. You can call us and we can work with you to tell you, you know, this is what it generally would sell for based upon rules of thumb, but, You know, based upon your profitability or based upon your projected growth, you’re worth more or less the same than that.

You know, unfortunately, if you’re going through a divorce, planning on going through a divorce, you can certainly reach out to us or you’re doing a state and gift planning where you know, grandpa, grandma want to pass, the family business onto the children, or they have a large. [00:22:00] Stock portfolio and they want to, they’re doing Medicaid planning, so they wanna move those securities out of their name and they wanna put it into a family limited partnership.

And how can we accomplish this over time? We get involved in those transfers as well. You know, financial planning, business planning going for. Additional financing, and they’re asking what the value of your business is. We can get involved in those, and it’s not just a one size. Fits all engagement.

You tell me what you need, we’ll work up a budget to work within, your needs and we’ll, uh, we’ll get to work. 

Larry: Yeah. Great. So this has been real en enlightening and I hope the audience has enjoyed it as much as I did today. So if they, if I wanna get in touch with you, Karl, what’s the best way for someone to get in touch with you?

Karl: It is call my office. It’s (631) 928-6300. I’m in Port Jefferson, but we’ve done engagements across the United States. We just finished up an engagement of [00:23:00] a manufacturing company in Hong Kong. So, just give me a call. Phone’s always on, and I will always be happy to speak to you about whatever your needs are.

Larry: Great. Karl, thanks so much for joining us today. This has been terrific. 

Karl: Thank you for having me. Appreciate it.

Aric: Gentlemen. This has been fantastic, Karl, uh, lot of great information in this podcast. Things that I never really thought of before and I, I’d appreciate your time, Larry. This has been fantastic.

Again, brought a great guest on, had a wonderful conversation, so thank you so much. If folks are, you know, thinking maybe, how could this fit into my overall plan? This is what you do, this is what you specialize in. Can you give your contact info as well? 

Larry: Sure. They can reach out to us at 631-248-3600 or real easy, they can go on to our website Heller wealth management.com, and they can schedule a free 20 minute consultation with me, one of the certified financial planners on staff. 

Aric: Perfect. All right. [00:24:00] Thank you both again, and of course our last thank you goes to the listening audience. Thank you so much for tuning in and listening to the Life Unlimited podcast with Larry Heller.

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