How to Make Sure Buy-Sell Valuation Provisions Are Clear

All closely held businesses should have buy-sell agreements. If designed properly, these agreements help ensure a smooth ownership transition if an owner dies or leaves the business. They can also provide an owner’s surviving family members with the liquidity they need to pay estate taxes and other expenses.

Perhaps the most critical aspect of a buy-sell agreement is its valuation provision. This establishes the price (and thus the methodology for determining the same) for which the company or remaining owners are permitted, or required, to buy back a departing owner’s interest. Any ambiguity in the agreement’s pricing terms — or misunderstandings about what they mean — can lead to unpleasant surprises when the buy-sell agreement is triggered.

3 approaches to setting a price

In general, there are three ways to set the price: 1) an independent appraisal, 2) a formula, such as book value or a multiple of earnings, and 3) negotiation by the parties. All buy-sell agreements use one or a combination of these approaches, and each approach has its pros and cons.

Independent appraisals generally produce the best results. They account for the special characteristics that distinguish a particular business from others in its industry. They also ensure that the price reflects an interest’s value at the time it’s transferred. An appraisal is the best way to ensure that all parties are treated fairly. The downside of this approach is that it’s the most expensive.

Valuation formulas are inexpensive and easy to use, but they fail to reflect changes in a company’s value over time. Book value, for example, might be a good indicator of value when a company is founded, but often it becomes less accurate over time because it fails to account for earnings, goodwill or the current fair market value of the company’s assets. (See the sidebar “Book value undervalues interest by millions.”)

Formulas based on multiples of earnings or cash flow also may be unreliable. For one thing, multiples are derived from industry averages, which may not accurately reflect the characteristics of the business being valued. Also, the values produced by these formulas tend to fluctuate, often underestimating value in good times and overestimating it in bad times. In essence, valuation multiple formulas can result in an undesirable outcome for one or more parties to the agreement.

Negotiated pricing can be effective, so long as the parties are able to agree. If they can’t, litigation may be the only option. One potential solution is to call for a negotiated price, but provide for an independent appraisal in the event the parties can’t agree.

Terminology matters

To avoid litigation over a buy-sell agreement, it’s critical to choose terminology carefully and define key terms if necessary to eliminate ambiguity. For example, business owners often provide that the buyout price for an interest is its “value,” without specifying whether the term refers to fair market value, fair value, investment value, book value or some other standard.

It’s also important to specify the level of value, such as controlling interest or minority interest. Often, parties to buy-sell agreements assume that in the event of a buyout they’ll receive their pro-rata share of the business’s value as a whole. But if the agreement sets the price based on “fair market value,” the price may be discounted to reflect lack of control or marketability. If the parties intend for the buyout price to be fair market value without regard to discounts or premiums, the agreement should say so explicitly.

One issue that’s often overlooked is the valuation date. The value of a business can change dramatically over a short time, so the selection of a valuation date can have a big impact on the buyout price. Generally, it’s best to use a specific date, such as the last day of the company’s most recent fiscal year. If the date of the triggering event is used, owners may be able to time their departures in a manner that maximizes the price they’ll receive.

Get professional help

It’s always a good idea to consult a valuation professional when planning a buy-sell agreement. An expert can help you draft the valuation provision to help ensure that all parties are treated fairly, and also to make certain there are no surprises. Further, it’s imperative that the parties to the agreement periodically review it, since circumstances and issues may change over time.

Appelrouth, Farah & Co., offers business valuation services by a team of professionals who are recognized by industry leaders for their extensive training and background as well as their skills in the discipline. For more information, please call (305) 444-0999.

© 2014

 

Typosquatting: Fraud’s New Frontier

You’ve probably heard of cybersquatting. It involves someone registering a website’s domain name that includes a trademark and then trying to profit by selling that name to the trademark owner. But are you familiar with typosquatting? You should be — because these schemes can make just about any organization, along with visitors to its website, the victims of fraud.

Fat fingers

Like cybersquatting, typosquatting involves the purchase of domain names in bad faith. It takes advantage of a tendency among Internet users known as “fat fingers” — basically, our tendency to hit the wrong keys and enter misspelled trademarks or brands. For example, in a recent case involving the retailer Lands’ End, a typosquatter registered domains such as landswnd.com and lnadsend.com.

How widespread is typosquatting? Sophos, an IT security firm, chose several websites — Facebook, Google, Twitter, Microsoft, Apple and its own site — and generated all possible one-character mistakes in their domain names. Researchers produced 2,249 unique site names, including pple.com, facemook.com and twitterz.com.

They then checked how many of these names were registered. According to Sophos, Microsoft typosquats were at 61% (meaning 61% of the domain names similar to Microsoft.com were registered), Twitter at 74%, Facebook at 81%, Google at 83% and Apple at 86%.

Dangers galore

Some of these fraudsters seek to divert consumers away from competitors or just draw more traffic to their own sites (often pornography or dating sites). That’s bad enough. But others go further. For example, the websites they divert to might feature a phishing scheme, whereby a visitor is induced to download malicious software (malware) that steals their personal information and log-in credentials.

Earlier this year, Twitter users were lured in by messages sent on the service that said, “Did you see this pic of you?” When users clicked on the included link, they were sent to spoofed Twitter log-in pages with URLs like tivitter.com and iftwtter.com. Unsuspecting users entered their Twitter usernames and passwords, allowing fraudsters to hijack their accounts.

Typosquatting can also be used for corporate espionage. In a lawsuit filed in 2012, for instance, the Gioconda Law Group sued a programmer who obtained the domain name giocondolaw.com, whereas the firm’s URL is giocondalaw.com. The law firm alleges that the defendant used his doppelgänger domain name to create fake e-mail accounts and intercept e-mail sent to the firm.

Best defenses

When it comes to avoiding fraud on the Internet, awareness and education are probably the best defenses. And this certainly holds true with typosquatting. Organizations should regularly check various mistyped versions of their URLs and consider purchasing as many similar domain names as possible.

Do you suspect that you’re a victim of fraud? Learn more about our fraud examination services.

© 2013

Monitoring Section 530 Eligibility

As the IRS continues to focus on worker classification, it has become increasingly important that eligible businesses take precautionary steps to ensure compliance with Section 530 to avoid a costly reclassification. Section 530 of the Revenue Act of 1978 (not part of the Internal Revenue Code) allows the business to treat a worker as an independent contractor (i.e., as not being an employee) for employment tax purposes regardless of the worker’s status under the common law control rules. Many businesses rely on Section 530 relief to provide protection.

Section 530 relief is available only if the business meets all the following requirements:

1.  Files all information returns (i.e., Form 1099-MISC) for the workers or classes of workers at issue for the current year.

2.  Has not and will not treat the workers at issue (or classes of workers performing substantially similar job positions) as employees on income tax returns, payroll tax returns, or other returns filed by the business during the year.

3.  Has a reasonable basis for treating the workers as independent contractors. The law provides certain safe harbors to meet this requirement, or the business can rely on some other reasonable basis.

These requirements must be met each year. If the company fails to file Form 1099-MISC on a worker, it loses Section 530 relief for that worker for that year. More importantly, if the business fails to treat the worker (and workers performing substantially similar job positions) as an independent contractor during a particular year, it loses the Section 530 relief (for the year of violation and for all subsequent years) for the entire class. Thereafter, the company cannot obtain Section 530 relief for that class of workers.

Consistency in treatment and information is the key. A business that wants to use the Section 530 rules to classify workers must be aware of the importance of consistent treatment across the years and throughout the ranks of workers holding substantially similar positions. Treating even one worker as an employee can eliminate Section 530 treatment for all workers within the same class.

© 2014

Limiting losses when your credit or debit card is stolen

As several recent high-profile security breaches have taught consumers, credit and debit cards are never entirely safe from thieves. Fortunately, if your physical card — or account information — is stolen, you aren’t likely to be liable for most fraudulent transactions. However, liability rules can vary by card type and when you report the theft.

Credit or debit?

According to the Federal Trade Commission, if your physical credit card is lost or stolen and you report the loss before it’s used in a fraudulent transaction, your card issuer can’t hold you responsible for unauthorized charges. However, you may be responsible for up to $50 in fraudulent charges if you don’t report the card loss until after a thief has used it.

The rules governing debit cards are a little different. If you report a missing debit card before any unauthorized transactions are made, you aren’t responsible for them. And if you report a card loss within two business days after you learn of the loss, your maximum liability is $50.

However, if you report the missing card after two business days but within 60 calendar days of the date your statement showing an unauthorized transaction was mailed, liability can jump to $500. Worse, if you report the card loss more than 60 calendar days after your statement showing unauthorized transactions was mailed, you could be liable for all of the funds taken from your account.

What if you notice an unauthorized debit card transaction on your statement, but your card is still in your possession? In that case, you have 60 calendar days after the statement showing the unauthorized transaction is mailed to report it and avoid liability.

Additional protections

Lower liability protections on debit cards may make you wonder if you’re safer using a credit card. Keep in mind that some debit card companies offer protections that go above what the law requires. For example, your issuer may waive charges if your account is in good standing and you’ve exercised reasonable care in safeguarding your card.

Finally, if you’re liable for fraudulent charges, check your homeowners insurance policy. Some policies cover liabilities incurred when credit and debit cards are stolen.

Did you know that we have a fraud examination team? Contact us for more information. 

© 2014

Generous and tax-savvy – Following IRS rules on charitable gifts

Donating to charity makes it possible to do good and do well. But to claim an income tax deduction or reduce the size of your taxable estate with charitable gifts, you must follow IRS rules carefully.

Vetting charities

First, ensure that you’re donating to a qualified charity. There are thousands of organizations soliciting contributions, many with similar missions and names, so it can be easy to confuse a legitimate charity with an unqualified or even a fraudulent one.

Watchdog groups — for example, Charity Navigator and CharityWatch — provide information on many nonprofit organizations. They rate them based on such qualities as transparency and fiscal responsibility. Keep in mind that nonprofits that were once qualified could lose their tax-exempt status due to noncompliance. A current database of qualified charities is found on the IRS website.

Deducting donations

Many donations to qualified charities, such as cash gifts, are fully deductible if you have proper records. Others are only partially deductible. If, for example, you do volunteer work, you may deduct only your out-of-pocket expenses, not the fair market value of your services. And if you donate tangible personal property that isn’t related to the charity’s primary function, your deduction is limited to your “basis” in the property — generally what you paid for it. Also know that, if you receive an in-kind benefit for your donation, such as merchandise or a meal, you can deduct only the amount that exceeds the fair market value of that benefit.

Good record-keeping is critical. For any contribution of $250 or more, keep on file a bank or payroll deduction record documenting the contribution, as well as a contemporaneous written communication from the charity stating its name, the amount and date of your contribution, and the value of any goods or services you received in conjunction with your contribution.

For substantial donations — such as an item valued at more than $5,000 — you must submit an additional tax form and obtain a professional appraisal of the property. To ensure your gift qualifies and that you’re receiving the full allowable deduction, work with your tax advisor when making major gifts.

Planning your estate

Charitable gifts also can help you reduce gift and estate taxes. But before you make a charity part of your estate plan, consider your own lifetime income needs and what you want to leave your heirs.

Two types of trusts are designed to help people make tax-advantaged charitable gifts. With a charitable lead trust, you can make charitable gifts during your lifetime and preserve assets for your heirs to be paid out after your death. With a charitable remainder trust, you can elect to receive regular income payments during your lifetime and leave the trust’s remaining assets to charity when you die.

Setting up and maintaining a charitable trust is complicated. So be sure to work with experienced estate and tax planning experts.

© 2014

 

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