Income approach is best in bankruptcy, with ‘nuances’

BVWireIssue #114-3
March 21, 2012

Thirty years ago, the guideline public company method was the primary method to determine enterprise or “reorganization value” in bankruptcy, “but today the income approach” is preferred, say Jesse Ultz and Jeffrey Risius (both Stout Risius Ross), co-presenters of the recent BVR webinar, “Valuation in Bankruptcy.”  “Some of the things to think about are no different than valuing a business outside of bankruptcy,” Ultz said, but there are some “nuances” that appraisers and insolvency experts should keep in mind. In considering the growth rate, for example, has the business bottomed out or it does it still have huge growth potential once it puts the stigma of bankruptcy behind? At what point will it reach a normalized level and hit a steady rate of growth?

The rate of return also presents “unique factors,” Ultz says. “There are really two types of companies in bankruptcy: You have good companies with bad balance sheets and you have bad companies with bad balance sheets.” With the former, the only issue is “right-sizing” the capital structure; the company poses financial but not operational risks. But a bad company with a bad balance sheet may also be a bad operator, “and the business might not be viable on a standalone basis even if it is well capitalized.” Or consider—the business “might not be a bad operator,” Risius said, it might just be a company with a “bad base business.” (Think Smith Corona and the typewriter 15 years ago.)

Look for a comprehensive overview of all the finer points to valuing a business in bankruptcy, based on the Ultz and Risius presentation, in a future Business Valuation Update.

Please let us know if you have any comments about this article or enhancements you would like to see.