How do you treat cash on hand (in excess of working capital) in your discounted cash flow analysis of a privately held company under the income approach? That was the lively topic of discussion in a recent LinkedIn thread (registration required). It was also a key focus of the Chesemore ESOP case, above, particularly the way the annual appraisal firm changed its treatment from prior valuations to the final.
In particular, in its first two annual appraisals of the ESOP holdings, the firm concluded that the storage company needed $2.5 million and $4 million in working capital, respectively, and only then included any excess cash in equity. In the year prior to the leveraged buyout, it included only “non-operating capital” in equity without identifying its specific working-capital assumption. Finally, in the abbreviated appraisal conducted specifically for the ESOP trustees, the same firm included all cash in equity, excluding only current customer deposits. Similarly, the fairness opinion provider assumed all cash above customer deposits was nonoperating and counted it as part of the company’s value.
Notably, the court found that neither valuation estimated the company’s “necessary operating capital in light of its historic needs,” but “incorrectly” assumed the company needed no operating cash beyond the amounts necessary to cover its unfunded customer deposits.
Surveying the ‘accepted’ aspects of a DCF. Whether to include cash in net working capital requirements might be a “no-brainer” for most business appraisers—and yet, in the month since the LinkedIn thread began, over 100 comments have challenged this “accepted” DCF practice. Admittedly, some are from the more active participants—but the continued debate prompted us to put together a new online survey (with the help of Rod Burkert, Burkert Valuation) of the “settled-but-unsettled” mechanics of the DCF. Do you ever apply a DLOM to a 100% controlling interest? Should depreciation always equal capital expenditures in the terminal year? There are seven questions in all. The survey won’t take long, and we’ll publish the results in next week’s issue. To participate, click here now.
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