Reasonable comp and other "normalization" adjustments: problematic but common
“Owners’ compensation is always the most difficult,” says one participant in our latest online survey of normalization adjustments, “especially in professional practices.” Others say these are difficult, too:
- Adjustments that the owners cannot support—e.g., they estimate spending $10,000 a year on business travel, but then cannot verify the expenses through receipts or other documentation;
- Values for nonoperating assets such as real property (and convincing the owners to pay for the related appraisals);
- Debt and interest expenses and amortization relating to fair value adjustments;
- Unreported cash;
- Fixed asset outlays, especially when the mix of accumulated depreciation and historical increases in additional outlays creates a downward-trending net fixed asset figure, which cannot continue in perpetuity; and
- Retirement benefits.
“Kids involved in the business always present challenges,” answers another survey-taker. Still another maintains that no single adjustment is problematic, “but some are more time-consuming and require greater research and thought.” Indeed—consider these highlighted results of the survey, so far:
- Respondents are evenly split as to when they perform financial analysis relative to normalization adjustments. Nearly a third (32%) analyze before, 30% perform after, and 38% perform financial analysis both before and after normalization adjustments.
- As to the ever-challenging adjustment to owners’ compensation, just over half (58.5%) of respondents consider this a “normalization” adjustment, but 41.5% consider this a “control” adjustment.
- On average, a strong majority (75%) does not adjust for nonowner’s compensation, but 25% do.
- Just over half (53.7%) make owner compensation adjustments in minority interest valuations, but, on average, nearly 47% do not.
“The results so far emphasize both the large variance among practitioners and the overall importance of normalization adjustments to the valuation results,” says Brandi Ruffalo (Valuation & Forensic Partners), who designed the survey.
Still seeking input & insights. “Please take the time to participate in this groundbreaking study,” Ruffalo says. “You will help shape our profession and ensure the results reflect how we collectively practice today.” To participate, click here now.
And don’t miss the Advanced Workshop on Normalization Adjustments on December 6, a four-hour workshop in which Ruffalo and Garth Tebay (Value Defined) will analyze the complete survey results and provide the most current and credible methods for making these critical adjustments.