The ethanol industry is on an upward growth trend. As the number of ethanol plants increases, so does the number of people who have invested in ethanol plants. A common topic among those investors—whether they own shares of common stock or membership units in a limited liability company, or are contemplating investment in one of the plants—is the value of their investment.
Typical situations in which the fair market value of an interest in an ethanol plant would be useful include a desire to buy or sell the interest, a desire to gift interests in the plants, a determination of value for capital gains purposes, or the death of the investor and the filing of an estate tax return.
The value of a business interest depends on the cash flow an owner receives while they own the interest. The financial benefits from ownership of a business interest, such as an investment in an ethanol plant, must come from one of the following sources: distribution of earnings, distribution from the liquidation of assets or distribution from the sale of the interest. In determining the value of a business interest, we focus on the benefits shareholders may receive from these three sources in long-term ownership.
At the beginning of the appraisal, it is necessary to establish whether the interest to be appraised represents a controlling or minority interest in the business. A minority interest may or may not be worth a pro rata percentage of the value of the whole company. This is because a minority interest does not have the prerogatives of control, which include but are not limited to the ability to elect directors and appoint management, determine management compensation and perquisites, acquire or liquidate assets, declare or pay dividends, change the articles of incorporation or bylaws, or register the company's stock for a public offering. Because of this lack of control, a minority interest in a company is usually worth less—often much less—than a pro rata portion of the value of the entire company. Furthermore, minority interests in closely held companies (like undivided interests in real property) are more difficult to sell relative to controlling interests. This lack of marketability also reduces the value of a minority interest, compared to the value of a controlling interest.
Valuation Approaches
The valuation of an investment in a closely held company involves consideration of the three standard approaches to value: the cost, market and income approaches. These are the same approaches used to value any asset, including a house, a piece of artwork or a machine. The valuation of companies is more complex than the value of a single asset because a business owns many assets. Also, the income a business generates is generally much more volatile than the income real estate or machinery produces.
In the income approach, appraisers typically use a discounted cash flow analysis where they discount forecasted cash flows or a sustainable level of cash flow, assuming a constant growth rate for the cash flow. The expected future cash flows are discounted to a net present value at a rate that reflects the risk of the cash flows actually happening. Rates of return for business interests typically range from 15 percent to 30 percent, depending on the risk.
In the market approach, the appraiser collects data on sales of entire ethanol plants or interests in ethanol plants. This information is used to estimate how much the subject ethanol plant would sell for after adjusting for differences between the company and the comparable sales.
In the cost approach, or asset-based approach, the appraiser adds together the market values of the individual assets (both tangible and intangible) of the ethanol plant business and then deducts the liabilities to arrive at another indication of the market value of the business.
Based on these three indications of value, the appraiser concludes a single value for the business. If a minority interest is being appraised, the appraiser will then apply discounts to reflect the relative lack of control and liquidity of the minority interest being appraised.
Appraisal Process
The typical appraisal takes anywhere from three weeks to two months, depending on demands of the client and the complexity of the project. Typically, 30 to 60 days is necessary to produce a value and a full written appraisal report, if necessary. The appraiser asks for preliminary information, such as the nature of the business, revenues, some idea of profitability and the reason for the appraisal, in order to establish a preliminary fee range and tentative schedule. Along with the appraiser's engagement letter or professional services agreement, the appraiser will provide a list of requested documents that are needed for the appraisal. The appraiser that begins the work will then begin on relevant economic and industry research and analysis, and a search for comparative transactions data if appropriate. Management is interviewed, ananalysis is completed, and a preliminary valuation conclusion is reached and communicated to the client and/or client representative. The appraiser then completes the valuation report.
In selecting an appraiser, you should look at the appraiser's experience and qualifications. Experienced business appraisers typically have a variety of credentials and qualifications, including professional designations such as:
4 Accredited Senior Appraiser (ASA)—Senior member of the American Society of Appraisers, accredited in business valuation. This requires five years of experience, successful completion of a valuation curriculum and successful peer review of two written appraisal reports.
4 Chartered Financial Analyst (CFA)—Chartered by the Association of Investment Management and Research, this requires successful completion of three annual six-hour exams.
Conclusion
If you need to determine the value of your interest in an ethanol plant, or any other business for that matter, be sure to contact an experienced appraiser to assist in that determination. Columbia Financial Advisors Inc. (CFAI) stand ready to answer any questions you might have about the value of your interest.
CFAI is an appraisal and financial advisory firm dedicated to providing independent and thorough business appraisal analysis and advice. Business appraisal services include estate and gift tax valuations, appraisal and financial advisory services for Employee Stock Ownership Plan (ESOP) purposes, financially related litigation support services, appraisals for mergers and acquisitions, corporate planning purposes, buy/sell agreements, and quantification of appropriate appraisal discounts and premia.
CFAI has a professional appraisal staff of 11, including six senior appraisers who are ASAs and/or CFAs.
Mary McCarter, Phillip Smith and Donna Walker are CFA and ASA certified, and have a combined 65 years of appraisal experience among them. They can be reached at
info@cfai.com or (503) 222-0562.