Riley: valuing a wholesaler

Importer valuation dispute

Riley & Riley (2016), family matter

The matter related to an importing business owned and operated by the husband. The business brought overseas goods into Australia for wholesalers, processors and re-packers. The husband’s expert valued the business at approximately $900,000. The wife’s expert valued the business at $2.68m.

Key areas of disagreement

• Earnings.  The wife’s expert assessed earnings at $820,000 (EBIT), based on the last 5 years of earnings.  The Husband assessed earnings at $390,000, based on the last 3 years of earnings.
• Multiple: The wife’s expert assessed the multiple at 3.00 to 3.50.  The Husband’s expert assessed the multiple at 2.25 (attaching a high risk to the creditor financing facility)

The husband’s expert concluded that the normalised EBIT generated an insufficient rate of return on net operating assets to identify and measure any goodwill. Thus, according to the expert the value of the net operating assets of the business was deemed the appropriate way to measure the value of the business.

Reasons for disagreement

Per the husband’ expert, the underlying trading terms that influenced gross profit in 2009 and 2011 would not reoccur. The gross profit in 2014 and 2015 was highly probable to reflect the gross profit margins in the foreseeable future. Reasons given for this, included:

• Reduced margins due to increased stock of certain products
• Increase warehouse costs
• Loss of two large customers
• Increased number of competitors in the market
• The likely downward trend in the Australian Dollar

A key difference between experts was their treatment of interest expenses relating to the creditor financing facility. The wife’s expert assumed that that the business used a line of credit and so didn’t incorporate the creditor financing facility interest in the calculation.

The husband’s expert argued that in the wife’s expert report “debt is included in the business valuation and not excluded as required by a pre-interest valuation model” and regarded this error as “fatal to the credibility of the report”.

Counsel for the wife referred to Lenehan & Lenehan, where: “the vendor’s borrowing are irrelevant to the question of the value of that business which is to be calculated independently of those factors”

The husband’s expert analysed the Australian dollar against the US dollar over the last 20 years.The wife’s expert didn’t do any historical analysis and chose to incorporated the financial years when the Australian currency was high against the US dollar.

Conclusion

In summing up the Judge identified these key areas:

• Lack of information provided to the wife’s expert, including no discussion by the expert with the husband or financial controller. This compared to the detailed information provided to and considered by the husband’s expert, particularly the treatment of creditors.
• Wife’s expert assumed incorrectly that the company used a letter of credit instead of the more expensive trade finance facility which was in place.
• The three-year period of earnings is reasonable having regard to the fluctuations in the Australian dollar.
• Lenehan’s case involved the valuation of a pharmacy: “An importation business operating in international markets is very different from a pharmacy business because it is a business where borrowing and foreign exchanges fluctuation are integral to the operations of the business”.  “Any prudent purchase must factor in the costs of borrowings in order to determine the value of the business”

In conclusion, the Judge was satisfied with the evidence provided by the husband’s expert.

Related articles

Corbon & Kloisner

Riley & Riley (2016) FamCA 535 (1 July 2016)

Simon specialises in providing forensic accounting and valuation services. Prior to founding Lotus Amity, he was a Forensic Accounting partner with BDO Australia and led their National Forensics practice. He has worked as a forensic director for a major offshore forensic accounting practice which included assisting in multi-billion-dollar litigation in relation to the largest Bernie Madoff feeder fund. He has also held senior management positions with Deloitte and Crowe Horwath. Simon is a Chartered Accountant, CA Accredited Business Valuer and a Certified Fraud Examiner.