By Ron J. Anfuso, CPA, ABV, CFF, CDFA, FABFA
Industry-Specific Databases
The specific databases I have subscribed to for several years are surveys of attorneys, physicians, and accountants. Although some accountants may not obtain these surveys due to their cost, I subscribe because each provides a wealth of information that enables me to more accurately calculate reasonable compensation reports, which are well received by triers of fact (i.e. judges).
Arimanino Law Practice Survey: Arimanino’s annual benchmark provides up-to-date information on a regional basis for compensation and several other areas of interest to law practice principals. Reports break down compensation by firm size, practice services, years of professional experience, and position title (owner, partner, etc.). The report also breaks down several other position categories such as director of administration, office manager, administrative assistant, and chief financial officer.
Its regional surveys include reports for Southern and Northern California. These enable me to analyze what an individual attorney should be making based on several criteria, thus allowing me to create a profile for any attorney located in a large metropolitan area of the state.
Medical Group Management Association Survey: This annual survey provides information that enables me to determine what a physician’s annual salary should be based on their respective region, specialty, number of years in practice, and the number of physicians within a group. Since most physicians today are employed by groups, this survey is useful.
The Medical Group Management Association Survey also breaks down the compensation trends for physicians, as well as bonus incentives, so we can calculate an average salary for the past several years. We will know whether a metropolitan area’s physicians’ salaries are trending up or down. Of interest is that these surveys find doctors practicing in large and mid-sized metropolitan areas pay lower salaries. Conversely, physicians in rural areas tend to pay more due to the difficulty for rural communities to recruit top talent.
The Rosenburg Survey: Four-hundred firms participated in the most recent nationwide survey that reveals the compensation of CPA partners. The compensation data for accounting firms are only relevant within a specific market. Therefore, if we are analyzing a practice in the greater Los Angeles area, we should consider similar-sized firms within that same geographic area.
The survey also categorizes firms based on the type of practice, i.e., tax practice, corporate practice, general accounting, etc. The income of CPAs within a firm is usually higher for larger firms with more than $20 million in gross revenue than for firms grossing less than $20 million.
Reasonable Compensation and Goodwill
Goodwill is defined by California Business and Professions Code Section 14100 as the expectation of future public patronage. When I rely on a survey to determine reasonable compensation, the survey must be statistically accurate and relevant to the practice being valued to accurately determine goodwill.
In the marriage of Rosen, {in re marriage of Rosen (2002) 105 Cal.App.4th 808} the valuation of a solo practitioner who handled state-appointed criminal appeals was poorly performed. In this case, the expert had no knowledge of the lawyer’s compensation. He admitted he was not familiar with this type of law practice, and failed to conduct a survey or study of lawyer compensation in Southern California. Rather, he relied on two surveys of compensation neither of which dealt with a sole practitioner who handled state-funded criminal appeals. As a result, the expert’s reasonable compensation findings (including goodwill) concerning what it would cost to hire an attorney to replace this attorney were ruled inadmissible.
When a practice is appraised and the reasonable compensation turns out to exceed the actual compensation received, that business has no value of goodwill and only has net asset value (value of hard assets). If there is money in the bank account or receivables, that computes to a net asset.
When the actual earnings of the business exceed the reasonable compensation, that difference is capitalized into a value for goodwill, which is an intangible value.
There is a considerable amount of subjectivity involved in determining goodwill. I always initially explain to clients, judges, and attorneys that business valuation is not an exact science. Subjectivity includes what capitalization rate to use, and how to apply surveys and discounts. The other issue, as mentioned in the previous newsletter, is how much risk the expert associates with the operation of the business. That risk is captured in the cost of the capital and commonly referred to as the capitalization rate. A portion of this determination is objective and a portion is subjective. You have market risk, specific company risk and size risk, as I explained in Issue 67 of Forensic Accounting Today in Ron’s Corner.
Age and Health Issues
Age or health factors can come into play when determining reasonable compensation as in the case of Lopez {In re Marriage of Lopez (1974) 38 Cal. App. 3d 93, 110}. An example would be a 35-year-old in excellent health compared to an owner who is 64 years old with health issues. When I appraise a professional practice, I assume that the business will continue for at least five years based on its current operating results. If the party is seriously ill, the expert may need to add additional risk to his capitalization rate because the business might not have the same longevity as one owned by a younger, healthy individual.
However, in many cases, the business owner who is ill might be able to sell the practice. In such a case, the expert would have to examine the potential for finding a buyer. The expert would need to evaluate the potential sale based on a number of factors, such as potential demand, financial status, competition, personnel situation, location, as well as goodwill.
A Recent Case
I recently prevailed in a case against an opposing CPA. This involved a long well-established CPA firm. I based my calculations on a detailed analysis using, in part, the Rosenburg Survey. My valuation of the subject practice resulted in a considerably higher value than the other CPA’s calculations. One primary difference was each of our opinions on the reasonable compensation.
The approach the other accountant used resulted in undervaluing the practice. Prior to (and after) the parties’ date of separation, the CPA purchased three practices. I summarized the multiples that the CPA paid for these practices, which calculated to approximately 1.2 times their annual gross. The opposing forensic CPA was using 80 percent of a one-time gross instead of 100 percent as most of the data reflected. This did not make sense because the CPA litigant was buying the practices and paying considerably more than 80% of gross revenues as a pricing model. As a result, the judge placed more weight on my valuation and found that my testimony related to the actual purchases was more persuasive and valued the practice at $200,000 more than my conclusion of value! This is an example demonstrating how an expert uses database reports and why accurate, logical reports will typically enhance the credibility of CPAs with judges.