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Business Valuations

Business Valuations. Reasons for wanting to know about value :. Market transactions Scorecards Estate planning Family transfers ESOP Litigation Divorce Buy/Sell Agreements. Fair Market Value.

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Business Valuations

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  1. Business Valuations

  2. Reasons for wanting to know about value: • Market transactions • Scorecards • Estate planning • Family transfers • ESOP • Litigation • Divorce • Buy/Sell Agreements

  3. Fair Market Value A price agreed upon between a willing buyerand a willing seller, with neither party being forced into the transaction and both parties having access to all relevant information.

  4. Tangible Assets + Intangible Assets = Fair Market Value - Outside Debt = Purchase/Sales Price Fair Market Value

  5. Valuation Approaches Income Market Assets

  6. Valuation Approaches • Income Methods • Capitalization of Earnings • Capitalization of Excess Earnings • Discounted Future Earnings • Discounted Cash Flow • Capitalization of Dividend Capacity • Gross Revenue Multiplier • “Rules of Thumb”

  7. Valuation Approaches • Income Methods: Capitalization Issues • Appropriate Capitalization (Discount) Rate • Capitalization versus Multiples • Effect of Risk? • Historical or Projected Information? • Net Earnings or Excess Earnings?

  8. Valuation Approaches • Market Methods • Price to Earnings • Comparable Sales • Industry Valuation Methods • Comparable Investments

  9. Valuation Approaches • Asset Methods • Book Value • Adjusted Book Value • Economic Balance Sheet • Liquidation Value

  10. Goodwill What is it? Difference between the purchase price paid for a business and the fair market value of the assets included in the transaction. Company’s ability to achieve earnings on operating assets in excess of the average earnings normal for the industry.

  11. Goodwill • What are some of the things that create goodwill? • Customer loyalty • A high percentage of “annuity” revenues • Favorable market positions • A “blocking and tackling” organization • High product and service quality • High, secure margins • Good debt to equity ratios • Balanced leverage • Growth potential

  12. Financial Accounting Standards Board Statement #141 - Business Combinations Eliminates the “pooling” method of accounting for business combinations. Statement #142 - Goodwill Eliminates amortization of goodwill unless the asset has been “impaired”.

  13. Other Factors • What else impacts the value of my business? • Control and Ownership • Terms and Conditions • Lack of marketability (liquidity) • Terms and Conditions • Non-business assets • Terms and Conditions

  14. Basis Prospective information versus historical information DCF versus CCF Orientation Buyers will (always want to) use historical information Sellers will (always want to) use prospective information

  15. Earnings Before Interest Taxes Depreciation Amortization EBITDA* * Operational Cash Flow

  16. EBITDA Valuation Steps • Restate earnings to eliminate the “owners’ impact” • Excess salaries and bonus payments • Insurance, country clubs, travel • Other purely personal expenditures • Restate earnings for other business purposes. • Identify amounts for interest, taxes, depreciation and amortization. • Determine the proper multiple or capitalization rate.

  17. EBITDA Multiples Growth 4 Profits u Net Assets 2X 4X 6X 3X 5X 7X 2X 6X 8X 2X 4X 7X 9X 3X 5X 4X 6X 8X 10X 5X 7X 9X ? 6X 8X 10X 10 7X 9X ? ?

  18. Capitalization Rates Risk-adjusted capitalization rates reflect the expected rate of return attainable on alternative investment opportunities with comparable risk.

  19. Capitalization Rate Build-Up Model Risk-Free Rate – Equal to the current yields on Long Term U, S, Treasury Bonds Market Equity Risk Premium - the return in excess of the Risk-Free Rate required by an average equity investor. Size Premium - generally used if the company is significantly smaller than those companies used in the formulation of the Market Equity Risk Premium. Company specific risk - identifiable risk factors specific to the company being valued.

  20. Company Specific Risks Death of owner Loss of key personnel Competitive environment Patent lapse Market volatility Customer loyalty Pending litigation

  21. Build-Up Model Risk Factors Risk Free Rate 5.2% Market Equity Risk Premium 9.1% Size Premium 3.0% Company Specific Risk 50.0% Discount Rate for Equity Capital 67.3% Discount Rate for Debt 8.5%

  22. Weighted Average Cost of CapitalEstimated mix of equity and debt = 20% / 80% WACC - Equity 67.3% X 20% 13.5% WACC - Debt 8.5% X 80% 6.8% WACC 20.3% Less LT EBITDA Growth Rate 6.0% WA Capitalization Rate 14.3% Multiple 7 Times

  23. Valuation Calculation EBITDA $ 354,000 Capitalization Rate 14.3% FMV Total $ 2,480,000 Less debt < 2,250,000> FMV Equity $ 230,000

  24. Terms and Conditions • Considerations: • Assets v. Stock? • Licenses for Name, Logo, etc. • How much cash at close? • Tax-free exchange of stock? • Outside debt v. Owner carry? • Payout over time?

  25. Terms and Conditions • Considerations: • Shared risks • Contingent Agreements? • Variable Sales Price? • Goodwill v. Operating Expense • LT Gain v. Ordinary Income • Non-Compete Agreements

  26. How do I make sure I don’t overpay? • Know the business • Sensitivity analysis • Bank loan limits • Measure debt capacity • Contingent sales price

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