acquisition and valuation of business venture

8/2/2019 Acquisition and Valuation of Business Venture

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October 5, [email protected] 0

Acquisition andValuation of

Business Venture

Na, Yong Sik


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Issues in Acquisition

Acquisition valuations are complex, because thevaluation often involved issues like synergy andcontrol, which go beyond just valuing a targetfirm. It is important on the right sequence,including

When should you consider synergy?

Where does the method of payment enter the

process. Can synergy be valued, and if so, how?

What is the value of control? How can you

estimate the value?


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Steps involved in

Acquisition Valuation Step 1: Establish amotive for the acquisition

Step 2: Choose atarget

Step 3:Value the target with the acquisitionmotive built in.

Step 4: Decide on themode of payment - cash

or stock, and if cash,arrange for financing - debtor equity.

Step 5: Choose theaccounting method for themerger/acquisition -purchase or pooling.


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Process Overview


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Business Valuation Steps - 1

Define Purpose

Understand size & characteristics of Client

Assessment of People and Markets

Gather Additional Data

Recast Financial Statements Ratio Analysis / Industry Comparison


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Business Valuation Steps - 2

Application of Valuation Methods

Reconciliation

AdjustmentsValuation Report


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Financial problems (68,6%) Lack of information (48%)

Lack of qualification (48%) Deficits in planning (30,1%) Family problems (29,9%)

Overestimation of own resources (20,9%) Influences from outside (15,4%)

Reasons for giving up the venture


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Preparing to sell

Strategic and financial considerations

Assembling the transaction team

Types of sale processes Pre-marketing

Marketing efforts

Documents Process


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Strategic/Financial consideration

Strategic

Horizontal vs. Vertical (Distribution)

Diversification Eliminate competitor

Financial

Growth (organic vs. M&A); relative risk Scale

Utilize excess capital (reinvest); returns


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Auction Process

Deal structuring considerations

Due diligence (buy and sell side)

Buy side evaluation

Bidding process

Negotiation

The Definitive Agreement

Closing the deal


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Components of Value

Statutory Net Worth

Embedded Value = SNW+ Value of In-

force Business

Actuarial Value = EV + Value of NewBusiness

Buyers Value = Actuarial Value +

Strategic Value Integration Costs


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Actuarial Appraisal

DCF analysis, where:

Distributable Cash flow

= After-tax Earnings Increase in Required Capital

= Premium + Investment Income

Benefits Expenses Commissions Increase in Statutory Reserves Taxes Increase in Required Capital


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Tax Issues

Understanding the impact of federal and statetax issues on M&A transactions

Transaction structuring can be highly tax-sensitive

Post-closing tax opportunities affect the value of thetarget

Investigating tax issues is an important part of the

due diligence process


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Integration

Successful outcome of acquisition hingeson integration!

Comparatively little typically spent onintegration vs. acquisition

Goal is to capture the value drivers usedto justify the acquisition to the board


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Making it work

Essentially change management

Leadership

Speed Communication

Planning

Project management


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Making it work

Essentially change management

Leadership

Speed Communication

Planning

Project management


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Risk and Return


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Valuation MethodsDiscounted Cash Flow

- Machine to produce 100 USD bill in 3 years

- Risk = 0

- Discount rate = 8% (time value of money)

- No input needed

Value of machine?(one time in year 3) 100/(1.08)3 = 79.4

(every year) 100/0.08 = 1250


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Discounted Cash Flow


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Discounted Cash Flow[1/4] Free Cash Flow


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Discounted Cash Flow[2/4] Calculate Terminal Value


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Discounted Cash Flow[3/4] Discount Rate


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Discounted Cash Flow[4/4]


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Liquidation Value


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Relative Value


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Market Comparable


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Exit Value (VC Method)


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Summary Method


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Financial Statement Analysis

Basic ratio analysis

DuPont Model (ROE in three parts) Return on assets Asset turnover Leverage

Financial Statement Quality Risk of manipulation Risk of bankruptcy


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Preparing Forecasted Financials

1) Are prior financials reasonable startingpoint?

2) Prepare forecasted financial statements

3) Utilize excel (including circular arguments)

4) Develop reasoning skills


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Prepare estimates of value

1) Theory of valuation

Numerous techniques but ALL begin with theidea of discounted cash flows

2) Calculate discount rates

Theory and practice very different in this area

Finance theory focuses on capital asset pricing

model In practice, frequently use build-up method


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PER

Price/earning ratio

Interpretation of the PER Level future equity earnings of the firm. Expected return on the investments made by the

firm, ROE.


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Limitations of PER model

Estimates post-acquisition earnings for target forone period, and assumes this level will bemaintained.

No explicit recognition of the time pattern of

earnings growth. Does not explicitly consider the investor-perceived

risk of the target firms earnings.

Problems in selection of benchmark PER

Despite limitations, model provides valuation basedon capital market consensus view of value ofearnings.

Widely used by the investment community.


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EVM / EBITDA

Enterprise value multiple (EVM) Enterprise value /earnings before interest

and tax (EV/EBIT)

Its cash flow variant Enterprise value/earnings before interest, tax, depreciationand amortization (EV/EBITDA)

EBIT = pre-tax return to both

shareholders and debt holders Since most firms funded by equity and

debt, sum of equity and debt values =

value of the firm or enterprise.


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EVM / Firm value

Adding back non-cash expensesdepreciation and amortization, EBITDA =operating cash flow.

EVM widely used by investment analystsAsset based valuation

Tobins q=

Firm value = Replacement cost of assets+ Value of growth options


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Fair Market Value

Fair Market Value is defined as the value

that a willing seller and a willing buyer, both

being informed of the relevant facts aboutthe company, could reasonably conduct a

buy-sell transaction, neither party under any

compulsion to do so.


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Purposes of valuation

Business Sale

Business Purchase

Bank Financing

Estate Planning Estate Taxes

Gifting

Divorce

Partner Buy In/Out

ESOP(Employee Stock

Ownership Plan) Inter-Generation

Other

Always dealing with two sides someone wants a highervaluation, someone wants a lower valuation.

One side is frequently the IRS.


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Market Evaluation

Size of Market in area

Growth in area

Companys Position

Top Customers

Concentration

Company Growth

Desire-ability ofproduct/service

Location, Location,

Location


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Example - Hightech AG

Valuation of Hightech AG

Company founded 2002

Service company Screening for Biotech companies

First revenues from screening services

Requires investment of: EUR 100000 Financing stage: First Stage

Valuation according to DCF method


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Data of Hightech AG

Good, experienced management

Medium market size, little expansion possibilities /

ambition Product innovation small, me-too, inexpensive

production

Qualitative analyses produces thefollowing data:

Discount rate (d): 35% (medium risk)

Growth rate (g): 7%


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