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

A price agreed upon between a willing buyer

and a willing seller, with neither party being forced into the transaction and both

parties having access to all relevant information.

Tangible Assets

+ Intangible Assets

= Fair Market Value

- Outside Debt

=Purchase/Sales Price

Fair Market Value

Valuation Approaches

Income

Market

Assets

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”

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?

Valuation Approaches

Market Methods Price to Earnings Comparable Sales Industry Valuation Methods Comparable Investments

Valuation Approaches

Asset Methods Book Value Adjusted Book Value Economic Balance Sheet Liquidation Value

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.

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

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”.

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

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

EBITDA*

Earnings

Before

Interest

Taxes

Depreciation

Amortization

* Operational Cash Flow

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.

Low Growth

Moderate Growth

High Growth

Strategic Acquisition

Low Profitability

Moderate Profitability

High Profitability

Strategic Acquisition

Growth4Profits u

Net Assets

2X

2X

2X

3X

4X

5X

6X

7X

3X

4X

5X

6X

7X

8X

9X

4X

5X

6X

7X

8X

9X

10X

?

6X

7X

8X

9X

10X

?

10

?

EBITDA Multiples

Capitalization Rates

Risk-adjusted capitalization rates reflect the expected rate of return

attainable on alternative investment opportunities with comparable risk.

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.

Company Specific Risks

Death of owner Loss of key personnel Competitive environment Patent lapse Market volatility Customer loyalty Pending litigation

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%

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

Valuation Calculation

EBITDA $ 354,000

Capitalization Rate 14.3%

FMV Total $ 2,480,000

Less debt < 2,250,000>

FMV Equity $ 230,000

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?

Terms and Conditions

Considerations:

Shared risks Contingent Agreements? Variable Sales Price? Goodwill v. Operating Expense LT Gain v. Ordinary Income Non-Compete Agreements

How do I make sure I don’t overpay?

Know the business

Sensitivity analysis Bank loan limits Measure debt capacity Contingent sales price