Copyright © 2017 Deloitte Development LLC. All rights reserved.
1
The Lawyer's MBA
November 15, 2017
Copyright © 2017 Deloitte Development LLC. All rights reserved.
2
• Understanding key financial concepts is critical to the ability of in-house attorneys to advise their business clients
• Being an effective counselor requires an understanding of the financialaspects of many different transactions, such as capital-raising transactions and M&A deals
• In-house counsel may be called upon to structure and negotiate key deal terms, including financial terms, and monitor ongoingcompliance
Why are we here today?
Copyright © 2017 Deloitte Development LLC. All rights reserved.
3
Financial accounting• Financial statements and accounting terminology• Relevance of financial statements and accounting to corporate legal matters, including
negotiating equity and debt financing, securities law compliance and M&A
Financial statements workshop activity – monthly management review
Valuation theory• What is valuation and value? • How is value measured? • Defining the intrinsic value of a company - market and income approaches used to
estimate the value of an operating business
Valuation workshop activity – review of potential acquisition
What we will cover
Copyright © 2017 Deloitte Development LLC. All rights reserved.
4
• 8:00-8:30AM Registration/check-in
• 8:30-8:45AM Opening remarks
• 8:45-10:00AM Introduction to financial statements and accounting
• 10:00-10:15AM Break
• 10:15-11:30AM Financial statements workshop
• 11:30-12:00PM Lunch
• 12:00-1:00PM Valuation theory
• 1:00-1:15PM Break
• 1:15-2:30PM Valuation workshop
• 2:30-2:45PM Conclusion
Agenda
Copyright © 2017 Deloitte Development LLC. All rights reserved.
5
Financial ReportingBuilding Blocks andConcepts
Module 1 - Introduction toAccounting & Financial Statements
6
Copyright © 2017 Deloitte Development LLC. All rights reserved. Module 1 – Introduction to Accounting & Financial Statements
Course Map
Financial Reporting,
Building BlocksAnd Concepts
US GAAP Financial Statements and Analysis Points
Common Accounting
Terminology
7
Copyright © 2017 Deloitte Development LLC. All rights reserved. Module 1 – Introduction to Accounting & Financial Statements
8
Copyright © 2017 Deloitte Development LLC. All rights reserved. Module 1 – Introduction to Accounting & Financial Statements
9
Copyright © 2017 Deloitte Development LLC. All rights reserved. Module 1 – Introduction to Accounting & Financial Statements
Course Map
Financial Reporting,
Building BlocksAnd Concepts
US GAAP Financial Statements and Analysis Points
Common Accounting
Terminology
10
Copyright © 2017 Deloitte Development LLC. All rights reserved. Module 1 – Introduction to Accounting & Financial Statements
Financial reporting building blocks and concepts
11
Copyright © 2017 Deloitte Development LLC. All rights reserved. Module 1 – Introduction to Accounting & Financial Statements
Financial statement reporting: A full set of financial statements
12
Copyright © 2017 Deloitte Development LLC. All rights reserved. Module 1 – Introduction to Accounting & Financial Statements
Sources of financial statements/reporting—Form 10-K
� Annual
� Required by SEC
� Audited financial statements
� MD&A
13
Copyright © 2017 Deloitte Development LLC. All rights reserved. Module 1 – Introduction to Accounting & Financial Statements
Sources of financial statements/reporting—Form 10-Q
� Quarterly
� Reviewed financial statements
� MD&A
14
Copyright © 2017 Deloitte Development LLC. All rights reserved. Module 1 – Introduction to Accounting & Financial Statements
Sources of financial statements/reporting—Form 8-K
� Filed for significant events
� Securities act of 1933
15
Copyright © 2017 Deloitte Development LLC. All rights reserved. Module 1 – Introduction to Accounting & Financial Statements
Sources of financial statements/reporting—Registration Statements
� Form S-1 - Initial registration proceedings for a Company going public
� Form S-3 – Debt and Equity Offerings
16
Copyright © 2017 Deloitte Development LLC. All rights reserved. Module 1 – Introduction to Accounting & Financial Statements
Sources of financial statements/reporting—Foreign private issuer� Form 20-F
� Form 6-K
17
Copyright © 2017 Deloitte Development LLC. All rights reserved. Module 1 – Introduction to Accounting & Financial Statements
Sources of financial statements/reporting—Private
� Company’s website
18
Copyright © 2017 Deloitte Development LLC. All rights reserved. Module 1 – Introduction to Accounting & Financial Statements
The Financial statement audit
“The auditor must obtain sufficient appropriate audit evidence by performing audit procedures to afford a reasonable basis for an opinion regarding the
financial statements under audit”Source: AU section 326, Audit Evidence, Statement on Auditing Standards, AICPA
Evaluate
Test Balances Comply with GAAP
Gain an Understanding
The auditor will:
19
Copyright © 2017 Deloitte Development LLC. All rights reserved. Module 1 – Introduction to Accounting & Financial Statements
Accounting information used for financial reporting requires:Financial reporting concepts
Source: CON 2, Qualitative Characteristics of Accounting Information
Relevance
Capacity to make a difference in a decision
Predictive value
Feedback value (timely)
Reliability
Information is reasonably free from error and bias
Representatively faithful (validity)
Verifiable and Neutral
20
Copyright © 2017 Deloitte Development LLC. All rights reserved. Module 1 – Introduction to Accounting & Financial Statements
Accounting information used for financial reporting requires:Financial reporting concepts (cont.)
Source: CON 2, Qualitative Characteristics of Accounting Information
Comparability
The quality of information that enables users to identify similarities in and differences between two sets of economic phenomena
Consistency
Conformity from period to period with unchanging policies and procedures
21
Copyright © 2017 Deloitte Development LLC. All rights reserved. Module 1 – Introduction to Accounting & Financial Statements
GAAP vs. IFRS
GAAP• Rules or conventions that govern what, when,
and how to record transactions
• Prescribes what information should be disclosed and how it should be disclosed
• Promulgated primarily by the Financial Accounting Standards Board (“FASB”)
IFRS• Established accounting standards promulgated by the
London-based International Accounting Standards Board (IASB)
• IFRS is a broad, globally accepted set of accounting standards
• IFRS will require more exercise of judgment, supported by contemporaneous analysis and documentation
22
Copyright © 2017 Deloitte Development LLC. All rights reserved. Module 1 – Introduction to Accounting & Financial Statements
Course Map
Financial Reporting,
Building BlocksAnd Concepts
Common Accounting
Terminology
US GAAP Financial Statements and Analysis Points
23
Copyright © 2017 Deloitte Development LLC. All rights reserved. Module 1 – Introduction to Accounting & Financial Statements
US GAAP financial statements and analysis points
Balance sheet
25
Copyright © 2017 Deloitte Development LLC. All rights reserved. Module 1 – Introduction to Accounting & Financial Statements
Classification of assets
Assets
Tangible Assets (Physical)
Intangible Assets (Not Physical)
Current Assets (<1 year)
Non-currentassets
(>1 year)
Current Assets (<1 year)
Non-currentassets
(>1 year)
26
Copyright © 2017 Deloitte Development LLC. All rights reserved. Module 1 – Introduction to Accounting & Financial Statements
Classification of liabilities
Liabilities
Known Amounts Estimated Amounts
Current Liabilities (<1 year)
Non-currentLiabilities(>1 year)
Current Liabilities (<1 year)
Non-currentLiabilities(>1 year)
27
Copyright © 2017 Deloitte Development LLC. All rights reserved. Module 1 – Introduction to Accounting & Financial Statements
As of December 25, 2015 (in thousands)Example: Dynamites, Inc. balance sheet
AssetsCurrent assets:
Liabilities and stockholders' equityCurrent liabilities:
Cash and equivalents Unearned franchise fees
Marketable securities Accounts payable
Accounts receivable, net of allowance of $25 Accrued compensation and benefits
Inventory Accrued Expenses
Prepaid expenses Current portion of deferred lease credits
Taxes System-wide payables
Restricted as Current portion of long-term debt
Total current assets Total current liabilities
Property and equipment, net Long-term liabilities:
Other Intangibles Other liabilities
Goodwill* Deferred income taxes
Total assets Deferred lease credits, net of current portion
Long-term debt
Total liabilities
Commitments and contingencies (notes 4 & 8) Stockholders' equity:
Common stock
Retained earnings
Accumulated other compensation loss
Total stockholders' equity
Total liabilities and stockholders' equity
Data is for illustrative purposes only.
$ 13,150
25,594
7,792
4,043
2,375
8,893
27,346
89,193
198,679
21,891
11,383
$ 321,146
$ 1,186
19,274
19,536
4,855
-
28,344
641
73,836
989
24,669
14,763
3,203
117,460
72,708
131,167
(189)
203,686
$ 321,146
28
Copyright © 2017 Deloitte Development LLC. All rights reserved. Module 1 – Introduction to Accounting & Financial Statements
What to look for in the Balance Sheet
0302
01
The balance sheet is an indicator of the overall health of a company
Generally, asset values are recorded at cost and not FMV
Certain items which can significantly impact a company may not be included in the balance sheet, or may be underestimated
Income statement
30
Copyright © 2017 Deloitte Development LLC. All rights reserved. Module 1 – Introduction to Accounting & Financial Statements
Revenue and GainsIncome statement elements
Source: CON 2, Qualitative Characteristics of Accounting Information
Revenue
Inflows
Enhancements
Settlements
Gains
Increases in equity
Peripheral or incidental transactions
31
Copyright © 2017 Deloitte Development LLC. All rights reserved. Module 1 – Introduction to Accounting & Financial Statements
Expenses and LossesIncome statement elements (cont.)
Source: CON 2, Qualitative Characteristics of Accounting Information
Expenses
Outflows
“Using up” assets
Incurrence of liabilities
Losses
Decreases in equity
Peripheral or incidental transactions
32
Copyright © 2017 Deloitte Development LLC. All rights reserved. Module 1 – Introduction to Accounting & Financial Statements
For the years ended December 25, 2015 and December 26, 2014 (in thousands)
Example: Dynamites, Inc. income statement
Data is for illustrative purposes only.
Dec. 25, 2015 'Dec. 26, 2014
Revenue:
Restaurant sales
Franchise royalties and fees
Total revenue
Costs and Expenses:
Restaurant operating costs
Depreciation and amortization
General and administrative
Preopening
Loss on asset disposals and store closures
Total costs and expenses
Income from operations
Investment income
Earnings before income taxes
Income tax expense
Net earnings
$ 459,527 $ 355,623
42,970 37,198
502,497 392,821
366,778 290,339
31,972 25,112
46,561 34,587
9,329 5,379
1,236 1,314
455,876 356,731
46,621 36,090
76 438
46,697 36,528
14,397 11,931
$ 32,300 $ 24,597
33
Copyright © 2017 Deloitte Development LLC. All rights reserved. Module 1 – Introduction to Accounting & Financial Statements
What to look for in the Income Statement
0302
01
Statement of owners’ or stockholders’ equity
35
Copyright © 2017 Deloitte Development LLC. All rights reserved. Module 1 – Introduction to Accounting & Financial Statements
Statement of changes in owners’ equity
Presents changes over a certain time period
Reconciles the balance from beginning to end of time period
Shows connection between income statement and balance sheet
36
Copyright © 2017 Deloitte Development LLC. All rights reserved. Module 1 – Introduction to Accounting & Financial Statements
For the year ended December 25, 2015 (in thousands)
Example: Dynamites, Inc. statement of stockholders’ equity
Data is for illustrative purposes only.
Common StockRetained Earnings
Other Comprehensive(Loss) Income
TotalShares Amounts
Balance at December 26, 2014
Net earnings
Other comprehensive loss
Comprehensive income
Purchase and cancelation of common stock
Shares issued under employeestock purchase plan
Shares issued from restricted stock units
Units effectively repurchased for required employee withholding taxes
Exercise stock options
Tax benefit from stock issued
Stock-based compensation
Balance at December 25, 2015
$ 18,214,065
-
-
-
-
30,127
142,797
(45,539)
36,470
-
-
18,377,920
$ 65,647
-
-
-
-
879
-
(4,183)
216
2,858
7,291
72,708
$ 98,866
32,300
-
-
1
-
-
-
-
-
-
131,167
$ (6)
-
(183)
-
-
-
-
-
-
-
-
(189)
$ 164,507
32,300
(183)
32,117
1
879
-
(4,183)
216
2,858
7,291
203,686
Statement of cash flows
38
Copyright © 2017 Deloitte Development LLC. All rights reserved. Module 1 – Introduction to Accounting & Financial Statements
Statement of Cash Flow: What it MeasuresIt measures the firm’s performance in terms of generating and using cash in three areas of activity:
39
Copyright © 2017 Deloitte Development LLC. All rights reserved. Module 1 – Introduction to Accounting & Financial Statements
For the year ended December 25, 2015 (in thousands)
Example: Dynamites, Inc. statement of cash flows (indirect method)
Cash flows from operating activities:
Net Earnings
Adjustments to reconcile net earnings to cash provided by operations:
Depreciation
Amortization
Loss on asset disposals and store closures
Deferred lease credits
Deferred income taxes
Stock-based compensation
Excess tax benefit from stock issuance
Changes in operating assets and liabilities, net effect of acquisition:
Trading securities
Accounts receivable
Inventory
Prepaid expenses
Other assets
Unearned franchise fees
Accounts payable
Income taxes
Accrued expenses
Net cash provided by operating activities
$ 32,300
31,389
583
1,076
2,326
8,209
7,291
(2,857)
(203)
(783)
(1,179)
(13)
(1,633)
(165)
11,322
2,093
5,185
$ 94, 967
Cash flows from investing activities:
Purchase of property and equipment
Purchase of marketable securities
Proceeds of marketable securities
Acquisition of franchised restaurants
Net cash used by investing activities
$ (83,353)
(62,228)
73,239
(21,615)
(93,957)
Cash flows from financing activities:
Issuance of Common Stock
Excess tax benefit from stock issuance
Tax payments for restricted stock units
Net cash provided by financing activities
Effect of exchange rate changes on cash and cash equivalents
Net increase in cash and cash equivalents
Cash and cash equivalents at beginning of year
Cash and cash equivalents at end of year
1,095
2,858
(1,589)
2,364
(30)
3,344
9,806
$13,150
40
Copyright © 2017 Deloitte Development LLC. All rights reserved. Module 1 – Introduction to Accounting & Financial Statements
What to look for in the Statement of Cash Flows
0302
01
41
Copyright © 2017 Deloitte Development LLC. All rights reserved. Module 1 – Introduction to Accounting & Financial Statements
Relationships among financial statement line items
Data is for illustrative purposes only.
Income Statement
Revenue
Cost of Sales
Depreciation and Amortization
Other Operating Expenses
Other Non-Operating Expenses
Net Income
Cash Flow Statement
Net Income
Depreciation and Amortization
Other Cash Flow From Operating
Cash Flow From Operations
Cash Flow From Investing
Cash Flow From Financing
Effect of exchange rate changes on cash and cash equivalents
Increase in cash
Beginning Period Cash and Cash Eq
Ending Period Cash and Cash Eq
Balance Sheet
Assets
Cash
Other Current Assets
Property & Equipment
Accumulated Depreciation
Other Non-Current Assets
Total Assets
Liabilities
Current Liabilities
Long-Term Liabilities
Total Liabilities
Shareholders' Equity
Total Liabilities + Equity
Statement of Stockholder's Equity
Beginning Balance
Net Income
Other Comprehensive Loss
Stock & Option Repurchase
Other Equity Transactions
Total Stockholder's Equity
$ 502,497
366,778
31,972
57,126
14,321
$ 32,300
$ 32,300
31,972
30,695
94,967
(92,957)
2,364
(30)
3,344
9,806
$ 13,150
$ 13,150
76,043
306,988
(108,309)
33,274
$ 321,146
$ 73,836
43,624
117,460
203,686
$ 321,146
$ 164,507
32,300
(183)
(3,087)
10,149
$ 203,686
A
B
C
D
E
Notes to the financial statements
43
Copyright © 2017 Deloitte Development LLC. All rights reserved. Module 1 – Introduction to Accounting & Financial Statements
Provides further explanations and may provide the only explanations for significanttransactions and contains required disclosures
Financial statement reporting: Notes to the financial statements
Overview of the business
Significant accounting
policies
Discontinued operations
Related party transactions
Subsequent events
Commitments and
contingencies
Business combinations
Debt offerings and credit risk Income taxes Notes to the
Financial Statement
44
Copyright © 2017 Deloitte Development LLC. All rights reserved. Module 1 – Introduction to Accounting & Financial Statements
Financial statement reporting: limitations on financial statements• Information often results from approximate, rather than exact measures
• Information is based upon historical data and does not measure or discuss management’s plans for the future
• Information is generally recorded at cost and may not reflect the current market value
45
Copyright © 2017 Deloitte Development LLC. All rights reserved. Module 1 – Introduction to Accounting & Financial Statements
Course Map
Financial Reporting,
Building BlocksAnd Concepts
US GAAP Financial Statements and Analysis Points
Common Accounting
Terminology
46
Copyright © 2017 Deloitte Development LLC. All rights reserved. Module 1 – Introduction to Accounting & Financial Statements
This is a sample text. Insert your desired text here.
Sample Text
This is a sample text. Insert your desired text here.
Sample Text
Common accounting terminology
47
Copyright © 2017 Deloitte Development LLC. All rights reserved. Module 1 – Introduction to Accounting & Financial Statements
Materiality
A measure of the significance of a transaction or event. A transaction is considered material if its omission or misstatement would affect the judgement
of a reasonable person relying on the financial statements.
Source: AU section 326, Audit Evidence, Statement on Auditing Standards, AICPA
48
Copyright © 2017 Deloitte Development LLC. All rights reserved. Module 1 – Introduction to Accounting & Financial Statements
Conservatism
A prudent reaction to uncertainty to try to confirm that uncertainty and risks inherent in the business situations are adequately considered
Source: AU section 326, Audit Evidence, Statement on Auditing Standards, AICPA
49
Copyright © 2017 Deloitte Development LLC. All rights reserved. Module 1 – Introduction to Accounting & Financial Statements
Contingencies
A contingency is defined as an existing condition, situation, or set of circumstances involving uncertainty as to possible gain or loss to an enterprise that will ultimately be resolved when one or more future events occur of fail to occur. Resolution of the uncertainty may confirm the acquisition of an asset or
the reduction of a liability or the loss or impairment of an asset or the incurrence of a liability.
Source: AU section 326, Audit Evidence, Statement on Auditing Standards, AICPA
50
Copyright © 2017 Deloitte Development LLC. All rights reserved. Module 1 – Introduction to Accounting & Financial Statements
Loss contingency
Determination and consideration of facts bycompany management and auditors
Common Accounting Terminology
Reasonably possible(medium) Remote (low)
Can amount be reasonably estimated?
Is loss guarantee of indebtedness?
Probability that future event(s) will confirm loss
Accrual, with disclosure required Disclosure required Neither accrual nor
disclosure required
*Includes estimation of range of loss, in which case the minimum amount is accrued and the amount of the range is disclosed
YesNo
NoYes*
51
Copyright © 2017 Deloitte Development LLC. All rights reserved. Module 1 – Introduction to Accounting & Financial Statements
Pro forma vs. historical financial statements
Historical Financial StatementsMeasures income or presents afinancial position for past events. The information as reported inhistorical financial statements is a summarized presentation ofthe operations of the businessduring a specific period of time
Pro FormaProvides information about thecontinuing impact of a particular transaction by showing how itmight have affected historicalfinancial statements if atransaction (acquisition or disposition) had beenconsummated at an earlier time
52
Copyright © 2017 Deloitte Development LLC. All rights reserved. Module 1 – Introduction to Accounting & Financial Statements
GAAP vs. non-GAAP measures
Non-GAAP• Not defined in the GAAP
accounting literature• EBITDA (Earnings Before
Interest, Taxes, Depreciation & Amortization)
GAAP• What, when, and how to record
transactions• What information should be
disclosed and how it should be disclosed
Copyright © 2017 Deloitte Development LLC. All rights reserved.
53
Module 2 – Valuation Theory
Copyright © 2017 Deloitte Development LLC. All rights reserved.
54
Agenda
• Valuation definitions & considerations
• Who needs valuations?
• Introduction to valuation methodologies- Income approach- Market approach- Cost approach- Relative considerations
• Little English Pub valuation- Income approach valuation- Market approach valuation- Value reconciliation & conclusion
• Public company valuation
• Common litigation issues in valuation
Module 2 – Valuation Theory
Valuation Overview
Copyright © 2017 Deloitte Development LLC. All rights reserved.
56
Value definitions & considerations
Fair value
Specific to financial reporting
• Defined by FASB (ASC 805)• Assumes willing buyer and seller• Used for stockholder dissent and
value estimates on financials
Investment value
Specific to investment decisions
• No formal definition / guidance• Reflects value to a specific
investor (but not price paid)• Includes expected synergies
Unit of measure
What is being valued?
• Enterprise• Equity• A single share• Intangible asset (e.g
technology)
Fair market value
Specific to tax reporting
• Defined by US Treasury Reg• Assumes hypothetical
transaction• Used for US tax analyses
Book value
Specific to accounting records
• Equals recorded value of asset / liability on financials
• Book value equals assets less liabilities
Basis of value
Considerations that impact value
• Going concern vs. liquidation• Marketability / Liquidity• Control vs. minority share• Valuation date
Definitions Considerations
Module 2 – Valuation Theory
Copyright © 2017 Deloitte Development LLC. All rights reserved.
57
Who needs valuations?
• Increased consensus and consistency in the resolution of valuation issues both in the courts and business world has led to the demandfor business valuation for many purposes and professions– Strategic / Economic– Legal– Financial– Regulatory
• Most business valuations that are performed have the potential forlegal challenge– Courts rely on professional standards and guidance in deciding
disputed issues
Module 2 – Valuation Theory
Copyright © 2017 Deloitte Development LLC. All rights reserved.
58
Introduction to valuation methodologyHow do you measure the value of….
Income approach
Equivalent to the sum of expected rental income (less costs of marketing and maintenance) over life of property ownership
Market approach
Estimated based on the value of comparable homes at a point in time (e.g.,location, size, features, etc.)
Cost approach
Estimated based on the hypothetical costs to re-build the exact same house in the exact same location with the exact same furnishings
Income approach
Equivalent to the cash inflows and outflows expected to be generated by the business over time
Market approach
Estimated based on the value of comparable companies based on publicly available information (including share price, recent transactions)
Cost approach
Estimated based on the hypothetical costs to recreate/build the exact same business with the same performance and outlook
House
Business
Module 2 – Valuation Theory
Copyright © 2017 Deloitte Development LLC. All rights reserved.
59
$ millions 2016 2017 2018 2019 2020 2021 2022 2023 2024 2025
Revenue 120 130 135 150 145 145 145 145 145 145
COGS 36 39 40 45 43 43 43 43 43 43
SG&A 18 20 20 23 22 22 22 22 22 22
Taxes 20 21 22 25 24 24 24 24 24 24
NOPAT 46 50 52 58 56 56 56 56 56 56
CF Adjustments (5) 5 15 (10) 2 2 2 2 2 2
Free cash flows 41 55 67 48 58 58 58 58 58 58
Present value of FCFs 35 41 45 29 31 28 25 22 20 18
Income approach
The income approach estimates the value of a business as the sum of the present value of cash flows generated over time by the business
Cash inflows• Sales from
goods/services• Rental income• Licensing income• Subscription income Cash outflows
• Salaries/wages• Raw materials• Rental expense• Machinery/equipment• Sales & marketing• Utilities & insurance
Cash in
Cash out
Business
Module 2 – Valuation Theory
Copyright © 2017 Deloitte Development LLC. All rights reserved.
60
Summary metrics
Subject Comp 1 Comp 2 Comp 3 Comp 4 Low Average High
Value $437,500 $550k $425k $600k $460k $425k $508.5k $600k
Transaction date May ’16 June ’16 Aug ’16 Aug ’16 May ’16 N/A Aug ’16
Sq. Ft. 3,500 4,000 2,500 6,000 3,500 2,500 4,000 6,000
Yr. built 1992 2001 2010 1948 1995 1948 N/A 2010
Pool No Yes Yes Yes Yes N/A N/A N/A
Price / Sq. Ft. $125 $137.5 $170 $100 $131 $100 $134 $170
Market approach
The market approach estimates the value by looking at publicly available information regarding the value of similar assets. Data points may include publicly traded stock prices and value of recent mergers & acquisitions
?$600k$460k
$550k$425k
Module 2 – Valuation Theory
Copyright © 2017 Deloitte Development LLC. All rights reserved.
61
Month 1 Month 2 Month 3 Month 4 Month 5 Month 6 Total
Labor 70,000 33,000 34,000 34,000 $171,000
Materials 45,000 33,000 34,000 34,000 $146,000
Furniture 40,000 5,000 $45,000
Fixtures 28,000 5,000 $33,000
Landscaping 15,000 15,000
Total 115,000 66,000 68,000 68,000 68,000 25,000 $410,000
Cost approach
The cost approach estimates the value by estimating the cost that would be incurred to independently recreate the same asset
Module 2 – Valuation Theory
Copyright © 2017 Deloitte Development LLC. All rights reserved.
62
Which approach should be used?Relative considerations
Approach Strength Weakness
Income (DCF)
x Common and generally acceptedx Applicable for nearly all businesses x Flexible, easily adaptable x Incorporates future expectations regarding
prices, costs, investment, etc. x Only market data is discount rate x Provides a measure of economic
obsolescence
x Highly subjective x Dependency on financial projections x Sensitive to inputs such as the discount rate
and projections x Easily manipulated x Projections not directly linked to market x Inability to incorporate key assumptions of
market participants
Market
x Common and generally acceptedx Based primarily on market data x Use of market participant inputs x Reflects buyers' and sellers' current actions x Applicable for nearly all business interests
x Sensitive to small changes x May lack adequate guideline companies or
data on guideline transactions x Comparability is subjective x May need many adjustments
Cost
x Easily understandable conceptx Relatively easy to estimate costs of tangible
assets (e.g., buildings, machinery)
x Difficult to forecast less tangible costs (e.g.,training employees, acquiring customer base)
x Can be skewed by estimated depreciation of tangible assets
x Value does not consider value of intangibles (e.g., going concern value)
Module 2 – Valuation Theory
Case Study
Copyright © 2017 Deloitte Development LLC. All rights reserved.
64
Little English Pub Income Statement as of December 25, 2015
Sales• Food sales• Beverage sales• Possible licensing income or merchandising income
Costs of good sold• Cost of food and beverage ingredients• Cost of tables, chairs, cutlery, flatware, glasses, etc.• Cost of entertainment (e.g., A/V)
= Gross profit • Money earned on sales after accounting for direct costs
Salary & wages • Wages of staff at pubs• Salaries of managers and executives
Sales, general & administrative
• Rent for pubs & corporate offices, utilities, insurance• Expenses for advertising
Depreciation • Non-cash expense related to usage of owned buildings, restaurant equipment, etc.
Taxes • Income taxes payable on profits generated by pubs
= Net operating profit after tax
• Money earned on sales after accounting for operating expenses and taxes
- Capital expenditures • Cash payments for purchasing / building / repairingrestaurants, offices, kitchen equipment, etc.
+ Depreciation • Non-cash expense related to usage of buildings, restaurant equipment, etc. (see above)
+
/-
Changes in net working capital
• Changes in required level of cash for daily operatinos (i.e.,delay in making payments to suppliers and collecting cash from customers)
= Free cash flow • Cash flow available to investors (debt and equity holders)
Income Statement
Cash Flow Adjustments
Little English Pub – income approach
Module 2 – Valuation Theory
Copyright © 2017 Deloitte Development LLC. All rights reserved.
65
2016 2017 2018 2019 2020 2021 2022 2023 2024 2025 2026Terminal
Year
Food Sales 113 122 129 135 141 148 154 159 164 168 173 177 Drink Sales 113 122 129 135 141 148 154 159 164 168 173 177 Total Revenue 225 244 259 270 282 295 308 318 327 337 347 354
% growth 8.4% 5.9% 4.5% 4.5% 4.5% 4.5% 3.0% 3.0% 3.0% 3.0% 2.0%
Food & Beverage Costs 73 80 84 87 91 95 100 103 106 109 112 114 Salary & Wages 84 92 97 101 106 111 116 119 123 126 130 133 Sales, General & Administrative 17 19 20 21 21 22 23 24 25 26 26 27 Depreciation 11 12 13 14 15 15 16 16 17 17 18 25 Operating Profit 39 42 45 47 49 51 54 55 57 59 60 55
Margin % 17.4% 17.4% 17.4% 17.4% 17.4% 17.4% 17.4% 17.4% 17.4% 17.4% 17.4% 15.5%
Income Taxes 35% 14 15 16 16 17 18 19 19 20 21 21 19 NOPAT 25 28 29 31 32 33 35 36 37 38 39 36
Cash Flow AdjustmentsCapital Expenditures (25) (25) (25) (25) (25) (25) (25) (25) (25) (25) (25) (25) Depreciation 11 12 13 14 15 15 16 16 17 17 18 25 Incremental Working Capital (5) (4) (3) (2) (2) (3) (3) (2) (2) (2) (2) (1) Free Cash Flows 6 11 14 17 19 21 23 26 27 29 30 34
Terminal Value 381
Partial Period 50% 100% 100% 100% 100% 100% 100% 100% 100% 100% 100% 100%Periods Discounting 0.25 1.00 2.00 3.00 4.00 5.00 6.00 7.00 8.00 9.00 10.00 10.00 Discount Factor 11% 0.974 0.901 0.812 0.731 0.659 0.593 0.535 0.482 0.434 0.391 0.352 0.352 Present value of FCFs 6 10 12 13 13 13 12 12 12 11 11 134
Business Enterprise Value (rounded) 260
Little English Pub – income approachDiscounted cash flow analysis
1 Estimate cash flow until steady growth 2
Estimate long-term
growth
3
Discount back to present
In millions $
Module 2 – Valuation Theory
Copyright © 2017 Deloitte Development LLC. All rights reserved.
66
Income approach – discount ratesHigher the risk, higher the expected rate of return
Investment Profile Discount rate
Venture/early stage equity 20%-40%
Growth stage equity 15%
Mature/Blue chip equity 9%
Corporate bond 5%
Risk-free rate 2%
High risk
Low risk
Low rate
High rate
Module 2 – Valuation Theory
Copyright © 2017 Deloitte Development LLC. All rights reserved.
67
Business EnterpriseCompany Value (BEV) Revenue EBITDA BEV / Revenue BEV / EBITDA
Cheesy Delights Restaurants 224.0$ 237.0 30.0 0.9x 7.5xYum Burgers Inc. 1,255.0$ 1,010.0 150.0 1.2x 8.4xOlives & Bread Restaurant Co. 355.0$ 355.0 47.0 1.0x 7.6xPublic Houses Incorporated 100.0$ 100.0 9.0 1.0x 11.1x
Little English Pub 255 34
Average 425.5 59.0 1.0x 8.6xMedian 296.0 38.5 1.0x 8.0xMaximum 1,010.0 150.0 1.2x 11.1xMinimum 100.0 9.0 0.9x 7.5x
LTM 2016 Multiples
1Identify publicly traded comparable companies 2 Select metrics
3 Select / adjust multiple to fit subject company
4Apply multiples to subject company metrics to estimate value
Market approachGuideline public company method
In millions $
Selected 1.0x 8.0x
Little English Pub 255 34
Implied value 255.0 270.6 Weighting 50% 50%
Estimated Value (rounded) 260.0
Module 2 – Valuation Theory
Copyright © 2017 Deloitte Development LLC. All rights reserved.
68
Close Date Target Buyer BEVRevenue EBITDA
12/16/2011 Foodscape Kitchen, Inc. Zonia Restaurant Group, Inc. 184.3 0.6x 7.6x7/25/2011 Hazel's Wood Fired Pizzeria Accel Wear Capital Corp. 360.8 1.1x 6.9x6/13/2011 Hogan Steakhouse Saturn Road LLC 1,558.0 0.6x 6.6x5/25/2011 Yen's Texas Bagels, LLC Interix International 451.5 0.7x 7.9x11/8/2010 Satay Curry Shop House Zonia Restaurant Group, Inc. 112.5 0.6x 6.5x
10/29/2010 Corinth Café, Inc. Zonia Restaurant Group, Inc. 76.6 0.3x n/a5/10/2010 West Chester's Prime Ribs Lake District Capital 80.9 0.4x 6.7x
Average 0.6x 7.0xMedian 0.6x 6.8x
Maximum 1.1x 7.9xMinimum 0.3x 6.5x
1 Identify transactions with targets that are similar to the subject company 2 Select metrics
3 Apply multiples to subject company metrics to estimate value
Source: Capital IQ
Market approachGuideline transactions method
In millions $BEV / LTM BEV / LTM
Implied Multiples
Module 2 – Valuation Theory
Copyright © 2017 Deloitte Development LLC. All rights reserved.
69
Income approach
• Considers company-specific growth and profits
• Inherent risks of forecasting 10+ years• Discount rate may be subjective
Market approach
• Little English Pub has comparable companies• Availability of recent market data• May not represent pure comparability to LEP
Concluded value
• Given the strength of the market data related to companies similar to Little English Pub, it may be more appropriate to weight the market approach heavier than the income approach
$260
$260
$260
50%
50%
100%
Based on the relative value indications from each approach, as well as the selected weighting based on analysis of the relatives strengths and weaknesses of each, it was decided to offer $260 million for Little English Pub
Value reconciliationHow much should be paid?
Module 2 – Valuation Theory
Copyright © 2017 Deloitte Development LLC. All rights reserved.
70
Market trading value + control premium
Calculation Known?
Share price Market data
x Shares outstanding Market data
= Market cap (i.e., equityvalue) on a minority basis
Calculation
+ Control premium Transactiondata
= Equity value (control) Calculation
+ Debt Balance sheet
- Excess cash Balance sheet
= Business enterprise value Calculation
Control premium estimate
Data is for Illustrative Purposes Only
Acquiring public companies
XYZ Co. (Nasdaq:XYZ)
Module 2 – Valuation Theory
Copyright © 2017 Deloitte Development LLC. All rights reserved.
71
Common litigation issues in valuationSome challenges in valuation that may result in litigation include someof the following:
• General– Industry/market movements not taken into account– Lack of support for discounts for marketability/control– Failure to reconcile approaches
• Income approach– Minimal insight into projections– Discount rates not supported– Terminal growth rate/ exit multiple not supported
• Market approach– Comparable companies are not representative– Multiple selection is not adequately supported (adjustments, or
lack thereof, to market evidence)– Transaction price is not representative
Module 2 – Valuation Theory
Copyright © 2017 Deloitte Development LLC. All rights reserved.
72
DisclaimerThis presentation contains general information only and Deloitte is not, by means of this presentation, rendering accounting, business,financial, investment, legal, tax, or other professional advice or services. This presentation is not a substitute for such professionaladvice or services, nor should it be used as a basis for any decision or action that may affect your business. Before making any decision or taking any action that may affect your business, you should consult aqualified professional advisor.
Deloitte shall not be responsible for any loss sustained by any personwho relies on this presentation.
About DeloitteAs used in this document, “Deloitte Risk and Financial Advisory” means Deloitte & Touche LLP, which provides audit and risk advisory services; Deloitte Financial Advisory Services LLP, which provides forensic, dispute, and other consulting services; and its affiliate, Deloitte Transactions and Business Analytics LLP, which provides a wide range of advisory and analytics services. These entities are separate subsidiaries of Deloitte LLP. Please see www.deloitte.com/us/about for a detailed description of our legal structure. Certain services may not be available to attest clients under the rules and regulations of public accounting.
Copyright © 2017 Deloitte Development LLC. All rights reserved.