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Understanding & using business valuations. Pesented by: Brooke A. Liggett, CPA, CVA. “How much is my business worth?”. What is a Business Valuation?. The act or process of determining the value of a business enterprise or ownership interest therein Valuing a bundle of rights. - PowerPoint PPT Presentation
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Pesented by:Brooke A. Liggett, CPA, CVA
UNDERSTANDING & USING BUSINESS VALUATIONS
“How much is my business worth?”
What is a Business Valuation?
The act or process of determining the value of a business enterprise or ownership interest therein
Valuing a bundle of rights
When is a business valuation needed?
Mergers and Acquisitions Buy/Sell Agreements Employee Stock Ownership Plans (ESOP) Expert Testimony/Litigation Support -
Damage Estate Planning and Taxations Gift Taxes Charitable Contributions Marital, Partnership and Corporate
Dissolutions
Who Needs Business Valuations?
Attorneys Courts/judges Business owners Insurance companies Estates Additional users of financial statements
Business Valuation Considerations
Type of entity to be valued Purpose of valuation Valuation date Standards of value Premise of value
Business Valuation Considerations
Type of entity to be valued Purpose of valuation Valuation date Standards of value Premise of value
Standards
SSVS #1 Revenue Ruling 59-60
Definition of Value
The value of an interest in a closely held business is usually considered to be equal to the future benefits (income) that will be received from the business; discounted to the present value.
Basis of Value
A valuation is based on a hypothetical arms-length sale between a buyer and a seller, usually for cash.
Fair Market Value
The price at which the property would change hands between a hypothetical willing buyer and a willing seller, when the former is not under any compulsion to buy and the latter is not under any compulsion to sell, both parties having reasonable knowledge of relevant facts.
BENEFITS RISK
VALUE =
RISK VS RETURN
RISK
RETURN
U.S. Treasury Bills
Long Term Bonds
High Quality Growth Stocks
Lesser Quality Stocks
Privately Held Stocks
Valuation Methodology
Understanding the business
Valuation Methodology
Analyze the financials
Normalize the financials
Valuation Methodology
Analyze the adjusted financials
Financial ratios Industry averages
Valuation Methodology
Estimate future earnings stream
Business Valuation Methodology
Develop a capitalization rate
A multiplier used to convert a defined stream of income to a present indicated value.
(A Function of Risk!)
BENEFITS RISK
VALUE =
Developing the Capitalization Rate
BUILD-UP METHOD Risk-free Rate Risk Premium Size Premium Specific Company Risk Premium
Rate PercentageSafe rate 5.50%
Equity risk 7.80
Small company risk 7.70
Specific company risk 4.00
Indicated Capitalization Rate 25.00%
Build Up Method
METHODS OF VALUATION
Income Approach
Asset-based Approach
Market Approach
Asset Approach
Based on the principal of substitution In other words, what a buyer would pay for
a similar asset of equivalent utility Often the primary approach when the
business has losses or nominal projected cash flow or is asset-intensive
Can be used for both control and minority level valuations
Asset Approach – cont.
Net Asset Value (NAV) Method – all assets and liabilities are adjusted to current valuesNAV = assets less liabilitiesPitfall – if done incorrectly fails to capture
intangible and other unrecorded assets Excess Earnings Method – hybrid of the asset
and income approaches
Market Approach
Also based on the principal of substitution A buyer would pay no more than the cost to
acquire a substitute property with the same utility
Can be used for both control and minority level valuations
Market Approach – cont.
Two methods generally used:Guideline public company method; based on sales of
similar publicly traded company sharesCan be difficult to use for small and medium sized
companies due to size, capital structure, and other differences
Merger and acquisition transaction data method; based on acquisition of similar privately held or publicly traded companiesWorks best when companies are sufficiently similar to the
subject businessPositive correlation between price and multiples used is
desirableExercise caution with dated transactions
Income Approach
Value is based on the present value of expected future benefits to be derived from ownership
Discounted or capitalized cash flow methods are typically utilized for operating companies
Used for both control and minority level valuations
Income Approach – cont.
Two methods generally used under the income approach: Discounted Cash Flow Method
– Projects future cash flows for a number of years
– Terminal value Capitalized Income Method
– Estimated future cash flow is capitalized– Often used for companies with stable growth
rates
29
Most Common Methods Used
Adjusted Net Asset Method
Excess Earnings (Return on Assets) Reasonable Rate Method
Discounted Earnings/Cash Flow Method
VALUE
Valuation Adjustments
Key issue in many valuations A number of considerations, including
subjective assessments, are considered when determining the appropriate discounts/premiums or lack thereof
The standard of value will impact the discounts/premiums that may be appropriate
Prerogatives of control of the ownership interest being valued will also impact adjustments
Discounts (And Premiums)
Minority Interest Discount Lack of Marketability Discount Premium for Pass-through Entity Tax Benefits
Minority Interest Discount
Minority interest deals with the relationship between the interest being valued and the total enterprise. The primary factor is how much control the minority interest has over the particular entity.
Minority Interest Discounts/ Control Premiums
Controlling interest typically has a greater value (pro-rata)
Control does not always mean more than 50% - can be defined differently in the entity’s governing agreements
Large enough block to influence management decisions (e.g. swing vote)
State law can determine ownership level necessary for control
The potential benefits of optimizing the economic benefit stream
Minority interest is typically discounted Minority interest can generally be defined as less than
50%, or a lack of ability to affect management decisions
Marketability Discount
The concept of marketability deals with the liquidity of the interest—how quickly and certainly it can be converted to cash at the owner’s discretion.
Marketability Discounts
Control vs. minority interest can make a difference
The ability to affect a saleExpected holding period can impact size of discount
Restrictions on transferability can be significantPool of potential buyers?
Marketability Discounts – cont.
Mandelbaum Factors Financial statement analysis Company dividend policy The nature of the company, its history, its position in the industry, and its economic outlook Company's management Amount of control in transferred shares Restrictions on transferability of stock Holding period for stock Company's redemption policy Costs associated with making a public offering
Marketability Discount – cont.
An unlisted closely-held stock of a corporation in which trading is infrequent and which therefore lacks marketability, is less attractive than a similar stock which is listed on an exchange and has ready access to the investing public.
Premium for Pass Through Entity Tax Benefits
Adjustment for dividend tax avoided by S-Corporation shareholders
Discount Ranges
Minority Interest Discounts are usually in the range of 25% to 40%
Lack of Marketability Discounts are usually in the range of 20% to 30%
Discounts are Applied Multiplicatively
FMV of XYZ, Inc. $ 2,150,000
Less Minority Interest Discount (30%) (645,000)
1,505,000 Less MarketabilityDiscount (25%) (376,250)
Fair Market Value $1,128,750
Valuator Qualifications
Valuing a business requires a significant amount of experience and training
Accredited in Business Valuation Credential (CVA) Backed by the National Association of Certified
Valuation Analysts (NACVA) Experience requirements Education requirements Training requirements Comprehensive examination
Defining the Engagement
Determination of Benefit Stream
Risk Analysis
Determine Approaches and Methods
Select Appropriate Premiums and Discounts
Determination of Value
Reasonableness Check
VALUE
Education
The Valuation Process Ladder
Questions?
For additional information, please contact:
Brooke A. Liggett, CPA, CVA [email protected] 417-882-4300
Kirkpatrick, Phillips, & Miller CPAs www.kpmcpa.com