Christine Minelli CAChristine Minelli CA••CBV, CFICBV, CFIchrism@vine.on.cachrism@vine.on.ca(905) 549(905) 549--8463 or (905)5178463 or (905)517--37413741www.vine.on.cawww.vine.on.ca

Offices in Hamilton, Burlington andOffices in Hamilton, Burlington andKitchenerKitchener

Vine Valuations Inc.Vine Valuations Inc.

Transfer to FamilyTransfer to FamilyMembersMembers

Sell toSell toShareholdersShareholders

Sell toSell toManagementManagement

Sell to EmployeesSell to Employees(Stock Ownership(Stock OwnershipPlan)Plan)

Sell to Third PartySell to Third Party

Refinance orRefinance orRecapitalizeRecapitalize

Go PublicGo Public

Liquidate theLiquidate theBusinessBusiness

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Business needs to be valuedBusiness needs to be valued

Business valuation is a criticalBusiness valuation is a criticalcomponent of a well planned exitcomponent of a well planned exitstrategy:strategy:

For benchmarking/planning exitFor benchmarking/planning exitstrategystrategy

For negotiating the saleFor negotiating the sale

For maximizing wealthFor maximizing wealth

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Independent & objectiveIndependent & objective

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Business Valuation:Business Valuation:

““the act or process of determiningthe act or process of determiningthethe valuevalue of a business enterpriseof a business enterpriseor ownership interest thereinor ownership interest therein””

Value:Value: thethe desirabilitydesirability or worth of a thing; theor worth of a thing; the raterate

at which a commodity is potentially exchangeableat which a commodity is potentially exchangeablefor othersfor others

WebsterWebster’’s International Dictionarys International Dictionary

Business Owner:Business Owner:

““WhatWhat’’s the value of mys the value of mybusiness?business?””

Business Valuator:Business Valuator:

““ It dependsIt depends…”…”

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Price and Value are not the same.Price and Value are not the same. ““Price is whatPrice is whatyou pay. Value is what you getyou pay. Value is what you get””.... Warren BuffettWarren Buffett

Each business is unique and will command aEach business is unique and will command adifferent price for different reasons.different price for different reasons.

Buyer/SellerBuyer/Seller -- different perspectivesdifferent perspectives

To conclude a transaction, both parties must beTo conclude a transaction, both parties must besatisfied with Price and understand how it wassatisfied with Price and understand how it wasdetermineddetermined

Valuation is a starting point in exit planning, notValuation is a starting point in exit planning, notan end unto itselfan end unto itself

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PricePrice = Value + Terms= Value + Termsnegotiated between buyer andnegotiated between buyer andsellerseller

FMVFMV = a notional or intrinsic= a notional or intrinsic

value estimatevalue estimate

Business Valuation = an Art,Business Valuation = an Art,

not a Science!not a Science!

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““TheThe highest pricehighest price, expressed in terms of, expressed in terms of cashcash

equivalents, at which property would change handsequivalents, at which property would change hands

between abetween a hypotheticalhypothetical willing and able buyer and awilling and able buyer and a

hypotheticalhypothetical willing and ablewilling and able seller, acting atseller, acting at armarm’’ss

lengthlength in anin an open and unrestricted marketopen and unrestricted market,, whenwhen

neither is underneither is under compulsioncompulsion to buy or sell and whento buy or sell and when

both have a reasonableboth have a reasonable knowledgeknowledge of the relevantof the relevant

facts.facts.””

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Not the real world, but a starting pointNot the real world, but a starting point

Recent profit historyRecent profit history

General condition of the company (facilities,General condition of the company (facilities,books & records, technology, processes,books & records, technology, processes,employees, proprietary rights, contracts, etc.)employees, proprietary rights, contracts, etc.)

Market demand for particular type of businessMarket demand for particular type of business

Economic conditions (cost/availability of capitalEconomic conditions (cost/availability of capitaland factors directly affecting the business)and factors directly affecting the business)

Ability to transfer goodwill or other intangiblesAbility to transfer goodwill or other intangibles

Future profit/cash flow potential: Cash is KING!Future profit/cash flow potential: Cash is KING!

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But: Businesses rarely change hands atBut: Businesses rarely change hands atfair market valuefair market value

Transaction Value : Price + Deal TermsTransaction Value : Price + Deal Terms

NegotiatedNegotiated between seller and abetween seller and a specificspecific buyerbuyer

Tradeoff between cash &Tradeoff between cash & termsterms

May not be the same as fair market value butMay not be the same as fair market value butFMV a reasonable starting pointFMV a reasonable starting point

Value unknown until businessValue unknown until business exposed for saleexposed for sale

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Transaction Value is affected by:Transaction Value is affected by:

Timing of sale:Timing of sale: Value is timeValue is time--specific.specific. Price today notPrice today notthe same as Price next year.the same as Price next year.

Economic outlook and outlook for specific industry:Economic outlook and outlook for specific industry: thethemarket dictates investormarket dictates investor’’s required rate of return.s required rate of return.

Earnings capacity.Earnings capacity. Value is prospective, present valueValue is prospective, present valuefuture benefits measured in cash flows.future benefits measured in cash flows. Owner sellingOwner sellingbusiness but the buyer is buying a business opportunity.business but the buyer is buying a business opportunity.Nature and history of business. S.W.O.T. assessmentNature and history of business. S.W.O.T. assessmentpart of buyer due diligence.part of buyer due diligence.

Comparable market transactions/pricesComparable market transactions/prices –– aabenchmark. Pay no more than would pay for similarbenchmark. Pay no more than would pay for similarinvestment.investment.

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Transaction Price is affected by:Transaction Price is affected by:

Liquidity of investmentLiquidity of investment –– size of market/existence ofsize of market/existence of

more than one special purchasermore than one special purchaser

Level of the businessLevel of the business’’ net tangible assetsnet tangible assets. The higher. The higher

the value of net tangible assets, the lower the buyerthe value of net tangible assets, the lower the buyer’’ss

risk, and the higher the price (usually).risk, and the higher the price (usually).

IntangiblesIntangibles: sometimes the only valuable assets: sometimes the only valuable assets

GoodwillGoodwill: Commercial or personal? Transferable?: Commercial or personal? Transferable?

Size of interest being sold:Size of interest being sold: controlling interest orcontrolling interest or

minority interest?minority interest?

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Exit planning tip: Find the right buyers, more than one.Exit planning tip: Find the right buyers, more than one.

Transaction Price is also affected by:Transaction Price is also affected by:

Negotiating strengths of buyer and sellerNegotiating strengths of buyer and seller

Personal reasons (distress or planned)Personal reasons (distress or planned)

Available leverage (wait for proceeds/earnAvailable leverage (wait for proceeds/earn--out)out)

Who the owner is actually prepared to sell to:Who the owner is actually prepared to sell to:

Sale to third partiesSale to third parties

Intergenerational sale to familyIntergenerational sale to family

Sale to managementSale to management

Sale to employeesSale to employees

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Price & Terms may be differentPrice & Terms may be different

Possible Deal TermsPossible Deal Terms --

HoldHold--back of sale proceeds, buyer has recourse if infoback of sale proceeds, buyer has recourse if info

wrongwrong

Seller financing helps close deal, risk on the sellerSeller financing helps close deal, risk on the seller

Performance payouts/earnPerformance payouts/earn--outs can bridge theouts can bridge the ““priceprice

gapgap””, but risk transfers to seller. Timing of cash flow to, but risk transfers to seller. Timing of cash flow to

consider.consider.

NonNon--competition agreements, protect the buyer.competition agreements, protect the buyer.

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Buyer to owner:Buyer to owner: ““You tell me your price, IYou tell me your price, I’’ll tell you the termsll tell you the terms””

Exit Planning : What terms will owner consider? WhatExit Planning : What terms will owner consider? What

terms can owner afford?terms can owner afford?

Buyer to owner:Buyer to owner: ““You tell me your price, IYou tell me your price, I’’ll tell you thell tell you the

termsterms””

Possible Deal TermsPossible Deal Terms ––

Employment contracts. NormallyEmployment contracts. Normally favourfavour buyer. 100% taxbuyer. 100% tax

deductible and buyer gets extended terms. Retiring? Candeductible and buyer gets extended terms. Retiring? Can

be a dealbe a deal--breaker.breaker.

Price adjustments made postPrice adjustments made post--closing: contingent andclosing: contingent and

unknown liabilities, i.e. estimates, provisions, bad debts,unknown liabilities, i.e. estimates, provisions, bad debts,

warranty claims, similar. Need to consider.warranty claims, similar. Need to consider.

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Income Approach:Income Approach:

-- Focus on profits/cash flow produced by assetsFocus on profits/cash flow produced by assets

-- Capitalized earnings/cash flow method (single period)Capitalized earnings/cash flow method (single period)

-- Discounted cash flow method (multiple period)Discounted cash flow method (multiple period)

Market Approach:Market Approach:

-- Guideline Company methodGuideline Company method

-- Transactional methodTransactional method

-- Industry method:Industry method: ““rules of thumbrules of thumb””

Asset Approach:Asset Approach:

-- Adjusted book value (assumes going concern)Adjusted book value (assumes going concern)

-- Liquidation value (forced/orderly)Liquidation value (forced/orderly)

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Assumes the business is a going concern, expectedAssumes the business is a going concern, expected

to generate adequate return on investmentto generate adequate return on investment

FMV equal to present value of expected futureFMV equal to present value of expected future

earnings/cash flow (earnings, EBIT, EBITDA)earnings/cash flow (earnings, EBIT, EBITDA)

RequiresRequires::

Assessing future maintainable cash flowsAssessing future maintainable cash flows

Determining appropriate (buyer) tax rateDetermining appropriate (buyer) tax rate

Determining capitalization rate (& multiple)Determining capitalization rate (& multiple)

Assessing discounts for control & illiquidityAssessing discounts for control & illiquidity

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Exit Planning Tip: Consider ways to increase businesscash flow to exit date in order to increase exit price

Business net profit or loss +/Business net profit or loss +/--

◦◦ NonNon--operating/nonoperating/non--recurring revenue & expenserecurring revenue & expense

◦◦ Interest & nonInterest & non--cash expenses (depends)cash expenses (depends)

◦◦ Equipment replacements/additions (depends)Equipment replacements/additions (depends)

◦◦ Discretionary items, adjust to market:Discretionary items, adjust to market:

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••Owner's compensation & benefitsOwner's compensation & benefits

••Meals & entertainment expensesMeals & entertainment expenses

••Automobile expenses & allowancesAutomobile expenses & allowances

••Compensation of nonCompensation of non--working family membersworking family members

••Rent and other nonRent and other non--armarm’’s length expensess length expenses

Exit Planning Tip: Should ‘clean-up’ discretionary items before sale

Adjust assets/liabilities to fair market valueAdjust assets/liabilities to fair market value(real estate, receivables, inventory, F&E(real estate, receivables, inventory, F&E ……))

Identify redundant assets (nonIdentify redundant assets (non--operatingoperatingassets: excess cash, ATV, house, trailer, boat,assets: excess cash, ATV, house, trailer, boat,etc.)etc.)

Related party amounts: buyer does not want toRelated party amounts: buyer does not want tobuybuy

Remove purchased goodwillRemove purchased goodwill –– valuing goodwillvaluing goodwill

Identify liabilities buyer does not want toIdentify liabilities buyer does not want toassumeassume

Unusual items related to sellerUnusual items related to seller’’s tax planning,s tax planning,bonuses/advances, etc.bonuses/advances, etc.

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Exit Planning Tip: Consider removing redundant assets beforesale. May affect QSBC status and CGE.

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Adjusted earningsAdjusted earnings**** $$1,000,0001,000,000

Forecasted growthForecasted growth**** xx1.051.05

Estimated future earningsEstimated future earnings $ 1,050,000$ 1,050,000

Capitalization rateCapitalization rate**** 25.0 %25.0 %

P/E multiple (1P/E multiple (1 ÷÷ capitalization rate)capitalization rate)4.04.0

Indicated Value from OperationsIndicated Value from Operations $ 4,200,000$ 4,200,000

Add: Net redundant assetsAdd: Net redundant assets ****357,350357,350

Total Enterprise ValueTotal Enterprise Value $$4,557,3504,557,350

Cost of equity only, interest cost inCost of equity only, interest cost inearningsearnings

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InvestorInvestor’’s risk adjusteds risk adjustedrate of return on equityrate of return on equity

Reasonable capitalReasonable capitalstructure (debt/equity)structure (debt/equity)

Expected growthExpected growth

Cost of EquityCost of Equity

Risk free rate of return (GOC longRisk free rate of return (GOC long--term bond)term bond)

Equity risk premium (range 4% to 6%)Equity risk premium (range 4% to 6%)

Small company (size) premium (up to 10%)Small company (size) premium (up to 10%)

Industry risk premium ( +/Industry risk premium ( +/--))

Company specific risk premium ( +/Company specific risk premium ( +/--))

LongLong--term growth in excess of inflation reducesterm growth in excess of inflation reduces

riskrisk

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The higher the capitalization rate, the lower theThe higher the capitalization rate, the lower thePrice. Multiple of earnings/cash flow = 1Price. Multiple of earnings/cash flow = 1 ÷÷capitalization ratecapitalization rate

Economic riskEconomic risk

Business riskBusiness risk

Operating risksOperating risks

Financial risksFinancial risks

Asset risksAsset risks

Product risksProduct risks

Market risksMarket risks

Technological risksTechnological risks

Regulatory risksRegulatory risks

Legal risksLegal risks

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High Risk/Lower Multiple= Lower Price

Low Risk/Higher Multiple=Higher Price

New business, noNew business, nohistoryhistory

Weak balance sheetWeak balance sheet

Weak growth trendWeak growth trend

Weak industry/positionWeak industry/position

Few entry barriersFew entry barriers

Competes on priceCompetes on price

Customer loyalty is toCustomer loyalty is tothe business ownerthe business owner

Share purchaseShare purchase

Established earningsEstablished earningsbasebase

Strong balance sheetStrong balance sheet

Strong growth trendStrong growth trend

Strong industry/positionStrong industry/position

Significant barriersSignificant barriers

Not price dependentNot price dependent

Not tied to personalNot tied to personalgoodwillgoodwill

Asset purchaseAsset purchase24

High Risk/Lower Multiple= Lower Price

Low Risk/Higher Multiple=Higher Price

Seller not staying onSeller not staying on

No vendor take backNo vendor take backfinancingfinancing

Price not tied to postPrice not tied to post--closing, noclosing, no ‘‘earnearn--outout’’

No proprietary assetsNo proprietary assetsor competitiveor competitiveadvantageadvantage

Minimal synergy forMinimal synergy forbuyerbuyer

Seller stays long periodSeller stays long period

Vendor financing &Vendor financing &good termsgood terms

Vendor earnVendor earn--out,out,shares in postshares in post--closingclosingrisksrisks

Valuable intellectualValuable intellectualproperty/other rightsproperty/other rights

Significant synergiesSignificant synergiesidentifiedidentified

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This is not an allThis is not an all--inclusive list of riskinclusive list of riskfactorsfactors

Uses multiples derived from market prices of publicUses multiples derived from market prices of publiccompanies engaged in same or similar lines of businesscompanies engaged in same or similar lines of business

Market prices of public companies reflect minority interestMarket prices of public companies reflect minority interestpositions and high liquiditypositions and high liquidity

Selected companies should share characteristics such asSelected companies should share characteristics such asmarkets, products, growth and cyclical variability to themarkets, products, growth and cyclical variability to thebusinessbusiness

Valuator analyzes financial and operating performance,Valuator analyzes financial and operating performance,compares to the business being valuedcompares to the business being valued

Adjustments are made to multiples for differencesAdjustments are made to multiples for differencesidentified and for private co illiquidity of investmentidentified and for private co illiquidity of investment

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GUIDELINE CO.GUIDELINE CO. DATEDATE P/EP/E P/SalesP/SalesP/BookP/Book

Apple Company, Inc. 12/31/07Apple Company, Inc. 12/31/07 8.708.70 55.30%55.30%2.852.85

Bananas R Us, Inc.Bananas R Us, Inc. 10/31/0710/31/07 9.309.30 47.43%47.43%4.654.65

Fruits, Inc.Fruits, Inc. 12/31/0712/31/07 8.508.50 35.25%35.25%3.653.65

Cherry Corp.Cherry Corp. 10/31/0710/31/07 6.606.60 54.80%54.80%3.903.90

Grapes Corp.Grapes Corp. 11/30/0711/30/07 7.807.80 48.20%48.20%4.254.25

Median MultipleMedian Multiple 8.508.50 48.20%48.20%3.903.90

**Adjusted to normalize to business being valued**Adjusted to normalize to business being valued

PRICE TO EARNINGSPRICE TO EARNINGS

AfterAfter--tax earningstax earnings $ 959,446$ 959,446

Selected MultipleSelected Multiple xx 6.206.20

Operating Entity ValueOperating Entity Value $ 5,948,565$ 5,948,565

Net NonNet Non--operating assetsoperating assets + 250,000+ 250,000

Total Entity ValueTotal Entity Value $ 6,198,565$ 6,198,565

RoundedRounded $ 6,200,000$ 6,200,000

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Market Approach: Guideline Company Example

A rule of thumb is a mathematical formula developedA rule of thumb is a mathematical formula developedfrom the relationship between price and certainfrom the relationship between price and certainvariables based on experience, observation,variables based on experience, observation,hearsay, or a combination of these; usually industryhearsay, or a combination of these; usually industryspecific.specific.

Rules of thumb arise from observation of marketRules of thumb arise from observation of markettransactionstransactions

Expressed as multiples of revenue, cash flow, etc. AExpressed as multiples of revenue, cash flow, etc. Amultiple of revenues implicitly assumes there is amultiple of revenues implicitly assumes there is areasonably constant relationship between grossreasonably constant relationship between grossrevenues, maintainable earnings (or cash flow) andrevenues, maintainable earnings (or cash flow) andValue.Value.

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Rules of thumb assumesRules of thumb assumes ““one size fits allone size fits all””. But each business is unique.. But each business is unique.Good as a secondary check, not as primary valuation methodGood as a secondary check, not as primary valuation method

Multiples of:Multiples of:

Price/net earningsPrice/net earnings

Price/prePrice/pre--tax earningstax earnings

Price/cash flowPrice/cash flow

Price/revenuesPrice/revenues

Price/gross profitPrice/gross profit

Price/book valuePrice/book value

Price/EBITPrice/EBIT

Price/EBITDAPrice/EBITDA

Price/SDEPrice/SDE

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Restate assets & liabilities to FMV:Restate assets & liabilities to FMV:

Adjusted Book Value MethodAdjusted Book Value Method

•• Going concern basisGoing concern basis

•• FMV is in net assets owned, not in cashFMV is in net assets owned, not in cash

flow (i.e. real estate or other investmentflow (i.e. real estate or other investment

holding co.)holding co.)

Liquidation Value MethodLiquidation Value Method

•• Worth more dead than aliveWorth more dead than alive

•• Forced vs. orderlyForced vs. orderly

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Business Owner:Business Owner:

““WhatWhat’’s the value of mys the value of mybusiness?business?””

Business valuator:Business valuator:

““ It dependsIt depends…”…”

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Successful deal takes time and planning.Successful deal takes time and planning.Usually need 3 to 5 years track record ofUsually need 3 to 5 years track record ofprofits & good FS.profits & good FS.

Takes between 6Takes between 6 –– 18 months to sell18 months to sell

Business Valuator can:Business Valuator can:

◦◦ FindFind ‘‘hidden assetshidden assets’’

◦◦ Provide a baseline value nowProvide a baseline value now

◦◦ Identify weaknesses & areas ofIdentify weaknesses & areas ofimprovementimprovement

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Business Valuator can:Business Valuator can:

◦◦ Identify value drivers to maximize saleIdentify value drivers to maximize salevaluevalue

◦◦ Assess business risks and opportunitiesAssess business risks and opportunities

◦◦ Help target buyers / best sale processHelp target buyers / best sale process

◦◦ Evaluate offers/assist in negotiations andEvaluate offers/assist in negotiations andgive the owner an edge!give the owner an edge!

Integrating a business valuator into exitIntegrating a business valuator into exitplanning team can translate into a higherplanning team can translate into a highervalue when the owner ultimately retires.value when the owner ultimately retires.

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Christine Minelli CAChristine Minelli CA••CBV, CFICBV, CFIchrism@vine.on.cachrism@vine.on.ca(905) 549(905) 549--8463 or (905)5178463 or (905)517--37413741www.vine.on.cawww.vine.on.ca

Offices in Hamilton, Burlington andOffices in Hamilton, Burlington andKitchenerKitchener

Vine Valuations Inc.Vine Valuations Inc.