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Pesented by: Brooke A. Liggett, CPA, CVA

Pesented by: Brooke A. Liggett, CPA, CVA

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Pesented by: Brooke A. Liggett, CPA, CVA

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  1. Understanding & using business valuations Pesented by:Brooke A. Liggett, CPA, CVA

  2. “How much is my business worth?”

  3. 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

  4. 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

  5. Who Needs Business Valuations? • Attorneys • Courts/judges • Business owners • Insurance companies • Estates • Additional users of financial statements

  6. Business Valuation Considerations • Type of entity to be valued • Purpose of valuation • Valuation date • Standards of value • Premise of value

  7. Business Valuation Considerations • Type of entity to be valued • Purpose of valuation • Valuation date • Standards of value • Premise of value

  8. Standards • SSVS #1 • Revenue Ruling 59-60

  9. 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.

  10. Basis of Value A valuation is based on a hypothetical arms-length sale between a buyer and a seller, usually for cash.

  11. 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.

  12. BENEFITS RISK VALUE =

  13. R E T U R N RISK VS RETURN Privately Held Stocks Lesser Quality Stocks High Quality Growth Stocks Long Term Bonds U.S. Treasury Bills RISK

  14. Valuation Methodology • Understanding the business

  15. Valuation Methodology • Analyze the financials • Normalize the financials

  16. Valuation Methodology • Analyze the adjusted financials • Financial ratios • Industry averages

  17. Valuation Methodology • Estimate future earnings stream

  18. 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!)

  19. BENEFITS RISK VALUE =

  20. Developing the Capitalization Rate BUILD-UP METHOD • Risk-free Rate • Risk Premium • Size Premium • Specific Company Risk Premium

  21. Build Up Method

  22. METHODS OF VALUATION Income Approach Market Approach Asset-based Approach

  23. 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

  24. Asset Approach – cont. • Net Asset Value (NAV) Method – all assets and liabilities are adjusted to current values • NAV = assets less liabilities • Pitfall – if done incorrectly fails to capture intangible and other unrecorded assets • Excess Earnings Method – hybrid of the asset and income approaches

  25. 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

  26. Market Approach – cont. • Two methods generally used: • Guideline public company method; based on sales of similar publicly traded company shares • Can 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 companies • Works best when companies are sufficiently similar to the subject business • Positive correlation between price and multiples used is desirable • Exercise caution with dated transactions

  27. 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

  28. 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

  30. 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

  31. Discounts (And Premiums) • Minority Interest Discount • Lack of Marketability Discount • Premium for Pass-through Entity Tax Benefits

  32. 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.

  33. 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

  34. 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.

  35. Marketability Discounts • Control vs. minority interest can make a difference • The ability to affect a sale • Expected holding period can impact size of discount • Restrictions on transferability can be significant • Pool of potential buyers?

  36. 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

  37. 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.

  38. Premium for Pass Through Entity Tax Benefits • Adjustment for dividend tax avoided by S-Corporation shareholders

  39. 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%

  40. Discounts are Applied Multiplicatively FMV of XYZ, Inc. $ 2,150,000 Less Minority Interest Discount (30%) (645,000) 1,505,000 Less Marketability Discount (25%) (376,250) Fair Market Value $1,128,750

  41. 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

  42. The Valuation Process Ladder VALUE Reasonableness Check Determination of Value Select Appropriate Premiums and Discounts Risk Analysis Determination of Benefit Stream Education Defining the Engagement Determine Approaches and Methods

  43. Questions? For additional information, please contact: • Brooke A. Liggett, CPA, CVA • bliggett@kpmcpa.com • 417-882-4300 • Kirkpatrick, Phillips, & Miller CPAs • www.kpmcpa.com