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Business Valuation in Practice

Business Valuation in Practice. Michael F. Cannon, MA, MBA, AVA President, MCOM Corporation. Overview. The concept of value Standards of value Approaches to value. The valuation process Some Examples. Valuation vs. Appraisal. Valuation

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Business Valuation in Practice

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  1. Business Valuation in Practice Michael F. Cannon, MA, MBA, AVA President, MCOM Corporation

  2. Overview The concept of value Standards of value Approaches to value The valuation process Some Examples MCOM Corporation

  3. Valuation vs. Appraisal • Valuation • “To establish a value for an entire or partial interest in a closely held businessor professional practice, taking into account both quantitative and qualitative tangible and intangible factors associated with the specific business being valued.” • Appraisal • “To establish a value of certain specific tangible assetsbased upon special market knowledge, education, and vocational training possessed by the appraiser.” • NACVA Fundamentals, Techniques & Theory MCOM Corporation

  4. Financial Value • “The value of any financial asset is the net present value of all future cash flows discounted at the appropriate rate of return.” • Brealey & Meyers—Principles of Corporate Finance MCOM Corporation

  5. Types (Standards) of Value Fair market value Fair value (value before dissenting action) Intrinsic value Investment value Book value Replacement value Value in place Insured value Loan value Social value Moral value Ethical value Religious value Sentimental value MCOM Corporation

  6. Fair Market Value • “The price at which a property would change hands between a 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 and both parties have reasonable knowledge of the relevant facts.” • Revenue Ruling 59-60 MCOM Corporation

  7. Investment Value • “The value to a particular investor based on individual investment requirements and expectations.” • International Glossary of Business Valuation Terms • May include synergies to a particular buyer • Economies of scale • Reduced competition MCOM Corporation

  8. Levels of Value Investment or Synergistic Value $12 Marketable, control value Control Value $10 Marketable, control value Minority Value $8 Marketable, non-control value Non-Marketable, Minority Interest Value $6 Non-marketable, non-control value MCOM Corporation

  9. Premise of Value • Going concern • Assumes the business will continue into the future • Liquidation value • Forced liquidation • Orderly liquidation MCOM Corporation

  10. Common Approaches to Valuation Asset Approach – (Assets less Liabilities) Market Approach – (Comparable Transactions) Income Approach – (Future Benefit Stream) MCOM Corporation

  11. Income Approach • Discounted earnings method (inconsistent growth) • Capitalization of earnings method (consistent growth) • Dividend pay-out method (capitalize 5 yr avg.) • Excess earnings method • Treasury method • Reasonable rate method MCOM Corporation

  12. Discounts & Premiums Discount for lack of control Premium for control Discount for lack of marketability Key person discount They depend on the interest to be valued and the techniques used to establish the value conclusion MCOM Corporation

  13. Value of Control Premium (20-50%) • Control prerogatives • Hire and fire • Distribute earnings/declare dividends • Buy and sell assets • Enter into contracts • Liquidate the business • Set strategic objectives and other goals • Set compensation and performance standards MCOM Corporation

  14. Control Premium Case Media Buying Company: Miami Valuation Impact: Ability to purchase majority shares added significant premium to otherwise lowered value due to poor results, operations and staffing. Potential of rapidly improving operations and solving operational problems. • Pros • Strong underlying fundamentals • Key Man, majority shareholder ready to share duties • New ownership experienced and capable of needed changes • Cons • Poorly organized service company • Excessive staff, low efficiency • Dismal operating ratios • Dissatisfied customers MCOM Corporation

  15. Marketability Discounts Range <> 23-45% • The ability to convert an ownership interest to cash • The time required to do so affects the level of marketability • Other factors that affect marketability • Distributions of earnings • Active market or industry roll-up • Key person • Number and profile of owners e.g., family owned • Restrictions on transfer of stock • Investors pay a premium for marketability and discount an investment for the lack of marketability MCOM Corporation

  16. Key Person Discounts Hotly Contested • One man operations can suffer large discounts without succession planning • Earn out schemes developed to circumvent this problem • IRS scrutinizes these carefully, often will not allow them to be “stacked” on control and marketability discounts MCOM Corporation

  17. Management Analysis CaseDiesel Engine Service & Repair: Florida Keys Valuation Impact: Bring in succession management, train and allow buy in over time, make 5 year exit plan, clean up financials. • Pros • Solid, 200+ loyal clients • Fast, efficient, fair prices • Extremely low overhead • No payment problems • Cons • Excessive officer compensation, loans • Customer loyalty to owner • Next generation family members, incompetent, arrogant, not service oriented MCOM Corporation

  18. It Is Best To Do a Valuation Before You Need One • The best way to see if management is adding value to the firm • Tool “par excellence” for business planning • Takes subjectivity out of the equation • Considers all asset values, tangible and intangible • Includes market, competitive and industry analyses • Cleans up financial statements for the long term • Allows normalization of unrelated expenses and assets • Provides parameters for accurate forecasting • Takes litigation and other material factors into consideration • Values key man, succession and growth plans correctly MCOM Corporation

  19. It Is Best To Do a Valuation Before You Need One • Helps owners identify the next step for the business… and how to get there • Divestiture • Maintain • Growth • Reorganization • Acquisition • Merger • Pre-Preparation for tax needs or triggering events MCOM Corporation

  20. The Valuation Process • Define the engagement • Gather all necessary information • Analyze all information and make adjustments to “normalize” financials • Apply valuation approaches/methods to estimate the value of the enterprise • Communicate the results • Prepare and issue the valuation report MCOM Corporation

  21. Industry Analysis Case Advertising Agency: Mexico Valuation Impact: Gave owner choices; either negotiate better sale price or move operation to local acquisition mode. • Pros • Work System reduced headcount • Profitability very high • Principals primary skilled employees • Proprietary Techniques • Cons • Declining Industry Lifecycle • Reduced Margins • Industry Consolidation • Becoming Commodity Service • Low ball offer from multi-national MCOM Corporation

  22. Market Analysis CaseElectrical SubContractor: Las Vegas Valuation Impact: Re-orient business to custom higher margin market and RFP business for government projects. • Pros • Excellent structure, staff, profitability • 3 generations of service, great reputation • Best efficiency • Cons • Industry downturn • Low cost illegal alien labor • Declining margins • Loss of customer loyalty MCOM Corporation

  23. Company Analysis CaseCustom Closet Designer/Manufacturer: New York Valuation Result: Reduction in Overall Value, higher Discount for lack of marketability • Pros • Excellent in all operational areas • Higher than industry average profit margins • Strong, motivated management and staff • Cons • Dependence on two major developers • Unable to penetrate aftermarket • Low margins • Cut throat competition MCOM Corporation

  24. Business Wisdom and Technical Expertise Combined • Business Wisdom • Market Analysis • Company Analysis • Management Analysis • Control Adjustments • Normalizing adjustments • Technical/Research Expertise • Fundamental analysis • Economic Analysis • Financial Analysis • Industry Analysis MCOM Corporation

  25. Subjective Issues Size of discounts and premiums Discount or capitalization rate Projected growth rates Normalizing adjustments Assumptions and limiting conditions How to analyze all the existing conditions (ex. Market, competition, management, economic factors, etc.) MCOM Corporation

  26. Professional Valuation Standards Results in a combination of technical expertise and business wisdom • Require • Confidentiality • Analysis of all relevant data • Independence and objectivity • Declaration of assumptions and limiting conditions • Provide guidelines for developing and communicating valuation results and conclusions • Meet Standards from; • Department of Labor (ESOPs) • Internal Revenue Service • Federal and state laws • Rules of applicable courts • Case law • Valuation organizations MCOM Corporation

  27. Materials for your review Sample Business Valuations List of Valuation Questions Database of Valuation uses, experiences and case law verdicts Valuation Process Database Comparable Transactions Further research into the industry MCOM Corporation

  28. Thank You! MCOM Corporation

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