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

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 sale

Expected 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 Marketability

Discount (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 bliggett@kpmcpa.com 417-882-4300

Kirkpatrick, Phillips, & Miller CPAs www.kpmcpa.com