BUSINESS VALUATION

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BUSINESS VALUATION

• Linda B. Trugman CPA/ABV, MCBA, ASA, MBA

Offices in Florida and New Jersey
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Why Businesses Are Appraised

• Financing
• Ad Valorem Taxes
• Incentive Stock Option Considerations
• Initial Public Offering
• Damages Litigation
• Insurance Claims
• Charitable Contributions
• Eminent Domain Actions
• Financial Reporting

• Mergers and Acquisitions
• Allocation of Purchase Price
• Estate and Gift Taxes
• Marital Dissolution
• Employee Stock Ownership Plans
• Liquidation or Reorganization of a Business
• Buy-Sell Agreements
• Stockholder Disputes

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Appraisal Principles

• Principle of Substitution
• Principle of Future Benefits
• a/k/a Principle of Anticipation

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Standards of Value

• Fair Market Value

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Fair Market Value
...the price at which the 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, both parties having
reasonable knowledge of relevant facts.
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Standards of Value

• Fair Market Value
• Fair Value

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Fair Market Value v Fair Value

• 1. Willing Buyer.
• 2. Willing Seller.
• 3. Neither is under compulsion.
• 4. Assumes a typical hypothetical buyer and
  seller.
• 5. A price that is equitable to both.
• 6. Assumes both buyer and seller have equal
  knowledge.
• 7. Assumes reasonable knowledge of both parties.
• 8. Applicable to controlling interests or
  minority blocks.
• 9. Applies to all Federal Tax valuations.

• 1. Not always a Willing Buyer.
• 2. Not always a Willing Seller.
• 3. Buyer may be compelled, but seller is.
• 4. The impact of the proposed transaction is not
  considered, but the concept of fairness to the
  seller may be a consideration.
• 5. A concept of "fairness" to the seller,
  considering the inability to keep the stock.
• 6. No such assumption.
• 7. No such assumption.
• 8. Applicable to minority blocks.
• 9. The most common value standard in state
  dissenting and oppressed shareholder statutes.

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Standards of Value

• Fair Market Value
• Fair Value
• Investment Value

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Standards of Value

• Fair Market Value
• Fair Value
• Investment Value
• Intrinsic Value

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Revenue Ruling 59-60 (Factors To Consider)

• Nature of the business and history of the
  enterprise since its inception.
• The economic outlook in general and the condition
  and outlook of the specific industry in
  particular.
• The book value of the stock and the financial
  condition of the business.
• The earning capacity of the company.
• The dividend-paying capacity.
• Whether or not the enterprise has goodwill or
  other intangible value.
• Sales of the stock and the size of the block of
  stock to be valued.
• The market price of stocks of corporations
  engaged in the same or similar line of business
  having their stocks actively traded in a free and
  open market, either on an exchange or
  over-the-counter.

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Financial Statement Adjustments

• GAAP adjustments
• Non-operating/non-recurring adjustments
• Discretionary adjustments

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Discretionary Adjustments

• Owner's compensation
• Owner's perquisites
• Entertainment expenses
• Automobile expenses
• Compensation to family members
• Rent expenses (if not an arm's length lease)
• Interest expense

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Business Valuation Approaches

• Market Approach
• Asset Based Approach
• Income Approach

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Market Approach

• Guideline company method
• Transactional method
• Industry method (sometimes
  called "rule of thumb")

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Commonly Used Multiples

• Price/net earnings
• Price/pre-tax earnings
• Price/cash flow
• Price/revenues
• Price/dividend capacity or yield
• Price/operating profit
• Price/gross profit
• Price/book value
• Price/EBIT
• Price/EBDIT
• Price can also be invested capital

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Risk Factors

• Economic risk
• Business risk
• Operating risks
• Financial risks
• Asset risks
• Product risks
• Market risks
• Technological risks
• Regulatory risks
• Legal risks

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Market Approach Example
GUIDELINE CO. DATE P/E P/S P/B Apple
Company, Inc. 12/31/95 8.70 55.30 2.85 Bananas
R Us, Inc. 10/31/95 9.30 47.43 4.65 Fruits,
Inc. 12/31/95 8.50 35.25 3.65 Cherry Corp.
12/31/95 6.60 54.80 3.90 Grapes Corp.
11/30/95 7.80 48.20 4.25 Median
Multiple 8.50 48.20 3.90 Selected
Multiple 6.20 44.00 2.50
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PRICE TO EARNINGS After-tax
earnings 959,446 Multiple x
6.20 Oper. Entity Value 5,948,565 Net
Non-oper. Assets 250,000 Total Entity
Value 6,198,565 Rounded 6,200,000
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Asset Based Approach

• Adjusted Book Value Method
• Liquidation Value Method
• Cost to Create Method

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Income ApproachDefinitions of Income

• Net income after tax
• Net income before tax
• Cash flow (gross or net)
• Debt free net income
• Debt free cash flow (gross or net)
• EBIT, EBDIT or EBDITA (EBITDA)
• Earnings before owners compensation, interest
  and taxes (owners discretionary cash flow)

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Income ApproachSingle Period Model
Capitalization The process of converting a
benefits stream into value by dividing the
benefits stream by a rate of return that is
adjusted for growth.
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Income ApproachMulti-Period Model
Discounting The process of converting a future
series of benefit streams into value by bringing
them to present value at a rate of return that
reflects the risk inherent in the benefits stream.
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Income Approach

• Capitalization of benefits method
• Discounted future benefits method
• Excess earnings method

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Capitalization Model
V E / k-g
E Earnings expected in next period k
Discount rate g Long term sustainable growth
rate
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Single Period Model Example
Adjusted Net Income 1,000,000 Forecasted
Growth x 1.05 Estimated Future
Income 1,050,000 Capitalization Rate
25.0 Indicated Value from Operations
4,200,000 Add Net Nonoperating Assets
357,350 Total Enterprise Value
4,557,350 Rounded 4,600,000
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Multi-Period Model
E1 E2 E3
Et V ---------
--------- --------- ... -------- (1
i)1 (1 i)2 (1 i)3
(1 i)t Where E Benefit stream i
Discount rate
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Discount and Capitalization Rates
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Components of a Discount Rate

• Risk free rate of return
• General or equity risk premium
• Specific risk premium

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What is the Theory?
Venture Capital
Junk Bonds
Small Company Stocks
Large Company Stocks
Corporate Bonds (AAA)
Certificates of Deposit
Treasury Bonds
Treasury Bills
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The Build Up Method
"Safe" rate 7.44 Equity Risk Premium
6.90 Small Company Risk Premium
5.30 Specific Company Risk Premium
3.00 Discount Rate 22.64 Less Long Term
Growth 2.00 Capitalization Rate 20.64
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Most Common Valuation Premiums and Discounts

• Control Premium
• Minority discount
• Discount for lack of marketability

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Levels of Value
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Discount For Lack of Marketability

• Restricted Stock
• IPO Studies
• Cost of Floatation

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Thank You