business valuation in practice

••• MCOM CorporationBusiness Valuation in

Practice

Michael F. Cannon, MA, MBA, AVAPresident,

MCOM Corporation

••• MCOM Corporation

Overview

The concept of value

Standards of value

Approaches to value

The valuation process

Some Examples

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Valuation vs. Appraisal

Valuation “To establish a value for an entire or partial interest in

a closely held business or 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 assets

based upon special market knowledge, education, and vocational training possessed by the appraiser.”

NACVA Fundamentals, Techniques & Theory

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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

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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

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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

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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

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Levels of Value

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Investment or Synergistic Value

Control Value

Minority Value

Non-Marketable, Minority Interest Value

$12

$10

$8

$6

Marketable, control value

Marketable, control value

Marketable, non-control value

Non-marketable, non-control value

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Premise of Value

Going concern Assumes the business will continue into the future

Liquidation value Forced liquidation Orderly liquidation

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••• MCOM CorporationCommon Approaches to

Valuation

Asset Approach – (Assets less Liabilities)

Market Approach – (Comparable Transactions)

Income Approach – (Future Benefit Stream)

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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

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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

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••• MCOM CorporationValue 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

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Control Premium Case

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

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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.

Media Buying Company: Miami


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

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••• MCOM CorporationKey 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

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Management Analysis CaseDiesel Engine Service & Repair: Florida Keys

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

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Valuation Impact: Bring in succession management, train and allow buy in over time, make 5 year exit plan, clean up financials.


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

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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

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It Is Best To Do a Valuation Before You Need One


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

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••• MCOM CorporationIndustry Analysis Case Advertising Agency:

Mexico

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

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Valuation Impact: Gave owner choices; either negotiate better sale price or move operation to local acquisition mode.

••• MCOM Corporation Market Analysis Case

Electrical SubContractor: Las Vegas

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

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Valuation Impact: Re-orient business to custom higher margin market and RFP business for government projects.


Company Analysis CaseCustom Closet Designer/Manufacturer: New York

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

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Valuation Result: Reduction in Overall Value, higher Discount for lack of marketability


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

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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.)

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Professional Valuation Standards

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

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Results in a combination of technical expertise and business wisdom


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

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Thank You!

MCOM Corporation

business valuation in practice

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