WHAT IS THE VALUE OF YOUR BUSINESS

© Vladimir Hulpach, P.O.Box 17005, Fountain Hills, AZ 85269, USA

Do You Want to Know What Is Your Business Net Worth?Common approach:I will be concerned about my business net worth when there is a “need” for a valuation.

Needs for a valuation do come up!

Common Examples:

Sale of a business Mergers and acquisitions Estate and gifting Succession planning Insurance Financing

Why and When Should You Care

Responsive Approach

Previous examples = mostly forced by circumstances.

Proactive Approach

Allows to fix a price or set methods to determine business value in planning for foreseeable events:

• Buy/Sell Agreements• Family Business Succession• Insurance• Stock Options• Trigger Value

Are we able to predict situations dictating a need for business valuation?

Can We Influence the Business Value?

Negligible Influence - Examples:• Inflated salaries• Non-recurring expenses• Non-related assets

Essential Influence - Examples:• Growth rate• State of the industry• Position among competition

Using the Momentum:• Global and local economic

outlook• State of capital markets• State of the industry• Current competitive position of

the Business

Understanding the Factors

Timing of the Valuation

Introduction into the Valuation ProcessIllustration – A value of a traded securityAnalogy of valuation techniques – elements missing:

Free marketability Adequate comparables

Business Valuation=

Part Art, Part Science

Valuation by a definition (mostly “FMV”)Valuation vs. AppraisalUse of Third Party Appraisals (art, collectibles, antiques, jewelry, real estate, machinery and equipment)

Valuation Methods

Valuation by Purpose:

Sale, purchase or transfer of a business Mergers and acquisitions Shareholders transactions, buy/sell agreements Employee benefit plans, stock options Valuation of insurance Estate taxation and estate planning Gift taxation, charitable contributions Loan applications, collateral valuations Solvency/insolvency opinions Purchase price allocation (FAS 141R) Goodwill impairment (FAS 142) Bankruptcy determinations (liquidation value, NOL) Marital dissolution

Valuation Methods (continued)

Standard of Value: Fair Market Value Fair Value Synergistic Value

Premise of Value: Book Value Going Concern Value Liquidation Value Replacement Value

Effects of Purpose of Value on Conclusion of Value: Obvious interest of the owner (gifting, sale)× FMV, 3rd party expert opinion, IRS scrutiny

Some Myths about Valuation„Valuation of a private business should be only be performed when the business is ready to be sold or a lender requires it as part of its due diligence process.“

If this is the first-time valuation, usually: Resulting Value < Optimum Value Planning issues and taxation benefits have not been addressed

Benefits of critical planning: Business Tax Ownership

Examples: Value of Loan Collateral Estate tax Buy/Sell Agreements secured by Life Insurance

Some Myths about Valuation - continued„Businesses in my industry usually sell for two times annual revenue, why should I pay someone to elaborately value my business?“

Quick estimates using various multiples (Revenue Multiple, Net Income/Profit Multiple...):What do the Multiples tell us?

Source: Pratt´s Stats2012 Real Net Revenue Multiples

Where exactly does a firm within the industry, with $2,000,000 in revenues fit?

What your business is worth today generally depends on: How much cash it generates today Expected growth in cash in the foreseeable future The return buyers require on their investment in your business

Industry Year Min. Max. Average Median

Auto – Parts 2012 0,93 8,30 2,91 3,18

Some Myths about Valuation - continued„My business loses money, so it cannot be worth much.“

Fact: Most private businesses appear to lose money.

Financial statements reflect an array of discretionary and non-standard items.Examples:

Salaries Accelerated depreciation Value of intangible assets Non-business assets

Þ Need to normalize financial statements (duty of a valuation analyst)

NORMALIZED FINANCIAL STATEMENTS +OTHER ELEMENTS OF THE VALUATION PROCESS ↓ REALISTIC VALUE

The Valuation ProcessMethodology by NACVA (National Association of Certified Valuators and Analysts):

1. Value Estimate Assignment• Description of Assignment• Purpose and Function of Valuation• Standard, Premise and Level of Value• Methods of Valuation• Value Estimate Key Assumptions• Limiting Conditions• Executive Summary

2. Company Overview• History and Background• Capital Structure• Management and Personnel• Facilities and Equipment• Products and Services• Other

3. Economic Conditions• Global and/or US Economic Outlook• Regional and Local Economic Conditions

The Valuation Process (continued)4. Comparative Analysis

• Industry Overview• Company’s Position in the Industry• Qualitative Factors Affecting the Value (SWOT)

5. Financial Analysis• Financial Information• Balance Sheet Analysis• Income Statements Analysis• Cash Flow Analysis• Ratio Analysis• Normalizing Adjustments

6. Valuation Methods and Findings• Asset Approach• Market Approach • Income Approach

7. Valuation Adjustments• Control Premium or Minority Discount• Lack of Marketability/Liquidity Discount• Other Premiums and/or Discounts

8. Reconciliation and Conclusion of Value

The Value of Intangibles

Intangible assets may represent an important part of your business’s value!

Your business = typically a collection of assets of different nature:

Tangible Assets: Cash & Cash Equivalents Receivables Inventory Investments Property, Plant and Equipment

Intangible Assets: Patents Trademarks Copyrights Brand Recognition Workforce in Place Customer Lists Goodwill

The Value of Intangibles (continued)What is Goodwill?

Typically goodwill = a residuum: When a business is sold for a price higher than Fair Market Value, goodwill represents the difference. „Goodwill is a proclamation of the new management about how it will use the acquired assets in a way impossible for the previous owner.“ Synergy example: A hotel chain buys an independent golf course.

Acquired Goodwill (on the books) x

Hidden Goodwill (built-in)Not amortized but tested for impairment

Different approaches to valuation of Intellectual Property:

Income vs. cost methods (patents) Comparative methods (effective royalty rate) Substitution methods (workforce value) Projection - distribution simulation

Planning an Exit StrategyThe benefits of understanding Factors determining the value → maximize the value Structure of the value → asset separation, tax strategies

Advantages of a family business in Exit Strategy Planning!

Sale of BusinessPreparation for a sale of a business: Learn about comparable transactions Recognize the market conditions Optimalize the business operations Normalize financials and/or adjust practices Invest in the company? Estimate tax implications Select the sales and marketing tools

Planning an Exit Strategy (continued)Mergers and AcquisitionsPros and Cons

Loans and Private Equity The Wall Street Journal - April 2014: ”Direct lending takes off in Europe“Interest of global investors – private equity funds - examples

Succession Planning Buy/Sell agreements Third party purchase options ESOPs Use of insurance Quick estimates of value for succession planning

Tax Strategies Gifting Charity Other tax deductions

Keep track of your business’ s net worth!