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Business Valuation - Where Should I start and what should I know .pptx

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					           Business Valuation:
Where Should I start and what should I know
                Brian A. Reed, CPA, CVA
         Partner, Transaction Advisory Services
                        Weaver
                     Overview
• Identify the events and reasons when an independent
  business valuation may be needed
• Understand the key factors involved in the valuation of a
  privately held business
• Describe a typical valuation engagement, process and report
• Discuss discounts and premiums
• Court case updates
                      Reasons to perform a business
                      valuation analysis
• Gift and estate tax purposes   •   Lost profit analyses
• Marital disputes               •   Mergers and acquisitions
• Minority shareholder           •   Purchase price allocations
  disputes                       •   Goodwill impairment analysis
• Buy-sell agreements            •   Stock option valuation
• Employee stock ownership
  plans (ESOPs)
• Management buyouts
                         Standards and Premise of value

• Standards of value
   – Fair market value
   – Fair value
   – Investment value


• Premise of value
   – Going concern value
   – Orderly liquidation value
   – Forced liquidation
                            Standards of value
•   Revenue ruling 59-60 defines fair market value as:
     – “ … in effect, it is 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.”
•   ASC Topic 820, Fair Value Measurements and Disclosures (ASC 820)
    (formerly FASB Statement No. 157, Fair Value Measurements) defines fair
    value as:
     – “[T]he price that would be received to sell an asset or paid to transfer a
        liability in an orderly transaction between market participants at the
        measurement date."
                       Standards of value
• Revenue ruling 59-60 outlines approaches, methods and
  factors to consider in valuing shares of closely held
  corporations
   – It was meant to apply to valuations for estate and gift tax
     purposes
   – Has been accepted in the valuation community as a basis
     for all valuations of interests in closely held businesses
     without a public market
   – Establishes the factors that should be considered as part of
     a valuation analysis
       • Nature of the business and the history of the Company
                Standards of value

• Industry outlook
• Book value of the stock and the financial condition of
  the Company
• Earnings capacity of the Company
• Dividend paying capacity
• Assessment of whether the Company has goodwill or
  other intangible value
• Sales of the stock and the size of the block of stock to
  be valued
• Market price of stocks of corporations engaged in the
  same or similar line of business
                      Standards of value

• Fair value as defined by ASC 820 includes the following
  components:
   – Exit price
   – Market participants
   – Orderly transaction
   – Principal or most advantageous market
   – Highest and best use
                         Standards of value
Valuation Purpose                 Applicable standard of value
Gift and estate tax               FMV
ESOPs                             FMV
Financial acquisitions            FMV
Dissenting stockholders actions   Legal fair value (in most states)

Minority oppression statutes      Legal fair value (in most states)

Strategic acquisitions            Investment value
Buy-sell agreements               Anything parties agree on
Marital dissolution               No standard of value specified in
                                  most states – court specific
Financial reporting value         Accounting fair value as defined by
                                  ASC 820
                            Valuation Methodologies
                                       Valuation
                                     methodologies


Publicly traded          Comparable
 comparable              transactions         Income approach              Other
  companies                analysis
• “Public market       • “Private market      • Present value of      • Adjusted book
  valuation”             valuation”             projected free cash     value (Cost
                                                flows                   approach)
• Value based on       • Value based on
  market trading         multiples paid for   • Incorporates short-   • Dividend
  multiples of           comparable             term and long-term      discount model
  comparable             companies in sale      expected
  companies              transactions           performance           • Liquidation
                                                                        analysis
• Applied using        • Generally includes   • Risk in cash flows
  historical and         a control premium      and capital           • Break-up
  prospective                                   structure captured      analysis
  multiples                                     in discount rate

• Does not include a
  control premium
                             Valuation Methodologies
•   Publicly traded comparable companies or guideline publicly traded
    company analysis
     – Revenue Ruling 59-60 indicates that the market approach should at
       least be considered
     – There are rarely, if ever, companies that are exactly like the subject
       company
     – The common issues surrounding the use of comparable company
       information includes the following:
          • Are the public companies selected by the valuation analyst
            sufficiently "comparable" to the subject company?
          • What specific factors make two companies similar?
          • What adjustments are appropriate, if any, to the chosen market
            multiple?
          • Which market multiple is most appropriate?
                      Valuation Methodologies

• Publicly traded comparable companies or guideline publicly
  traded company analysis
   – Steps to be considered under the guideline company method:
      • Step 1 – Obtain financial statements for the subject
         company
      • Step 2 – Analyze and adjust financial statements of the
         subject company as needed
      • Step 3 – Adjust tax expense accordingly, given the other
         adjustments that were made
      • Step 4 – Perform a search for and select publicly traded
         guideline companies
                Valuation Methodologies
• Step 5 – Obtain appropriate financial information for a
  representative period of time for the guideline public
  companies
• Step 6 – Consider adjusting or normalizing guideline public
  company financial data for the following
• Step 7 – Analyze the differences between the public
  companies and the subject company including the
  following:
    – Business description
    – Company operations
    – Financial condition
    – Other qualitative and quantitative considerations
               Valuation Methodologies

• Step 8 – Select appropriate valuation multiple for
  guideline public companies
• Step 9 – Calculation of valuation multiples
• Step 10 – Selection of valuation multiple
• Step 11 – Application of selected multiple to subject
  company
• Step 12 – Consider whether any discounts or premiums
  should be applied to the conclusion of value
                     Valuation Methodologies
Guideline publicly traded company analysis example
                     Valuation Methodologies

Guideline publicly traded company analysis example
                       Valuation Methodologies

• Comparable transaction analysis
   – The theory behind this method is that prices paid in the
     acquisition of entire companies that are similar to the subject
     business that have sold in the marketplace can provide a
     reasonable approximation of the value of the subject
     company.
   – The value generally obtained under the direct market data
     method is a control value.
   – Adjustments could be necessary if the value to be calculated
     is that of a minority interest.
                     Valuation Methodologies
• Comparable transaction analysis
   – Common transaction multiples include price or MVIC to the
     following:
      • Revenues
      • EBIT
      • EBITDA

   – Sources include
      • BIZCOMPS®
      • Business Brokers
      • Pratt's Stats™
      • Thomson Financial Securities
      • Institute of Business Appraisers Market Database
                     Valuation Methodologies
Comparable transaction analysis example
                     Valuation Methodologies
Comparable transaction analysis example
                      Valuation Methodologies

• Income approach
   – There are two methods that can be used to value direct
     equity or invested capital:
      • Discounted cash flow (DCF)
          – Multi-period
          – Present value of expected future cash flows
          – Erratic or unstable net cash flows
          – Discount by use of a discount rate
              • Cost of equity capital
              • WACC
                Valuation Methodologies

   – Utilizes residual period after stabilization of cash flow
       • Capitalization of future net cash flows
       • CF0(1 + g) / (Discount rate - g)
• Capitalization cash flow method
   – Single period
   – Stable net cash flows
   – Shortcut of DCF method
   – Discount using capitalization rate
                       Valuation Methodologies

• Income approach
   – There are two primary models to determine the appropriate
     cash flow:
      • Direct equity
          – Direct valuation of common equity
          – Often used when valuing minority interests because a
            minority interest holder has no ability to influence the
            capital structure
          – PV = [NCFe(1))/(1 + ke)] + [NCFe(2))/(1 + ke)2] + ... +
            [NCFe(n))/(1 + ke)n]
                Valuation Methodologies

• Invested capital
    – Enterprise valuation
    – Often used when the capital structure is expected to
      change and/or control value, especially when the
      enterprise has little to no debt or too much debt, and
      an optimal amount of debt would enhance entity value
    – Based on net cash flow to invested capital
    – PV = [NCF(1))/(1 + WACC)] + [NCF(2))/(1 + WACC)2] + ... +
      [NCF(n)/(1 + WACC)n]
                        Valuation Methodologies
Income approach: Net cash flow to equity:
 Net income after tax

 Plus:     Non-cash charges (typically depreciation, amortization and
           deferred taxes)
 Less:     Incremental working capital to support growth
 Less:     Anticipated capital expenditures (typically property, plant and
           equipment)
 Plus:     New debt principal in (borrowings)
 Less:     Debt principal out (repayments)
 Equals:   Net cash flow to equity
                         Valuation Methodologies
Income approach: Net cash flow to invested capital:
 Net income after tax

 Plus:      Interest expense (tax-effected)
 Less:      Non-cash charges (typically depreciation, amortization, and
            deferred taxes)

 Less:      Incremental working capital (excluding interest bearing debt
            obligations) to support growth
 Plus:      Anticipated capital expenditures (typically property, plant, and
            equipment)
 Equals:    Net cash flow to invested capital
                      Valuation Methodologies

• Income approach
   – Cost of capital
      • The expected rate of return that the market requires to
        attract funds to a particular investment
      • Referred to as the discount rate
      • Should represent the perceived risk of the investment
      • “Forward looking" expected rate of return (or required
        rate of return)
                   Valuation Methodologies

– Cost of capital (continued)
   • Commonly used approaches for calculating the return on
     common equity
       – Capital asset pricing model (CAPM)
           • CAPM = Rf + (Rp x β)
       – Modified CAPM
           • CAPM = Rf + (Rp x β) + Size risk + Specific company
             risk
       – Build-up method
           • Ke = Rf + Rp + Size risk + Specific company risk
                     Valuation Methodologies

Income approach – Cost of capital example
                     Valuation Methodologies
Income approach – Cost of capital example
                    Valuation Methodologies
Income approach – Discounted cash flow example
                      Types of Reports
• Detailed report
   – Only for valuation engagements
• Summary report
   – Cannot restrict valuation approaches that are applicable
   – No difference in relation to economic and industry
     background research between a summary and a detailed
     report
   – No changes in the due diligence measures taken with a
     summary report versus a detailed report
• Calculation report
   – Requires fewer procedures than a detailed report
                          Discounts and premiums
• Discount for Lack of Control
   – A controlling interest
       • Is an interest in a business enterprise where the necessary elements
         of control are active and tied to the interest
   – A minority interest lacks potentially valuable rights that a controlling
     shareholder or group enjoys.
   – Necessary to evaluate the facts and circumstances surrounding the
     situation to determine whether effective control exists.
                            Discounts and premiums
• Discount for Lack of Marketability
   – The principal economic factor causing a lack of marketability (“LOM”) discount is
     the increase in risk caused by the inability to quickly and efficiently return the
     investment to a cash position
   – There are two types of empirical studies used to quantify valuation adjustments
     associated with the lack of marketability of noncontrolling ownership interests in
     closely held businesses:
       • Restricted Stock Studies
            – Studies that measure the difference between the private price of a
               restricted and the publicly traded stock price of the security the same
               company
       • Pre-IPO Studies
            – Studies based on the difference between the initial pubic offering (IPO)
               price of a company and transactions in the same company’s stock prior
               to the IPO.
                        Discounts and premiums
Discount for Lack of Marketability
                       Discounts and premiums
Discount for Lack of Marketability
                                Discounts and premiums
Discount for Lack of Marketability

Case                                Court            Date               DLOM

Estate of William G. Adams v.       U.S. Tax Court   March 28, 2002     35.0%
Commissioner

Jane Z. Astleford v. Commissioner   U.S. Tax Court   May 5, 2008        21.23%


Estate of Dunn v. Commissioner      U.S. Tax Court   August 1, 2002     22.5%

Gross v. Commissioner               U.S. Tax Court   July 29, 1999      25.0%

Kelly v. Commissioner               US. Tax Court    October 11, 2005   23.0%
                          Court Case Updates
• Malik v. Falcon Holdings, LLC, 2012 U.S. App. LEXIS 5336 (March
  14, 2012)
   – Actual transaction is the “gold standard” of valuation
   – “The value of a thing [asset] is what people will pay.”
• Gearreald v. Just Care, Inc., 2012 Del. Ch. LEXIS 91 (April 30,
  2012)
   – Delaware Court accepts supply-side equity risk premium
   – Court rejects liquidity argument for lesser size premium
• Holber v. M&T Bank (In re Scheffler), 2012 Bankr. LEXIS (June 5,
  2012)
   – Cost method inappropriate method to value technology
                          Disclaimer of Liability
Weaver provides the information in this presentation for general guidance
only, and it does not constitute the provision of legal advice, tax advice,
accounting services, investment advice or professional consulting of any
kind. The information included herein should not be used as a substitute for
consultation with professional tax, accounting, legal or other competent
advisers. Before making any decision or taking any action, you should
consult a professional adviser who has been provided with all pertinent
facts relevant to your particular situation. Tax information is not intended
to be used and cannot be used by any taxpayer for the purpose of avoiding
accuracy-related penalties that may be imposed on the taxpayer. The
information is provided "as is," with no assurance or guarantee of
completeness, accuracy or timeliness of the information, and without
warranty of any kind, express or implied, including but not limited to
warranties of performance, merchantability and fitness for a particular
purpose.
                              Presenter Biography
Brian A. Reed, CPA, CVA
Partner, Transaction Advisory Services

Brian Reed has more than 12 years of diversified financial advisory experience ranging
from acquisition due diligence and valuation services to ligation support and fraud
investigations. He has worked with a wide range of clients including both private equity
and corporate clients. In addition, he has provided financial support services to attorneys.

Brian has participated in acquisition due diligence engagements ranging from $1 million
to over $500 million. Additionally, he has performed a significant number of valuation
engagements related to purchase price allocations, goodwill impairment analysis, gift and
estate taxes and litigation consulting engagements. His experience includes engagements
in the manufacturing, retail, software, distribution, professional services and oil and gas
industries.

He received his Bachelor of Arts degree at the University of Texas at Austin and a Master
of Business Administration degree in finance and accounting from Tulane University.
             Conclusion

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