Valuation Methodology by keara


									Valuation Methodology
The question most frequently asked Alpha Omega Capital Partners

(AOCP) is “What is the value of my business and how is it determined?”
In this edition, we will explore          • Transaction Value is the Enterprise
definitions for value, EBITDA and           value less debt or net proceeds
SDE, the financial factors that affect      from the deal before taxes
value, methodologies for determining        and fees.
value, valuation preparation,
valuation multiples, how you can          When advising clients, AOCP
estimate your company’s value,            defines value as the present value                      FA S T                    FA C T S
and why equity values will vary           of all future income streams in
by method.                                today’s market.                                                  U.S. Businesses
                                                                                                        90 percent are family owned.
                                          • EBITDA means earnings before
Definitions To Remember:                    interest, taxes, depreciation,                       40 percent are facing ownership transfer.
• Market Value is defined by the IRS        and amortization.                                      A large % fail after the founder leaves.
  as the amount at which a company
  would change hands between a            • SDE means seller discretionary                               Succession Issues
  willing buyer and a willing seller        earnings and equals the total of                    • Who will participate & who will watch
  when neither is acting under              EBITDA plus seller compensation
                                                                                                • Conditions of participation
  compulsion and when both have             after replacement value, and
                                                                                                • Leadership preparation
  knowledge of the relevant facts.          nonrecurring one-time expenses.
                                                                                                • Letting go
                                            Because the owners of privately
• Investment Value is the value of a        held companies typically target                     • Liquidity — funding retirement
                                                                                                  & estate taxes
  company to a particular investor.         a zero tax strategy, SDE attempts
                                                                                                • Cornucopia kids — bridging
                                            to recapture the earnings
• Fair Value is a judicially determined                                                           generational values
                                            that would be available to
  concept used in divorces, partner                                                             • Attracting & retaining
                                            shareholders after the payment                        non-family managers
  buy-outs, etc. and varies widely.
                                            of industry competitive
                                                                                                • Compensation — equity versus merit
• Book Value is simply assets               compensation to management.
                                                                                                • Successors — who chooses and
  minus liabilities using GAAP                                                                    how to choose
                                          • M&A means mergers and
  accounting standards.
                                            acquisitions.                                        Source: u.S. Small Bu Sine SS a dmi n i St r a t i o n
• Liquidation Value is the proceeds
                                          • Discount Factors are tangible and
  from quick & orderly liquidation
                                            intangible conditions that exist in
  of assets.                                                                                  VOLUME II, ISSUE 2
                                            a company that reduce its value                   I N S I D E :
• Enterprise Value is the                   below the theoretical Market
  market value of the business              Value of the same company if                      Estimate Your Company’s Value .........3
  including debt.                           those conditions did not exist. In                Meet Fred Doster................................4
                                                             C O N T I N U E D O N PA G E 2   Business Listings................................4
Valuation Methodology,   CONTI NUED fr Om PAGE 1

     other words, those shortcomings               Market (Enterprise) Value is             of each. Although these buyer types
     in your business that increase the            determined by taking a weighted          share the profit objective, their tactics
     risk to the buyer and cause him               average of M&A industry accepted         in obtaining profit vary greatly. We
     to lower his estimate of value. To            calculation methods taking into          sometimes refer to Private Buyers
     maximize value, buyer risk must be            consideration the strength of a          as “job seekers” and they are often
     minimized. Discount Factors include           company’s balance sheet, selling         “refugees of corporate America”.
     but are not limited to the following:         prices for comparable companies,         Although there are a large number of
                                                   growth in total revenues and             private buyers in the market place,
                                                   earnings, and discount factors:          they face the highest personal level
       The Big Four                                                                         of risk when initiating a transaction
       Business Size                               Valuation Methods Used                   and therefore offer the lowest prices.
                                                   By AOCP:                                 PEGs are fewer in number and are
       Industry Type                                                                        strategically focused which further
                                                   • Book Value (Balance Sheet
                                                     Method) — Used To Determine            reduces the number that may pursue
       Revenue Trends (Top Line Growth)
                                                     Adjusted Going Concern Value           a specific project. They formulate
       Profitability Trends (Bottom Line)                                                   their offers based nearly 100% on the
                                                   • DCF — Discounting Future               potential of the acquisition to meet the
       Organizational Factors                        Earnings With and Without              return objectives of their investors.
                                                     Growth (Discount Factors Used          Strategic buyers are typically the least
       Depth and Breadth of Management
                                                     in Calculation)                        price sensitive because they are most
       Importance Of Key Personnel                                                          likely to profit from economies of
                                                   • Industry Sale Comparables
                                                                                            scale and consolidation. At AOCP we ,
       Organizational Structure/policies           • Multiples of Cash Flow                 calculate market value three ways:
       Age Of Workforce                            • Multiples of Revenue                   1. Private Buyer (lowest)
                                                     (Cap of Earnings)
       Operational Factors                                                                  2. Private Equity Group
                                                   • Partner Experience — Integration          (middle to high)
       Geographic Location
                                                     of Experience and Judgment
                                                                                            3. Strategic Buyer (highest)
       Facilities And Equipment Age                  (Discount Factors Considered).
                                                                                            Why leave money on the table by
       Quality Of Operations/systems               The valuation analyst starts by
                                                                                            selling to the wrong buyer?
                                                   conducting research to obtain market
       Regulatory Compliance                       and transaction information to
                                                   determine market comparables.            Company Size
       Financial Factors                           By obtaining and analyzing the           Affects Value:
       Reliability Of Financial Statements         historic financial records of the        Larger companies command higher
                                                   client company, the analyst can then     multiples. Large strategic buyers and
       Lending Environment                         determine EBITDA and then adjust         PEGs realize that the transaction
                                                   for owner’s compensation, perks,         and management costs are similar
       Capital Deficiencies
                                                   and non-recurring items to determine     for both small and medium sized
       Product And                                 SDE. After all of the calculations are   companies resulting in a lower return
                                                   completed, a strong dose of common
       Marketing Factors                           sense, experience & judgment are
                                                                                            on their time for smaller companies.
                                                                                            Seldom will strategic or PEG buyers
       Barriers To Entry And Life Of Patents       then added to the analysis to obtain     consider companies with revenues
                                                   the estimated market value of the        less than $10 million unless the
       Company Or Product Life Cycle
                                                   company for the three buyer types:       acquisition target can be quickly and
       Diversification Of Customer Base            for a private (job seeking) buyer, for   easily consolidated into an existing,
                                                   a private equity fund (PEG) buyer,       larger business that they already
       Misc. Factors                               and for a strategic buyer (a direct or   own. This fact often times leaves
       Legal Structure                             indirect competitor).                    the owners of small businesses with
                                                                                            a singular option: private buyers.
       Stability Of The Industry                   Buyer Types Affect Value:                We want to emphasize that there is
                                                   As noted above, there are three          always a direct correlation between
       Buyer Type And Terms Of Sale
                                                   distinct buyer types with subsets        company size and value.
Industry Type Affects Value:                                                                     E C O N O M I C                                      T R E N D S
Your industry type will “significantly” affect both the                                                CFO Outlook For U.S. Manufacturing Sector
value and the selling terms of your business. In addition
to the generic issues that buyers will consider such
as investment required, special knowledge required,                                           eXPand
professional licenses, and the general business model,
                                                                                                                67%            53%                44%               33%     26%
you must also analyze the effect that industry conditions
will have on your transaction. What are the trends in your                                    contract                         16%                24%               32%     35%
industry? Are competitors or customers moving offshore?
Are customers consolidating? Are large corporations
moving into your space?                                                                                          ‘03            ‘04                ‘05               ‘06    ‘07
                                                                                            SOURCE: CFO MAGAZINE


                                  HYPOTHETICAL EXAMPLES
                          SELLER DISCRETIONARY EARNINGS (SDE)                                                Estimate Your Own
                              by Industry Type & Company Size                                                 Company’s Value
 11          1. FOOD SERVICE
             2. GENERIC RETAIL
                                                                                                                        Multiple of SDE Method
             4. CONSTRUCTION                                                                    Earnings Before Taxes                         $
             5. VALUE ADDED DISTR.
 8           6. CONTRACT MFG.                                                                   + Interest Expense                            $
             7. PROPRIETARY MFG.
                                                                                        5       +Depreciation                                 $
                                                                                                Total EBITDA                                  $
                                                                        S INVE
                                                                                ORY     1       One Time Expenses                             $
                                                                  PLUS INVE

                                                                  PLUS INVENTOR
                                                                               Y        2       Owner’s Compensation                          $
                                                                                                Total SDE                                     $
  1                                                                   COMPANY REVENUE
                                                                                                SDE Multiplier
             $5     $10   $15     $20   $25   $30   $35   $40   $45      $50     $55            Refer To Fig. 1 To Determine The SDE Multiple For Your Industry

                                                                                                Enterprise Value                              $

                Industry Type                         Value As Percentage                       Less Funded Debt                              $
                                                          of Revenues
                                                                                                Transaction Value                             $
      Food Service                                         35% to 50%
         •Independents                                     (low end)
         •Franchises                                       (high end)
      Generic Retail                                       30% to 35%                                                        Revenues Method
      (Increases with revenues)
                                                                                                Company Sales                                 $
      Generic Distribution                                 30% to 50%
      (Increases with revenues)
      Value Added Distribution                             40% to 60%                           Refer To Fig. 2 To Determine The % of Revenues Multiple For Your Industry
      (Increases with revenues)
                                                                                                Enterprise Value                              $
        • General Contracting                              20%                                  Less Funded Debt                              $
        •Specialty Trades                                  30%
      Contract Manufacturing                               60% to 80%                           Transaction Value                             $
      (Increases with revenues)

      Proprietary Manufacturing                            80% to 110%                        As always, we are here for you from Beginning to End.
      (Increases with revenues)
Business Listings
$   Construction Machinery & Equipment Dealer
    Annual Revenues $44,000,000
    Adj. EBITDA $1,700,000
$   Independent Distributor to the Mining Industry
    Annual Revenues $19,100,000                                We are pleased to announce the
    Adj. EBITDA $1,200,000                                     addition of Fred Doster to the Alpha
$   Blank Video, Data, and Disc Media Distributor              Omega team to head our new
    Annual Revenues $13,100,000                                Kentucky office. “Fred” has a strong
    Adj. EBITDA $1,400,000
                                                               business background that includes
$   Logistics Transportation Operation
    (Moving & Final Mile Delivery Service)                     over 20 years of service to public
    Annual Revenues $9,440,000                                 and privately held manufacturing
    Adj. EBITDA $403,000                                       and retail companies such as
$   Design-Build, Commercial & Industrial                      Pillsbury (Division Controller), Perry
    General Contractor
    Annual Revenues $6,800,000                                 Oceanographics (VP Finance),
    Adj. EBITDA $630,000                                       Camping World (Treasurer) and Minit
$   Home and Hearth Products Distributor                       Mart Foods (CFO). In these capacities, he was responsible
    Annual Revenues $6,300,000
    Adj. EBITDA $690,000                                       for a variety of complex acquisition and divestiture activities.
$   Medical Device Manufacturer
    Annual Revenues $5,100,000                                 Since 1994, Fred has worked independently as a financial
    Adj. EBITDA $1,000,000                                     consultant and investment banker for business owners,
$   Ticket & Tour Operator                                     private equity funds, and individuals selling, buying and
    Annual Revenues $3,900,000                                 recapitalizing privately held businesses.
    Adj. EBITDA $287,000
$   Value Added Distributor to the Coal Mining Industry        Fred earned Bachelor and Master of Science Degrees in
    Annual Revenues $3,100,000
    Adj. EBITDA $415,000                                       Accounting from Syracuse University and University of Miami
$   Mechanical Contractor (HVAC & Electrical)                  (FL), respectively. Fred resides with his wife, Jennie, in
    Annual Revenues $2,800,000                                 Lexington, Kentucky.
    Adj. EBITDA $213,500
$   Online Retailer, U.S. Produced Japanese Anime Products     If you’re interested in selling your company, please call
    Annual Revenues $2,650,000
    Adj. EBITDA $400,000                                       Fred at Alpha Omega’s new Lexington, Kentucky office:
$   Specialty Manufacturer                                     859.223.8157 or send Email to
    Annual Revenues $2,560,000
    Adj. EBITDA $600,000

                        Learn more about Alpha Omega Capital Partners at

                                                             Pre-sort Standard
                                                                US Postage
                                                               richmond VA
       7202 Glen Forest Dr., Suite 300                         Permit # 240            Telephone Directory 
       Richmond, Virginia 23226
                                                                                       Richmond, VA Office:
                                                                                       Robert Louthan ...........804.282.7680 (307)
                                                                                       Larry Miller ................ 804.673.2589
                                                                                       Robert Mitchell............804.282.7680 (306)
                                                                                       George Sydnor ............804.282.7680 (302)
                                                                                       Anthony Vincent ..........804.282.7680 (303)

                                                                                       Lexington, KY Office:
                                                                                       Fred Doster .................859.223.8157

                                                                                       New York, NY Office:
                                                                                       Paula Brancato............212.608.2724

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