Transcript Slide 1
NQLA Conference 25 May 2011
Valuing Businesses and Property after
Matrimonial Breakdown
What is Valuation?
Purpose of Valuation
Is a Valuation necessary?
The Valuation process
Types of methodologies
How business Valuer conducts process
Issues to take into consideration for matrimonial breakdown
Issues for Valuers
The application of retrospectivity (Kizbeau case)
Summary for Lawyers
Appendix 1 – 41 factors affecting a Business Valuation
What is valuation?
“Valuation can be described as estimating a fair price for
the parties to exchange an asset having regard to the risk
and the expected return of the asset”
Concept of risk and return – key to valuation
Purpose of a valuation
Why are valuations conducted:
“to arrive at a value as a reference point for a transaction”
Purpose of a valuation
A valuation must have regard for:
-
Expected returns
-
Risk free rate
-
Comparable returns of similar assets or classes of assets
-
Risks of the returns
-
Other variables
Market value
“the price that would be negotiated between an knowledgeable
and willing but not anxious buyer and a knowledgeable and
willing but not anxious seller acting at arm’s length within a
reasonable time frame.”
(Lonergan, 2003)
Alternatives to Market value definition
Intrinsic value
Fair market value
Realisable value
Going concern value (primarily for businesses)
Present value or net present value
Investment
Deprival value
Intrinsic Value
Intrinsic Value of a business is defined as being the value “inherent”
therein, “belonging to”, or “arising from” its “true or fundamental nature”.
Thus, the Intrinsic Value of a business equates to its value, to the
owner, in its present form, independent on the amount for which it can
be sold.
Intrinsic Value and Market Value
“Intrinsic Value” and “Market Value” cannot be one and the same,
because the value of a business, “in its current operating state”, includes
assets and liabilities that are not transferred to a purchaser, in a sale
thereof.
It may be described as “true value” inherent in the object of the
valuation. This may not be a reflection of current market price or
realisable value, but is rather an assessment of value computed on
true worth, irrespective of any other considerations. Intrinsic values
change less frequently, as a rule, than market values.
Intrinsic Value Assets
Assets included in the “Intrinsic Value” of a business, not transferred to
a buyer of the business, i.e., excluded from its “Market Value”, include:
Cash at Bank
Trade Debtors
Utilities Deposits
Intrinsic Value Liabilities
Liabilities accounted for in establishing the “Intrinsic Value” of a
business, not transferred to a buyer of the business i.e., excluded from
its “Market Value”, include:
Trade Creditors
Employee PAYG Tax Deducted
Employer Superannuation Contributions
Intrinsic Value and Market Value
Nevertheless, for “a knowledgeable and willing, but not anxious buyer
and a knowledgeable and willing, but not anxious seller, acting at arms
length, within a reasonable time frame”, “Market Value” would normally
equate to “Intrinsic Value”, adjusted for the above exclusions.
Price v value
“Price is what you pay, value is what you get”
(Kilpatrick 2006)
Price:
- is the amount realised in a transaction
- Price is objective
Value:
- is an estimate at what price should be
- Value is subjective
In a going concern business no two Valuers are
going to agree exactly on a value
Conceptual framework
Valuation is built around the concepts of risk and return
Put simply, the value of an asset (Business) is the
present value of the future cash flows of that asset
This applies to businesses and property
What is being valued?
Business
Shares
To value the shares you need to value the business
Is a Valuation necessary?
Is it profitable after deduction of owners wages and other adjustments
Has it been incurring losses
Is it solvent
Is it a going concern
Is it only worth in situ plant and equipment value
Does one of the parties have specific expertise
Is there any goodwill
Is business saleable
Small business – is the profit no more than the business owners
wage “Buying a job”
Maybe pertinent to just value plant and equipment
The valuation process
1. Understanding the business, its risks and industry
2. Selecting the relevant methodology
3. Determining the variables
4. Determine the result
5. Review the result
1. Understand the company’s business
PORTER MODEL – introduced in 1980’s
Understanding the business, its risks and industry, including:
- Barriers to entry
- Quality of management
- Company’s competitive position
- Industry and outlook
- Competition
Porters 5 forces
2. Select relevant methodology
Standalone value / value to acquirer
Methodologies:
- DCF
- Capitalisation multiples
Which methodology to use
Depends on information available and circumstances
Quite a number of issues are considered before determining the
methodology for valuation
Terms of premises occupancy can
determine the appropriate method for
valuing a business
E.g. If business is expected to have a limited life span business should
be valued by DCF method only
Types of methodologies
1. Relative
Capitalisation of Future Maintainable Earnings.
Aka Industry Peer Comparison. Apply an appropriate
multiple to anticipated future earnings to derive a
valuation.
E.g.: EBITDA, EBIT, PE, multiples
2. Intrinsic
Discounted Cash flow (DCF) approach.
Involves the calculation of Net Present Value by
applying a discount rate to projected cash flows.
3. Contingent
Claims
Real Options. Views investment decisions as options
which acknowledge the value of flexibility in businesses.
Involves valuing growth/deferral/ abandonment options.
4. Others
e.g. Industry-specific rules of thumb, asset value
comparable sales method
Capitalisation multiples
Capitalisation Multiples:
Surrogates for DCF
Less reliable
Capture growth and risk in multiple
Requires comparable companies
Issues with each method:
- EBITDA (Earnings before interest tax depreciation and amortisation)
- EBITA (Earnings before interest tax amortisation)
- EBIT (Earnings before interest tax)
- PE
Discounted cash flow
DCF is theoretically the best methodology
However it is not always practical
Therefore it is mainly used for:
- Lumpy cash flows
- Start ups
- Resource projects
- Finite timeframes
Capitalisation multiples - Advantages
Easy to understand and extensively used in practice
Inputs (published financials, short-term forecast, comparable
multiples) are widely available
Ability to benchmark against industry
Works well for stable established business
Capitalisation multiples - Drawbacks
Seen as less rigorous/simplistic
Inconsistency in accounting practices;
depreciation, amortisation, tax outstanding
Small sample size and sample reliability
Range of multiples are often wide and outliers exists
Uneven cash flows – start-ups, and turnarounds
3. Determining the variables
DCF
- Discount rate / WACC (weighted average cost of capital)
- Cash flow variables e.g. foreign exchange
Capitalisation multiples
- Earnings to be multiplied
- Earnings multiple based on comparable companies
Other detailed research
4. Determining the result
What is the result of the DCF of multiple valuation?
Sensitivities around key assumptions
5. Review the result
Cross check to other methodologies, i.e. what
multiples does the DCF valuation provide?
Check for reasonableness
Stand back and look at result
- Does it make sense?
- Should the company be worth more or less?
- Do the assumptions need revision?
Selection of appropriate maintainable
profits figure
“The selection of an appropriate maintainable profits figure is a matter of
judgment depending on the circumstances. For example, a company
may be in a position of short term decline, as a result of industry
pressures, or internal management problems.
In such a situation, it is important to adopt a longer term view so as to
discount any short term irregularities in the company’s profitability.”
(Lonergan)
Intrinsic value established by
capitalisation of future maintainable
earnings (FME) method
Quite common for small business operators not to prepare estimates
of future net cash flows
Reasons for this include:
a)
do not believe they can be reliably predicted
b)
simply do not have any idea about their future net cash flow
c)
not willing to incur the cost of professional assistance to
prepare them
Method preferred by small business operators
CAP FME method, an Earnings before Interest AFTER TAX
Capitalisation Rate is applied to expected FME
Criticisms of future maintainable
earnings methodology
“Too many FMP based valuations are flawed in that they automatically
employ historical profits as a proxy for FMP without undertaking
sufficient critical examination of past performance and likely future
events.
An understanding of the future of a business is essential for an accurate
valuation, yet is omitted when historical profits are used in isolation.”
Lonergan
Noted American valuation text author, Shannnon P. Pratt, also endorses
that view:
“There is a mind set that can be described as the ‘mechanistic
mentality’, for lack of a better expression. It mechanically relies on past
data, without considering whether adjustments should be made, or
whether it is reasonable to expect future results to conform to past
results.
Rules of thumb market value methods
Criticism is rules of thumb do not provide a real value of a
business in terms of the earnings derived from the net
assets employed
How does Business Valuer conduct
process?
Obtain last 3 - 5 years financials (tax returns preferable)
Review profit and loss for last 3 - 5 years
Establish whether future cash flow forecasts have been undertaken
and if so review same
Ascertain if owners wages have been paid and commercial rent
charged
Determine if any other applicable adjustments
Take into account inflation
Calculate adjusted net profit
Review assets and liabilities
Review Balance Sheet
Land and buildings – consult Property Valuer (not to be included in net
tangible assets calculation)
Plant & equipment/vehicles – obtain specialist valuer of plant and
equipment/vehicles
Stock – determine obsolete stock
Debtors – ascertain collectability
Review assets and liabilities
Work in progress – ascertain position
Directors loan accounts
Review other assets: and adjust for non business assets
- below market value
Review liabilities:
- normally bank borrowings, (not to be included in net tangible assets
calculation) trade creditors, ATO payable
Have any assets been omitted?
Most obvious – Goodwill
May be patents or trademarks (intellectual property)
Goodwill definition
The High Court of Australia provides a definition of Goodwill, from a
legal perspective: “For legal purposes, goodwill is the attractive force
that brings in custom and adds to the value of the business. It may be
site, personality, service, price or habit that obtains custom.”
Valuing Goodwill or other tangible assets
component of the value of a business
Whether business valued by DCF, CAP FME or combination
DCF and terminal value method, value of goodwill or other
intangible assets therein calculated by total value of business
Minus
The value of the tangible assets
How does Business Valuer conduct
process?
Alternatively described as price earnings ratio method
i.e. A Price Earnings Ratio (PER) is applied to expected FME to
establish the value of the business so that:
e.g. A PER of 5 is equivalent to a Capitalisation rate of 20%
most small business PER 2-5 (i.e. Multiples of 2-5)
Applies multiplier
How does Business Valuer conduct
process?
All Business Valuations, whether by the:
Discounted Future Net Cash Flows Method,
Capitalisation of Future Maintainable Profits Method,
or the Combination Discounted Future Net Cash Flows
and Terminal Value Method
should be based on After Tax Figures!
Calculation of Goodwill
E.g. Calculated FME to be $200,000
after adjustments
using a multiplier of say 4 (25%)
$800,000
if tangible assets
liabilities
Net tangible assets
Goodwill
$700,000
$300,000
$400,000
$400,000
Continuing businesses with no Goodwill
Value of business may be less than the value of net
tangible assets
Therefore no goodwill and value is tangible assets
less value of liabilities
Businesses discontinuing or closing
down
Value represented by value realised on disposal
Issues to take into consideration for
Matrimonial Breakdown
Saleability of business
Age of respective parties (is retirement looming)
Succession planning
Parties particular skill set
Whether business will be continuing
Issues for Valuers
Can only use figures they have been provided with
Does not undertake an audit of the business
Difficulties re cash economy (cannot have your cake and eat it)
Important for valuer to clearly articulate their assumptions
Necessary to comply with Valuation Standard Apes 225 –
Valuation Services
Issues for Valuers - continued
Expert witness if appointed by court their
overriding duty is to assist court
Expert witness is not an advocate for a party
Combine service trusts and other entities
The application of retrospectivity for
valuing the interests of an exiting equity
holder
Pertinent to divorce settlements where the interest of one of
the parties is to be transferred to the other party who will
continue to conduct the business
Not a hypothetical sale of a business to a hypothetical seller
Interest not available for sale on open market
Interest – intrinsic value method
Rather, Profits derived, subsequent to the exiting date, which may not
be ascertainable, until some time later, may be adopted as the Future
Maintainable Profits of the Business, by applying the principle
expounded in Kizbeau’s case:
“Although the value is assessed, as at the date of the acquisition,
subsequent events may be looked at, in so far as they illuminate the
value of the thing, as at that date.”
Kizbeau Pty Ltd v W G B Pty Ltd McLean [1995] HCA 4; (1995) 69 ALJR 787; (1995) 131 ALR 363; (1995) 184
CLR 281 (11 October 1995) [100%]
(From High Court of Australia; 11 October 1995; 50 KB)
Summary for Lawyers
1. Is a valuation required?
2. Establish clearly what is to be valued and instruct accordingly
3. Review methodology and assumptions used
4. If applicable query/challenge the valuation
Some incorrect assumptions or an overly generous multiplier can
have a significant effect on the end result for your client
e.g. If multiplier should be 3 and 4 is used and entity generated
$300,000 difference in the value is $300,000
Appendix 1
Factors Affecting a Business Valuation
Factors affecting a business valuation
Business History
Business Reputation
Market Share
Potential for growth
Industry conditions
Superiority
Vulnerability
Political and economic outlook
Cash flow
Management / staff competency
Reliance / non-reliance on founder
Factors affecting a business valuation
Production capacity (if applicable)
Ability to increase revenues
Cost competitiveness
Ability to reduce costs
Business’s use of technology
Comparable businesses
Comparable industries
Product / service quality and competitiveness
Encumbrances (if any)
Assets for sale – their condition, their remaining useful life
Factors affecting a business valuation
Prevailing legal issues (if any)
Ease of operation
Attractiveness of the industry – competitive forces, power of
suppliers, power of customers, risk of new entrants and risk of
substitutes
Rate of return
Potential to improve customer relationships
Ability to borrow against business or assets
Performance results and ratios
Location
Presentation of premises
Factors affecting a business valuation
Existing relationships with suppliers and customers
Intellectual property
Intangibles including relationships and contacts
Goodwill
Condition of books and records
Computerisation
Tax implications
Alternative opportunities
Affordability
Working conditions (including hours and days)
Property lease conditions and landlord
Please note that this is an incomplete list of just some of the
factors that can influence the valuation of a business.