Frequently Asked Questions About Business Valuations
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Transcript Frequently Asked Questions About Business Valuations
Pesented by:
Brooke A. Liggett, CPA, CVA
“How much is my business worth?”
What is a Business Valuation?
The act or process of determining the value of a
business enterprise or ownership interest
therein
Valuing a bundle of rights
When is a business valuation needed?
Mergers and Acquisitions
Buy/Sell Agreements
Employee Stock Ownership Plans (ESOP)
Expert Testimony/Litigation Support Damage
Estate Planning and Taxations
Gift Taxes
Charitable Contributions
Marital, Partnership and Corporate
Dissolutions
Who Needs Business Valuations?
Attorneys
Courts/judges
Business owners
Insurance companies
Estates
Additional users of financial statements
Business Valuation Considerations
Type of entity to be valued
Purpose of valuation
Valuation date
Standards of value
Premise of value
Business Valuation Considerations
Type of entity to be valued
Purpose of valuation
Valuation date
Standards of value
Premise of value
Standards
SSVS #1
Revenue Ruling 59-60
Definition of Value
The value of an interest in a closely held
business is usually considered to be equal
to the future benefits (income) that will be
received from the business; discounted to
the present value.
Basis of Value
A valuation is based on a hypothetical
arms-length sale between a buyer and
a seller, usually for cash.
Fair Market Value
The price at which the property would
change hands between a hypothetical
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.
RISK VS RETURN
R
E
T
U
R
N
Privately Held Stocks
Lesser Quality Stocks
High Quality Growth Stocks
Long Term Bonds
U.S. Treasury Bills
RISK
Valuation Methodology
Understanding the business
Valuation Methodology
Analyze the
financials
Normalize the
financials
Valuation Methodology
Analyze the adjusted
financials
Financial ratios
Industry averages
Valuation Methodology
Estimate future earnings stream
Business Valuation Methodology
Develop a capitalization rate
A multiplier used to convert a defined stream
of income to a present indicated value.
(A Function of Risk!)
Developing the Capitalization Rate
BUILD-UP METHOD
Risk-free Rate
Risk Premium
Size Premium
Specific Company Risk Premium
Build Up Method
Rate
Safe rate
Percentage
5.50%
Equity risk
7.80
Small company risk
7.70
Specific company risk
4.00
Indicated Capitalization Rate
25.00%
METHODS OF VALUATION
Market
Income
Approach
Approach
Asset-based
Approach
Asset Approach
Based on the principal of substitution
In other words, what a buyer would pay for
a similar asset of equivalent utility
Often the primary approach when the
business has losses or nominal projected
cash flow or is asset-intensive
Can be used for both control and minority
level valuations
Asset Approach – cont.
Net Asset Value (NAV) Method – all assets
and liabilities are adjusted to current values
NAV = assets less liabilities
Pitfall – if done incorrectly fails to capture
intangible and other unrecorded assets
Excess Earnings Method – hybrid of the asset
and income approaches
Market Approach
Also based on the principal of substitution
A buyer would pay no more than the cost to
acquire a substitute property with the same
utility
Can be used for both control and minority
level valuations
Market Approach – cont.
Two methods generally used:
Guideline public company method; based on sales of
similar publicly traded company shares
Can be difficult to use for small and medium sized
companies due to size, capital structure, and other
differences
Merger and acquisition transaction data method;
based on acquisition of similar privately held or
publicly traded companies
Works best when companies are sufficiently similar to the
subject business
Positive correlation between price and multiples used is
desirable
Exercise caution with dated transactions
Income Approach
Value is based on the present value of
expected future benefits to be derived from
ownership
Discounted or capitalized cash flow methods
are typically utilized for operating
companies
Used for both control and minority level
valuations
Income Approach – cont.
Two methods generally used under
the income approach:
Discounted Cash Flow Method
– Projects future cash flows for a number of
years
– Terminal value
Capitalized Income Method
– Estimated future cash flow is capitalized
– Often used for companies with stable growth
rates
Most
Common Methods Used
Adjusted Net Asset
Method
Excess Earnings
V
A
L
U
E
(Return on Assets)
Reasonable Rate
Method
Discounted
Earnings/Cash Flow
Method
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Valuation Adjustments
Key issue in many valuations
A number of considerations, including
subjective assessments, are considered when
determining the appropriate
discounts/premiums or lack thereof
The standard of value will impact the
discounts/premiums that may be appropriate
Prerogatives of control of the ownership
interest being valued will also impact
adjustments
Discounts (And Premiums)
Minority Interest Discount
Lack of Marketability Discount
Premium for Pass-through Entity Tax Benefits
Minority Interest Discount
Minority interest deals with the relationship
between the interest being valued and the total
enterprise. The primary factor is how much
control the minority interest has over the
particular entity.
Minority Interest Discounts/
Control Premiums
Controlling interest typically has a greater value
(pro-rata)
Control does not always mean more than 50% - can be
defined differently in the entity’s governing agreements
Large enough block to influence management decisions
(e.g. swing vote)
State law can determine ownership level necessary for
control
The potential benefits of optimizing the economic benefit
stream
Minority interest is typically discounted
Minority interest can generally be defined as less than
50%, or a lack of ability to affect management decisions
Marketability Discount
The concept of marketability deals with the
liquidity of the interest—how quickly and certainly it
can be converted to cash at the owner’s discretion.
Marketability Discounts
Control vs. minority interest can make a
difference
The ability to affect a sale
Expected holding period can impact size
of discount
Restrictions on transferability can be significant
Pool of potential buyers?
Marketability Discounts – cont.
Mandelbaum Factors
Financial statement analysis
Company dividend policy
The nature of the company, its
history, its position in the industry,
and its economic outlook
Company's management
Amount of control in transferred shares
Restrictions on transferability of stock
Holding period for stock
Company's redemption policy
Costs associated with making a public offering
Marketability Discount – cont.
An unlisted closely-held stock of a corporation in
which trading is infrequent and which therefore lacks
marketability, is less attractive than a similar stock
which is listed on an exchange and has ready access
to the investing public.
Premium for Pass Through Entity Tax
Benefits
Adjustment for dividend tax avoided
by S-Corporation shareholders
Discount Ranges
Minority Interest Discounts are usually in
the range of 25% to 40%
Lack of Marketability Discounts are
usually in the range of 20% to 30%
Discounts are Applied Multiplicatively
FMV of XYZ, Inc.
Less Minority Interest
Discount (30%)
Less Marketability
Discount (25%)
Fair Market Value
$ 2,150,000
(645,000)
1,505,000
(376,250)
$1,128,750
Valuator Qualifications
Valuing a business requires a significant amount of
experience and training
Accredited in Business Valuation Credential (CVA)
Backed by the National Association of Certified
Valuation Analysts (NACVA)
Experience requirements
Education requirements
Training requirements
Comprehensive examination
VALUE
Reasonableness Check
Determination of Value
Select Appropriate Premiums and Discounts
Determine Approaches and Methods
Risk Analysis
Determination of Benefit Stream
Education
Defining the Engagement
Questions?
For additional information, please contact:
Brooke A. Liggett, CPA, CVA
[email protected]
417-882-4300
Kirkpatrick, Phillips, & Miller CPAs
www.kpmcpa.com