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Valuation Overview and Commentary print this article


This seminar will introduce the participants to the basics of business valuation and appraisals. The differences between valuations and appraisals and the major valuation approaches and methods will be discussed, allowing the participants to understand the key concepts dealing with establishing a company's fair market value.


I) Introduction

A) Presenter's background and experience (see Bio)

B) Why obtain business valuation/appraisal?

1) contemplated sale or purchase
2) estate settlement
3) buy-sell agreement between partners
4) aid in obtaining bank loan or investment money
5) establish insurable value
6) ESOP purposes
7) divorce

C) How much do they cost? (valuations as little as $700; appraisals up to several thousand dollars)

II) Overview of Business Valuations and Appraisals

A) Valuations by anyone;

Appraisals by certified parties only (appraisals require understanding of appraisal theory/practice, general business principles, relevant industry insights, detailed factual knowledge of company and the business environment)

B) Typical components of valuations/appraisals (formal appraisal versus letter appraisal)

1) summary conclusions
2) function and purpose (e.g. to assist seller in establishing asking price and to determine fair market value)
3) definition of value (FMV defined as willing buyer and seller, arm's length, full information, reasonable time period, no duress, etc.; as opposed to book value, liquidation value, investment value, replacement value, loan value, etc.)
4) definition of property ( stock versus assets, personal versus real property)
5) description of business
6) valuation approaches (income, cost and market)
7) synthesis of valuation approaches ( typically not a weighted average)
8) assumptions and limiting conditions (appraiser has not audited information, effective as of certain date only, valuation effective for stated function and purpose only, calculated cash flow includes adjustment for family members/imputed rent)
9) highest and best use (legally permissible, reasonably feasible usage generating highest economic benefit to the owner)

C) Differences between small versus large companies

1) privately held versus publicly traded
2) compiled statements versus audited statements
3) active owner versus passive owners
4) higher discount rates versus lower discount rates
5) lower multiples of cash flow versus higher multiples of cash flow

D) Valuation results based upon all cash price E) Terms will impact final purchase price

1) higher down payment, shorter payback period, lower interest rate, more collateral, personal guarantees will reduce the required purchase price
2) purchase of stock will allow seller to accept lower price (tax advantages)

III) Common Valuation Approaches

A) Income Approach (multiple of cash flow or discounted cash flow; these are inverse of each other)

B) Cost Approach (typically asset oriented, e.g. sum of the assets minus sum of the liabilities)

C) Market Approach (find similar companies recently sold)

IV) Common Valuation Techniques/Methods

A) Multiple of cash flow or earnings

1) small businesses: multiple of adjusted cash flow (ACF) adjusted cash flow (ACF) is:
net income plus owner's salary/payroll taxes plus owner's perks (auto, life and health insurance, personal travel/entertainment, personal use of products/services, other discretionary expenses) plus depreciation/amortization plus interest expense plus or minus one-time, non-recurring expenses/revenues
2) larger businesses: multiples of net income, EBIT or EBITDA
3) the greater the cash flow, the higher the multiples:

a) ACF up to $250K, multiples of 1 to 3
b) ACF between $250K and $500K, multiples of 3 to 5
c) ACF between $500K and $1m, multiples of 5 to 7
d) ACF over $1m, multiples over 7

Note: these are generalizations only (all other things equal), unique industries and firms possess unique features and multiples (consult a professional)

B) Rules of thumb

1) are industry specific
2) are rough estimates of value only
3) should be used in conjunction with other methods
4) examples are:

a) accounting/tax firms: one times anticipated gross revenues (requires earnout)
b) travel agency: 3% to 7% of annual gross commissions
c) ISP's: $150 to $350 per customer
d) lawn maintenance: 30% to 50% of annual revenues
e) small retail: 1 to 2 times ACF plus inventory

C) Discounted cash flow analysis

1) the "purest" valuation method
2) based upon "present value" and the "time value of money"
3) used primarily for middle-market and M&A transactions

D) Excess Earnings method

1) first promulgated by IRS, which now shuns its usage
2) value of business is equal to FMV of tangible assets plus capitalized value of company's "excess" earnings (earnings above average return on similar assets)

E) Use of Market Comps

1) private versus publicly held comparables
2) comparability issues (equally desireable substitute, similar circumstances and terms, reliable and complete information)
3) data sources

a) VR Business Brokers (949-8825, ext.14), BIZCOMPS, Institute of Business Appraisers
b) Value Line, S&P, Hoovers, D&B, etc.

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