Business Valuation in Exit Planning

Sean Saari, CPA/ABV, CVA, MBA

Robert A. Ranallo, CPA/ABV, JD, CVA, CFF

May 23, 2013

After completing the session, participants will be able to…

• Recognize the methods typically utilized to value a business or ownership interest and understand their basic application

• Identify normalizing adjustments and assess their impact on value

• Reconcile values derived from multiple valuation approaches

• Capitalize on planning opportunities that help maximize the value received for the sale of a business

“In the long run, men hit only what they aim at.” – Henry David Thoreau

LEARNING OBJECTIVES

• Valuation Basics

• Case Study / Valuation Analysis Valuation Approaches Control and Marketability Considerations Planning Considerations

AGENDA

“There is no such thing as an absolute value in this world. You can only estimate

what a thing is worth to you.”

Charles Dudley Warner 1829-1900, American Writer

QUOTE OF THE DAY

• Standard of Value Fair Market Value Strategic / Investment Value

• Sales Price = Value?

• Type of Value Equity Value Market Value of Invested Capital (MVIC)

Equity Value + Interest-Bearing Debt

Enterprise Value (EV) MVIC - Cash

VALUATION BASICS

Reconciling Equity Value vs. Enterprise Value

VALUATION BASICS

Cash

Total Enterprise

ValueEquity Value

Debt Value Net Debt

• Asset Approach• Income Approach• Market Approach• LBO Method• Rules of Thumb

VALUATION APPROACHES

Practice TipRemember that both fair

market value and strategic value can be determined using these approaches depending upon the benefit stream used

in the valuation analysis.

ASSET APPROACHValuation Methodologies• Adjusted net asset method

Basic Steps• Adjust assets to fair market / strategic value• Adjust liabilities to fair market / strategic value

Pros• Provides “floor value” of the company• Relatively simple analysis

Cons• Typically provides a liquidation value which is

often not appropriate for healthy businesses• Rarely utilized in transactional value

Valuation Methodologies• Discounted cash flow method• Capitalization of cash flow method• Capitalization of earnings / Discounted future earnings

Basic Steps• Determine benefit stream and make normalizing adjustments as

appropriate• Determine discount/capitalization rate• Determine cash flow adjustments• Discount / capitalize cash flows

Pros• Provides most “company-specific” value• Can appropriately incorporate projected growth of the business

Cons• Most involved of the valuation analyses• May be disagreements over likelihood of meeting projections

INCOME APPROACH

Other Considerations• Mid-Period Discounting• Non-Operating Assets• Direct to Equity vs. Debt-Free Valuation• Normalizing Adjustments

“It’s the little details that are vital. Little things make big things happen.”

– John Wooden

INCOME APPROACH

• FMV vs. Strategic normalizing adjustments

• Compensation Family members paid other than FMV Officers paid other than FMV

• Personal expenses

• Related party transactions other than FMV

• Non-recurring income or expenses

• Expense trends

ADJUSTMENTSNORMALIZING

Valuation Methodologies• Guideline transaction method• Guideline public company method

Basic Steps• Determine benefit stream and make

normalizing adjustments as appropriate• Find comparable transactions/guideline

public companies• Calculate valuation multiples and apply to

subject company• Make adjustments as necessary to arrive

at equity value (if necessary)

MARKET APPROACH

Pros• Incorporates market conditions and prices

paid in recent relative transactions• Easy to explain and apply

Cons• Can be misleading if debt not appropriately

considered EBITDA multiples typically result in an

Enterprise Value, not an Equity Value

• In certain industries, there may be a lack of comparable transactions or public companies

MARKET APPROACH

Valuation Methodologies• LBO Method

Basic Steps• Prepare discounted cash flow analysis• Estimate financing and capital structure• Determine implied rate of return at

various exit points

LBO METHOD

Pros• Allows seller to determine maximum price that the

byer will be willing to pay based on the amount of debt financing available and rate of return required

Cons• Simply a derivation of the discounted cash flow

method• Not as widely-utilized as basic income and market

approaches• Buyer may not have reliable information available

regarding the extent of financing that the seller can obtain

LBO METHOD

Valuation Methodologies• Rule of Thumb

Basic Steps• Identify rule of thumb valuation metrics• Apply rule of thumb to the subject company

Pros• Simple application

Cons• Can result in misleading values• Often lacks support• Not permitted to be used as a sole valuation method

by most valuation standards

RULES OF THUMB

Asset Deal vs. Stock Deal• Asset Deal

Typically preferred by buyers Allows for step-up in basis of acquired assets, which may allow for

higher purchase price C Corporation sellers are subject to double taxation

• Stock Deal Typically preferred by sellers No step-up in basis in acquired assets for buyer Single level of seller taxation

OTHER VALUATIONCONSIDERATIONS

OTHER VALUATIONCONSIDERATIONS

Asset Deal vs. Stock Deal

Control Discounts / Premiums• Two options

Model in cash flows Discreet discount / premium

Marketability Discounts• Controlling ownership interest

Typically 0%-15%

• Non-controlling ownership interest Typically 25%-40% Would apply if trying to sell a non-controlling interest

when the business as a whole is not being sold

CONTROL & MARKETABILITYCONSIDERATIONS

Button Down Financial Reporting• Get in compliance with GAAP• Consider audited/reviewed F/S

Standardize Processes• Make it easy for someone new to come in and run the

business• Reduce reliance on key employees

Reverse Engineer Potential Buyer Preferences• Think about what characteristics would be desirable to

potential acquirers in the industry and work to implement them

PLANNINGCONSIDERATIONS

• Implement confidentiality agreements with employees

• Identify and reverse negative income/expense trends

• Diversify the customer base

• Right-size working capital

PLANNINGCONSIDERATIONS

After completing the session, participants will be able to…

• Recognize the methods typically utilized to value a business or ownership interest and understand their basic application

• Identify normalizing adjustments and assess their impact on value

• Reconcile values derived from multiple valuation approaches

• Capitalize on planning opportunities that help maximize the value received for the sale of a business

SUMMING UP

“Things only have the value that we give them.”

Moliere 1622-1673, French Actor/Playwright

CLOSING QUOTE

QUESTIONS?Bob Ranallo, CPA/ABV, JD, CVA, CFFPartnerPhone - (440) 449-6800 x7131Email - branallo@skodaminotti.com

Sean Saari, CPA/ABV, CVA, MBASenior ManagerPhone - (440) 449-6800 x7221Email - ssaari@skodaminotti.com