Business Valuation:
Where Should I start and what should I know
Brian A. Reed, CPA, CVA
Partner, Transaction Advisory Services
Weaver
Overview
• Identify the events and reasons when an independent
business valuation may be needed
• Understand the key factors involved in the valuation of a
privately held business
• Describe a typical valuation engagement, process and report
• Discuss discounts and premiums
• Court case updates
Reasons to perform a business
valuation analysis
• Gift and estate tax purposes
• Marital disputes
• Minority shareholder
disputes
• Buy-sell agreements
• Employee stock ownership
plans (ESOPs)
• Management buyouts
•
•
•
•
•
Lost profit analyses
Mergers and acquisitions
Purchase price allocations
Goodwill impairment analysis
Stock option valuation
Standards and Premise of value
• Standards of value
– Fair market value
– Fair value
– Investment value
• Premise of value
– Going concern value
– Orderly liquidation value
– Forced liquidation
Standards of value
• Revenue ruling 59-60 defines fair market value as:
– “ … in effect, it is the price at which the property would change hands
between a 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.”
• ASC Topic 820, Fair Value Measurements and Disclosures (ASC 820)
(formerly FASB Statement No. 157, Fair Value Measurements) defines fair
value as:
– “[T]he price that would be received to sell an asset or paid to transfer a
liability in an orderly transaction between market participants at the
measurement date."
Standards of value
• Revenue ruling 59-60 outlines approaches, methods and
factors to consider in valuing shares of closely held
corporations
– It was meant to apply to valuations for estate and gift tax
purposes
– Has been accepted in the valuation community as a basis
for all valuations of interests in closely held businesses
without a public market
– Establishes the factors that should be considered as part of
a valuation analysis
• Nature of the business and the history of the Company
Standards of value
• Industry outlook
• Book value of the stock and the financial condition of
the Company
• Earnings capacity of the Company
• Dividend paying capacity
• Assessment of whether the Company has goodwill or
other intangible value
• Sales of the stock and the size of the block of stock to be
valued
• Market price of stocks of corporations engaged in the
same or similar line of business
Standards of value
• Fair value as defined by ASC 820 includes the following
components:
– Exit price
– Market participants
– Orderly transaction
– Principal or most advantageous market
– Highest and best use
Standards of value
Valuation Purpose
Gift and estate tax
ESOPs
Financial acquisitions
Dissenting stockholders actions
Applicable standard of value
FMV
FMV
FMV
Legal fair value (in most states)
Minority oppression statutes
Legal fair value (in most states)
Strategic acquisitions
Buy-sell agreements
Marital dissolution
Investment value
Anything parties agree on
No standard of value specified in
most states – court specific
Accounting fair value as defined by
ASC 820
Financial reporting value
Valuation Methodologies
Valuation
methodologies
Publicly traded
comparable
companies
Comparable
transactions
analysis
• “Public market
valuation”
• “Private market
valuation”
• Value based on
market trading
multiples of
comparable
companies
• Value based on
multiples paid for
comparable
companies in sale
transactions
• Applied using
historical and
prospective
multiples
• Generally includes
a control premium
• Does not include a
control premium
Income approach
Other
• Present value of
projected free cash
flows
• Adjusted book
value (Cost
approach)
• Incorporates shortterm and long-term
expected
performance
• Dividend
discount model
• Risk in cash flows
and capital
structure captured
in discount rate
• Liquidation
analysis
• Break-up
analysis
Valuation Methodologies
• Publicly traded comparable companies or guideline publicly traded
company analysis
– Revenue Ruling 59-60 indicates that the market approach should at
least be considered
– There are rarely, if ever, companies that are exactly like the subject
company
– The common issues surrounding the use of comparable company
information includes the following:
• Are the public companies selected by the valuation analyst
sufficiently "comparable" to the subject company?
• What specific factors make two companies similar?
• What adjustments are appropriate, if any, to the chosen market
multiple?
• Which market multiple is most appropriate?
Valuation Methodologies
• Publicly traded comparable companies or guideline publicly
traded company analysis
– Steps to be considered under the guideline company method:
• Step 1 – Obtain financial statements for the subject
company
• Step 2 – Analyze and adjust financial statements of the
subject company as needed
• Step 3 – Adjust tax expense accordingly, given the other
adjustments that were made
• Step 4 – Perform a search for and select publicly traded
guideline companies
Valuation Methodologies
• Step 5 – Obtain appropriate financial information for a
representative period of time for the guideline public
companies
• Step 6 – Consider adjusting or normalizing guideline public
company financial data for the following
• Step 7 – Analyze the differences between the public
companies and the subject company including the
following:
– Business description
– Company operations
– Financial condition
– Other qualitative and quantitative considerations
Valuation Methodologies
• Step 8 – Select appropriate valuation multiple for guideline
public companies
• Step 9 – Calculation of valuation multiples
• Step 10 – Selection of valuation multiple
• Step 11 – Application of selected multiple to subject
company
• Step 12 – Consider whether any discounts or premiums
should be applied to the conclusion of value
Valuation Methodologies
Guideline publicly traded company analysis example
Average BEV / Rev
Average BEV / EBITDA
Median BEV / Rev
Median BEV / EBITDA
Lower quartile BEV / Rev
Lower quartile BEV / EBITDA
Currency: $US actual
TTM revenue
TTM EBITDA
Selected multiple
BEV/Rev
BEV/EBITDA
Indicated BEV
BEV/Rev
BEV/EBITDA
BEV, non-controlling, marketable basis
Control premium
BEV, on a controlling, marketable basis
Marketability discount
BEV, on a controlling, non-marketable basis
Industry Comps
1.1x
10.0x
0.7x
8.0x
0.5x
6.8x
`
ABC Company
27,564,712
1,173,016
0.7x
8.0x
18,305,725
9,426,061
Cash
1,726,820
1,726,820
BEV
20,032,545
11,152,881
Weighting
50%
50%
Weighted BEV
10,016,273
5,576,440
15,592,713
15.0%
17,931,620
10.0%
16,138,458
Valuation Methodologies
Guideline publicly traded company analysis example
Currency: $US in thousands, except per
share amounts
Operating Performance
Total revenue
Average days sales outstanding (DSO)
Average days payables outstanding (DPO)
Cost of revenue
Gross margin
EBITDA margin
Current ratio
Effective tax rate
Return on assets
Return on equity
CapEx as % of revenue
Working capital (3)
Net working capital (4)
Working capital as % of revenue
Net working capital as % of revenue
Depreciation exp as % of revenue
Average
Median
Lower quartile
Upper quartile
$3,348,403
53.90
40.51
84.22%
15.78%
9.52%
2.04
76.49%
4.28%
6.64%
3.90%
$449,501
$210,573
15.93%
10.15%
4.09%
$2,417,042
48.15
30.54
84.39%
15.61%
7.64%
1.95
32.84%
3.79%
9.54%
2.94%
$300,384
$96,850
15.48%
9.03%
3.16%
$701,799
38.20
22.19
88.23%
11.77%
5.28%
1.63
24.37%
1.45%
3.34%
0.87%
$111,312
$35,555
11.01%
4.55%
0.94%
$4,994,000
58.50
64.71
80.17%
19.83%
13.82%
2.24
36.41%
6.53%
18.42%
5.79%
$691,000
$380,981
19.54%
14.35%
6.44%
ABC Company
$27,565
66.85
22.87
86.58%
13.42%
4.26%
1.87
0.00%
10.18%
18.48%
0.18%
$4,115
$4,485
14.93%
16.27%
0.28%
Valuation Methodologies
• Comparable transaction analysis
– The theory behind this method is that prices paid in the
acquisition of entire companies that are similar to the subject
business that have sold in the marketplace can provide a
reasonable approximation of the value of the subject
company.
– The value generally obtained under the direct market data
method is a control value.
– Adjustments could be necessary if the value to be calculated
is that of a minority interest.
Valuation Methodologies
• Comparable transaction analysis
– Common transaction multiples include price or MVIC to the
following:
• Revenues
• EBIT
• EBITDA
– Sources include
• BIZCOMPS®
• Business Brokers
• Pratt's Stats™
• Thomson Financial Securities
• Institute of Business Appraisers Market Database
Valuation Methodologies
Comparable transaction analysis example
Target
SIC code
1541
1542
1541
1542
1542
1752
1731
1542
1541
1521
1796
1541
1542
Country
Denmark
England
Greece
Greece
Hong Kong
Canada
United States
Greece
Malaysia
United States
Japan
Canada
Malaysia
Lower quartile
Median
Mean
Upper quartile
Effective
Date
11/30/2000
12/27/2000
8/26/2002
9/9/2002
12/27/2002
5/13/2005
8/30/2007
9/12/2007
10/31/2007
9/1/2009
10/1/2009
7/13/2010
8/18/2011
Mergerstat
Control
Premium
117.4%
74.6%
-39.1%
-41.2%
42.9%
82.5%
27.1%
-2.9%
52.2%
23.3%
45.9%
17.8%
15.6%
Implied
Minority
Discount
54.00%
42.7%
-64.3%
-69.9%
30.0%
45.2%
21.3%
-3.0%
34.30%
18.9%
31.5%
15.1%
13.5%
15.6%
27.1%
32.0%
52.2%
13.5%
21.3%
13.0%
34.3%
Net Sales
$ 224.6
$ 733.8
$
21.7
$
20.9
$ 685.2
$
5.9
$ 992.3
$ 204.9
$ 155.4
$ 135.0
$ 283.4
$ 564.5
$ 686.5
$
$
$
$
$
$
$
$
$
$
$
$
$
$
$
$
$
$
$
$
$
135.0
224.6
362.6
685.2
EBITDA
8.1
53.8
1.5
1.9
31.4
0.6
77.4
11.5
15.5
7.3
7.7
39.2
55.1
7.3
11.5
23.9
39.2
$
$
$
$
$
$
$
$
$
$
$
$
$
EBIT
4.8
47.1
1.5
1.9
21.0
0.5
50.8
1.7
15.3
5.3
6.5
34.6
55.1
$
$
$
$
$
$
$
$
$
$
$
$
$
MVIC
(BEV)
36.7
135.9
10.1
16.3
386.0
2.6
191.4
119.8
40.7
52.8
47.2
99.5
256.9
EBIT
Margin
2.12%
6.41%
6.72%
9.06%
3.06%
8.01%
5.12%
0.83%
9.82%
3.93%
2.29%
6.13%
8.03%
Net
Income
Margin
1.30%
4.09%
1.24%
2.64%
1.45%
5.75%
2.77%
0.31%
7.16%
3.74%
0.95%
4.19%
4.93%
$
$
$
$
1.9
6.5
18.9
34.6
$ 36.7
$ 52.8
$ 107.4
$ 135.9
3.06%
6.13%
5.50%
8.01%
1.30%
2.77%
3.12%
4.19%
EBITDA MVIC/ MVIC/ MVIC/
Margin Sales EBITDA EBIT
3.58%
0.16
4.56
7.69
7.34%
0.19
2.52
2.89
6.72%
0.47
6.94
6.94
9.06%
0.78
8.62
8.62
4.58%
0.56 12.30 18.41
10.17%
0.45
4.39
5.57
7.80%
0.19
2.47
3.77
5.62%
0.58 10.39 70.01
10.00%
0.26
2.62
2.67
5.44%
0.39
7.19
9.94
2.73%
0.17
6.10
7.29
6.95%
0.18
2.54
2.88
8.03%
0.37
4.66
4.66
5.44%
6.95%
6.77%
8.03%
0.19
0.37
0.37
0.47
2.62
4.66
5.79
7.19
3.77
6.94
11.64
8.62
Valuation Methodologies
Comparable transaction analysis example
ABC Company
TTM revenue (in $US actual)
TTM Adjusted EBITDA (in $US actual)
Selected multiple
BEV/Rev
BEV/EBITDA
Indicated BEV
BEV/Rev
BEV/EBITDA
BEV on a controlling, non-marketable basis (in $US actual)
Discount for lack of control
BEV on a non-controlling, non-marketable basis
27,564,712
1,173,016
0.5x
7.2x
Weighting
12,850,002
50.0%
8,434,623
50.0%
6,425,001
4,217,311
10,642,312
13.5%
9,205,600
Valuation Methodologies
• Income approach
– There are two methods that can be used to value direct
equity or invested capital:
• Discounted cash flow (DCF)
– Multi-period
– Present value of expected future cash flows
– Erratic or unstable net cash flows
– Discount by use of a discount rate
• Cost of equity capital
• WACC
Valuation Methodologies
– Utilizes residual period after stabilization of cash flow
• Capitalization of future net cash flows
• CF0(1 + g) / (Discount rate - g)
• Capitalization cash flow method
– Single period
– Stable net cash flows
– Shortcut of DCF method
– Discount using capitalization rate
Valuation Methodologies
• Income approach
– There are two primary models to determine the appropriate
cash flow:
• Direct equity
– Direct valuation of common equity
– Often used when valuing minority interests because a
minority interest holder has no ability to influence the
capital structure
– PV = [NCFe(1))/(1 + ke)] + [NCFe(2))/(1 + ke)2] + ... +
[NCFe(n))/(1 + ke)n]
Valuation Methodologies
• Invested capital
– Enterprise valuation
– Often used when the capital structure is expected to
change and/or control value, especially when the
enterprise has little to no debt or too much debt, and
an optimal amount of debt would enhance entity value
– Based on net cash flow to invested capital
– PV = [NCF(1))/(1 + WACC)] + [NCF(2))/(1 + WACC)2] + ... +
[NCF(n)/(1 + WACC)n]
Valuation Methodologies
Income approach: Net cash flow to equity:
Net income after tax
Plus:
Non-cash charges (typically depreciation, amortization and
deferred taxes)
Less:
Incremental working capital to support growth
Less:
Anticipated capital expenditures (typically property, plant and
equipment)
Plus:
New debt principal in (borrowings)
Less:
Debt principal out (repayments)
Equals:
Net cash flow to equity
Valuation Methodologies
Income approach: Net cash flow to invested capital:
Net income after tax
Plus:
Interest expense (tax-effected)
Less:
Non-cash charges (typically depreciation, amortization, and
deferred taxes)
Less:
Incremental working capital (excluding interest bearing debt
obligations) to support growth
Plus:
Anticipated capital expenditures (typically property, plant, and
equipment)
Equals:
Net cash flow to invested capital
Valuation Methodologies
• Income approach
– Cost of capital
• The expected rate of return that the market requires to
attract funds to a particular investment
• Referred to as the discount rate
• Should represent the perceived risk of the investment
• “Forward looking" expected rate of return (or required
rate of return)
Valuation Methodologies
– Cost of capital (continued)
• Commonly used approaches for calculating the return on
common equity
– Capital asset pricing model (CAPM)
• CAPM = Rf + (Rp x β)
– Modified CAPM
• CAPM = Rf + (Rp x β) + Size risk + Specific company
risk
– Build-up method
• Ke = Rf + Rp + Size risk + Specific company risk
Valuation Methodologies
Income
approach
Currency: $US
in millions – Cost of capital example
Assumptions
Tax Rate
Risk-Free Rate of Return (Rf)(1)
Market Risk Premium (Rm - Rf)
Size Premium
Company Specific Risk Premium
Industry D/(D+P+E)
Industry D/E
Industry P/E
Industry Cost of Debt (Rd)
Industry Cost of Preferred (Rp)
Industry Tax Rate
30.0%
3.34%
6.0%
4.1%
3.0%
22.0%
28.5%
1.1%
5.3%
0.0%
30.0%
Valuation Methodologies
Income approach – Cost of capital example
Market Risk Premium (Rm - Rf)
Multiplied by: Industry Levered Beta
Adjusted Market Risk Premium
Add: Risk-Free Rate of Return (Rf)
Add: Size Premium
Add: Company Specific Risk Premium
Cost of Equity
Multiplied by: Industry E/(D+P+E)
Cost of Equity Portion
Industry Cost of Debt (Rd)
Industry Tax Rate
After-Tax Cost of Debt
Multiplied by: Industry D/(D+P+E)
Cost of Debt Portion
I ndustry Cost of Preferred (Rp)
Multiplied by: Industry P/(D+P+E)
Cost of Preferred Portion
W ACC
9.45%
1.26
11.88%
3.3%
3.9%
3.0%
22.1%
76.6%
16.93%
5.3%
0.0%
5.3%
23.4%
1.24%
0.0%
0.0%
0.0%
18.2%
Valuation Methodologies
Income approach – Discounted cash flow example
Currency: $US actual
Net income
Add: interest expense (income)
Add: depreciation and amortization
Less: capital expenditures
Add/Less: incremental working capital
Net Cash Flow
Discount period (years)
Present value (PV) factor:
PV of cash flow
Residual growth rate
Multiple
Residual net cash flow
Future value of residual
Discount period (years)
Discount factor
PV of residual value
18.2%
Sum of PV of cash flow
PV residual value
Business enterprise value on a controlling, marketable basis
Discount for lack of control
Business enterprise value on a non-controlling, marketable basis
Less: discount for lack of marketability
Business enterprise value on non-controlling, non-marketable basis
2012F (6)
2,684,263
31,580
126,318
(157,898)
(1,831,383)
852,880
0.38
0.9390
800,883
2013F
4,008,093
47,154
188,616
(235,770)
(864,491)
3,143,602
1.25
0.8112
2,549,941
2014F
4,408,902
51,869
207,478
(259,347)
(778,042)
3,630,861
2.25
0.6864
2,492,257
2015F
3,423,383
57,056
228,226
(285,282)
(855,846)
2,567,537
3.25
0.5808
1,491,354
2016F
3,594,552
59,909
239,637
(299,546)
(470,715)
3,123,837
4.25
0.4915
1,535,440
2017F
3,774,280
62,905
251,619
(314,523)
(494,251)
3,280,029
5.25
0.4159
1,364,278
Residual
3,962,994
66,050
264,200
(330,249)
(518,963)
3,444,030
5.0%
7.59
3,444,030
26,144,047
5.75
0.3826
10,003,188
10,234,152
10,003,188
20,237,339
13.5%
17,505,299
25.0%
13,128,974
Types of Reports
• Detailed report
– Only for valuation engagements
• Summary report
– Cannot restrict valuation approaches that are applicable
– No difference in relation to economic and industry
background research between a summary and a detailed
report
– No changes in the due diligence measures taken with a
summary report versus a detailed report
• Calculation report
– Requires fewer procedures than a detailed report
Discounts and premiums
• Discount for Lack of Control
– A controlling interest
• Is an interest in a business enterprise where the necessary elements
of control are active and tied to the interest
– A minority interest lacks potentially valuable rights that a controlling
shareholder or group enjoys.
– Necessary to evaluate the facts and circumstances surrounding the
situation to determine whether effective control exists.
Discounts and premiums
• Discount for Lack of Marketability
– The principal economic factor causing a lack of marketability (“LOM”) discount is
the increase in risk caused by the inability to quickly and efficiently return the
investment to a cash position
– There are two types of empirical studies used to quantify valuation adjustments
associated with the lack of marketability of noncontrolling ownership interests in
closely held businesses:
• Restricted Stock Studies
– Studies that measure the difference between the private price of a
restricted and the publicly traded stock price of the security the same
company
• Pre-IPO Studies
– Studies based on the difference between the initial pubic offering (IPO)
price of a company and transactions in the same company’s stock prior to
the IPO.
Discounts and premiums
Discount for Lack of Marketability
Study
SEC Institutional Investor Study (for NYSE companies)
SEC Institutional Investor Study (for non-reporting entities)
Gelman Study
Moroney Study
Maher Study (unadjusted)
Trout Study
Pittock/Stryker (Standard Research Consultants) Study
Willamette Management Associates, Inc. Study
Silber Study
Hall/Polacek (FMV Opinions) Study
Management Planning, Inc. Study
John Emory Study (1997-2000)
John Emory Study (1995-1997)
John Emory Study (1994-1995)
John Emory Study (1992-1993)
John Emory Study (1990-1992)
John Emory Study (1989-1990)
John Emory Study (1987-1989)
John Emory Study (1985-1986)
John Emory Study (1980-1981)
Minimum
25th percentile
Average
Median
75th percentile
Maximum
Type of study
Restricted stock
Restricted stock
Restricted stock
Restricted stock
Restricted stock
Restricted stock
Restricted stock
Restricted stock
Restricted stock
Restricted stock
Restricted stock
Pre-IPO
Pre-IPO
Pre-IPO
Pre-IPO
Pre-IPO
Pre-IPO
Pre-IPO
Pre-IPO
Pre-IPO
Mean
25.8%
32.6%
33.0%
35.6%
35.4%
33.5%
Median
33.0%
32.8%
45.0%
31.2%
33.8%
25.2%
27.7%
50.0%
43.0%
45.0%
45.0%
42.0%
45.0%
45.0%
43.0%
60.0%
25.2%
33.1%
38.9%
38.8%
45.0%
60.0%
22.1%
28.9%
52.0%
42.0%
45.0%
44.0%
40.0%
40.0%
45.0%
43.0%
66.0%
22.1%
32.9%
40.7%
42.0%
45.0%
66.0%
Discounts and premiums
Discount for Lack of Marketability
Inputs
Discount for lack of
marketability (DLOM)
Price of underlying stock (5) S 0 =
Strike price (5)
K=
rf =
Risk-free rate (6)
$1.00
$1.00
1.24%
Ghaidarov method (1)
Chaffee method (2)
Finnerty method (3)
35.70%
49.17%
61.41%
Dividend yield (7)
Cumulative yield
PV of dividend
Adjusted So
q =
r =
PV(Div) =
Adj S o =
0.00%
1.24%
0
$1.00
Longstaff method (4)
181.51%
T=
σ=
60 Months
5.000
65.7%
Time in
Months
Option time in years
Volatility (8)
Discounts and premiums
Discount for Lack of Marketability
Case
Court
Date
DLOM
Estate of William G. Adams v.
Commissioner
U.S. Tax Court
March 28, 2002
35.0%
Jane Z. Astleford v. Commissioner
U.S. Tax Court
May 5, 2008
21.23%
Estate of Dunn v. Commissioner
U.S. Tax Court
August 1, 2002
22.5%
Gross v. Commissioner
U.S. Tax Court
July 29, 1999
25.0%
Kelly v. Commissioner
US. Tax Court
October 11, 2005
23.0%
Court Case Updates
• Malik v. Falcon Holdings, LLC, 2012 U.S. App. LEXIS 5336 (March
14, 2012)
– Actual transaction is the “gold standard” of valuation
– “The value of a thing [asset] is what people will pay.”
• Gearreald v. Just Care, Inc., 2012 Del. Ch. LEXIS 91 (April 30,
2012)
– Delaware Court accepts supply-side equity risk premium
– Court rejects liquidity argument for lesser size premium
• Holber v. M&T Bank (In re Scheffler), 2012 Bankr. LEXIS (June 5,
2012)
– Cost method inappropriate method to value technology
Disclaimer of Liability
Weaver provides the information in this presentation for general guidance
only, and it does not constitute the provision of legal advice, tax advice,
accounting services, investment advice or professional consulting of any
kind. The information included herein should not be used as a substitute for
consultation with professional tax, accounting, legal or other competent
advisers. Before making any decision or taking any action, you should
consult a professional adviser who has been provided with all pertinent
facts relevant to your particular situation. Tax information is not intended to
be used and cannot be used by any taxpayer for the purpose of avoiding
accuracy-related penalties that may be imposed on the taxpayer. The
information is provided "as is," with no assurance or guarantee of
completeness, accuracy or timeliness of the information, and without
warranty of any kind, express or implied, including but not limited to
warranties of performance, merchantability and fitness for a particular
purpose.
Presenter Biography
Brian A. Reed, CPA, CVA
Partner, Transaction Advisory Services
Brian Reed has more than 12 years of diversified financial advisory experience ranging
from acquisition due diligence and valuation services to ligation support and fraud
investigations. He has worked with a wide range of clients including both private equity
and corporate clients. In addition, he has provided financial support services to attorneys.
Brian has participated in acquisition due diligence engagements ranging from $1 million
to over $500 million. Additionally, he has performed a significant number of valuation
engagements related to purchase price allocations, goodwill impairment analysis, gift and
estate taxes and litigation consulting engagements. His experience includes engagements
in the manufacturing, retail, software, distribution, professional services and oil and gas
industries.
He received his Bachelor of Arts degree at the University of Texas at Austin and a Master
of Business Administration degree in finance and accounting from Tulane University.
Conclusion
Questions?