5/11/2016
THE ART SCIENCE OF
BUSINESS VALUATIONS
May 11, 2016
Rand Gambrell, CPA, CVA,
CFE, ABV, CFF
Director
Forensic & Valuation Services
rgambrell@bkd.com
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5/11/2016
TO RECEIVE CPE CREDIT
• Participate in entire webinar
• Answer polls when they are provided
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emailed their CPE certificates within 15 business days of live
webinar
THE SCIENCE OF BUSINESS VALUATIONS
• Objectives
 Understand the nature of business valuation
 Understand how & why business valuations have changed in the recent past
 Recognize the degree of analysis required
 Understand how common practice is more a science than an art
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WHAT IS BUSINESS VALUATION?
• Definition
 The act or process of determining the value of a business,
business ownership interest, security or intangible asset
• When to get a valuation
 Useful at any stage during a company’s lifecycle from
development stage to dissolution
• Common reasons
 Financing, management planning, tax compliance & planning,
financial reporting, restructuring, corporate & shareholder
disputes, sale &/or acquisition, dissolution
ART OR SCIENCE?
• “Valuation is not an exact science subject to precise formula. It is
based on relevant facts, elements of common sense, informed
judgment & reasonableness.”
• “The valuation of a business is more an art than a science. The
process is based not only on the collection & analysis of relevant
facts, but also on the use of our experts' well-developed business
judgment & experience.”
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HOW A VALUATION IS PREPARED …
PERCEPTION
REALITY
ART OR SCIENCE?
• Prior to the financial crisis …
 Limited reference to detailed calculations performed in the background
while performing the valuation
 Heavy reliance on appraiser experience & judgment
• During & after the financial crisis …
 According to … accounting guidance … case law … our detailed
calculations included in Exhibit XX & supported by relevant market data
considered comparable for XX reasons
 Heavy reliance on appraiser experience & judgment based on
supporting documentation, facts & circumstances
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WHAT IS SCIENCE?
… the intellectual & practical activity encompassing the systematic
study of the structure & behavior of the physical & natural world
through observation & experiment
… knowledge or a system of knowledge covering general truths or
the operation of general laws especially as obtained & tested
through scientific method
… a system or method reconciling practical ends
with scientific laws
MOST COMMON DEFINITIONS OF VALUE
• Fair market value – the price, expressed in terms of
cash equivalents, at which property would change
hands between a hypothetical willing & able buyer & a
hypothetical willing & able seller, acting at arm’s length
in an open & unrestricted market, when neither is
under compulsion to buy or sell & when both have
reasonable knowledge of the relevant facts
• Fair value – the 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. The transaction to sell the asset or transfer the liability is a
hypothetical transaction at the measurement date, considered from the
perspective of a market participant that holds the asset or owes the liability.
Therefore, the objective of a fair value measurement is to determine the price that
would be received to sell the asset or transfer the liability at the measurement
date (an exit price)
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APPROACHES TO VALUATION
Cost Approach – a general way of determining a value indication of an individual asset by
quantifying the amount of money required to replace the future service capability of that
asset
Market Approach – a general way of determining a value indication of a business,
business ownership interest, security or intangible asset by comparing the subject to
similar businesses, ownership interests, securities or intangible assets that have been
sold
Income Approach – a general way of determining a value indication of a business, business
ownership interest, security or intangible asset that convert anticipated economic benefits
into a single present value amount
METHODOLOGIES FOR VALUATION
• Cost Approach – net asset value, recreate/replacement value
 Advantage – minimum value can be identified based on known or knowable facts
 Disadvantage – minimum value identified, single point in time, poor indication of
expected future growth
• Market Approach – multiples derived from comparable assets using
transaction data & private or public company data
 Advantage – best indication of value based on definitions for arm’s-length data
 Disadvantage – single point in time, sufficient data to make adjustments to arrive at
comparable multiple is often not available or not identified
• Income Approach – capitalized income based on historical or future earnings
expectations, analysis of other income based factors, e.g., cost savings,
premiums paid
 Advantage – easiest way to drill down into details, considered most indicative of a
subject’s expected performance which can not be captured under other
methodologies
 Disadvantage – uncertainty in achievability, most likely to be manipulated
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UNDER SCRUTINY
Tax
authorities
Regulatory
agencies
Auditors
Investors
Opposition
MARKET APPROACH
• Factors to consider
 Source of market data
•
•
•
•
Private or public company data
Transparency of company data
Calculations utilized by data source provider
Whether multiple sources will be required
 Appropriate multiple to utilize
• Revenue vs. earnings
• Historic or future
 Subject financial data
• Determination of appropriate subject financial data
• Identification of subject financial data to ensure consistency with
market benchmark
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MARKET APPROACH
• Factors to consider
 Adjustment of market multiple
• Whether sufficient information is available to ensure that subject
& market benchmark are truly comparable
• Determination of how & why to make adjustments
 Underlying financial data – time period, currency,
restatements, nonrecurring items
 Forward (future) based multiples
 Comparability – size, asset leverage, revenue growth,
profitability
 Additions/deductions to derived value for consistency with purpose
• Market multiple may not include certain items (debt,
excess/deficit assets & liabilities or other items)
INCOME APPROACH
• Factors to consider
 Cash flows
 Underlying financial data – time period, currency,







restatements, nonrecurring items, nonoperating items
Economic vs. accounting treatment
Capacity
Working capital needs vs. use
Historical vs. future expected earnings – comparability,
feasibility
Short- & long-term growth expectations
Asset & liability leverage
Multiple scenarios
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INCOME APPROACH
• Factors to consider
 Cost of capital discount rate
• Consistency, comparability, feasibility
 Build-up method
E(Ri) = Rf + RPm + RPs + RPu
 Capital asset pricing model (CAPM)
E(Ri) = Rf + b(RPm)+ RPs + RPu
 Weighted average cost of capital (WACC)
WACC = (ke x We) + (kp x Wp) + kd/t [1-t] x Wd
OTHER CONSIDERATIONS
• Minority discounts
 Data sourcing, market studies, regression analysis, facts &
circumstances
• Marketability discounts
 Data sourcing, market studies, facts & circumstances
• Derivatives & complex securities
 Stock options
 Warrants
 Multiples classes of preferred & common shares
 Fair value of debt
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DAUBERT FACTORS
• “… whether a theory or technique … can be (& has been) tested.”
• “… whether the theory or technique has been subjected to peer
review & publication.”
• “… the known or potential rate of error … & the existence &
maintenance of standards controlling the technique’s operation.”
• “… explicit identification of a relevant scientific community & an
express determination of a particular degree of acceptance within
that community.”
COMMON PEER CHALLENGES
• Testing of theory & calculations against other known
methodologies
• Results consistent across different scenarios
• When variations to results are acceptable
• Proper application of theory (not limited to valuation)
• Consistency in theory, assumptions & calculations
• Appropriateness of underlying assumptions & facts
• Cost/benefit analysis
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QUESTIONS?
CONTINUING PROFESSIONAL EDUCATION (CPE)
CREDITS
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Accountancy (NASBA) as a sponsor of continuing professional
education on the National Registry of CPE Sponsors. State boards of
accountancy have final authority on the acceptance of individual
courses for CPE credit. Complaints regarding registered sponsors may
be submitted to the National Registry of CPE Sponsors through its
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The information in BKD webinars is presented by BKD professionals, but applying specific
information to your situation requires careful consideration of facts & circumstances. Consult
your BKD advisor before acting on any matters covered in these webinars.
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CPE CREDIT
• CPE credit may be awarded upon verification
of participant attendance
• For questions, concerns or comments
regarding CPE credit, please email the BKD
Learning & Development Department at
training@bkd.com
THANK YOU!
FOR MORE INFORMATION
Rand Gambrell | 303.861.4545 | rgambrell@bkd.com
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