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E. N. Kemp & Associates, Inc.
BUSINESS VALUATION 101
Where do I begin to tell the story…...
E. N. Kemp & Associates, Inc.
Definition of Business Valuation
A business valuation (or appraisal) is an
opinion, usually in writing, as to the value of
a business or of the major assets of a
business. A business valuation may include
the opinion of other appraisers as to the
value of certain tangible assets, such as real
property, machinery, collectibles, etc., but
does not usually offer any additional
assurance on these opinions of value for the
tangible assets.
E. N. Kemp & Associates, Inc.
Appraisal or Valuation
The words are used somewhat interchangeably
by those professionals who estimate the value of
business interests. The term “Valuation” is being
used more often now to differentiate the specialty
from the appraisal of real estate, machinery and
other tangible assets. However, the terms
Business Appraisal and Business Appraisers are
still used by many in the profession.
E. N. Kemp & Associates, Inc.
Who does it?
• No restrictions in State of Hawaii (or most
states) so it’s “Buyer Beware”
• Real estate appraisers perform somewhat
similar analysis for commercial properties
• Real estate and business brokers often
estimate value in assisting buyer or seller
• Some CPA firms expanding services by
offering business valuations
E. N. Kemp & Associates, Inc.
Qualifications
Since there are really very few barriers to
providing business valuation services, the
qualifications of those offering services
vary widely, from entire firms specializing
in business valuations down to part-time
practitioners.
E. N. Kemp & Associates, Inc.
Professional Associations
• American Institute of Certified Public
Accountants (CPA, ABV, CFF)
• American Society of Appraisers (ASA)
• The Institute of Business Appraisers (CBA)
• National Association of Certified Valuation
Analysts (CVA)
E. N. Kemp & Associates, Inc.
Uses of Business Valuation
• Purchase or sale of business interest
(including buy-sell agreements)
• Estate and gift tax returns
• ESOP
• Divorce
• Loan or insurance
• Damages
E. N. Kemp & Associates, Inc.
Standards of Value
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Fair Market Value
Fair Value
Investment Value
Intrinsic Value
E. N. Kemp & Associates, Inc.
Fair Market Value
“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.” Court decisions frequently state in addition
that the hypothetical buyer and seller are assumed
to be able, as well as willing, to trade and to be
well informed about the property and concerning
the market for such property.
E. N. Kemp & Associates, Inc.
Revenue Ruling 59-60
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Nature of business and its history
Outlook for economy and for the industry
Book value and financial condition
Earning capacity
Dividend paying capacity
Presence of goodwill or intangible value
Sales of stock and size of block to be valued
Market price of similar businesses
E. N. Kemp & Associates, Inc.
Valuation Approaches
• Asset-based Approach
• Market Approach
• Income Approach
E. N. Kemp & Associates, Inc.
Asset-based Approach
May be used for appraising businesses with little
value beyond that of their tangible assets, such as
investment companies or real estate holding
companies. Individual assets and liabilities are
adjusted to reflect current values. Total assets
less liabilities equals value of enterprise. Net
asset value, as described, or liquidation value may
be appropriate.
E. N. Kemp & Associates, Inc.
Market Approach
Comparability with similar businesses is used to
estimate value under this approach. Methods
most often used are: guideline company method,
transaction (merger and acquisition) method and
the industry method (sometimes called “rules of
thumb”). Price/sales and price/earnings ratios
are often applied to financial data adjusted to
enhance the comparability of the entities.
E. N. Kemp & Associates, Inc.
Income Approach
This approach values an enterprise based on its
earnings or cash flow generating abilities. These
benefit streams are converted into estimates of
value by discounting or capitalization.
Discounting future returns tends to be more
appropriate when these returns are expected to be
substantially different from current operations.
Capitalization is appropriate when a normal
growth rate in operations is expected.
E. N. Kemp & Associates, Inc.
Levels of Value
• CONTROL VALUE
• Less: Lack of control (minority) discount =
• MARKETABLE MINORITY INTEREST
VALUE
• Less: Lack of marketability discount =
• NON-MARKETABLE MINORITY
INTEREST VALUE
E. N. Kemp & Associates, Inc.
Lack of Control (Minority)
Discount
A minority discount is a reduction in the control
value of the appraisal subject that is intended to
reflect the fact that the owner of a minority interest
can not control the daily activities or the policy
decisions of an enterprise. The size of the discount
will depend on the amount of control which can be
exercised by the minority interest, including the
ability to block actions, and various other factors.
E. N. Kemp & Associates, Inc.
Lack of Marketability Discount
The concept of “Marketability” deals with the
liquidity of an ownership interest, that is, how
quickly and easily can it be converted to cash if the
owner chooses to sell. Discounts are usually
appropriate for any ownership interest that can not be
sold in a timely manner with cash proceeds received
in three business days. Some transfers of ownership
are restricted by the documents establishing the
enterprise.
E. N. Kemp & Associates, Inc.
Other Discounts
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Undivided fractional interests
Built-in capital gains
Key person discount
Small company discount
Blockage discount
Litigation uncertainties
E. N. Kemp & Associates, Inc.
Professional Practices
• Typical Professional Practices would
include law offices, accounting & tax
preparation, medical practices, investment
advisors and insurance sales
• Often has only one key person (rainmaker)
• May have some staff but usually no one
qualified to step into the shoes of the key
person in case of death or incapacitation
E. N. Kemp & Associates, Inc.
Reasons for Valuation
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Sale or transfer
Divorce
Death of owner
Dispute between partners
Damages
E. N. Kemp & Associates, Inc.
Sale or Transfer
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Sale of entity or assets
Involvement of seller in transition
Transferability of seller’s attributes
Internship or partnership leading to
purchase
• Terms and conditions of sale
• Covenant “not to compete”
E. N. Kemp & Associates, Inc.
Divorce
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Client files
Trained staff
Location(s)
Phone number
Enterprise goodwill
Personal goodwill (transferable?)
Antolik v. Harvey
E. N. Kemp & Associates, Inc.
Mahalo
E. N. Kemp & Associates, Inc.