Aloha 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 • • • • 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 • • • • • • • • 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 • • • • • • 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 • • • • • Sale or transfer Divorce Death of owner Dispute between partners Damages E. N. Kemp & Associates, Inc. Sale or Transfer • • • • 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 • • • • • • • 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.