How to Value a Small Business Professional Development Seminar South Carolina Small Business Development Center Pete Smith C&S Associates Copyright C&S Associates, July 2007 0 Introduction Business Valuation: Estimating the Fair Market Value of a business entity Principles are consistent Application of principles is diverse Objectives of a Business Valuation Accuracy Fairness - Objectivity Defend-ability Copyright C&S Associates, July 2007 1 Seminar Objectives Understanding of the basic Principles Understanding of the basic Terms used Understanding of the basic Methods used With a hands-on example, gain the: Ability to apply to appropriate client situations Ability to know when not to apply!!! Copyright C&S Associates, July 2007 2 Fair Market Value “Fair Market Value is defined as the value that a willing seller and a willing buyer, both being informed of the relevant facts about the company, could reasonably conduct a buy-sell transaction, neither party under any compulsion to do so.” Copyright C&S Associates, July 2007 3 PURPOSES Business Sale Business Purchase Bank Financing Estate Planning Estate Taxes Gifting Divorce Partner Buy In/Out Report Card ESOP Inter-Generation Other Always dealing with two sides – someone wants a higher valuation, someone wants a lower valuation. One side is frequently the IRS. Copyright C&S Associates, July 2007 4 SMALL BUSINESS CHARACTERISTICS Size & Business Model Markets People Copyright C&S Associates, July 2007 5 Market Evaluation Size of Market in area Growth in area Company’s Position Top Customers Concentration Company Growth Desire-ability of product/service Location, Location, Location Copyright C&S Associates, July 2007 6 Business Valuation Steps - 1 Define Purpose Understand size & characteristics of Client Assessment of People and Markets ---------------------------------------------Gather Additional Data Recast Financial Statements Ratio Analysis / Industry Comparison Copyright C&S Associates, July 2007 7 Business Valuation Steps - 2 Application of Valuation Methods Reconciliation Adjustments Valuation Report Copyright C&S Associates, July 2007 8 GLOSSARY -1 Pro Forma Adjustments Reflect Nature of Deal Adjust for Real Estate Adjust for discretionary and one-time items Book Value of Stockholder’s Equity Book Value of Total Capital Goodwill Copyright C&S Associates, July 2007 9 GLOSSARY – 2 Income Measures Sales Contribution Value Prime Gross Profit Gross Profit SDE – Seller’s Discretionary Earnings PBITDA, EBITDA, IBITDA PBIT, EBIT, IBIT PBT, EBT, IBT PAT, EAT, IAT Copyright C&S Associates, July 2007 10 Glossary - 3 Arm’s Length Date of Valuation Discretionary Expenses Materiality One-time events Control / Minority Interest Ranges of Values Copyright C&S Associates, July 2007 11 Discretionary Expenses Owner’s Bonus Management’s Bonus Country/Golf Club Airplane Director’s Fees Guaranty Fees Family Salaries Car Expenses Life Insurance Interest Earned NASCAR tickets London Travel Trade Show Training Class Copyright C&S Associates, July 2007 12 Valuation Methods - 1 Income Methods Cost Methods Comparable Value Methods Copyright C&S Associates, July 2007 13 Valuation Methods - 2 Income Methods* ROI Cash Flow Excess Income (IRS) SDE DCF – Ugly! Other Multiples Others Cost Methods Book Depreciation add back Replacement – new Replacement – used Cost plus 1x GP Multiple of Book Others * Can’t use many income methods if there is no income! Copyright C&S Associates, July 2007 14 Valuation Methods - 3 Comparable Value Methods Deals Done – tough finding sources – privately held businesses, definition of price. Publicly held – minority vs. majority, liquidity? Industry Rules-of-Thumb Copyright C&S Associates, July 2007 15 BUSINESS VALUATION EZ ELECTRIC Purpose: Joe would like to retire sometime in his mid50’s. Wants to get an idea of the value of the business to plan ahead. Make sure he has enough life insurance to cover the value, knowing that much of the value is gone in the event of his death. Copyright C&S Associates, July 2007 16 EZ ELECTRIC – Size /Other 20 Employees including Joe Sales $3m 100% owned by Joe Founded, Dad 1970 Joe took over 1997 Dad passed 2000 Key Man Life Insur. Joe’s Mom in Florida Comes to annual meeting at Xmas. She owns building Lease to EZ Son and Daughter work at EZ Copyright C&S Associates, July 2007 17 Markets Apparatus service market in area $10m 1 competitor same size, 3 smaller Industry Growth: Flat Top Four Customers Mining Automotive Manufacturing Health Care 15% 10% 10% 10% Copyright C&S Associates, July 2007 18 Adjustments - 1 Joe bought out Mom’s stock at the then fair market value, balance is part of Long Term Debt. Payments of $3k per month for principal and interest on 8% note. Pays her an additional $10k at year end to for attending board meeting to supplement her income. Any discretionary? Any one time? Copyright C&S Associates, July 2007 19 Adjustments - 2 Joe’s only sister is an attorney. Keeps track of the corporate records, member of the board of directors, handles collection letters and other minor legal matters. Joe pays her $1k per month. Any discretionary? Any one time? Copyright C&S Associates, July 2007 20 Apply Methods 1-4 Method/Calculate 1. 4 to 6 x 160 Lower Higher Notes 640 960 Total Equity* 2. 3 to 5 x 250 less debt 750 (375) 375 3. 40% to 60% Book Equity 180 375 555 4. 1250 Total Capital (375) 875 Total Equity* 270 375 645 Acc. Depre. Total Equity* No Information * Valuation of Total Equity is the objective Copyright C&S Associates, July 2007 21 Apply Methods 5-6 Method/Calculate 5. 1.5 to 2.5 SDE Cash, A/R, OCA Total Liab. 6. 25% to 40% All Tot. CA Total Liab. Lower Higher Notes 600 1,000 FA+GW+Inv** 310 310 (525) (525) 385 785 Total Equity* 525 550 (525) 550 840 FA+ GW only 550 Current Assets (525) 865 Total Equity* *Valuation of total equity is the objective ** Typical Small Business Sale Copyright C&S Associates, July 2007 22 EZ Electric - Reconciliation 1200 1000 800 Lower Higher 600 400 200 0 ROI Cash Flow Cost SDE Copyright C&S Associates, July 2007 Rule of Thumb 23 THANK YOU Please complete the feedback form. Other Questions? 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