How to Value a
Small Business
Professional Development Seminar
South Carolina Small Business Development Center
Pete Smith
C&S Associates
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Introduction
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Business Valuation: Estimating the Fair
Market Value of a business entity
Principles are consistent
Application of principles is diverse
Objectives of a Business Valuation
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Accuracy
Fairness - Objectivity
Defend-ability
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Seminar Objectives
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Understanding of the basic Principles
Understanding of the basic Terms used
Understanding of the basic Methods used
With a hands-on example, gain the:
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Ability to apply to appropriate client situations
Ability to know when not to apply!!!
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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.”
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PURPOSES
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Business Sale
Business Purchase
Bank Financing
Estate Planning
Estate Taxes
Gifting
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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.
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SMALL BUSINESS
CHARACTERISTICS
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Size & Business Model
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Markets
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People
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Market Evaluation
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Size of Market in area
Growth in area
Company’s Position
Top Customers
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Concentration
Company Growth
Desire-ability of
product/service
Location, Location,
Location
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Business Valuation Steps - 1
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Define Purpose
Understand size & characteristics of Client
Assessment of People and Markets
---------------------------------------------Gather Additional Data
Recast Financial Statements
Ratio Analysis / Industry Comparison
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Business Valuation Steps - 2
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Application of Valuation Methods
Reconciliation
Adjustments
Valuation Report
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GLOSSARY -1
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Pro Forma Adjustments
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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
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GLOSSARY – 2
Income Measures
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Sales
Contribution Value
Prime Gross Profit
Gross Profit
SDE – Seller’s
Discretionary Earnings
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PBITDA, EBITDA,
IBITDA
PBIT, EBIT, IBIT
PBT, EBT, IBT
PAT, EAT, IAT
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Glossary - 3
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Arm’s Length
Date of Valuation
Discretionary Expenses
Materiality
One-time events
Control / Minority Interest
Ranges of Values
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Discretionary Expenses
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Owner’s Bonus
Management’s Bonus
Country/Golf Club
Airplane
Director’s Fees
Guaranty Fees
Family Salaries
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Car Expenses
Life Insurance
Interest Earned
NASCAR tickets
London Travel
Trade Show
Training Class
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Valuation Methods - 1
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Income Methods
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Cost Methods
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Comparable Value Methods
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Valuation Methods - 2
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Income Methods*
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ROI
Cash Flow
Excess Income (IRS)
SDE
DCF – Ugly!
Other Multiples
Others
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Cost Methods
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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!
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Valuation Methods - 3
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Comparable Value Methods
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Deals Done – tough finding sources –
privately held businesses, definition of price.
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Publicly held – minority vs. majority, liquidity?
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Industry Rules-of-Thumb
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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.
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EZ ELECTRIC – Size /Other
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20 Employees
including Joe
Sales $3m
100% owned by Joe
Founded, Dad 1970
Joe took over 1997
Dad passed 2000
Key Man Life Insur.
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Joe’s Mom in Florida
Comes to annual
meeting at Xmas.
She owns building
Lease to EZ
Son and Daughter
work at EZ
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Markets
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Apparatus service market in area $10m
1 competitor same size, 3 smaller
Industry Growth: Flat
Top Four Customers
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Mining
Automotive
Manufacturing
Health Care
15%
10%
10%
10%
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Adjustments - 1
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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?
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Adjustments - 2
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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?
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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
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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
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EZ Electric - Reconciliation
1200
1000
800
Lower
Higher
600
400
200
0
ROI
Cash
Flow
Cost
SDE
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Rule of
Thumb
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THANK YOU
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Other Questions?
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