VALUATION of CLOSELY HELD BUSINESSES Richard A. Warner Principal Great Lakes Valuations 224-764-2280 rawarner@greatlakesval .com
Mar 26, 2015
VALUATION of CLOSELY HELD BUSINESSES
Richard A. WarnerPrincipal
Great Lakes Valuations224-764-2280
Agenda
Introductory Comments
Business Appraisal Concepts
Approaches to Valuation
Wrap-Up
Selected Business Demographics
Business Size by Employees
Average Annual Revenues
Average Number of Employees
1 to 4 $321,000 2.1
5 to 9 $792,000 6.6
10 to 19 $1,600,000 13.4
20 to 99 $5,701,000 39.2
100 to 499 $27,056,000 192.2
500 to 999 $540,467,000 688.6
Source: 1997 US Census material
Why Do We Need Valuations?
Mergers & Acquisitions
Estate Planning and Wealth Management
Family Law – Marital Dissolution
Shareholder Disputes & Oppression
Succession Planning/Buy-Sell Agreements
ESOPs
Other “Stuff”
Attorney – Appraiser Roles & Relationships
Objectivity & Bias
Appraiser Skills, Knowledge, Certification
Business Valuation Concepts
Standards of Value
• Fair Market Value
• Investment Value
• Fair Value
• Intrinsic Value
Premise of Value
Valuation Date
Present Value
Would you rather have $10,000 now, or $14,025 five years from now?
$10,000
2011
$14,025
2016
Future Value
Present Value
Investment Yield5%7%10%
?
Balance Sheet Basics
=
Current Assets
$41,500,000
Tangible Assets
$41,000,000
Intangible Assets and Goodwill
$126,500,000
+
+
Current Liabilities
$25,000,000
Long Term Debt (including current
portion)
$34,000,000
Equity
$150,000,000
$209,000,000 $209,000,000=
+
+
Box analysis diagram ©Financial Valuation Group International
Income Statement Basics
Revenue: $6,000,000Less Cost of Goods Sold $4,500,000
Equals: Gross Margin $1,500,000
Less Operating ExpensesSelling Expenses $450,000General Expenses $450,000Administrative Expenses $450,000
Equals: Operating Profit $150,000
Plus/minus Other Income/Expenses $0
Earnings Before Taxes $150,000
Income Taxes (40%) $60,000
Net Income After Taxes $90,000
DEFINING the ENGAGEMENT
Who is the client? Who is the appraiser?
What is the specific interest being appraised?
What is the valuation date?
What is the purpose of the appraisal?
What is the standard of value?
What type of report is needed?
Schedules? Fees?
GATHERING COMPANY INFORMATION
Key focus –
•Estimate the stream of future benefits from the business
•Estimate the risk associated with achieving those benefits
•Value = Benefits/Risk
ANALYZING THE INFORMATION
Financial Analysis:• Common-size analysis• Comparative analysis• Trends
Non-financial analysis• Management• Competition• Products & Quality• Customer/supplier concentration
ESTIMATING THE VALUE
Valuation Approaches
• Asset Approaches
• Market Approaches
• Income Approaches
ASSET APPROACH – WHEN TO USE
Appropriate when valuing:• Marginally profitable companies (better
dead than alive?)• Asset-heavy companies• Holding companies and non-profits• Controlling interests
Generally not useful:• When significant intangible value exists• For valuing service companies• For valuing professional practices• When considering minority interests
MARKET APPROACHES - GPTCM
Guideline Publicly Traded Company MethodUsing information from publicly traded, similar companies, determine “multiples” to apply to the subject company’s operating results to obtain a value
Completed Transactions MethodSimilar to GPTCM – based on sales of business interests in the market (M&A)Data Sources
Institute of Business AppraisersBizcomps©Pratt’s Stats©Mergerstat©
CAPITALIZATION OF INCOME
Basic capitalization formula:
PV = E1/c
Where:
E1 = expected economic income at the end of next year
c = capitalization rate
Example:
If E1 = $100,000 and c = 20%
then PV = $500,000
DISCOUNTED CASH FLOW
The value of a business is the present value of the “income” it can reasonably be expected to generate in the future…
Basic DCF formula:
nd
Income
d
Income
d
Income
d
IncomeValue
n
1...
1 1 1 321
321
What about after the forecast period?
tn d
Value Terminal
d
IncomeValue
1 1
tntn
1n
Where “d” is the discount rate…
DISCOUNTED CASH FLOW –
TERMINAL VALUE
One method is to calculate the terminal value using a capitalization of income method…
n
n
k
gkgE
PV
1
1
Where:PV = Terminal ValueEn = “Earnings” during last period of forecastk = discount rate (required rate of return)g = growth rate of En in perpetuityn = number of periods in the projection period
DISCOUNT AND CAPITALIZATION
RATES
• A discount rate is a rate of return used to convert a monetary sum into a present value; also known as
• opportunity cost of capital
• weighted average cost of capital
• required rate of return
• How to determine for a closely held company?
• Build-up models
• CAPM
DISCOUNT AND CAPITALIZATION
RATES – BUILD-UP EXAMPLE
Risk free rate = 5.1%
General equity risk premium = 7.2%
Size Premium = 9.3
Specific risk premium = 4.0%
Discount rate = 25.6%
DISCOUNTED CASH FLOW
EXAMPLE
Valuation - DCF ApproachFair market valueDecember 31, 2010
Discount Rate 15.41%Growth Rate 5%
Year
Forecasted Net Cash Flow to
EquityPresent Value
Factor
Present Value Future Cash
Flows
2011 755,696$ 0.93085 703,438$ 2012 537,746$ 0.80656 433,722$ 2013 643,674$ 0.69886 449,839$ 2014 804,113$ 0.60555 486,928$ 2015 984,646$ 0.52469 516,636$
Terminal Value 9,931,586$ 0.52469 5,211,024$
Value of Equity as of Valuation Date 7,801,587$
CONTROL AND MARKETABILITY
Controlling Interest ValueControlling Interest Value
Marketable Minority Interest ValueMarketable Minority Interest Value(“WSJ Listed Price”)(“WSJ Listed Price”)
Marketable Minority Interest ValueMarketable Minority Interest Value(“WSJ Listed Price”)(“WSJ Listed Price”)
Nonmarketable Minority Nonmarketable Minority Interest ValueInterest Value
Nonmarketable Minority Nonmarketable Minority Interest ValueInterest Value
Control PremiumControl Premium Minority Interest DiscountMinority Interest Discount
Discount for Lack of MarketabilityDiscount for Lack of Marketability
Application of Discounts and Premiums
Value on a control, marketable basis $100.00
Less discount for lack of control (25%) 25.00
Value on a minority, marketable basis $75.00
Less marketability discount (35%) 26.25
Value of minority, non-marketable interest (51.25% discount) $48.75
A CONCLUSION OF VALUE –
WHEW!
Check the math…
Review the facts…
• Review company strengths and weaknesses
• Review economic conditions
• Review comparative financial analysis
Subjectively weight results obtained by different valuation approaches?
Did we value the right property correctly?
QUESTIONS…….