BUSINESS VALUATION

INTERNATIONAL VALUATION
STANDARDS COMMITTEE
INTRODUCTION
A. What is being appraised?
B. Definitions of Value.
"Fair Market Value" usually the standard of value in the United States of America. It is well defined. Market
Value, as defined in real property and by IVSC, is the same as Fair Market Value in business appraisal.
Fair market value is considered to represent a value at which a willing buyer and a willing
seller, both being informed of the relevant facts about the business, could reasonably conduct
a transaction, neither person acting under the compulsion to do so.
Although not stated in the definition, it assumes: 1) a cash value; 2) both parties can perform (buyer
has financing and seller has clear title and can deliver); 3) a reasonable time for exposure in the
market; and 4) normal contacts will be signed.
Unusual factors must be explained if not valued.
C. Who Performs Business Valuations
Chartered Financial Analyst (CFA) of the Institute of Chartered Financial Analysts
Accredited Senior Appraiser (ASA) of American Society of Appraisers in Business Valuation
Certified Business Appraiser (CBA) of the Institute of Business Appraisers
Accredited in Business Valuation (ABV) of the American Institute of Certified Public Accountants.
Chartered Business Valuator (CBV) of the Canadian Institute of Chartered Business Valuators.
BUSINESS APPRAISAL
STANDARDS
A. International Valuation Standards 2003, Guidance Note 6.
B. Uniform Standards of Professional Appraisal Practice (USPAP)
Standards 9 and 10 as well as the Preamble
Standard 9: In developing a business appraisal, an appraiser must be
aware of, understand and correctly employ those recognized methods
and techniques that are necessary to produce a credible appraisal.
Standard 10: In reporting the results of a business appraisal, an
appraiser must communicate each analysis, opinion and conclusion in a
manner that is not misleading.
C. American Society of Appraisers Business Valuation Standards
D. Institute of Business Appraisers Business Valuation Standards
BUSINESS VALUATION
THEORY
A.The value of a business arises from:
Assets, either Tangible or Intangible; and
Cash Flow (different definitions of income)
B.The Phases of Business Value
Orderly Liquidation is often the least value if the
owner has ability to sell the assets
As cash flow increases, the value of the business
increases from the liquidating value of tangible assets
to the going concern value of tangible assets
As cash flow increases further, the value of the
business increases to include the value of specific,
identifiable and non-identifiable intangible assets
VALUE=(INCOME,ASSETS)
Relations hip of Value, Income and As s ets
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0 1 2 3 4 5 6 7 8 9
Income
V
a
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Value in Us e
Liquidation Value
Goodwill
Income Level Value
Company Value
The Three Basic Approaches to
Value
1. Cost
Is a balance sheet focused approach (also called Adjusted
Balance Sheet)
Based on the premise that a prudent buyer will pay no more for a
property than it would cost to replace with a substitute property
with the same utility -- the principal of substitution
Concept: Value all the assets of a company, subtract the
liabilities, to arrive at the value of FMV stockholders' equity
Value of each asset may be derived by using any of the three
approaches for valuing those individual assets
Assets and company may be valued as a going concern or in a
liquidation scenario
COST APPROACH
FAIR MARKET VALUE BALANCE
SHEET
GOODWILL
EQUITY
FIXED ASSETS
LONG TERM DEBT
WORKING
CAPITAL
CURRENT
LIABILITIES
CURRENT ASSETS
ASSETS LIABILITIES + EQUITY
The Three Basic Approaches to
Value - Continued
2. Market
a) Again, principle of substitution.
b) Comparison between subject property and similar
properties which have recently sold. Normally either
publicly traded shares of similar companies or
acquisitions of similar companies.
c) May be either balance sheet or income statement
focused
d) Value the equity or invested capital of a company
through comparison with the pricing of investment in
companies (often as traded in the stock market)
e) Generally, is a going concern assumption, not
liquidation
The Three Basic Approaches to
Value - Continued
3. Income
Based on theory that the value of any asset is the
present value of expected future benefits to be
derived by the ownership of that asset
Income statement focused
Value the equity or invested capital of a company by
deriving the present value of the expected flow of
future economic benefits
Generally, is a going concern assumption, not
liquidation
Generally, may take two forms
Discounted cash flow
Capitalization of cash flow
Basic Variables Affecting Value
1. Economic conditions
2. Industry Conditions
3. Business Background and Conditions
Earnings history of the firm
Future earning capacity
Balance sheet
Qualitative factors
4. Risk Assessment
Risk free rates of return
General equity risk
Industry specific risk
Company specific risk
Revenue Ruling 59-60
a) The nature of the business and history of the enterprise
b) The economic outlook in general and condition and outlook of the
specific industry in particular
c) The book value of the stock and the financial condition of the
business
d) The earnings capacity of the company
e) The dividend-paying capacity
f) Whether or not the enterprise has goodwill or other intangible value
g) Sales of stock and the size of the block to be valued
h) The market prices of stocks of corporations engaged in the same or
similar lines of business whose stocks are actively traded in a free
and open market, either on an exchange or over-the-counter
FINANCIAL STATEMENT
ANALYSIS
What is the goal of financial analysis?
Identify unusual items
Identify what happened and why it happened
Identify trends and what caused them
Identify how the company departs from the
industry norm and why
Comparison with comparable companies to
assist in selection of appropriate valuation
multiples
Adjusted Book Value
1. Purpose - To replace cost of assets and liabilities with current economic
value
2. Typical balance sheet adjustments
Non-operating assets and liabilities such as excess cash and securities,
excess investment property and related obligations
Uncollectible receivables
LIFO or current replacement cost inventory adjustments
Marketable securities
Unmarketable securities
Accelerated depreciation
Real property per appraisal
Machinery & equipment per appraisal
Intangible assets like goodwill, non-compete agreement
Advantageous terms on debt
Contingencies such as lawsuit or pension obligations
Deferred taxes
Liquidation Value
1. Orderly or forced liquidation
2. Consult management, auctioneer, P&M
appraiser, and/or real estate appraiser
concerning appropriate liquidating discounts
3. Consider liquidation costs
Auctioneer's fees and commissions
Continued fixed cost and administrative costs during
liquidation period
Legal, accounting and other professional fees
Taxes payable by the corporation
Market Based Asset Approaches
1. Price/book value - where do similar companies
stocks sell relative to book value
2. Price/adjusted book value
Conceptually the best asset approach
Most applicable when assets consist primarily of:
Inventory - LIFO adjustments to market data
Real Property - Publicly traded Real Estate Investment Trusts
(REITs) for market data
Securities - Publicly traded investment companies
Advantages - Uses adjusted company data and market data
Disadvantages - Difficult or impossible to get adjusted asset data
for similar companies. Cannot make valid comparisons.
ADJUSTMENTS TO INCOME
GOAL: REACH NORMALIZED OPERATING INCOME
A. Non-operating Items - Remove effect on income
statement of non-operating assets. Examples include:
Excess real property - adjust for rental income, property taxes,
depreciation, debt service
Excess cash and securities - adjust for interest income, gain
(loss) on securities
B. Varying Accounting Treatments
LIFO/FIFO inventory
Depreciation (tax lives vs. economic lives)
Capital versus operating lease
Pension Accounting
Non-recurring Items
1. Gain (loss) on sale of assets
2. Bad debts
3. Professional fees
4. Unusual production costs - labor or materials
5. Start-up costs
6. Discontinued operations
7. Unusual revenues - price or volume
CAPITALIZATION OF INCOME
Variations of "Income
Net income after income tax
Income before income tax (EBT)
Operating income or earnings before interest and taxes (EBIT)
Earnings before interest, taxes, depreciation and amortization
(EBITDA)
Cash flow = Net income plus non-cash charges such as
depreciation and amortization
Invested Capital methods
Which measure is most appropriate will depend on the specific
situation
Capitalization Rate
A rate to translate income (or expected income) into
value
Definition: Capitalization rate = required rate of return
(discount rate) minus expected long term growth
Capitalization Rate = Required Rate of Return - Growth
(For All Non-Zero Growth Rates)
Capitalization Rate = Required Rate of Return
Only If Growth Rate is Zero
Value = Expected Income/Capitalization Rate
Value = Expected Income .
Required Rate of Return less Growth Rate
MARKET DATA APPROACHES
A. Conceptual Basis - Principle of substitution
B. Get "market" multiples for similar companies that have recently sold or
whose shares are actively traded. Multiple based on :
Current earnings and/or cash flow
Historical average earnings and/or cash flow
Projected future earnings and/or cash flow
Revenues - key on comparative profit margins
Volume (revenue)
Equity or adjusted equity - key on comparative return on equity
C. Make qualitative and quantitative comparisons between subject company
and market data.
D. Assess comparative growth and risk characteristics. Should pricing
multiples for subject company be above, below or similar to the market
norms?
MARKET DATA APPROACHES
E. Sources of Market Data
Similar publicly traded companies
Similar acquired companies
Industry rules of thumb
Make sure the comparisons are accurate, i.e., make the same
adjustments to the market data that were made to the subject
company
F. Summary
Do proper company analysis and adjustments
Adjust data of comparables, if appropriate
Determine appropriate norms for market multiples
Determine how the company's multiples should differ from the
market norms
OTHER CONSIDERATIONS
Buy/Sell Agreements
History of Past Transactions or Offers to Buy
Discounts for Minority Interest (or Lack of
Control) and Lack of Marketability
Premium for Control
Special Attributes of Control
Control or Minority Assignment can largely
dictate appraisal methodology
Special rights or privileges, i.e., put options,
preferred stock conversion or redemption
features
VALUATION CONCLUSION
Briefly review all source documents to see if any
important factors were missed
Re-read the appraisal assignment
Summarize and compare the conclusions of the various
approaches
Recheck methods that give extreme values
Determine the relevance of the various approaches or
the particular assignment
Arrive at a single point estimate, by either quantitative or
qualitative techniques. Better to round than to imply a
false sense of precision
Check the final conclusion against adjusted income or
adjusted equity. Does the answer make sense?