BUSINESS VALUATION

Linda B. Trugman CPA/ABV, MCBA, ASA, MBA

Offices in Florida and New Jersey

Why Businesses Are Appraised

Mergers and Acquisitions Allocation of Purchase Price Estate and Gift Taxes Marital Dissolution Employee Stock Ownership Plans Liquidation or Reorganization of a Business BuyBuy-Sell Agreements Stockholder Disputes Financing Ad Valorem Taxes Incentive Stock Option Considerations Initial Public Offering Damages Litigation Insurance Claims Charitable Contributions Eminent Domain Actions Financial Reporting

Appraisal Principles
Principle of Substitution Principle of Future Benefits


a/k/a Principle of Anticipation

Standards of Value
Fair Market Value

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, both parties having reasonable knowledge of relevant facts.

Standards of Value
Fair Market Value Fair Value

Fair Market Value v Fair Value

1. 2. 3. 4. 5. 6. 7. 8. 9. Willing Buyer. Willing Seller. Neither is under compulsion. Assumes a typical hypothetical buyer and seller. A price that is equitable to both. Assumes both buyer and seller have equal knowledge. knowledge. Assumes reasonable knowledge of both parties. Applicable to controlling interests or minority blocks. blocks. Applies to all Federal Tax valuations.

1. Not always a Willing Buyer. 2. Not always a Willing Seller. 3. Buyer may be compelled, but seller is. is. 4. The impact of the proposed transaction is not considered, but the concept of fairness to the seller may be a consideration. consideration. 5. A concept of "fairness" to the seller, considering the inability to keep the stock. 6. No such assumption. 7. No such assumption. assumption. 8. Applicable to minority blocks. 9. The most common value standard in state dissenting and oppressed shareholder statutes.

Standards of Value
Fair Market Value Fair Value Investment Value

Standards of Value
Fair Market Value Fair Value Investment Value Intrinsic Value

Revenue Ruling 59-60 59(Factors To Consider)

Nature of the business and history of the enterprise since its inception. The economic outlook in general and the condition and outlook of the specific industry in particular. The book value of the stock and the financial condition of the business. The earning capacity of the company. The dividend-paying capacity. dividendWhether or not the enterprise has goodwill or other intangible value. Sales of the stock and the size of the block of stock to be valued. The market price of stocks of corporations engaged in the same or similar line of business having their stocks actively traded in a free and open market, either on an exchange or over-the-counter. over-the-

Financial Statement Adjustments

GAAP adjustments Non-operating/nonNon-operating/non-recurring adjustments Discretionary adjustments

Discretionary Adjustments
Owner's compensation Owner's perquisites Entertainment expenses Automobile expenses Compensation to family members Rent expenses (if not an arm's length lease) Interest expense

Business Valuation Approaches

Market Approach Asset Based Approach Income Approach

Market Approach
Guideline company method Transactional method Industry method (sometimes called "rule of thumb")

Commonly Used Multiples

Price/net earnings Price/pre-tax earnings Price/prePrice/cash flow Price/revenues Price/dividend capacity or yield Price/operating profit Price/gross profit Price/book value Price/EBIT Price/EBDIT Price can also be invested capital

Risk Factors
Economic risk Business risk Operating risks Financial risks Asset risks Product risks Market risks Technological risks Regulatory risks Legal risks

Market Approach Example

GUIDELINE CO. Bananas R Us, Inc. Fruits, Inc. Cherry Corp. Grapes Corp. DATE 10/31/95 12/31/95 12/31/95 11/30/95 P/E 8.70 9.30 8.50 6.60 7.80 8.50 6.20 P/S 55.30% 47.43% 35.25% 54.80% 48.20% 48.20% 44.00% P/B 2.85 4.65 3.65 3.90 4.25 3.90 2.50 Apple Company, Inc. 12/31/95

Median Multiple Selected Multiple

After-tax earnings Multiple Oper. Entity Value Net Non-oper. Assets Total Entity Value Rounded

PRICE TO EARNINGS $ 959,446 x 6.20

$ 5,948,565 + 250,000 $ 6,198,565 $ 6,200,000

Asset Based Approach

Adjusted Book Value Method Liquidation Value Method Cost to Create Method

Income Approach Definitions of Income

Net income after tax Net income before tax Cash flow (gross or net) Debt free net income Debt free cash flow (gross or net) EBIT, EBDIT or EBDITA (EBITDA) Earnings before owners compensation, interest and taxes (owners discretionary cash flow)

Income Approach Single Period Model

Capitalization: The process of converting a benefits stream into value by dividing the benefits stream by a rate of return that is adjusted for growth.

Income Approach MultiMulti-Period Model

Discounting: The process of converting a future series of benefit streams into value by bringing them to present value at a rate of return that reflects the risk inherent in the benefits stream.

Income Approach

Capitalization of benefits method Discounted future benefits method Excess earnings method

Capitalization Model V = E / k-g

E = Earnings expected in next period k = Discount rate g = Long term sustainable growth rate

Single Period Model Example

Adjusted Net Income Forecasted Growth Estimated Future Income Capitalization Rate $ 1,000,000 x 1.05

$ 1,050,000 25.0 %

Indicated Value from Operations $ 4,200,000 Add: Net Nonoperating Assets Total Enterprise Value Rounded 357,350 $ 4,557,350 $ 4,600,000

MultiMulti-Period Model
E1 V= --------- + (1 + i)1 E2 E3 Et --------- + --------- +... -------(1 + i)2 (1 + i)3 (1 + i)t

Where E = Benefit stream i = Discount rate

Discount and Capitalization Rates

Components of a Discount Rate

Risk free rate of return General or equity risk premium Specific risk premium

What is the Theory?

Venture Capital Junk Bonds Small Company Stocks Large Company Stocks Corporate Bonds (AAA) Certificates of Deposit Treasury Bonds Treasury Bills

The Build Up Method

"Safe" rate Equity Risk Premium Small Company Risk Premium Specific Company Risk Premium Discount Rate Less: Long Term Growth Capitalization Rate 7.44% 6.90% 5.30% 3.00% 22.64% 2.00% 20.64%

Most Common Valuation Premiums and Discounts

Control Premium Minority discount Discount for lack of marketability

Levels of Value

Discount For Lack of Marketability

Restricted Stock IPO Studies Cost of Floatation