How to Pre-Screen Deals from a Business Appraiser & BDO s Perspective 2015 AMERICA EAST CONFERENCE August 13, 2015

Transcription

1 How to Pre-Screen Deals from a Business Appraiser & BDO s Perspective 2015 AMERICA EAST CONFERENCE August 13, 2015 Neal Patel, CBA, CVA Scott Gilman Neal Patel, CBA, CVA Neal Patel, CBA, CVA is the Principal of Reliant Business Valuation, a business valuation and equipment appraisal firm specialized in SBA related valuations nationwide. He is a Certified Business Appraiser through the Institute of Business Appraisers (IBA) and a Certified Valuation Analyst through the National Association of Certified Valuators and Analysts (NACVA). Reliant Business Valuation is a leading business valuation and equipment appraisal firm for SBA lenders and currently works with over 150 of the nation s top SBA lenders. 1

2 Scott Gilman SVP, Senior SBA Business Development Officer Scott has over 20 years of experience dedicated exclusively to SBA lending. Having originated over $1.5 billion in SBA loans over the two decades, Scott ranks among the top 1.0% of all SBA loan originators, nationwide. Scott is a veteran of several large, national lenders including Wells Fargo, Community South, and now BankUnited Small Business Finance. Scottisrecognizedasanexpertinbothfranchiseand hospitality lending, annually originating close to $100 million in combined SBA 7a and SBA 504 volume to these industries. Sourcing a Deal SBA Rules Pursuing the Deal Valuation Process Sourcing Deals When is a Business Appraisal Required? Sourcing the Deal Cash Flow Analysis: Liquor Store Valuation Methods SOP Updates Prescreen Reasonable Valuation Multiples BDO Key Tips The Role of Intangible Assets Identifying Red Flags Typical Addbacks & Normalizing Adjustments 2

3 Successful Business Development Officers (BDOs) know. Know how to say no..and yes quickly Work with those that you like.and that like you Become recognizable in circles that are important to you The three C s Credit, Capacity, Creativity The three B s Be available, Be knowledgeable, Be likable Attend business / loan broker conferences Think long term success.. rather than one off deals Time kills all deals.they never get prettier It s not always about the deal.be a resource Communicate and keep your word...manage expectations Don t sweat the small stuff..stay calm always Act with integrity..always do the right thing TEAM everyone is important.it is not just about YOU 3

4 BDO s Should Know the SBA Rules Set expectations for all parties When do you need a business appraisal? What happens if the business appraisal comes in lower than purchase price? Is the subject deal a Special Purpose or Non Special Purpose Property? Do you need an equipment appraisal? Will the transaction be structured as an asset or stock transaction? How much equity does the borrower need to inject? This may depend on intangible assets. When is a Third Party Valuation Required? (Non Special Purpose Property) If the amount being financed (including any 7(a), 504, seller or other financing) minus the appraised value of real estate and/or equipment is greater than $250,000, or.. If there is a close relationship between the buyer and seller (for example, transactions between family members or business partners), or.. If the lender s internal policies and procedures require an independent business valuation from a qualified source 4

5 SOP (H) Updates Terminology Throughout the SOP, the term "business valuation" has been replaced with the term "business appraisal", in order to align with standard terminology within the lending industry. These terms are used interchangeably in the business valuation profession I believe we will continue to see both terms being used in the lending industry. SOP (H) Updates A Special Purpose Property is now defined in the SOP as "a limited market property with a unique physical design, special construction materials, or a layout that restricts its utility to the specific use for which it was built." Examples of Special Purpose Properties include: hotels, car washes, gas stations, bowling alleys, funeral homes with crematoriums, service center with pits and in ground lifts A complete list of Special Purpose Properties is on pages of the SOP. 5

6 SOP (H) Updates For Special Purpose Properties, "the lender must obtain an independent appraisal performed by a Certified General Real Property Appraiser. Additionally, The appraisal must allocate separate values to the individual components of the transaction including land, building, equipment and intangible assets. The Certified General Real Property Appraiser must have completed no less than four going concern appraisals of equivalent special use property as the property being appraised, within the last 36 months, as identified in the qualifications portion of the Appraisal Report. Each appraisal assignment under this section must be... in compliance with current USPAP guidelines. What if the Appraised Value is Lower than Purchase Price? A loan can still be processed under delegated authority (PLP) SOP states: Any amount in excess of the business valuation may not be financed with the SBA guaranteed loan In other words, the appraised value of the business must be greater than the lender s loan amount (portion of loan allocated towards the business acquisition) 6

7 What if the Appraised Value is Lower than Purchase Price? Reasons why a buyer would overpay for a business: Buyout of an inefficient or disgruntled partner Strategic transaction Intrinsic value / investment value The SBA s intent is not to limit the amount that a buyer can pay for a business, but instead to limit the amount that is financed to a percentage of the appraised value. Who is a "qualified source" as per the SBA? (a) Accredited Senior Appraiser (ASA) (b) Certified Business Appraiser (CBA) (c) Accredited in Business Valuation (ABV) (d) Certified Valuation Analyst (CVA) (f) Business Certified Appraiser (BCA)** **new in the SOP (H) (e) Accredited Valuation Analyst (AVA)* *(the AVA designation was merged with CVA and dropped) 7

8 Important Reminder: Transaction Type SOP50105(G)States:"The scope of work should identify whether the transaction is an asset purchase or stock purchase and be specific enough for the individual performing the business appraisal to know what is included in the sale (including any assumed debt)." The SBA Office of Financial Assistance notes multiple cases where a business appraisal fails to include the same assets and liabilities that are included in a proposed transaction, or even worse, the appraiser assumes an incorrect transaction type (stock vs. asset). If the transaction type changes after the business appraisal has been compiled and prior to closing, the lender must request an updated business appraisal that mirrors the final deal structure. Similarly, all assets and liabilities that are included in the final transaction must be included in the business appraisal. This is similar to the basic concept of "comparing apples to apples". When do Intangibles Matter? SOP (G) States: If the purchase price of the business includes intangible assets (including, but not limited to, goodwill, client/customer lists, patents, copyrights, trademarks and agreements not to compete) in excess of $500,000, the borrower and/or seller must provide an equity injection of at least 25% of the purchase price of the business for the application to be processed under delegated authority. 8

9 SBA's Definition: Intangible Assets The value of the intangible assets is determined by either the book value as reflected on the business balance sheet, a separate appraisal for the particular asset, or the value of the business as identified in the business valuation minus the sum of the working capital assets and the fixed assets being purchased. Intangible Assets: SOP Definition The value of the intangible assets is determined by...the value of the business as identified in the business valuation minus the sum of the working capital assets and the fixed assets being purchased. In other words: intangible assets = business value (working capital* + fixed assets) *Working Capital = Current Assets Current Liabilities 9

10 Intangible Assets: SOP Definition Final Value $700,000 Cash or Cash Equivalent $0 Accounts Receivable $0 Inventory $50,000 Other Current Assets $0 Fixed Assets (net book value) $100,000 Other Assets $0 Total Tangible Assets Included in Value $150,000 Current Liabilities $0 Long Term Liabilities $0 Total Liabilities Included in Value $0 Assets less Liabilities (rounded) $150,000 Final Value minus (Assets less Liabilities) Total Intangible Assets Included in Value $550,000 Intangible Assets: SOP Definition Final Value $700,000 Cash or Cash Equivalent $0 Accounts Receivable $0 Inventory $50,000 Other Current Assets $0 Fixed Assets (appraised value) $250,000 Other Assets $0 Total Tangible Assets Included in Value $300,000 Current Liabilities $0 Long Term Liabilities $0 Total Liabilities Included in Value $0 Assets less Liabilities (rounded) $300,000 Final Value minus (Assets less Liabilities) Total Intangible Assets Included in Value $400,000 10

11 Intangible Assets: SOP Definition Final Value $600,000 Cash or Cash Equivalent $0 Accounts Receivable $0 Inventory $50,000 Other Current Assets $0 Fixed Assets (appraised value) $250,000 Other Assets $0 Total Tangible Assets Included in Value $300,000 Current Liabilities $100,000 Long Term Liabilities $0 Total Liabilities Included in Value $100,000 Assets less Liabilities (rounded) $200,000 Final Value minus (Assets less Liabilities) Total Intangible Assets Included in Value $400,000 The Valuation Process Cash Flow Analysis: Liquor Store Valuation Methods Reasonable Valuation Multiples Cash Flow Analysis: Dentist Typical Add backs & Normalizing Adjustments Red Flags / FAQ 11

12 Prescreen the Deal Learn how to do it quickly and with limited information: Simple description of the deal 2 years of business tax returns and/or financial statements Year to date (interim) financial statement Personal Financial Statement Owner/buyer/principal s experience & background Ask about personal credit.don t pull credit upfront Identify red flags early!! The three strike rule. Differences in Cash Flow for Lending vs. Business Valuations Cash Flow for Lending Specific to the deal terms and the borrower s requirements Cash flow in underwriting: Takes into consideration buyer s global debt service and personal revolving debt (cars, house, credit card, etc.) Loan amount and proposed Debt Service Coverage Cash Flow for Valuations Based on a hypothetical transaction Cash flow in valuations: Assume one owner operator Does NOT consider the buyer s financial obligations, buyer s management skills, and buyer s global income. 12

13 Case Study Liquor Store How to calculation Seller s Discretionary Earnings Finding all appropriate add backs Difference between lender s and appraiser s cash flow Rule of thumb value using market approach (earnings multiple) Liquor Store LLC 13

14 Liquor Store LLC Liquor Store Cash Flow Step 1: Calculate EBITDA 14

15 Liquor Store Cash Flow Amortization $40,000 1 Step 1: Calculate EBITDA Liquor Store Cash Flow Amortization $40,000 1 EBITDA Calculation Net income (loss) from financials $ 90,923 Add: Interest $ 30,105 Add: Taxes $ Add: Depreciation $ 28,644 Add: Amortization $ 40,000 EBITDA (unadjusted) $ 189,672 15

16 Liquor Store Cash Flow Officer s Comp $15,000 1 Owner s Heath $5,000 Step 2: Calculate Normalized Seller s Discretionary Earnings EBITDA + Owner's Compensation + Normalizing Adjustments* = Normalized SDE *Normalizing Adjustments Non Recurring Expenses Non Business Expenses Owner's Perks Rent Adjustment Typical Add backs Owner(s) compensation (over/under compensated) Manager s Salary (if absentee owned) or Family Salaries (supported by W2 s) Related payroll taxes, benefits, profit sharing Other Discretionary expenses: Spouse s Compensation (if not involved in business) Personal auto Occupancy (i.e. rent expense, lease costs, moving costs, etc) Nonrecurring items or events: Non recurring legal fees Non recurring consulting fees paid to previous owner Unrelated income / pass through income Transactions with affiliate(s) (i.e. arm s length) 16

17 Add backs Not Generally Accepted Advertising / Marketing (difficult to know how much revenue was generated) Full Rent If real estate is owned by the business owner, the rent must be normalized to market rates Adjusting expenses such as Cost of Goods Sold or Salaries to Industry (RMA) Averages Synergistic Add backs certain expenses that may change when a specific buyer takes over Travel Expenses and Meals/Entertainment Expenses (in most cases) Liquor Store Cash Flow Officer s Comp $15,000 1 Owner s Heath $5,000 Appraiser's Cash Flow for Liquor Store EBITDA $ 189,672 Add: Owner's Compensation $ 15,000 Add: Non Business / Non Recurring / Owner's "Perks" $ 5,000 Add: Rent Paid to Affiliate Holding Company (EPC/OC) $ 144,000 Less: Fair Market Rent $ (100,000) Seller's Discretionary Earnings (SDE) $ 253,672 Sq. Feet Gross Rent PSF 5,000 $

18 Liquor Store Cash Flow Appraiser s Cash Flow(s) Appraiser's Cash Flow for Liquor Store EBITDA $ 189,672 Add: Owner's Compensation $ 15,000 Add: Non Business / Non Recurring / Owner's "Perks" $ 5,000 Add: Rent Paid to Affiliate Holding Company (EPC/OC) $ 144,000 Less: Fair Market Rent $ (100,000) Adjustment for market comp/rent Seller's Discretionary Earnings (SDE) $ 253,672 Less: Market Replacement Salary for Owner $ (35,000) Adjustment for fair market comp Adjusted EBITDA $ 218,672 vs. Underwriter s Cash Flow Cash Flow for Lenders (Underwriters) EBITDA $ 189,672 Add: Owner's Compensation $ 15,000 Adjustment for buyer s draw Deduct: Buyer's Required Draw $ (65,000) Add: Rent Paid to Affiliate Holding Company (EPC/OC) $ 144,000 No adjustment for market rent Cash Flow Available to Service Debt $ 283,672 How is a Business Valued? Asset approach Market approach Income approach Adjusted Book Value Method (Similar) Transaction Method Single Period Capitalization Method Multi Period Discounted Cash Flow Method *Each approach should be considered in every valuation engagement 18

19 Using the Market Approach Price / Sales multiple Apply a multiple to the sales Sales $ 2,000,000 Price / Sales Multiple 0.45 Value $ 900,000 The Price / Sales approach does not take into consideration many variable expenses that can impact the cash flow (rent, COGS, salaries, etc.), so this multiple is relied upon infrequently. Using the Market Approach Market Approach is the most frequently used appraisal method for small businesses (sales less than $2 - $3 million) Price / Earnings multiple Apply a multiple to the earnings Earnings (SDE) $ 250,000 Price / Earnings Multiple 4 Value $ 1,000,000 19

20 Which Multiple is Reasonable? What is the relationship between the Price / Earnings multiple and the Rate of Return (or Return on Investment / ROI)? Price / Earnings multiple of x Earnings = 2 year payback period = 1/2 or 50% Return on Investment Price / Earnings multiple of x Earnings = 3 year payback period = 1/3 or 33% Return on Investment Price / Earnings multiple of x Earnings = 4 year payback period = 1/4 or 25% Return on Investment Price / Earnings multiple of x Earnings = 5 year payback period = 1/5 or 20% Return on Investment Which Multiple is Reasonable for the Previous Liquor Store? Normalized SDE (rounded) 250,000 Chosen Price / Earnings Multiple x 2.0 Estimated Value (rule of thumb) 500,000 2 year return 50% ROI Normalized SDE (rounded) 250,000 Chosen Price / Earnings Multiple x 3.0 Estimated Value (rule of thumb) 750,000 3 year return 33% ROI Normalized SDE (rounded) 250,000 Chosen Price / Earnings Multiple x year return Estimated Value (rule of thumb) 1,000,000 25% ROI 20

21 Factors that Influence the Multiple Owner s involvement Financial Strength Transferability of Revenues Size of Potential Buyer Pool Customer Concentration Size of Company / Revenues Growth Prospects Marketability Brand recognition Industry and company risk Management depth Employee retention Ease of operations Quality of clients Product mix Which Multiple is Reasonable for the Previous Liquor Store? Normalized SDE (rounded) 250,000 Chosen Price / Earnings Multiple x 2.0 Estimated Value (rule of thumb) 500,000 2 year return 50% ROI Normalized SDE (rounded) 250,000 Chosen Price / Earnings Multiple x 3.0 Estimated Value (rule of thumb) 750,000 3 year return 33% ROI Normalized SDE (rounded) 250,000 Chosen Price / Earnings Multiple x year return Estimated Value (rule of thumb) 1,000,000 25% ROI 21

22 Cash Flow Valuations Recap (SDE) Appraiser's Cash Flow for Liquor Store EBITDA $ 189,672 Add: Owner's Compensation $ 15,000 Add: Non Business / Non Recurring / Owner's "Perks" $ 5,000 Add: Rent Paid to Affiliate Holding Company (EPC/OC) $ 144,000 Less: Fair Market Rent $ (100,000) Seller's Discretionary Earnings (SDE) $ 253,672 Dentist Practice S Corp Amortization $50,

23 Dentist Practice S Corp EBITDA Calculation Net income (loss) from financials $ 166,570 Add: Interest $ 63,773 Add: Taxes $ Add: Depreciation $ 14,790 Add: Amortization $ 50,000 EBITDA (unadjusted) $ 295,133 1 Amortization $50,000 Dentist Practice S Corp EBITDA + Owner's Compensation + Normalizing Adjustments* = Normalized SDE *Normalizing Adjustments Non Recurring Expenses Non Business Expenses Owner's Perks Rent Adjustment 1 Amortization $50,000 23

24 Dentist Practice S Corp 1 Spouse s Salary $25,000 1 Amortization $50,000 Dentist Practice S Corp Appraiser's Cash Flow for Liquor Store EBITDA $ 295,133 1 Spouse s Salary $25,000 Add: Owner's Compensation $ 185,150 Add: Non Business / Owner's "Perks" $ 7,024 Less: Non Recurring Gain on Sale (Equipment) $ (6,842) Add: Non working Spouse's Salary (W2 proof) $ 25,000 Seller's Discretionary Earnings (SDE) $ 505,465 1 Amortization $50,000 SDE Sales Margin $ 505,465 / $ 1,328,318 = 38.1% 24

25 Which Multiple is Reasonable for the Dentist Practice? Normalized SDE (rounded) 500,000 Chosen Price / Earnings Multiple x 1.0 Estimated Value (rule of thumb) 500,000 1 year return 100% ROI Normalized SDE (rounded) 500,000 Chosen Price / Earnings Multiple x 2.0 Estimated Value (rule of thumb) 1,000,000 2 year return 50% ROI Normalized SDE (rounded) 500,000 Chosen Price / Earnings Multiple x year return Estimated Value (rule of thumb) 1,500,000 33% ROI Factors that Influence the Multiple Owner s involvement Financial Strength Transferability of Revenues Size of Potential Buyer Pool Customer Concentration Size of Company / Revenues Growth Prospects Marketability Brand recognition Industry and company risk Management depth Employee retention Ease of operations Quality of clients Product mix 25

26 Which Multiple is Reasonable for the Dentist Practice? Normalized SDE (rounded) 500,000 Chosen Price / Earnings Multiple x 1.0 Estimated Value (rule of thumb) 500,000 1 year return 100% ROI Normalized SDE (rounded) 500,000 Chosen Price / Earnings Multiple x 2.0 Estimated Value (rule of thumb) 1,000,000 2 year return 50% ROI Normalized SDE (rounded) 500,000 Chosen Price / Earnings Multiple x year return Estimated Value (rule of thumb) 1,500,000 33% ROI Q&A / Contact Information Please contact Neal Patel with any questions you have regarding these slides. Neal Patel, CBA, CVA neal@reliantvalue.com Scott Gilman SGilman@BankUnited.com