CANDO 23 rd Annual National Conference A Guide to Business Valuation. What s it worth?

Transcription

1 CANDO 23 rd Annual National Conference A Guide to Business Valuation. What s it worth? by Hugh G. Livingstone CPA, CGA, CBV October 6,

2 Introduction of Crowe MacKay LLP Iain MacKay started the firm in Whitehorse in 1969 Almost 50 years of experience and relationships in the North Offices in Whitehorse, Yellowknife, Edmonton, Calgary, Regina, Kelowna, Surrey and Vancouver Associated with Crowe International for crossborder work 2

3 Practice areas of Crowe MacKay LLP Accounting Auditing Tax compliance and planning Forensic auditing, restructuring and insolvency Business valuations Litigation support 3

4 Aboriginal services provided by Crowe MacKay LLP Working with First Nation, Inuit and Métis communities for over 40 years Financial reporting Training Governance Economic development Management support Internal control review Bookkeeping services 4

5 Introduction of Hugh Born in Vancouver White Pass railway connection Coming to Whitehorse for 30 years 5

6 Introduction of Hugh cont d. Fished on the Teslin river near Johnson's Crossing Fished Little Atlin lake Fished on the Nakina river 6

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8 Introduction of Hugh cont d. Professionally a Chartered Business Valuator Done numerous business valuations in the north (hotels, stores, mills, bulk fuel distribution, airlines) Taught local lesson early re Air North vs. Air Canada Mostly for purchase or sale of business, some redemption of shares 8

9 Today s presentation What is a business valuation? When do you need valuation services? Why choose a Chartered Business Valuator (C.B.V.)? Professional standards Valuation principles Valuation definitions 9

10 Today s presentation cont d. Valuation approaches Capitalized earnings example EBITDA multiples Pitfalls Impact of shareholders agreements Income taxes What to look for when acquiring a business 10

11 What is a business valuation? A business valuation is an independent examination towards rendering an estimate or opinion of the value of either the shares or assets of a business, at a given point in time. Vendor s preference for share transaction Buyer s preference for asset purchase 11

12 When do you need valuation services? Buying or selling businesses Shareholder disputes Business interruption claims Corporate reorganizations Information to stakeholders Financing 12

13 Why choose a Chartered Business Valuator (C.B.V.)? The Canadian Institute of Chartered Business Valuators is the only recognized professional valuation organization in Canada. Chartered Business Valuators are fully qualified to serve as independent expert witnesses when valuation matters arise before courts, security commissions or other regulatory bodies. 13

14 Professional standards Types of financial statements Audit Review } useful to valuator Compilation (Notice to Reader) GIGO 14

15 Professional standards cont d. Types of valuation reports Comprehensive Report (highest assurance) Financing larger acquisitions Real estate appraisals Environmental reports Market studies Borrowing > $1,000,000 Reliance on audits 15

16 Professional standards cont d. Types of valuation reports cont d. Estimate Report Calculation Report (lowest assurance) No reports or studies Reliance on compilations Borrowing < $50,000 16

17 Valuation principles 1. Value is determined at a point in time 2. Valuation is forward looking 3. The market dictates the appropriate rate of return 4. Higher tangible asset value supports higher going concern value 5. Not all value is transferable 6. Higher liquidity = higher value 7. Minority interest less than pro-rata value 17

18 Fair Market Value The highest price available in an open and unrestricted market between informed and prudent parties, acting at arm s length and under no compulsion to act, expressed in terms of cash or cash equivalents. (This definition of fair market value relates to a notional marketplace) Fair market value is generally expressed in a range 18

19 Fair Value A definition held by the Courts to mean fair market value without the application of a minority discount. Oppression remedies Value to Owner Community building 19

20 Minority Discounts Discount applicable due to lack of control A 40% shareholder is unable to elect a majority of the Board of Directors A 5% shareholder is unable to block a special resolution Corporate legislation does provide some relief Articles of incorporation Shareholder agreements Restrictions on transfer of shares 20

21 Price The price at which a transaction occurs. Price is influenced by: Relative negotiating strengths Desire to do the deal Community or social issues Access to information Deep pockets vs. need for cash Vendor take-backs 21

22 Goodwill and Tangible Asset Backing Goodwill Commercial vs. personal Key man Assessment of management Tangible Asset Backing The fair market value of net tangible and identifiable intangible assets (includes patents or royalties, but not goodwill) used in the business. Down-side risk 22

23 Special Purchasers Possible economies of scale Strategic fit Vertical or horizontal synergies Reduced competition Experienced management 23

24 Special Purchasers cont d. New customers and/or sources of supply Acquisition of existing facilities rather than having to build new facilities Desired result: = >2 Community or social issues 24

25 Redundant Assets and EBITDA Redundant assets are assets that are not required in the business, e.g. raw land, excess cash Land used in business treated as a redundant asset EBITDA (Earnings before Interest, Taxes, Depreciation and Amortization) 25

26 Going Concern? NO YES Liquidation approaches Going Concern approaches 26

27 Liquidation approaches Orderly Liquidation Forced Liquidation 27

28 Going Concern approaches Net Assets-Based approach (no goodwill) Capitalized Earnings or Cash Flows approach (goodwill likely) 28

29 Valuation approaches Going Concern approaches Capitalized Earnings Capitalized Cash Flow Discounted Cash Flow Market Comparables Rules of Thumb Net Assets Based Method; no goodwill 29

30 An earnings approach to value Maintainable earnings from operations x Price/Earning Multiple = Going concern value of operations + Redundant assets = Fair market value of the shares 30

31 Capitalized Earnings Approach Balance sheet of target company (000 s) (000 s) Cash $ 500 Payables $ 200 Receivables 300 Bank loan 800 Trucks 1,000 Equipment loan 300 Licenses 500 Equity 1,000 $ 2,300 $ 2,300 31

32 Capitalized Earnings Approach cont d. Tangible Asset Backing (000 s) (000 s) Equity per financial statements (book value) $ 1,000 Adjust: FMV of licenses $ 700 Book value of licenses 500 Excess 200 Tangible asset backing $ 1,200 (fair market value of operating assets) 32

33 Capitalized Earnings Approach cont d. Income statement analysis (000 s) (000 s) (000 s) Net income (loss) per f/s (five years) $ 300 $ 210 $(280) Adjustments: - spouse s salary bonus to owner loss from discontinued operations income taxes (recovery) (40) Adjustable earnings before taxes $ 540 $ 370 $ 70 Maintainable earnings before taxes $ 500 Capital replacement - Income taxes 100 Maintainable earnings from operations $

34 Capitalized Earnings Approach cont d. (Multiple is the inverse of the rate of return required for the RISK of the cash flows) Factors considered in multiplier: Size of business Nature of industry Market position Growth prospects Long-term contracts Value of operating assets Many others.. 34

35 Capitalized Earnings Approach cont d. LOW (000 s) HIGH (000 s) Maintainable earnings from operations $ 400 $ 400 Earnings multiplier (25%; 20% return) 4 5 Capitalized earnings 1,600 2,000 Tax shield on existing assets Going-concern value of operations 1,650 2,050 Redundant assets - - Leverage adjustment - - Estimated fair market value $ 1,650 $ 2,050 35

36 Capitalized Earnings Approach cont d. Goodwill LOW (000 s) HIGH (000 s) Going concern value of operations $ 1,650 $ 2,050 Less tangible asset backing 1,200 1,200 Goodwill $ 450 $ 850 NOTE: Goodwill is times maintainable earnings from operations. 36

37 Capitalized Earnings approach using EBITDA (000 s) Maintainable earnings from operations $ 400 Add: Interest 55 Taxes 100 Depreciation and amortization 15 EBITDA $

38 Capitalized Earnings approach using EBITDA cont d. (000 s) (000 s) EBITDA $ 570 $ 570 EBITDA multiple 5 6 Enterprise value 2,850 3,420 Less: debt 1,100 1,100 Equity value $ 1,750 $ 2,320 38

39 Capitalized Earnings approach cont d. Is the EBITDA real? What s the impact of errors when you use a 5 times multiple? $15,000 of spouse s car expenses $50,000 quasi-personal travel High income to support owner s lifestyle Low income for owner s tax planning 39

40 Capitalized Earnings approach cont d. Accounting policy that capitalizes small tools of $100,000 Short-term vs. long-term impact of aggressive pricing Inflate current profits and lose customers long-term Rent, exchange amount Treat real estate as if a redundant asset 40

41 Pitfalls Does goodwill make sense? Banks won t lend on goodwill because they can t seize it and sell it What could make the goodwill disappear? Source of supply cut off (vendors, roads) Are contracts signed? Relationships without contracts more at risk 41

42 Pitfalls cont d Does goodwill make sense? Change in competition Change in management Environmental accident 42

43 Pitfalls cont d Did we identify all redundant assets? Valuing business or shares? Did we select the appropriate EBITDA multiples i.e., rate of return for risk? 43

44 Impact of Shareholder Agreements on Value Third party offers Restrictions on who can buy the shares Right of first refusal Tag-along and Drag-along provisions Shot-gun clauses Good for deep-pocket shareholders Agreement should specify process and timing 44

45 Impact of Shareholder Agreements on Value cont d. Problems with 3 times prior year s earnings Often useful to state fair value Prefer to be determined by CBV 45

46 Income Taxes Buying shares vs buying business Accrued capital gains e.g. real estate Accrued losses; transferrable? When will taxes be triggered? 46

47 What to look for when acquiring a business Management team running the business Will they be replaced? Are they happy? Are they treated well? Engaged employees rarely steal Ensure long-term arrangements in contractual form; assess quality of relationships Suppliers Customers Management Premises 47

48 What to look for when acquiring a business cont d. Consider environmental issues Consider accounting records Audits vs. compilations Number of year end adjustments Legal issues/structure Governance issues/structure Financing issues/structure; consider earn-outs Consider having vendor remove non-operating assets Do tax planning early 48

49 THANK YOU! Contact: (604)