VALUATION BOOTCAMP Presented by:

Transcription

1 VALUATION BOOTCAMP Presented by: David Guadagnoli, Sullivan & Worcester LLP Chris Mellen, Valuation Research Corporation

2 SEMINAR OVERVIEW This session is designed to demystify the process of valuation by relating more technical financial concepts to a family s financial situation, and then explaining the various valuation approaches commonly used. 2

3 CASE STUDY The Story of Charles Darrow: Income and Expenses 2018 Sullivan & Worcester LLP 3

4 CASE STUDY The Story of Charles Darrow: Assets and Liabilities 2018 Sullivan & Worcester LLP 4

5 SOME SIMPLE VALUATION METHODS Book Value $59,138 Equity 3,250 shares = $18.18 per share 2018 Sullivan & Worcester LLP 5

6 SOME SIMPLE VALUATION METHODS Liquidation Value 2018 Sullivan & Worcester LLP 6

7 SOME SIMPLE VALUATION METHODS Discounted Cash Flow Remember that $1 in a year is worth less than $1 today Why? Because I can put the $1 in the bank and earn interest $0.95 earning about 5% is worth $1 in a year (and $1 earning about 5% is worth $1.05 in a year) 2018 Sullivan & Worcester LLP 7

8 SOME SIMPLE VALUATION METHODS Discounted Cash Flow (cont d) Year Cash Cash in 2018 Dollars 2018 $ 3,382 $ 3, ,382 3, ,382 3, ,382 2, ,382 2, ,382 2, ,382 2, ,382 2,404 $ 27,056 $ 22, Sullivan & Worcester LLP 8

9 SOME SIMPLE VALUATION METHODS Discounted Cash Flow BUT, projected business earnings are valued as if the earnings stream will continue for many, many years $60,933 [PV of 40 years of earnings] 3,250 shares = $18.75/share AND if we plow 10% of the earnings back into the business each year $385,570 [PV of 40 years of earnings] 3,250 shares = $118.64/share 2018 Sullivan & Worcester LLP 9

10 IMPORTANCE OF VALUATION PROCESS TO AN ESOP Price paid cannot exceed Adequate Consideration (ERISA 408(e)) Adequate Consideration defined as Fair Market Value (ERISA 3(18)) Valuation must be determined annually using an independent appraiser Valuation must be in detailed written report form Trustee must understand valuation and valuation process 2018 Sullivan & Worcester LLP 10

11 ESOP MUSTS Valuation must be timely Trustee must understand the valuation and the valuation process Valuation report must fully and adequately reflect all relevant factors Valuation must be performed by independent, experienced business appraisers 2018 Sullivan & Worcester LLP 11

12 ESOPs AND VALUATIONS Exit and Succession Planning Initial ESOP Steps: Company Due Diligence Multi-year Forecasts Estimate of Value Full Opinion of Value and Appraisal Report Fairness Opinion of ESOP Transaction for ESOP Trustee Annual Compliance Valuations for ESOP Trustee Existing ESOPs Peer Reviews of Valuations Necessary periodic due diligence for both Trustees and Board Members 12

13 KEY TAKEAWAYS ON BUSINESS VALUATION Valuation is both an art and a science. 1 Valuation is both a quantitative and a qualitative assessment of a business. 2 To boil it down to one sentence: Business valuation is about the risk of achieving a company s expected future cash flow. 2 Or even more simply, it is about risk and return. 2 Ultimately, when estimating value, the question you are trying to answer is not simply What is the value? ; it is Why is the value what you are concluding on? 3 1 Mellen & Evans, Valuation for M&A: Building and Measuring Private Company Value, 3 rd edition, Wiley, p Ibid., p Ibid., p

14 APPROACHES TO VALUE BUSINESS VALUATION APPROACHES INCOME APPROACH MARKET APPROACH ASSET APPROACH Single Period Capitalization Method Discounted Cash Flow Method Guideline Guideline Public Company Method Company Method Transaction Multiple Method Adjusted Book Value Method Liquidation Value Method 14

15 APPROACHES TO VALUE Income Approach Converts anticipated benefits into a present single amount. Looks at future returns discounted to reflect their relative level of risk. May be difficult to use when a company lacks a positive return to discount or capitalize. 15

16 APPROACHES TO VALUE Market Approach Compares the subject to similar businesses or assets that have been sold. Establishes value based on the price paid for alternative investments. May be difficult to use when there is a lack of similar companies for comparison or where the resulting data is inconclusive. 16

17 APPROACHES TO VALUE Asset Approach Reflects the value of the assets of a business, net of its liabilities. Establishes a value based on a hypothetical sale of the company s underlying assets (either orderly or forced). It is difficult to accurately portray general intangible or goodwill value that is not shown at market value on a company s balance sheet. 17

18 APPROACHES TO VALUE Basic Income Approach Example: *EBIT = $100 Net Income = $73 (assuming a 27% corporate tax rate) Net Capital Expenditures, Depreciation, and Net Working Capital Changes = $13 No Debt Cash Flows = $60 ($73-$13) Discount Rate = 18%, Growth = 3%, Capitalization Rate = 15% Value of the Company = $400 ($60/15%) Basic Market Approach Example: EBIT = $100 Multiple = 4 times No Debt Value of the Company = $400 ($100*4) *EBIT = Earnings Before Interest and Taxes 18

19 APPROACHES TO VALUE 19

20 APPROACHES TO VALUE 20

21 APPROACHES TO VALUE Market Approach: Valuation by comparison with transactions in guideline businesses or business interests based on the principle of substitution. Guideline companies are companies that provide a reasonable basis for comparison to the characteristics of the subject company being valued. Invested capital multiples include: IC to revenue, IC to EBITDA, IC to EBIT, and (rarely used) IC to book value. Invested Capital (IC) = Equity + Debt If your house is worth $700,000 and you had a $200,000 mortgage on it, your invested capital is $700,000 = your equity of $500,000 and your debt of $200,000. Equity multiples include: price to revenue, price to gross cash flow, price to earnings, and (rarely used) price to book value. 21

22 APPROACHES TO VALUE Market Approach (continued): The two principal methods within the market approach include: Transaction Multiple Method This method relates multiples from sales of companies to fundamental financial variables for the subject company. The benefit of this method is that the data reveals information about what well-informed strategic players in the industry are doing and the prices they have paid. Note that this data will include transactions involving different types of buyers (strategic and financial), different types of deals (stock vs. asset), and different terms. As such, accurate application of this method can be complicated, involving several adjustments. Guideline Public Company Method This method relates multiples for public company stocks (or partnership interests) to fundamental financial variables for the subject company. While this method can provide some insight into multiples paid within a given industry, there are vast differences between public and private capital markets raising deep concerns about the validity of this method for private companies. There are also ways to reach value based on prior transactions, offers, or agreements in the subject company to its current data. 22

23 APPROACHES TO VALUE Other Considerations: Excess and non-operating assets Real Estate ESOP Tax Shield Repurchase Liability Valuation Adjustments: Discount for lack of marketability (DLOM) Discount for lack of control (DLOC) Control premium 23

24 RISK AND VALUE DRIVERS Macro Industry environment Merger & acquisition activity Seasonality & cyclicality Financial Revenue growth Profitability Financial ratios (LAPS Liquidity, Activity, Profitability, Solvency) 24

25 RISK AND VALUE DRIVERS Operations Strategic / business plan Technological position Structural capital (IP) Management Human capital Depth of management Corporate culture Sales & Marketing Competitive position Customer concentration Backlog 25

26 RISK AND VALUE DRIVERS Value Drivers: Possess strong brand name or customer loyalty. Operate in a well-maintained physical plant. Generate a high sustainable net cash flow to shareholders. Possess competitive advantages (e.g., technology, location, or an exclusive product line). Generally favorable future economic and industry conditions. Sell a diverse mix of products to customers located in broad geographic markets. Operate in large, high-growth industry. High barriers in industry impede entry by new competition. Possess strong position in niche industry. Are either the most efficient low-cost producer or high-quality producer, or both. Source: Mellen & Evans, Valuation for M&A: Building and Measuring Private Company Value, 3 rd edition, Wiley, p

27 RISK AND VALUE DRIVERS Value Detractors: Sales concentrated with a few key customers. Operate in a small industry with a limited customer base. Have compiled or reviewed, rather than audited financials. Operate with deficient working capital and generally limited financial capability. Operate with limited management on whom the company is heavily dependent. Sell commodity-type products that possess little differentiation from competitors. Substantial excess capacity exists in the industry. Continual threat posed by substitute products and technological obsolescence. Sell products through brokers, creating limited knowledge of or contact with product end users. Possess history of litigation with customers, suppliers, and employees. Source: Mellen & Evans, Valuation for M&A: Building and Measuring Private Company Value, 3 rd edition, Wiley, p

28 QUESTIONS THANK YOU! 28

29 CHRIS MELLEN, ASA, MCBA, CVA, ICVS, ABAR, CM&AA Managing Director, VRC Boston Chris Mellen is managing director with Valuation Research Corporation and leads VRC s Boston office. Previously, Chris was the president and founder of Delphi Valuation Advisors, Inc., which he founded in 2000 and sold to VRC in His experience includes involvement in over 3,000 valuations of businesses and intangible assets since Chris holds the Accredited Senior Appraiser (ASA), Master Certified Business Appraiser (MCBA), Certified Valuation Analyst (CVA), International Certified Valuation Specialist (ICVS), Accredited in Business Appraisal Review (ABAR), and Certified Merger and Acquisition Advisor (CM&AA) designations. He earned his MBA from Babson College in Boston with a concentration in finance, and his Bachelor of Arts from McGill University in Montreal with concentrations in industrial relations and economics. He has performed business valuations in a wide range of industries for such purposes as tax planning and compliance, exit planning, strategic planning, estate planning, post-acquisition purchase price allocation, goodwill impairment, employee stock options, financing, mergers and acquisitions, buy-sell agreements, marital dissolution, shareholder disputes, and appraisal review. Chris is co-author of the book, Valuation for M&A: Building and Measuring Private Company Value, third edition, published by Wiley in May (781) CMellen@ValuationResearch.com 220 Norwood Park South Norwood, MA ValuationResearch.com 29

30 DAVID A. GUADAGNOLI, ESQ. Tax Partner, Sullivan & Worcester Boston David Guadagnoli is a tax partner in the Boston office of Sullivan & Worcester. He concentrates his practice in the employee benefits area and is experienced in the design, implementation and administration of welfare and fringe benefit arrangements and qualified retirement plans (including 401(k) plans and ESOPs) for large and small employers, retirement distribution planning for individuals and the design and implementation of nonqualified deferred compensation and equity compensation arrangements for public and private employers. David has extensive practical experience with nondiscrimination testing issues, plan recordkeeping and conversion issues, IRS and DOL audits and the use of self-correction and agency-approved programs and the use of ESOPs as a succession planning tool. David also regularly counsels clients in the financial services industry by advising on and negotiating investment management agreements, structuring pension plan investments to avoid ERISA where possible (using venture capital operating companies (VCOCs) and real estate operating companies (REOCs), as appropriate), and helping clients navigate fiduciary and prohibited transaction issues under ERISA when not. +1 (617) dguadagnoli@sandw.com Sullivan & Worcester LLP One Post Office Square Boston, MA sandw.com 2018 Sullivan & Worcester LLP 30