Warren D. Miller – Value Maps: Valuation Tools That Unlock Business Wealth | World Pakistan
Warren D. Miller – Value Maps: Valuation Tools That Unlock Business Wealth
Wiley | ISBN: 0470437561 | 2010-06-08 | PDF | 408 pages | 1.60 Mb
Author, speaker, and valuation expert Warren Miller explains how to guide client companies through self-assessment using the five-dimension SPARC framework: Strategy, People, Architecture, Routines, Culture. This framework helps analysts uncover the cause-and-effect relationships that explain business performance. In conjunction with Excel-based software accessible at wiley.com, the resulting value map lights the way for valu-ation professionals and consultants to help client companies increase business value.
Value Maps provides thorough coverage of:
- Why traditional approaches to valuing a privately owned business are incomplete
- The one level of the SPARC framework that matters far more than the other
- Why benchmarking a company against a public-company composite is the first step in value enhancement
Using the framework and tools offered by Value Maps, analysts, business appraisers, and consultants are provided with a nuts-and-bolts guide to enhancing the value of businesses in a way that can be replicated across the existing client bases of analysts and consultants.
With twenty-two vignettes illustrating real-world applications of the SPARC framework, Value Maps walks you step by step through a rigorous process to help companies unlock wealth.
http://hotfile.com/dl/51495378/dadbfc6/Value_Maps_-_Valuation_Tools_That_Unlock_Business_Wealth.rar.html
Wednesday, June 30, 2010
Valuation for M&A - Building Value in Private Companies
Valuation for M&A - Building Value in Private Companies
Evans, Bishop, «Valuation for M&A: Building Value in Private Companies»
Wiley | ISBN 0471411019 | 1 Edition (September 14, 2001) | PDF | 1 Mb | 288 Pages
Book Description
The only resource available to help calculate investment value versus fair market value
Whether buying or selling, the question of “what’s it worth?” is multifaceted. In an M&A setting, it is necessary to compute fair market value, but it is far more important to compute investment value-the value of the target company to a strategic buyer. This calculation varies with each prospective buyer, depending on synergies, benefits, and other competitive analyses that are seldom involved in business valuation. Valuation for M&A is the first book to focus on valuation for merger and acquisitions. This groundbreaking guide provides document request checklists, sample interview questions, a format for adjusting financial statements, a format for developing discount rates, a format for computation of net cash flow, and a valuation reconciliation form, all to help senior executives and M&A professionals better negotiate a successful deal.
Frank C. Evans is a certified business appraiser (CBA), Accredited Senior Business Appraiser in Business Valuation (ASA), and CPA (accredited in business valuation) and David M. Bishop is a Master Certified Business Appraiser (MCBA), Accredited Senior Business Appraiser in Business Valuation (ASA), Fellow of the Institute of Business Appraisers (FIBA), and Business Valuator Accredited for Litigation (BVAL).
Book Info
Provides an excellent roadmap for the M&A process and focuses on the elements critical to building value in private businesses. A must read for managers of private companies intent on creating value.
http://hotfile.com/dl/51495377/f18bba2/Valuation_for_MA_-_Building_Value_in_Private_Companies.rar.html
Tags: Valuation for M&A - Building Value in Private Companies
This entry was posted on Wednesday, June 30th, 2010 at 6:45 am and is filed under Ebooks.
Evans, Bishop, «Valuation for M&A: Building Value in Private Companies»
Wiley | ISBN 0471411019 | 1 Edition (September 14, 2001) | PDF | 1 Mb | 288 Pages
Book Description
The only resource available to help calculate investment value versus fair market value
Whether buying or selling, the question of “what’s it worth?” is multifaceted. In an M&A setting, it is necessary to compute fair market value, but it is far more important to compute investment value-the value of the target company to a strategic buyer. This calculation varies with each prospective buyer, depending on synergies, benefits, and other competitive analyses that are seldom involved in business valuation. Valuation for M&A is the first book to focus on valuation for merger and acquisitions. This groundbreaking guide provides document request checklists, sample interview questions, a format for adjusting financial statements, a format for developing discount rates, a format for computation of net cash flow, and a valuation reconciliation form, all to help senior executives and M&A professionals better negotiate a successful deal.
Frank C. Evans is a certified business appraiser (CBA), Accredited Senior Business Appraiser in Business Valuation (ASA), and CPA (accredited in business valuation) and David M. Bishop is a Master Certified Business Appraiser (MCBA), Accredited Senior Business Appraiser in Business Valuation (ASA), Fellow of the Institute of Business Appraisers (FIBA), and Business Valuator Accredited for Litigation (BVAL).
Book Info
Provides an excellent roadmap for the M&A process and focuses on the elements critical to building value in private businesses. A must read for managers of private companies intent on creating value.
http://hotfile.com/dl/51495377/f18bba2/Valuation_for_MA_-_Building_Value_in_Private_Companies.rar.html
Tags: Valuation for M&A - Building Value in Private Companies
This entry was posted on Wednesday, June 30th, 2010 at 6:45 am and is filed under Ebooks.
Healthcare Information Technology – Business Valuation – apageor2 IT Blog
Healthcare Information Technology – Business Valuation – apageor2 IT Blog
By Dave Kauppi http://apageor2.com/itblog/2010/06/healthcare-information-technology-business-valuation/
One of the most challenging aspects of selling a healthcare information technology company is coming up with a business valuation. Sometimes the valuations provided by the market (translation – a completed transaction) defy all logic. In other industry segments there are some pretty handy rules of thumb for valuation metrics. In one industry it may be 1 X Revenue, in another it could be 7.5 X EBITDA.
Since it is critical to our business to help our healthcare information technology clients maximize their business selling price, I have given this considerable thought. Why are some of these software company valuations so high? It is because of the profitability leverage of technology. A simple example is what is Microsoft’s incremental cost to produce the next copy of Office Professional? It is probably $1.20 for three CD’s and 80 cents for packaging. Let’s say the license cost is $400. The gross margin is north of 99%. That does not happen in manufacturing or services or retail or most other industries.
One problem in selling a small healthcare technology company is that they do not have any of the brand name, distribution, or standards leverage that the big companies possess. So, on their own, they cannot create this profitability leverage. The acquiring company, however, does not want to compensate the small seller for the post acquisition results that are directly attributable to the buyer’s market presence. This is what we refer to as the valuation gap.
What we attempt to do is to help the buyer justify paying a much higher price than a pre-acquisition financial valuation of the target company. In other words, we want to get strategic value for our seller. Below are the factors that we use in our analysis:
1. Cost for the buyer to write the code internally – Many years ago, Barry Boehm, in his book, Software Engineering Economics, developed a constructive cost model for projecting the programming costs for writing computer code. He called it the COCOMO model. It was quite detailed and complex, but I have boiled it down and simplified it for our purposes. We have the advantage of estimating the “projects” retrospectively because we already know the number of lines of code comprising our client’s products. In general terms he projected that it takes 3.6 person months to write one thousand SLOC (source lines of code). So if you looked at a senior software engineer at a $70,000 fully loaded compensation package writing a program with 15,000 SLOC, your calculation is as follows – 15 X 3.6 = 54 person months X $5,800 per month = $313,200 divided by 15,000 = $20.88/SLOC.
Before you guys with 1,000,000 million lines of code get too excited about your $20.88 million business value, there are several caveats. Unfortunately the market does not care and will not pay for what it cost you to develop your product. Secondly, this information is designed to help us understand what it might cost the buyer to develop it internally so that he starts his own build versus buy analysis. Thirdly, we have to apply discounts to this analysis if the software is three generations old legacy code, for example. In that case, it is discounted by 90%. You are no longer a technology sale with high profitability leverage. They are essentially acquiring your customer base and the valuation will not be that exciting.
If, however, your application is a brand new application that has legs, start sizing your yacht. Examples of this might be a click fraud application, Pay Pal, or Internet Telephony. The second high value platform would be where your software technology “leap frogs” a popular legacy application. An example of this is when we sold a company that had completely rewritten their legacy management platform in Microsoft.Net. They leap frogged the dominant player in that space that was supporting multiple second generation solutions. Our client became a compelling strategic acquisition. Fast forward one year and I hear the acquirer is selling one of these $100,000 systems per week. Now that’s leverage!
2. Most acquirers could write the code themselves, but we suggest they analyze the cost of their time to market delay. Believe me, with first mover advantage from a competitor or, worse, customer defections, there is a very real cost of not having your product today. We were able to convince one buyer that they would be able to justify our seller’s entire purchase price based on the number of client defections their acquisition would prevent. As it turned out, the buyer had a huge install base and through multiple prior acquisitions was maintaining six disparate software platforms to deliver essentially the same functionality.
This was very expensive to maintain and they passed those costs on to their disgruntled install base. The buyer had been promising upgrades for a few years, but nothing was delivered. Customers were beginning to sign on with their major competitor. Our pitch to the buyer was to make this acquisition, demonstrate to your client base that you are really providing an upgrade path and give notice of support withdrawal for 4 or 5 of the other platforms. The acquisition was completed and, even though their customers that were contemplating leaving did not immediately upgrade, they did not defect either. Apparently the devil that you know is better than the devil you don’t in the world of healthcare information technology.
3. Another arrow in our valuation driving quiver for our sellers is we restate historical financials using the pricing power of the brand name acquirer. We had one client that was a small healthcare IT company that had developed a fine piece of software that compared favorably with a large, publicly traded company’s solution. Our product had the same functionality, ease of use, and open systems platform, but there was one very important difference. The end-user customer’s perception of risk was far greater with the little IT company that could be “out of business tomorrow.” We were literally able to double the financial performance of our client on paper and present a compelling argument to the big company buyer that those economics would be immediately available to him post acquisition. It certainly was not GAP Accounting, but it was effective as a tool to drive transaction value.
4. Financials are important so we have to acknowledge this aspect of buyer valuation as well. We generally like to build in a baseline value (before we start adding the strategic value components) of 2 X contractually recurring revenue during the current year. So, for example, if the company has monthly maintenance contracts of $100,000 times 12 months = $1.2 million X 2 = $2.4 million as a baseline company value component. Another component we add is for any contracts that extend beyond one year. We take an estimate of the gross margin produced in the firm contract years beyond year one and assign a 5 X multiple to that and discount it to present value.
Let’s use an example where they had 4 years remaining on a services contract and the last 3 years were $200,000 per year in revenue with approximately 50% gross margin. We would take the final tree years of $100,000 annual gross margin and present value it at a 5% discount rate resulting in $265,616. This would be added to the earlier 2 X recurring year 1 revenue from above. Again, this financial analysis is to establish a baseline, before we pile on the strategic value components.
5. We try to assign values for miscellaneous assets that the seller is providing to the buyer. Don’t overlook the strategic value of Blue Chip Accounts. Those accounts become a platform for the buyer’s entire product suite being sold post acquisition into an “installed account.” It is far easier to sell add-on applications and products into an existing account than it is to open up that new account. These strategic accounts can have huge value to a buyer.
6. Finally, we use a customer acquisition cost model to drive value in the eyes of a potential buyer. Let’s say that your sales person at 100% of Quota earns total salary and commissions of $125,000 and sells 5 net new accounts. That would mean that your base customer acquisition cost per account was $25,000. Add a 20% company overhead for the 85 accounts, for example, and the company value, using this methodology would be $2,550,000.
7. Our final valuation component is what we call the defensive factor. This is very real in the healthcare information technology arena. What is the value to a large firm of preventing his competitor from acquiring your technology and improving their competitive position in the marketplace. One of our clients had an outcomes database and nurse staffing software algorithm. The owner was the recognized expert in this area and had industry credibility. This was a small add on application to two large industry players’ integrated hospital applications suite. This module was viewed as providing a slight features advantage to the company that could integrate it with their main systems. The selling price for one of these major software systems to a hospital chain was often more than $50 million. The value paid for our client was determined, not by the financial performance of our client, but by the competitive edge they could provide post acquisition. Our client did very well on her company sale.
After reading this you may be saying to yourself, come on, this is a little far fetched. These components do have real value, but that value is open to a broad interpretation by the marketplace. We are attempting to assign metrics to a very subjective set of components. The buyers are smart, and experienced in the M&A process and quite frankly, they try to deflect these artistic approaches to driving up their financial outlay. The best leverage point we have is that those buyers know that we are presenting the same analysis to their competitors and they don’t know which component or components of value that we have presented will resonate with their competition. In the final analysis, we are just trying to provide the buyers some reasonable explanation for their board of directors to justify paying 8 X revenues for an acquisition.
Dave Kauppi is the editor of The Exit Strategist Newsletter, a Merger and Acquisition Advisor and President of MidMarket Capital, representing owners in the sale healthcare and technology based businesses. We provide Wall Street style investment banking services to lower mid market companies at a size appropriate fee structure.
Author: Dave Kauppi
Article Source: EzineArticles.com
Digital economy, mobile technology
This entry was written by Dave Kauppi, posted on 06/29/2010 at 8:11 pm, filed under Health Care.
By Dave Kauppi http://apageor2.com/itblog/2010/06/healthcare-information-technology-business-valuation/
One of the most challenging aspects of selling a healthcare information technology company is coming up with a business valuation. Sometimes the valuations provided by the market (translation – a completed transaction) defy all logic. In other industry segments there are some pretty handy rules of thumb for valuation metrics. In one industry it may be 1 X Revenue, in another it could be 7.5 X EBITDA.
Since it is critical to our business to help our healthcare information technology clients maximize their business selling price, I have given this considerable thought. Why are some of these software company valuations so high? It is because of the profitability leverage of technology. A simple example is what is Microsoft’s incremental cost to produce the next copy of Office Professional? It is probably $1.20 for three CD’s and 80 cents for packaging. Let’s say the license cost is $400. The gross margin is north of 99%. That does not happen in manufacturing or services or retail or most other industries.
One problem in selling a small healthcare technology company is that they do not have any of the brand name, distribution, or standards leverage that the big companies possess. So, on their own, they cannot create this profitability leverage. The acquiring company, however, does not want to compensate the small seller for the post acquisition results that are directly attributable to the buyer’s market presence. This is what we refer to as the valuation gap.
What we attempt to do is to help the buyer justify paying a much higher price than a pre-acquisition financial valuation of the target company. In other words, we want to get strategic value for our seller. Below are the factors that we use in our analysis:
1. Cost for the buyer to write the code internally – Many years ago, Barry Boehm, in his book, Software Engineering Economics, developed a constructive cost model for projecting the programming costs for writing computer code. He called it the COCOMO model. It was quite detailed and complex, but I have boiled it down and simplified it for our purposes. We have the advantage of estimating the “projects” retrospectively because we already know the number of lines of code comprising our client’s products. In general terms he projected that it takes 3.6 person months to write one thousand SLOC (source lines of code). So if you looked at a senior software engineer at a $70,000 fully loaded compensation package writing a program with 15,000 SLOC, your calculation is as follows – 15 X 3.6 = 54 person months X $5,800 per month = $313,200 divided by 15,000 = $20.88/SLOC.
Before you guys with 1,000,000 million lines of code get too excited about your $20.88 million business value, there are several caveats. Unfortunately the market does not care and will not pay for what it cost you to develop your product. Secondly, this information is designed to help us understand what it might cost the buyer to develop it internally so that he starts his own build versus buy analysis. Thirdly, we have to apply discounts to this analysis if the software is three generations old legacy code, for example. In that case, it is discounted by 90%. You are no longer a technology sale with high profitability leverage. They are essentially acquiring your customer base and the valuation will not be that exciting.
If, however, your application is a brand new application that has legs, start sizing your yacht. Examples of this might be a click fraud application, Pay Pal, or Internet Telephony. The second high value platform would be where your software technology “leap frogs” a popular legacy application. An example of this is when we sold a company that had completely rewritten their legacy management platform in Microsoft.Net. They leap frogged the dominant player in that space that was supporting multiple second generation solutions. Our client became a compelling strategic acquisition. Fast forward one year and I hear the acquirer is selling one of these $100,000 systems per week. Now that’s leverage!
2. Most acquirers could write the code themselves, but we suggest they analyze the cost of their time to market delay. Believe me, with first mover advantage from a competitor or, worse, customer defections, there is a very real cost of not having your product today. We were able to convince one buyer that they would be able to justify our seller’s entire purchase price based on the number of client defections their acquisition would prevent. As it turned out, the buyer had a huge install base and through multiple prior acquisitions was maintaining six disparate software platforms to deliver essentially the same functionality.
This was very expensive to maintain and they passed those costs on to their disgruntled install base. The buyer had been promising upgrades for a few years, but nothing was delivered. Customers were beginning to sign on with their major competitor. Our pitch to the buyer was to make this acquisition, demonstrate to your client base that you are really providing an upgrade path and give notice of support withdrawal for 4 or 5 of the other platforms. The acquisition was completed and, even though their customers that were contemplating leaving did not immediately upgrade, they did not defect either. Apparently the devil that you know is better than the devil you don’t in the world of healthcare information technology.
3. Another arrow in our valuation driving quiver for our sellers is we restate historical financials using the pricing power of the brand name acquirer. We had one client that was a small healthcare IT company that had developed a fine piece of software that compared favorably with a large, publicly traded company’s solution. Our product had the same functionality, ease of use, and open systems platform, but there was one very important difference. The end-user customer’s perception of risk was far greater with the little IT company that could be “out of business tomorrow.” We were literally able to double the financial performance of our client on paper and present a compelling argument to the big company buyer that those economics would be immediately available to him post acquisition. It certainly was not GAP Accounting, but it was effective as a tool to drive transaction value.
4. Financials are important so we have to acknowledge this aspect of buyer valuation as well. We generally like to build in a baseline value (before we start adding the strategic value components) of 2 X contractually recurring revenue during the current year. So, for example, if the company has monthly maintenance contracts of $100,000 times 12 months = $1.2 million X 2 = $2.4 million as a baseline company value component. Another component we add is for any contracts that extend beyond one year. We take an estimate of the gross margin produced in the firm contract years beyond year one and assign a 5 X multiple to that and discount it to present value.
Let’s use an example where they had 4 years remaining on a services contract and the last 3 years were $200,000 per year in revenue with approximately 50% gross margin. We would take the final tree years of $100,000 annual gross margin and present value it at a 5% discount rate resulting in $265,616. This would be added to the earlier 2 X recurring year 1 revenue from above. Again, this financial analysis is to establish a baseline, before we pile on the strategic value components.
5. We try to assign values for miscellaneous assets that the seller is providing to the buyer. Don’t overlook the strategic value of Blue Chip Accounts. Those accounts become a platform for the buyer’s entire product suite being sold post acquisition into an “installed account.” It is far easier to sell add-on applications and products into an existing account than it is to open up that new account. These strategic accounts can have huge value to a buyer.
6. Finally, we use a customer acquisition cost model to drive value in the eyes of a potential buyer. Let’s say that your sales person at 100% of Quota earns total salary and commissions of $125,000 and sells 5 net new accounts. That would mean that your base customer acquisition cost per account was $25,000. Add a 20% company overhead for the 85 accounts, for example, and the company value, using this methodology would be $2,550,000.
7. Our final valuation component is what we call the defensive factor. This is very real in the healthcare information technology arena. What is the value to a large firm of preventing his competitor from acquiring your technology and improving their competitive position in the marketplace. One of our clients had an outcomes database and nurse staffing software algorithm. The owner was the recognized expert in this area and had industry credibility. This was a small add on application to two large industry players’ integrated hospital applications suite. This module was viewed as providing a slight features advantage to the company that could integrate it with their main systems. The selling price for one of these major software systems to a hospital chain was often more than $50 million. The value paid for our client was determined, not by the financial performance of our client, but by the competitive edge they could provide post acquisition. Our client did very well on her company sale.
After reading this you may be saying to yourself, come on, this is a little far fetched. These components do have real value, but that value is open to a broad interpretation by the marketplace. We are attempting to assign metrics to a very subjective set of components. The buyers are smart, and experienced in the M&A process and quite frankly, they try to deflect these artistic approaches to driving up their financial outlay. The best leverage point we have is that those buyers know that we are presenting the same analysis to their competitors and they don’t know which component or components of value that we have presented will resonate with their competition. In the final analysis, we are just trying to provide the buyers some reasonable explanation for their board of directors to justify paying 8 X revenues for an acquisition.
Dave Kauppi is the editor of The Exit Strategist Newsletter, a Merger and Acquisition Advisor and President of MidMarket Capital, representing owners in the sale healthcare and technology based businesses. We provide Wall Street style investment banking services to lower mid market companies at a size appropriate fee structure.
Author: Dave Kauppi
Article Source: EzineArticles.com
Digital economy, mobile technology
This entry was written by Dave Kauppi, posted on 06/29/2010 at 8:11 pm, filed under Health Care.
Sell Your Business Well – Helpful Tips That You Must Read | DL White Site
Sell Your Business Well – Helpful Tips That You Must Read | DL White Site
June 29th, 2010 | Author: Amanda Leer
Unlimited Rapid Massive Traffic
Many business owners know the 80-20 principle in doing business. This principle means that you will try to focus on 20% of the customers and provide good service for them. And for the rest of the customers, you may maintain a good relationship with them but they will not be the main target of your business.
There are plenty of reasons which can explain the failure of these businesses. And the general one is that the businessmen cannot target the suitable customers well. There are numerous customers for a business and it is difficult for the owner of the business to have a very close contact with every customer. Therefore, it is important for them to target certain groups of customers, which may account for 20% of the total number of customers. Of course, some businesses may use the total amount of sales as reference. It means that they will try to target the customers who altogether contribute to about 20% of the total sales.
But in order to make your focused customers happy, you have to do something. If you cannot provide them with the quality service, they will surely be unhappy. And as they are the focused customers, your business will collapse if you cannot gain their support. There are several ways that you can work on so as to make your customers loyal to your business.
You may say that it is hard to keep such record for all the customers. Well, I am not saying that you should treat every customer in this way. You should only treat part of the customers. The selection criteria depend on you, but you should only target about 20% of the customers. Or, you may select customers which can contribute to 20% of the total sales of your business.
If you want to explore new market, you can try to attend some seminars or trade shows. These will enable you to reach more customers who are in your target group. Of course, you should notice about the scale of the trade fairs before you confirm to attend it. Some of them may be really small and you cannot get new target customers well by attending it.
No doubt, the quality of service should be from your company but not you only. You have to train your company staff so that they have the mind to serve the customers well. Sometimes you may not be in the shop and your staff will be responsible to deliver the quality service.
When you do the promotion or when you contact your customers, you have to make them feel that they are important. If it is possible, you should send the email one by one. Sometimes, customers will see that you are sending the email to thousands of people at the same time and they know that they are just small in the group. If you can send the email one by one, they will feel warm because you can provide them with personal care.
To conclude, you should figure out some unique ways to provide impressive services to the clients of your company. It can help your business to be outstanding in the market.
June 29th, 2010 | Author: Amanda Leer
Unlimited Rapid Massive Traffic
Many business owners know the 80-20 principle in doing business. This principle means that you will try to focus on 20% of the customers and provide good service for them. And for the rest of the customers, you may maintain a good relationship with them but they will not be the main target of your business.
There are plenty of reasons which can explain the failure of these businesses. And the general one is that the businessmen cannot target the suitable customers well. There are numerous customers for a business and it is difficult for the owner of the business to have a very close contact with every customer. Therefore, it is important for them to target certain groups of customers, which may account for 20% of the total number of customers. Of course, some businesses may use the total amount of sales as reference. It means that they will try to target the customers who altogether contribute to about 20% of the total sales.
But in order to make your focused customers happy, you have to do something. If you cannot provide them with the quality service, they will surely be unhappy. And as they are the focused customers, your business will collapse if you cannot gain their support. There are several ways that you can work on so as to make your customers loyal to your business.
You may say that it is hard to keep such record for all the customers. Well, I am not saying that you should treat every customer in this way. You should only treat part of the customers. The selection criteria depend on you, but you should only target about 20% of the customers. Or, you may select customers which can contribute to 20% of the total sales of your business.
If you want to explore new market, you can try to attend some seminars or trade shows. These will enable you to reach more customers who are in your target group. Of course, you should notice about the scale of the trade fairs before you confirm to attend it. Some of them may be really small and you cannot get new target customers well by attending it.
No doubt, the quality of service should be from your company but not you only. You have to train your company staff so that they have the mind to serve the customers well. Sometimes you may not be in the shop and your staff will be responsible to deliver the quality service.
When you do the promotion or when you contact your customers, you have to make them feel that they are important. If it is possible, you should send the email one by one. Sometimes, customers will see that you are sending the email to thousands of people at the same time and they know that they are just small in the group. If you can send the email one by one, they will feel warm because you can provide them with personal care.
To conclude, you should figure out some unique ways to provide impressive services to the clients of your company. It can help your business to be outstanding in the market.
How to Sell a Home-Based Business - ProfitBrite
How to Sell a Home-Based Business - ProfitBrite
How to Sell a Home-Based Business
You've accomplished what many have sought but few have achieved: a profitable home-based business. Now, you want to turn your sweat equity into cash by selling your business. Maybe you intend to travel & play, start another business, or just sit by the pool and relax. Whatever your intention, you will need cash to do it.
There Are Plenty of Prospects for Your Business, but Few Are Buying
In 2010, the number of prospective buyers looking for home-based business opportunities is at an all-time high. Corporate layoffs and cutbacks have left many Americans short on cash and looking for ways to supplement their household income.
In spite of the abundance of prospective buyers, business brokers say that 4 out of 5 small businesses listed for sale will not sell. Those that do not sell are either taken off the market, sold at auction, or just closed down. Why, with so many willing sellers and willing buyers, are 4 out of 5 businesses not selling?
Financing is Difficult to Get
The 2010 economy is defined by tight credit. Currently, banks rarely make small business loans, even to long established bricks-and-mortar companies with hard assets like machinery and real estate. Banks almost never loan money to purchase a home-based business. Buyers of home-based businesses generally don't have the resources to pay cash for a business. Even though the seller is willing to sell and the buyer is willing to buy, there is no money available to complete the transaction.
In this article, I'll hit on a few key points that will make your business more attractive to buyers. Then, I will tell you the one slam-dunk approach that is guaranteed to sell your business, in spite of the economy.
Make Your Business More Attractive to Buyers
Buyers are motivated primarily by income and opportunity. To prove income, you must have kept good books and have your tax returns in order. If you have kept your books yourself and done your own tax returns, have your records reviewed by a CPA. Have your CPA re-cast your financial statements to show your Earnings Before Interest, Taxes, Depreciation and Amortization (EBITDA). EBITDA evaluation removes all discretionary expenditures from your financial statements and boosts your stated income. The higher your income, the more your business is worth. Use the re-cast income to value your business; you'll get more money for your business. The Business Reference Guide published by Business Brokers Press lists a Multiple-of-Income for businesses like yours. Multiply the "Multiple" by your annual income to arrive at a ballpark selling price for your business. The Reference guide is expensive, though, and you may do just as well to use the online valuation software provided by BizBuySell.com.
It must be easy for a new owner to take over your business; have your operating procedures, suppliers and contacts written down. Your business must also offer a buyer the opportunity to use their abilities to make the business their own. Entrepreneurs want to be their own boss, to do things their own way. If your customers buy from you because they really like doing business with you personally, the new buyer is at a disadvantage from the start. Make sure that your business is, indeed, transferable, and offers a genuine opportunity for the new owner to grow.
How to Guarantee the Sale of Your Business
The primary reason a home-based business does not sell is lack of financing. A seller who offers to finance the business purchase for the new buyer greatly increases the chance of selling the business. Done correctly, owner financing can be a low-risk and profitable undertaking. If you decide to offer financing for the business, be sure to have the note drawn up by an attorney and have your interests filed at the county courthouse.
What Are the Advantages of Owner Financing?
The biggest advantage of owner financing is that your business will actually be sold, and sold for the asking price. Buyers don't argue price with sellers who are providing financing. Also, the seller collects interest on the selling price, which increases the net gain from the sale. There is advantage, also, to the buyer: the loan is repaid from the profits of the business.
How Can I Be Sure I Will be Paid?
There are four keys to insuring repayment of an owner-financed loan: 1. Get a substantial down payment 2. Secure the note with the business itself 3. Make sure the buyer has attachable assets outside of the business (real estate, CD's, stocks) 4. Get a personal guarantee. If these four bases are covered and the buyer defaults on the loan, you can repossess the business and/or attach his personal assets for repayment. Again, discuss these details with an attorney.
What if I Don't Want to Wait Years for My Money?
Most sellers who finance their own business do not wait years for repayment; they sell the note at a discount to a note broker. Usually, if the buyer has put a 25-30% down payment on the loan, the interest is sufficiently high and the term no longer than 60 months, the note is eligible to be sold to a note broker. In as little as 3 months, a seller can cash out the note they are holding and walk away without ever collecting another monthly payment. The note broker becomes the owner of the note, and collects all the payments. If your intention is to sell your note to a broker to cash out your sale, it is best to work out the details with the note broker prior to the sale. For more information, Google the search term "secure your business note".
If you manage to sell your home-based business, you are a remarkable entrepreneur, indeed. You have beaten the odds twice: you have created a successful home-based business, and then sold it for a profit.
Wayne Jordan is a Virginia licensed Auctioneer, Certified Personal Property Appraiser, and Accredited Business Broker. He specializes in the Valuation and Liquidation of Estate and Business assets. Learn more at his website http://www.waynejordanauctions.com or his blog http://www.wayne-jordan.blogspot.com
Article Source: [http://EzineArticles.com/?How-to-Sell-a-Home-Based-Business&id=4555579] How to Sell a Home-Based Business
How to Sell a Home-Based Business
You've accomplished what many have sought but few have achieved: a profitable home-based business. Now, you want to turn your sweat equity into cash by selling your business. Maybe you intend to travel & play, start another business, or just sit by the pool and relax. Whatever your intention, you will need cash to do it.
There Are Plenty of Prospects for Your Business, but Few Are Buying
In 2010, the number of prospective buyers looking for home-based business opportunities is at an all-time high. Corporate layoffs and cutbacks have left many Americans short on cash and looking for ways to supplement their household income.
In spite of the abundance of prospective buyers, business brokers say that 4 out of 5 small businesses listed for sale will not sell. Those that do not sell are either taken off the market, sold at auction, or just closed down. Why, with so many willing sellers and willing buyers, are 4 out of 5 businesses not selling?
Financing is Difficult to Get
The 2010 economy is defined by tight credit. Currently, banks rarely make small business loans, even to long established bricks-and-mortar companies with hard assets like machinery and real estate. Banks almost never loan money to purchase a home-based business. Buyers of home-based businesses generally don't have the resources to pay cash for a business. Even though the seller is willing to sell and the buyer is willing to buy, there is no money available to complete the transaction.
In this article, I'll hit on a few key points that will make your business more attractive to buyers. Then, I will tell you the one slam-dunk approach that is guaranteed to sell your business, in spite of the economy.
Make Your Business More Attractive to Buyers
Buyers are motivated primarily by income and opportunity. To prove income, you must have kept good books and have your tax returns in order. If you have kept your books yourself and done your own tax returns, have your records reviewed by a CPA. Have your CPA re-cast your financial statements to show your Earnings Before Interest, Taxes, Depreciation and Amortization (EBITDA). EBITDA evaluation removes all discretionary expenditures from your financial statements and boosts your stated income. The higher your income, the more your business is worth. Use the re-cast income to value your business; you'll get more money for your business. The Business Reference Guide published by Business Brokers Press lists a Multiple-of-Income for businesses like yours. Multiply the "Multiple" by your annual income to arrive at a ballpark selling price for your business. The Reference guide is expensive, though, and you may do just as well to use the online valuation software provided by BizBuySell.com.
It must be easy for a new owner to take over your business; have your operating procedures, suppliers and contacts written down. Your business must also offer a buyer the opportunity to use their abilities to make the business their own. Entrepreneurs want to be their own boss, to do things their own way. If your customers buy from you because they really like doing business with you personally, the new buyer is at a disadvantage from the start. Make sure that your business is, indeed, transferable, and offers a genuine opportunity for the new owner to grow.
How to Guarantee the Sale of Your Business
The primary reason a home-based business does not sell is lack of financing. A seller who offers to finance the business purchase for the new buyer greatly increases the chance of selling the business. Done correctly, owner financing can be a low-risk and profitable undertaking. If you decide to offer financing for the business, be sure to have the note drawn up by an attorney and have your interests filed at the county courthouse.
What Are the Advantages of Owner Financing?
The biggest advantage of owner financing is that your business will actually be sold, and sold for the asking price. Buyers don't argue price with sellers who are providing financing. Also, the seller collects interest on the selling price, which increases the net gain from the sale. There is advantage, also, to the buyer: the loan is repaid from the profits of the business.
How Can I Be Sure I Will be Paid?
There are four keys to insuring repayment of an owner-financed loan: 1. Get a substantial down payment 2. Secure the note with the business itself 3. Make sure the buyer has attachable assets outside of the business (real estate, CD's, stocks) 4. Get a personal guarantee. If these four bases are covered and the buyer defaults on the loan, you can repossess the business and/or attach his personal assets for repayment. Again, discuss these details with an attorney.
What if I Don't Want to Wait Years for My Money?
Most sellers who finance their own business do not wait years for repayment; they sell the note at a discount to a note broker. Usually, if the buyer has put a 25-30% down payment on the loan, the interest is sufficiently high and the term no longer than 60 months, the note is eligible to be sold to a note broker. In as little as 3 months, a seller can cash out the note they are holding and walk away without ever collecting another monthly payment. The note broker becomes the owner of the note, and collects all the payments. If your intention is to sell your note to a broker to cash out your sale, it is best to work out the details with the note broker prior to the sale. For more information, Google the search term "secure your business note".
If you manage to sell your home-based business, you are a remarkable entrepreneur, indeed. You have beaten the odds twice: you have created a successful home-based business, and then sold it for a profit.
Wayne Jordan is a Virginia licensed Auctioneer, Certified Personal Property Appraiser, and Accredited Business Broker. He specializes in the Valuation and Liquidation of Estate and Business assets. Learn more at his website http://www.waynejordanauctions.com or his blog http://www.wayne-jordan.blogspot.com
Article Source: [http://EzineArticles.com/?How-to-Sell-a-Home-Based-Business&id=4555579] How to Sell a Home-Based Business
Personanondata: Do You Sincerely Want to Sell Your Publishing Business?: Michael Cairns - Content to Strategy
Personanondata: Do You Sincerely Want to Sell Your Publishing Business?: Michael Cairns - Content to Strategy
Tuesday, June 29, 2010
Do You Sincerely Want to Sell Your Publishing Business?
There are various approaches to selling a business and selling a publishing business is no different. The circumstances surrounding the decision to sell can greatly influence how smoothly the process goes; however, as with many things, the amount of preparation that goes into the process will ultimately determine whether there is a successful outcome.
As a seller, your immediate task is to eliminate questions, cynicism and doubt about your business in the minds of potential buyers. No matter how excited the potential purchaser seems to be about your company, they are going to be skeptical about key information. Their job is to (cynically) use anything negative to undercut a purchase price; your job is to be open and effectively back up any questions they will have with facts. (Bear in mind that adequately addressing these issues to their seeming satisfaction early in the process doesn't mean the purchaser won't raise them again during negotiations, so keep your story straight and simple).
If, as an owner, you always believed you would sell the business, then you should have a reasonable understanding when you would like this to happen. As a prelude to this event, you will want to focus on a number of key areas.
First, your financial statements: If Aunt Sally has been doing your taxes for the life of the company and you have never had periodic management accounts, then you are not in a position to achieve full value for your company. Treat Aunt Sally with respect but get yourself an accountant and a bookkeeper to put the numbers in order. At least a full year's audited financials and management accounts should be considered the basic financial reporting requirement when done by a qualified financial accountant. (They do not need to be full-time staff).
Second, if Aunt Sally is just one of several family members taking a salary in the company, you may want to think about their continued involvement in the run up to the sale. A buyer will want to know the actual operating cost of the business and you, as a seller, want to provide the best possible view of the business (that is, without extra expenses). Now, if the family member(s) has a legitimate and key role, then you may have other issues to address (such as their position with the company post-sale).
Third, many buyers will focus on future revenue growth. Do you have formal contracts or handshake deals? Is revenue dependent on one source? The buyer is going to second-guess your revenue projections; therefore, if there are any 'soft spots' it will undercut their confidence in the business overall. Saying so and so has always bought from us is not as valuable as being able to say 'we have a negotiated five-year deal' and we are currently in year two. If your revenue growth is rock solid - even if it is based on a small number of authors, commercial accounts or subscribers but supported in each case contractually - that will place you in a stronger position.
Fourth, your accountant will also create a balance sheet for the company and the key items concerning a buyer are those things that deal most immediately with cash. As a seller, you need details about your inventory turn, accounts receivable collections and accounts payable. Assuming you have prepared for the sale of the business more than twelve months in advance, you should have a clear picture of these items. Just because an item is listed as a company asset doesn’t mean a potential buyer is going to agree as to its value.
Other balance sheet items that require attention are fixed assets, which may include the building in which the company is located. Sometimes a seller wants to keep the building (if they own it) in which case you and your accountant will need to determine the best way to handle this. Bear in mind that the property could be the most valuable asset owned by the company. Similarly, the company may own patents and intellectual property that must be properly accounted for and (for the benefit of the acquirer) properly documented.
In summary, get your accounts audited, create a 'clean' income statement, deal proactively to get your revenue sources locked down and establish formal procedures to manage your cash flow and balance sheet items.
Obviously, the value of a business is stated in black and white in its financial statements but to the potential buyer they will be just as interested in the products you're selling and their future value as they are in your accounting policies. You must have clear ownership rights to any content or technology that represents a primary asset(s) of the company. If contracts aren't transferable, if certain rights are retained by content producers or if you 'collected' data to create your products without proper authority, these issues and others like them should be addressed and resolved before you market your company. If there is any doubt in the mind of a buyer that they will be able to carry the business forward, this will either scuttle a deal or significantly reduce your purchase price. And don't think they won't find out.
Sixth, your organization's human capital is important to the business for continuity reasons (if not for other reasons). Don't believe that you can keep the selling process a secret because even if your employees don't know everything, they will make up the rest. As a seller, you must maintain momentum and, for that, you need to maintain decent employee morale.
Bonuses and incentives can play a role, as can simple communication. Unfortunately, you can't control what the purchaser chooses to do with the business and placing restrictions on post-sale activities - even if you can get away with this - will only reduce your take. Key employees are important to the purchaser and they will want to know who these people are. The purchaser may want some guarantee that these key employees will remain with the business for some stated period after the sale and will be willing to pay the employees a bonus to stay.
As an owner, you may have provided equity to employees over the years, which would give them a piece of any sale. Often these deals can be 'casual' which is not what a buyer wants to hear. The last place a buyer wants to find him or herself is in the middle of an ownership dispute, so, no matter how painful this process may be, get those agreements formalized in advance of a sale.
Finally, as a seller you will want to practice speaking about your company so you are effective in communicating to potential buyers why acquiring your company represents good strategy. Your understanding of your market, your competitors' market positioning and market trends and opportunities all represent key components of your company's selling attributes - and reasons why a purchaser will see opportunity in acquiring your company. Work to prepare a briefing document of your company which you can use in presentations and discussions. Importantly, at industry events, seek out speaking and panel discussion opportunities where you can both present your company and your understanding of the market, as well as learn about what other similar companies are doing in your marketplace. Not everyone is comfortable with this type of communication; however, during a sales process the buyer is going to rely a lot on your perspective about the business, and the more comfortable you are, the better your views will come across. The only way to become a better and more effective communicator is through practice.
In summary, any hiccup in the process of acquiring your company could result in a buyer or buyers either getting cold feet or simply moving on to something else. There are lots of companies drawing acquisition attention and, having gained attention, you don't want to lose it and fall to the bottom of the pile. By the time you regain their interest, circumstances could have changed significantly and no longer exist to your advantage or worse - the opportunity maybe permanently lost to you.
Tuesday, June 29, 2010
Do You Sincerely Want to Sell Your Publishing Business?
There are various approaches to selling a business and selling a publishing business is no different. The circumstances surrounding the decision to sell can greatly influence how smoothly the process goes; however, as with many things, the amount of preparation that goes into the process will ultimately determine whether there is a successful outcome.
As a seller, your immediate task is to eliminate questions, cynicism and doubt about your business in the minds of potential buyers. No matter how excited the potential purchaser seems to be about your company, they are going to be skeptical about key information. Their job is to (cynically) use anything negative to undercut a purchase price; your job is to be open and effectively back up any questions they will have with facts. (Bear in mind that adequately addressing these issues to their seeming satisfaction early in the process doesn't mean the purchaser won't raise them again during negotiations, so keep your story straight and simple).
If, as an owner, you always believed you would sell the business, then you should have a reasonable understanding when you would like this to happen. As a prelude to this event, you will want to focus on a number of key areas.
First, your financial statements: If Aunt Sally has been doing your taxes for the life of the company and you have never had periodic management accounts, then you are not in a position to achieve full value for your company. Treat Aunt Sally with respect but get yourself an accountant and a bookkeeper to put the numbers in order. At least a full year's audited financials and management accounts should be considered the basic financial reporting requirement when done by a qualified financial accountant. (They do not need to be full-time staff).
Second, if Aunt Sally is just one of several family members taking a salary in the company, you may want to think about their continued involvement in the run up to the sale. A buyer will want to know the actual operating cost of the business and you, as a seller, want to provide the best possible view of the business (that is, without extra expenses). Now, if the family member(s) has a legitimate and key role, then you may have other issues to address (such as their position with the company post-sale).
Third, many buyers will focus on future revenue growth. Do you have formal contracts or handshake deals? Is revenue dependent on one source? The buyer is going to second-guess your revenue projections; therefore, if there are any 'soft spots' it will undercut their confidence in the business overall. Saying so and so has always bought from us is not as valuable as being able to say 'we have a negotiated five-year deal' and we are currently in year two. If your revenue growth is rock solid - even if it is based on a small number of authors, commercial accounts or subscribers but supported in each case contractually - that will place you in a stronger position.
Fourth, your accountant will also create a balance sheet for the company and the key items concerning a buyer are those things that deal most immediately with cash. As a seller, you need details about your inventory turn, accounts receivable collections and accounts payable. Assuming you have prepared for the sale of the business more than twelve months in advance, you should have a clear picture of these items. Just because an item is listed as a company asset doesn’t mean a potential buyer is going to agree as to its value.
Other balance sheet items that require attention are fixed assets, which may include the building in which the company is located. Sometimes a seller wants to keep the building (if they own it) in which case you and your accountant will need to determine the best way to handle this. Bear in mind that the property could be the most valuable asset owned by the company. Similarly, the company may own patents and intellectual property that must be properly accounted for and (for the benefit of the acquirer) properly documented.
In summary, get your accounts audited, create a 'clean' income statement, deal proactively to get your revenue sources locked down and establish formal procedures to manage your cash flow and balance sheet items.
Obviously, the value of a business is stated in black and white in its financial statements but to the potential buyer they will be just as interested in the products you're selling and their future value as they are in your accounting policies. You must have clear ownership rights to any content or technology that represents a primary asset(s) of the company. If contracts aren't transferable, if certain rights are retained by content producers or if you 'collected' data to create your products without proper authority, these issues and others like them should be addressed and resolved before you market your company. If there is any doubt in the mind of a buyer that they will be able to carry the business forward, this will either scuttle a deal or significantly reduce your purchase price. And don't think they won't find out.
Sixth, your organization's human capital is important to the business for continuity reasons (if not for other reasons). Don't believe that you can keep the selling process a secret because even if your employees don't know everything, they will make up the rest. As a seller, you must maintain momentum and, for that, you need to maintain decent employee morale.
Bonuses and incentives can play a role, as can simple communication. Unfortunately, you can't control what the purchaser chooses to do with the business and placing restrictions on post-sale activities - even if you can get away with this - will only reduce your take. Key employees are important to the purchaser and they will want to know who these people are. The purchaser may want some guarantee that these key employees will remain with the business for some stated period after the sale and will be willing to pay the employees a bonus to stay.
As an owner, you may have provided equity to employees over the years, which would give them a piece of any sale. Often these deals can be 'casual' which is not what a buyer wants to hear. The last place a buyer wants to find him or herself is in the middle of an ownership dispute, so, no matter how painful this process may be, get those agreements formalized in advance of a sale.
Finally, as a seller you will want to practice speaking about your company so you are effective in communicating to potential buyers why acquiring your company represents good strategy. Your understanding of your market, your competitors' market positioning and market trends and opportunities all represent key components of your company's selling attributes - and reasons why a purchaser will see opportunity in acquiring your company. Work to prepare a briefing document of your company which you can use in presentations and discussions. Importantly, at industry events, seek out speaking and panel discussion opportunities where you can both present your company and your understanding of the market, as well as learn about what other similar companies are doing in your marketplace. Not everyone is comfortable with this type of communication; however, during a sales process the buyer is going to rely a lot on your perspective about the business, and the more comfortable you are, the better your views will come across. The only way to become a better and more effective communicator is through practice.
In summary, any hiccup in the process of acquiring your company could result in a buyer or buyers either getting cold feet or simply moving on to something else. There are lots of companies drawing acquisition attention and, having gained attention, you don't want to lose it and fall to the bottom of the pile. By the time you regain their interest, circumstances could have changed significantly and no longer exist to your advantage or worse - the opportunity maybe permanently lost to you.
Start an Online Business or Buy an Existing One | Millionaire Books for Millionaire
Start an Online Business or Buy an Existing One | Millionaire Books for Millionaire
by admin on June 29, 2010
Start an Online Business or Buy an Existing One
You need to carefully consider if you want to rather invest to start an online business of your own and as there are pros and cons associated with buying any business you need to do your due diligence thoroughly.
Here are a few tips to consider to assist you in the decision of whether to buy an existing business or not.
The fact that most of the groundwork has already been done when buying an existing internet business has huge benefits including domain name, auto-responder, graphics, email address, and most probably a blog has already been set up too.
Of major importance is traffic as this is the lifeblood of any internet business. So instead of having to use your time to get the business set up you can concentrate on honing your internet marketing skills to drive targeted traffic to your site.
Do remember that an existing business does not necessarily mean it it is already receiving high volumes of targeted traffic. Even if it is you will still have to focus on driving targeted traffic on a consistent basis.
Depending on the quality of the business purchased you could also benefit from the existing traffic rank, Google page rank, back-links as well as the customer base. It may also be running at a profit as well.
Branding your business online is important and this may already be created in a purchased business. By adding a picture of yourself to the web pages and an about me page too you can also start branding yourself.
You may find that you may have to make adjustments to existing graphics if you intend branding your business around yourself, so that is something else to think about.
Even though an online business is relatively cheap and easy to start from scratch, buying an existing one is also not expensive when you compare it to what a traditional business costs to purchase. The price of purchasing a business will depend on a lot of factors and they range from a few hundred to a few thousand dollars.
Some are sold by auction or you can even find some advertised in the forums and there are sites on the internet dedicated to the sale of online businesses. By joining a discussion forum related to the theme of the business you are interested in would enable you post inquiring after existing businesses that are for sale. Many online transactions and business sales take place in forums.
Once you have found a business that you are interested in purchasing you must still look thoroughly into it and do a full due diligence. However, these are just a few tips to bear in mind when deciding whether you want to start an online business from scratch, expand your existing business or purchase an existing business.
Cynthia Minnaar runs her own Online Business full-time from home and she invites you to learn more about the opportunity she used to start an online business of her own.
by admin on June 29, 2010
Start an Online Business or Buy an Existing One
You need to carefully consider if you want to rather invest to start an online business of your own and as there are pros and cons associated with buying any business you need to do your due diligence thoroughly.
Here are a few tips to consider to assist you in the decision of whether to buy an existing business or not.
The fact that most of the groundwork has already been done when buying an existing internet business has huge benefits including domain name, auto-responder, graphics, email address, and most probably a blog has already been set up too.
Of major importance is traffic as this is the lifeblood of any internet business. So instead of having to use your time to get the business set up you can concentrate on honing your internet marketing skills to drive targeted traffic to your site.
Do remember that an existing business does not necessarily mean it it is already receiving high volumes of targeted traffic. Even if it is you will still have to focus on driving targeted traffic on a consistent basis.
Depending on the quality of the business purchased you could also benefit from the existing traffic rank, Google page rank, back-links as well as the customer base. It may also be running at a profit as well.
Branding your business online is important and this may already be created in a purchased business. By adding a picture of yourself to the web pages and an about me page too you can also start branding yourself.
You may find that you may have to make adjustments to existing graphics if you intend branding your business around yourself, so that is something else to think about.
Even though an online business is relatively cheap and easy to start from scratch, buying an existing one is also not expensive when you compare it to what a traditional business costs to purchase. The price of purchasing a business will depend on a lot of factors and they range from a few hundred to a few thousand dollars.
Some are sold by auction or you can even find some advertised in the forums and there are sites on the internet dedicated to the sale of online businesses. By joining a discussion forum related to the theme of the business you are interested in would enable you post inquiring after existing businesses that are for sale. Many online transactions and business sales take place in forums.
Once you have found a business that you are interested in purchasing you must still look thoroughly into it and do a full due diligence. However, these are just a few tips to bear in mind when deciding whether you want to start an online business from scratch, expand your existing business or purchase an existing business.
Cynthia Minnaar runs her own Online Business full-time from home and she invites you to learn more about the opportunity she used to start an online business of her own.
Begin New Business or Buy Aged Corporation? | Business Directory and Resources
Begin New Business or Buy Aged Corporation? | Business Directory and Resources
Posted in Business, Management - 29 June 2010 - No comment
Do you plan to begin your own business? If you are, you need to make ripe plan. There are two alternatives that you can choose to begin your own business, the following are start new business or buy an existing business. As we know, start a new business is a good choice if we have ripe plan about our business and if we have a new product or service that we offered in our new business. This is need hard work to make our business familiar on customer’s eye.
In other hand, if we buy an existing business or sometimes called an on-going concern, we just continue the business process. The management, marketing strategy, brand awareness and others has been formed so we just make sure that run in a good way to gain more profit. An existing business is a business that is operating and the owner wants to sell the corporation to other people.
Where we can find existing businesses for sale? It is easy to find existing businesses for sale on internet. There are some websites that offer list of aged shelf corporations for sale. Two of the websites are bbfmls.com and ibba.org. There we can easily choose the aged corporations and see the detail before buy it.
Posted in Business, Management - 29 June 2010 - No comment
Do you plan to begin your own business? If you are, you need to make ripe plan. There are two alternatives that you can choose to begin your own business, the following are start new business or buy an existing business. As we know, start a new business is a good choice if we have ripe plan about our business and if we have a new product or service that we offered in our new business. This is need hard work to make our business familiar on customer’s eye.
In other hand, if we buy an existing business or sometimes called an on-going concern, we just continue the business process. The management, marketing strategy, brand awareness and others has been formed so we just make sure that run in a good way to gain more profit. An existing business is a business that is operating and the owner wants to sell the corporation to other people.
Where we can find existing businesses for sale? It is easy to find existing businesses for sale on internet. There are some websites that offer list of aged shelf corporations for sale. Two of the websites are bbfmls.com and ibba.org. There we can easily choose the aged corporations and see the detail before buy it.
Tuesday, June 29, 2010
Tips on Selling a Business | Finance Analysis
Tips on Selling a Business | Finance Analysis
Selling a business takes preparation, planning and commitment by the owner. It is like any other project, set a goal, list the steps to get there and then work the plan. When you sell a business you will need to gather all of the important facts about your business and put them in a presentable form. Another important early decision is how you are going to sell your business. Are you going to do it yourself or with professional help. Most businesses change hands with the help of professional agents who are experts in selling a business. The help of a pro can be invaluable in getting a good fair price and selling the business in a timely manner. With the following ideas and tips an owner can begin to get at how to sell their business.
Information and valuation
In order to sell a business, the owner has to come up with a figure, which represents what he feels the business is worth. This price will become the asking price for the business. A price cannot be arrived at without accurate numbers and information about the business in question. Gathering this information is the first step in a number of them needed to sell your business.
The collected information is then used to come up with an asking price for your business. There are many formulas that are used to value a business. The industry the business is in will also determine how the sale price is developed. One of the current ways to get to this number is to hire an expert evaluator who has been certified by a recognized business seller’s organization. This certified evaluator is used in court cases, IRS cases and in the sale of a business like yours. Since this is a disinterested third party, both sides in the negotiation can usually use the value that is delivered. This valuation is arrived at by inspection of the company, use of your accountant’s figures and the industry you are in.
With the important first step, the game is on and the negotiations can be engaged in with serous intent. Every thing flows from this first step, so it must be as accurate as possible. This first move sets the tone for much of what follows in the sales meetings and conversations.
Get help or sell yourself
Selling your business without help from those that do it for a living, is the hard way to do it unless you have someone who is ready to buy At the very least it would be very useful to get a certified evaluation so you have third party support for your asking price. If you elect to try to sell the business yourself, you will be undertaking a time consuming project that may not fit in with running your business at the same time. But if this is your choice, then a way must be found to find a buyer. Advertising in trade magazines is one of the ways to find a buyer. Posting on acquireo.com when selling a business is a very effective way to let the public know of the sale. Acquireo has cheap advertising options for business owners and brokers and has proven marketing strategies to let the buyers know whenever a new business is up for sale. Locally you should let professionals you deal with and other business friends in on the fact that you are willing to entertain offers for your business.
The advantage of hiring a business selling pro is they have a network of buyers who are qualified and are seriously looking for a business to buy. If your business is a match for what his client is looking for you may have a quick and easy sale. Another plus is your business will be listed on their website and promoted throughout their network. You would not have this entry without being a potential customer of theirs. They may have access to financing your buyer may need in order to cash you out. A full service broker provides every service needed to make the sale of your business happen.
Cash out vs. terms for a sale
A “cash out” means the buyer pays an acceptable price in full to purchase your company. This purchase price may be less than one which includes terms, but this can be used as a negotiating tool. Cash in full is less than the price if the seller has to extend terms to complete the sale. If the seller agrees to be a holder of some paper to make the sale, then a higher price may be used as the final purchase price. Terms can be a powerful negotiating tool when getting down to the way the business will be sold. If the buyer wants terms, then you can agree if the purchase price can be raised.
After the sale help from the previous owner
After the sale is completed there may be time that the buyer and the seller agree that the old owner will help with the transition. This may include helping the new owner learn the business and how to handle the important customers. The old owner could take the new owner around and introduce him to the major customers. He can tell him about the strengths and weaknesses of the employees. His ideas for growth should be listened too with apt attention, as the old owner is more knowledgeable about what the company is facing and where it can improve.
He could also give a heads up about the competition and clients they should go after. His intimate knowledge of the facts, history and future possibilities should be noted and maybe even used. This is a terrific source that should not be wasted or forgotten about.
Conclusions
The many ins and outs for selling your business should be read about and studied. You have worked hard to make your company worthwhile and now that you are going to sell it you should get top dollar for it. A certified sale price is a step that all business sellers should make, for one reason. This value was given for your business by a pro who knows how to evaluate what a business is worth.
Selling a business is a tricky proposition and most owners would be wise to put this task in the hands of business broker who sells businesses for a living. They know how to do it and do it in a timely manner. They also can be of great value when in the negotiating stages. They keep this sometimes-tense situation on track and moving forward. They can talk both parties out of unreasonable demands.
If terms or financing become the only way to make the deal fly, their experience can be the deciding factor. This deal making knowledge can be the glue that keeps the deal together. The negotiating stage is a critical time in the sale of the business. Having an old hand involved in the talks can be very helpful and could make the final result be positive instead of negative. His clear-eyed view of the deal can help to dissolve hidden objections and misgivings that have not surfaced until now. Most owners would be wise to get out of the way and let their business be sold.
Bill Henthorn formerly was principal broker and owner of a resort / commercial real estate brokerage in Honolulu which specialized in representing sellers in transactions up to $50MM.He currently serves as the marketing director of http://www.acquireo.com
Selling a business takes preparation, planning and commitment by the owner. It is like any other project, set a goal, list the steps to get there and then work the plan. When you sell a business you will need to gather all of the important facts about your business and put them in a presentable form. Another important early decision is how you are going to sell your business. Are you going to do it yourself or with professional help. Most businesses change hands with the help of professional agents who are experts in selling a business. The help of a pro can be invaluable in getting a good fair price and selling the business in a timely manner. With the following ideas and tips an owner can begin to get at how to sell their business.
Information and valuation
In order to sell a business, the owner has to come up with a figure, which represents what he feels the business is worth. This price will become the asking price for the business. A price cannot be arrived at without accurate numbers and information about the business in question. Gathering this information is the first step in a number of them needed to sell your business.
The collected information is then used to come up with an asking price for your business. There are many formulas that are used to value a business. The industry the business is in will also determine how the sale price is developed. One of the current ways to get to this number is to hire an expert evaluator who has been certified by a recognized business seller’s organization. This certified evaluator is used in court cases, IRS cases and in the sale of a business like yours. Since this is a disinterested third party, both sides in the negotiation can usually use the value that is delivered. This valuation is arrived at by inspection of the company, use of your accountant’s figures and the industry you are in.
With the important first step, the game is on and the negotiations can be engaged in with serous intent. Every thing flows from this first step, so it must be as accurate as possible. This first move sets the tone for much of what follows in the sales meetings and conversations.
Get help or sell yourself
Selling your business without help from those that do it for a living, is the hard way to do it unless you have someone who is ready to buy At the very least it would be very useful to get a certified evaluation so you have third party support for your asking price. If you elect to try to sell the business yourself, you will be undertaking a time consuming project that may not fit in with running your business at the same time. But if this is your choice, then a way must be found to find a buyer. Advertising in trade magazines is one of the ways to find a buyer. Posting on acquireo.com when selling a business is a very effective way to let the public know of the sale. Acquireo has cheap advertising options for business owners and brokers and has proven marketing strategies to let the buyers know whenever a new business is up for sale. Locally you should let professionals you deal with and other business friends in on the fact that you are willing to entertain offers for your business.
The advantage of hiring a business selling pro is they have a network of buyers who are qualified and are seriously looking for a business to buy. If your business is a match for what his client is looking for you may have a quick and easy sale. Another plus is your business will be listed on their website and promoted throughout their network. You would not have this entry without being a potential customer of theirs. They may have access to financing your buyer may need in order to cash you out. A full service broker provides every service needed to make the sale of your business happen.
Cash out vs. terms for a sale
A “cash out” means the buyer pays an acceptable price in full to purchase your company. This purchase price may be less than one which includes terms, but this can be used as a negotiating tool. Cash in full is less than the price if the seller has to extend terms to complete the sale. If the seller agrees to be a holder of some paper to make the sale, then a higher price may be used as the final purchase price. Terms can be a powerful negotiating tool when getting down to the way the business will be sold. If the buyer wants terms, then you can agree if the purchase price can be raised.
After the sale help from the previous owner
After the sale is completed there may be time that the buyer and the seller agree that the old owner will help with the transition. This may include helping the new owner learn the business and how to handle the important customers. The old owner could take the new owner around and introduce him to the major customers. He can tell him about the strengths and weaknesses of the employees. His ideas for growth should be listened too with apt attention, as the old owner is more knowledgeable about what the company is facing and where it can improve.
He could also give a heads up about the competition and clients they should go after. His intimate knowledge of the facts, history and future possibilities should be noted and maybe even used. This is a terrific source that should not be wasted or forgotten about.
Conclusions
The many ins and outs for selling your business should be read about and studied. You have worked hard to make your company worthwhile and now that you are going to sell it you should get top dollar for it. A certified sale price is a step that all business sellers should make, for one reason. This value was given for your business by a pro who knows how to evaluate what a business is worth.
Selling a business is a tricky proposition and most owners would be wise to put this task in the hands of business broker who sells businesses for a living. They know how to do it and do it in a timely manner. They also can be of great value when in the negotiating stages. They keep this sometimes-tense situation on track and moving forward. They can talk both parties out of unreasonable demands.
If terms or financing become the only way to make the deal fly, their experience can be the deciding factor. This deal making knowledge can be the glue that keeps the deal together. The negotiating stage is a critical time in the sale of the business. Having an old hand involved in the talks can be very helpful and could make the final result be positive instead of negative. His clear-eyed view of the deal can help to dissolve hidden objections and misgivings that have not surfaced until now. Most owners would be wise to get out of the way and let their business be sold.
Bill Henthorn formerly was principal broker and owner of a resort / commercial real estate brokerage in Honolulu which specialized in representing sellers in transactions up to $50MM.He currently serves as the marketing director of http://www.acquireo.com
Financial Modelling | Term Life
Financial Modelling | Term Life
Financial modeling is a process of forecasting performance of a certain asset, using relationships among operating, investing, and financing variables. The central aim of all financial modeling is valuation under uncertainty: how to estimate the value of a security when its future trajectory, or the trajectory of the other securities or economic variables it depends on, is unknown. Usually, financial modeling requires a great deal of spreadsheet work.
Financial Modeling Application
ü Business valuation, especially discounted cash flow
ü Cost of capital or WACC
ü Modeling the term structure of interest rate and credit spread
ü Option pricing
ü Real options
ü Risk modeling
ü Portfolio problems
Standard and Premise of Business Value
Before the value of a business can be measured, the valuation assignment must specify the reason for and circumstances surrounding the business valuation. These are formally known as the business value standard and premise of value.
Business valuation results can vary considerably depending upon the choice of both the standard and premise of value. For example, a business buyer and seller may bargain to establish the value of business assets that approaches the fair market value standard.
However, the value conclusions based on the going concern premise and that of assemblage of business assets may be quite different. One reason is that an operating business creates value by means of its ability to coordinate its capital, human and management resources to produce economic income. The same set of assets not currently used to produce income is generally worth less.
Reasons for Business Valuation
Business people may need to conduct business valuation for a number of reasons including sale, estate tax planning, estate tax valuation, divorce, business purchase price allocation, collateral documentation, litigation and documenting that a sales price is equitable.
Fair market value
“Fair market value”, a central standard of measuring business value, is defined as the price at which 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. See IRS Rev. Rul. 59-60, 1959-1, Cum. Bulletin 237, codified at 26 C.F.R. § 20.2031-1(b).
The fair market value standard incorporates certain assumptions, including the assumptions that the hypothetical purchaser is reasonably prudent and rational but is not motivated by any synergistic or strategic influences; that the business will continue as a going concern and not be liquidated; that the hypothetical transaction will be conducted in cash or equivalents; and that the parties are willing and able to consummate the transaction.
These assumptions might not, and probably do not, reflect the actual conditions of the market in which the subject business might be sold. However, these conditions are assumed because they yield a uniform standard of value, after applying generally-accepted valuation techniques, which allows meaningful comparison between businesses which are similarly situated.
Elements of business valuation
Economic conditions
A business valuation report generally begins with a description of national, regional and local economic conditions existing as of the valuation date, as well as the conditions of the industry in which the subject business operates. A common source of economic information for the first section of the business valuation report is the Federal Reserve Board’s Beige Book, published quarterly by the Federal Reserve Bank. State governments and industry associations often publish useful statistics describing regional and industry conditions.
Financial Analysis
The financial statement analysis generally involves common size analysis, ratio analysis (liquidity, turnover, profitability, etc.), trend analysis and industry comparative analysis. This permits the valuation analyst to compare the subject company to other businesses in the same or similar industry, and to discover trends affecting the company and/or the industry over time. By comparing a company’s financial statements in different time periods, the valuation expert can view growth or decline in revenues or expenses, changes in capital structure, or other financial trends. How the subject company compares to the industry will help with the risk assesment and ultimately help determine the discount rate and the selection of market multiples.
Normalization of financial statements
The most common normalization adjustments fall into the following four categories:
Comparability Adjustments. The valuator may adjust the subject company’s financial statements to facilitate a comparison between the subject company and other businesses in the same industry or geographic location. These adjustments are intended to eliminate differences between the way that published industry data is presented and the way that the subject company’s data is presented in its financial statements.
Non-operating Adjustments. It is reasonable to assume that if a business were sold in a hypothetical sales transaction (which is the underlying premise of the fair market value standard), the seller would retain any assets which were not related to the production of earnings or price those non-operating assets separately. For this reason, non-operating assets (such as excess cash) are usually eliminated from the balance sheet.
Non-recurring Adjustments. The subject company’s financial statements may be affected by events that are not expected to recur, such as the purchase or sale of assets, a lawsuit, or an unusually large revenue or expense. These non-recurring items are adjusted so that the financial statements will better reflect the management’s expectations of future performance.
Discretionary Adjustments. The owners of private companies may be paid at variance from the market level of compensation that similar executives in the industry might command. In order to determine fair market value, the owner’s compensation, benefits, perquisites and distributions must be adjusted to industry standards. Similarly, the rent paid by the subject business for the use of property owned by the company’s owners individually may be scrutinized.
Income, Asset and Market Approaches
Three different approaches are commonly used in business valuation: the income approach, the asset-based approach, and the market approach. Within each of these approaches, there are various techniques for determining the fair market value of a business. Generally, the income approaches determine value by calculating the net present value of the benefit stream generated by the business (discounted cash flow); the asset-based approaches determine value by adding the sum of the parts of the business (net asset value); and the market approaches determine value by comparing the subject company to other companies in the same industry, of the same size, and/or within the same region.
In determining which of these approaches to use, the valuation professional must exercise discretion. Each technique has advantages and drawbacks, which must be considered when applying those techniques to a particular subject company. Most treatises and court decisions encourage the valuator to consider more than one technique, which must be reconciled with each other to arrive at a value conclusion. A measure of common sense and a good grasp of mathematics is helpful.
Income approaches
The income approaches determine fair market value by multiplying the benefit stream generated by the subject company times a discount or capitalization rate. The discount or capitalization rate converts the stream of benefits into present value. There are several different income approaches, including capitalization of earnings or cash flows, discounted future cash flows (“DCF”), and the excess earnings method (which is a hybrid of asset and income approaches). Most of the income approaches consider the subject company’s historical financial data; only the DCF method requires the subject company to provide projected financial data. Most of the income approaches look to the company’s adjusted historical financial data for a single period; only DCF requires data for multiple future periods. The discount or capitalization rate must be matched to the type of benefit stream to which it is applied. The result of a value calculation under the income approach is generally the fair market value of a controlling, marketable interest in the subject company, since the entire benefit stream of the subject company is most often valued, and the capitalization and discount rates are derived from statistics concerning public companies.
Discount or capitalization rates
A discount or capitalization rate is used to determine the present value of the expected returns of a business. The discount rate and capitalization rate are closely related to each other, but distinguishable. Generally speaking, the discount rate or capitalization rate may be defined as the yield necessary to attract investors to a particular investment, given the risks associated with that investment. The discount rate is applied only to discounted cash flow (DCF) valuations, which are based on projected business data over multiple periods of time. In DCF valuations, a series of projected cash flows is divided by the discount rate to derive the present value of the discounted cash flows. The sum of the discounted cash flows is added to a terminal value, which represents the present value of business cash flows into perpetuity. The sum of the discounted cash flows and the terminal value is the value of the business.
On the other hand, a capitalization rate is applied in methods of business valuation that are based on historical business data for a single period of time. The after-tax net cash flow capitalization rate is equal to the discount rate minus the long-term sustainable growth rate. The after-tax net cash flow of a business is divided by the capitalization rate to derive the present value. Capitalization rates may be modified so that they may be applied to after-tax net income or pre-tax cash flows or income. There are several different methods of determining the appropriate discount rates. The discount rate is composed of two elements: (1) the risk-free rate, which is the return that an investor would expect from a secure, practically risk-free investment, such as a government bond; plus (2) a risk premium that compensates an investor for the relative level of risk associated with a particular investment in excess of the risk-free rate. Most importantly, the selected discount or capitalization rate must be consistent with stream of benefits to which it is to be applied.
Build-Up Method
The Build-Up Method is a widely-recognized method of determining the after-tax net cash flow discount rate, which in turn yields the capitalization rate. The figures used in the Build-Up Method are derived from various sources. This method is called a “build-up” method because it is the sum of risks associated with various classes of assets. It is based on the principle that investors would require a greater return on classes of assets that are more risky. The first element of an Build-Up capitalization rate is the risk-free rate, which is the rate of return for long-term government bonds. Investors who buy large-cap equity stocks, which are inherently more risky than long-term government bonds, require a greater return, so the next element of the Build-Up method is the equity risk premium. In determining a company’s value, the long-horizon equity risk premium is used because the Company’s life is assumed to be infinite. The sum of the risk-free rate and the equity risk premium yields the long-term average market rate of return on large public company stocks.
Similarly, investors who invest in small cap stocks, which are riskier than blue-chip stocks, require a greater return, called the “size premium.” Size premium data is generally available from two sources: Morningstars’ (formerly Ibbotson & Associates’) Stocks, Bonds, Bills & Inflation and Duff & Phelps’ Risk Premium Report.
By adding the first three elements of a Build-Up discount rate, we can determine the rate of return that investors would require on their investments in small public company stocks. These three elements of the Build-Up discount rate are known collectively as the “systematic risks.”
In addition to systematic risks, the discount rate must include “unsystematic risks,” which fall into two categories. One of those categories is the “industry risk premium.” Morningstar’s yearbooks contain empirical data to quantify the risks associated with various industries, grouped by SIC industry code.
The other category of unsystematic risk is referred to as “specific company risk.” Historically, no published data has been available to quantify specific company risks. However as of late 2006, new research has been able to quantify, or isolate, this risk for publicly-traded stocks through the use of Total Beta calculations. P. Butler and K. Pinkerton have outlined a procedure using a modified Capital Asset Pricing Model (CAPM) to calculate the company specific risk premium. The model uses an equality between the standard CAPM which relies on the total beta on one side of the equation; and the firm’s beta, size premium and company specific risk premium on the other. The equality is then solved for the company specific risk premium as the only unknown. While this is ground-breaking research, it has yet to be adopted and used by the valuation community at large.
It is important to understand why this capitalization rate for small, privately-held companies is significantly higher than the return that an investor might expect to receive from other common types of investments, such as money market accounts, mutual funds, or even real estate. Those investments involve substantially lower levels of risk than an investment in a closely-held company. Depository accounts are insured by the federal government (up to certain limits); mutual funds are composed of publicly-traded stocks, for which risk can be substantially minimized through portfolio diversification; and real estate almost invariably appreciates in value of long time horizons.
Closely-held companies, on the other hand, frequently fail for a variety of reasons too numerous to name. Examples of the risk can be witnessed in the storefronts on every Main Street in America. There are no federal guarantees. The risk of investing in a private company cannot be reduced through diversification, and most businesses do not own the type of hard assets that can ensure capital appreciation over time. This is why investors demand a much higher return on their investment in closely-held businesses; such investments are inherently much more risky.
Capital Asset Pricing Model (“CAP-M”)
The Capital Asset Pricing Model is another method of determining the appropriate discount rate in business valuations. The CAP-M method originated from the Nobel Prize winning studies of Harry Markowitz, James Tobin and William Sharpe. Like the Ibbotson Build-Up method, the CAP-M method derives the discount rate by adding a risk premium to the risk-free rate. In this instance, however, the risk premium is derived by multiplying the equity risk premium times “beta,” which is a measure of stock price volatility. Beta is published by various sources (including Ibbotson Associates, which was used in this valuation) for particular industries and companies. Beta is associated with the systematic risks of an investment.
One of the criticisms of the CAP-M method is that beta is derived from the volatility of prices of publicly-traded companies, which are likely to differ from private companies in their capital structures, diversification of products and markets, access to credit markets, size, management depth, and many other respects. Where private companies can be shown to be sufficiently similar to public companies, however, the CAP-M model may be appropriate.
Weighted Average Cost of Capital (“WACC”)
The weighted average cost of capital is the third major approach to determining a discount rate. The WACC method determines the subject company’s actual cost of capital by calculating the weighted average of the company’s cost of debt and cost of equity. The WACC capitalization rate must be applied to the subject company’s net cash flow to invested equity. One of the problems with this method is that the valuator may elect to calculate WACC according to the subject company’s existing capital structure, the average industry capital structure, or the optimal capital structure. Such discretion detracts from the objectivity of this approach, in the minds of some critics.
Once the capitalization or discount rate is determined, it must be applied to an appropriate economic income streams: pretax cash flow, aftertax cash flow, pretax net income, after tax net income, excess earnings, projected cash flow, etc. The result of this formula is the indicated value before discounts. Before moving on to calculate discounts, however, the valuation professional must consider the indicated value under the asset and market approaches.
Careful matching of the discount rate to the appropriate measure of economic income is critical to the accuracy of the business valuation results. Net cash flow is a frequent choice in professionally conducted business appraisals. The rationale behind this choice is that this earnings basis corresponds to the equity discount rate derived from the Build-Up or CAP-M models: the returns obtained from investments in publicly traded companies can easily be represented in terms of net cash flows. At the same time, the discount rates are generally also derived from the public capital markets data.
Asset-based approaches
The value of asset-based analysis a business is equal to the sum of its parts. That is the theory underlying the asset-based approaches to business valuation. The asset approach to business valuation is based on the principle of substitution: no rational investor will pay more for the business assets than the cost of procuring assets of similar economic utility. In contrast to the income-based approaches, which require the valuation professional to make subjective judgments about capitalization or discount rates, the adjusted net book value method is relatively objective. Pursuant to accounting convention, most assets are reported on the books of the subject company at their acquisition value, net of depreciation where applicable. These values must be adjusted to fair market value wherever possible. The value of a company’s intangible assets, such as goodwill, is generally impossible to determine apart from the company’s overall enterprise value. For this reason, the asset-based approach is not the most probative method of determining the value of going business concerns. In these cases, the asset-based approach yields a result that is probably lesser than the fair market value of the business. In considering an asset-based approach, the valuation professional must consider whether the shareholder whose interest is being valued would have any authority to access the value of the assets directly. Shareholders own shares in a corporation, but not its assets, which are owned by the corporation. A controlling shareholder may have the authority to direct the corporation to sell all or part of the assets it owns and to distribute the proceeds to the shareholder(s). The non-controlling shareholder, however, lacks this authority and cannot access the value of the assets. As a result, the value of a corporation’s assets is rarely the most relevant indicator of value to a shareholder who cannot avail himself of that value. Adjusted net book value may be the most relevant standard of value where liquidation is imminent or ongoing; where a company earnings or cash flow are nominal, negative or worth less than its assets; or where net book value is standard in the industry in which the company operates. None of these situations applies to the Company which is the subject of this valuation report. However, the adjusted net book value may be used as a “sanity check” when compared to other methods of valuation, such as the income and market approaches.
Market approaches
The market approach to business valuation is rooted in the economic principle of competition: that in a free market the supply and demand forces will drive the price of business assets to a certain equilibrium. Buyers would not pay more for the business, and the sellers will not accept less, than the price of a comparable business enterprise. It is similar in many respects to the “comparable sales” method that is commonly used in real estate appraisal. The market price of the stocks of publicly traded companies engaged in the same or a similar line of business, whose shares are actively traded in a free and open market, can be a valid indicator of value when the transactions in which stocks are traded are sufficiently similar to permit meaningful comparison.
The difficulty lies in identifying public companies that are sufficiently comparable to the subject company for this purpose. Also, as for a private company, the equity is less liquid (in other words its stocks are less easy to buy or sell) than for a public company, its value is considered to be slightly lower than such a market-based valuation would give
Guideline Public Company method
The Guideline Public Company method entails a comparison of the subject company to publicly traded companies. The comparison is generally based on published data regarding the public companies’ stock price and earnings, sales, or revenues, which is expressed as a fraction known as a “multiple.” If the guideline public companies are sufficiently similar to each other and the subject company to permit a meaningful comparison, then their multiples should be nearly equal. The public companies identified for comparison purposes should be similar to the subject company in terms of industry, product lines, market, growth, and risk.
Transaction Method or Direct Market Data Method
Using this method, the valuation analyst may determine market multiples by reviewing published data regarding actual transactions involving either minority or controlling interests in either publicly traded or closely held companies. In judging whether a reasonable basis for comparison exists, the valuation analysis must consider: (1) the similarity of qualitative and quantitative investment and investor characteristics; (2) the extent to which reliable data is known about the transactions in which interests in the guideline companies were bought and sold; and (3) whether or not the price paid for the guideline companies was in an arms-length transaction, or a forced or distressed sale.
The most widely used transactional databases include:
Institute of Business Appraisers (smaller companies)
BIZCOMPS® (smaller companies)
Pratt’s Stats® (smaller to mid-sized companies)
Public Stats™ (larger companies)
DoneDeals® (larger companies)
Alacra (larger companies)
Discounts and premiums
The valuation approaches yield the fair market value of the Company as a whole. In valuing a minority, non-controlling interest in a business, however, the valuation professional must consider the applicability of discounts that affect such interests. Discussions of discounts and premiums frequently begin with a review of the “levels of value.” There are three common levels of value: controlling interest, marketable minority, and non-marketable minority. The intermediate level, marketable minority interest, is lesser than the controlling interest level and higher than the non-marketable minority interest level. The marketable minority interest level represents the perceived value of equity interests that are freely traded without any restrictions. These interests are generally traded on the New York Stock Exchange, AMEX, NASDAQ, and other exchanges where there is a ready market for equity securities. These values represent a minority interest in the subject companies – small blocks of stock that represent less than 50% of the company’s equity, and usually much less than 50%. Controlling interest level is the value that an investor would be willing to pay to acquire more than 50% of a company’s stock, thereby gaining the attendant prerogatives of control. Some of the prerogatives of control include: electing directors, hiring and firing the company’s management and determining their compensation; declaring dividends and distributions, determining the company’s strategy and line of business, and acquiring, selling or liquidating the business. This level of value generally contains a control premium over the intermediate level of value, which typically ranges from 25% to 50%. An additional premium may be paid by strategic investors who are motivated by synergistic motives. Non-marketable, minority level is the lowest level on the chart, representing the level at which non-controlling equity interests in private companies are generally valued or traded. This level of value is discounted because no ready market exists in which to purchase or sell interests. Private companies are less “liquid” than publicly-traded companies, and transactions in private companies take longer and are more uncertain. Between the intermediate and lowest levels of the chart, there are restricted shares of publicly-traded companies. Despite a growing inclination of the IRS and Tax Courts to challenge valuation discounts , Shannon Pratt suggested in a scholarly presentation recently that valuation discounts are actually increasing as the differences between public and private companies is widening . Publicly-traded stocks have grown more liquid in the past decade due to rapid electronic trading, reduced commissions, and governmental deregulation. These developments have not improved the liquidity of interests in private companies, however. Valuation discounts are multiplicative, so they must be considered in order. Control premiums and their inverse, minority interest discounts, are considered before marketability discounts are applied.
Discount for lack of control
The first discount that must be considered is the discount for lack of control, which in this instance is also a minority interest discount. Minority interest discounts are the inverse of control premiums, to which the following mathematical relationship exists: MID = 1 – [ 1 / (1 + CP)] The most common source of data regarding control premiums is the Control Premium Study, published annually by Mergerstat since 1972. Mergerstat compiles data regarding publicly announced mergers, acquisitions and divestitures involving 10% or more of the equity interests in public companies, where the purchase price is $1 million or more and at least one of the parties to the transaction is a U.S. entity. Mergerstat defines the “control premium” as the percentage difference between the acquisition price and the share price of the freely-traded public shares five days prior to the announcement of the M&A transaction. While it is not without valid criticism, Mergerstat control premium data (and the minority interest discount derived therefrom) is widely accepted within the valuation profession.
Discount for lack of marketability
Another factor to be considered in valuing closely held companies is the marketability of an interest in such businesses. Marketability is defined as the ability to convert the business interest into cash quickly, with minimum transaction and administrative costs, and with a high degree of certainty as to the amount of net proceeds. There is usually a cost and a time lag associated with locating interested and capable buyers of interests in privately-held companies, because there is no established market of readily-available buyers and sellers. All other factors being equal, an interest in a publicly traded company is worth more because it is readily marketable. Conversely, an interest in a private-held company is worth less because no established market exists. The IRS Valuation Guide for Income, Estate and Gift Taxes, Valuation Training for Appeals Officers acknowledges the relationship between value and marketability, stating: “Investors prefer an asset which is easy to sell, that is, liquid.” The discount for lack of control is separate and distinguishable from the discount for lack of marketability. It is the valuation professional’s task to quantify the lack of marketability of an interest in a privately-held company. Because, in this case, the subject interest is not a controlling interest in the Company, and the owner of that interest cannot compel liquidation to convert the subject interest to cash quickly, and no established market exists on which that interest could be sold, the discount for lack of marketability is appropriate. Several empirical studies have been published that attempt to quantify the discount for lack of marketability. These studies include the restricted stock studies and the pre-IPO studies. The aggregate of these studies indicate average discounts of 35% and 50%, respectively. Some experts believe the Lack of Control and Marketabilty discounts can aggregate discounts for as much as ninety percent of a Company’s fair market value, specifically with family owned companies.
Restricted stock studies
Restricted stocks are equity securities of public companies that are similar in all respects to the freely traded stocks of those companies except that they carry a restriction that prevents them from being traded on the open market for a certain period of time, which is usually one year (two years prior to 1990). This restriction from active trading, which amounts to a lack of marketability, is the only distinction between the restricted stock and its freely-traded counterpart. Restricted stock can be traded in private transactions and usually do so at a discount. The restricted stock studies attempt to verify the difference in price at which the restricted shares trade versus the price at which the same unrestricted securities trade in the open market as of the same date. The underlying data by which these studies arrived at their conclusions has not been made public. Consequently, it is not possible when valuing a particular company to compare the characteristics of that company to the study data. Still, the existence of a marketability discount has been recognized by valuation professionals and the Courts, and the restricted stock studies are frequently cited as empirical evidence. Notably, the lowest average discount reported by these studies was 26% and the highest average discount was 45%.
Option pricing
In addition to the restricted stock studies, U.S. publicly traded companies are able to sell stock to offshore investors (SEC Regulation S, enacted in 1990) without registering the shares with the Securities and Exchange Commission. The offshore buyers may resell these shares in the United States, still without having to register the shares, after holding them for just 40 days. Typically, these shares are sold for 20% to 30% below the publicly traded share price. Some of these transactions have been reported with discounts of more than 30%, resulting from the lack of marketability. These discounts are similar to the marketability discounts inferred from the restricted and pre-IPO studies, despite the holding period being just 40 days. Studies based on the prices paid for options have also confirmed similar discounts. If one holds restricted stock and purchases an option to sell that stock at the market price (a put), the holder has, in effect, purchased marketability for the shares. The price of the put is equal to the marketability discount. The range of marketability discounts derived by this study was 32% to 49%.
Pre-IPO studies
Another approach to measure the marketability discount is to compare the prices of stock offered in initial public offerings (IPOs) to transactions in the same company’s stocks prior to the IPO. Companies that are going public are required to disclose all transactions in their stocks for a period of three years prior to the IPO. The pre-IPO studies are the leading alternative to the restricted stock stocks in quantifying the marketability discount. The pre-IPO studies are sometimes criticized because the sample size is relatively small, the pre-IPO transactions may not be arm’s length, and the financial structure and product lines of the studied companies may have changed during the three year pre-IPO window.
Applying the studies
The studies confirm what the marketplace knows intuitively: Investors covet liquidity and loathe obstacles that impair liquidity. Prudent investors buy illiquid investments only when there is a sufficient discount in the price to increase the rate of return to a level which brings risk-reward back into balance. The referenced studies establish a reasonable range of valuation discounts from the mid-30%s to the low 50%s. The more recent studies appeared to yield a more conservative range of discounts than older studies, which may have suffered from smaller sample sizes. Another method of quantifying the lack of marketability discount is the Quantifying Marketability Discounts Model (QMDM).
DISCOUNTED CASH FLOW
In finance, the discounted cash flow (or DCF) approach describes a method to value a project, company, or financial asset using the concepts of the time value of money. All future cash flows are estimated and discounted to give them a present value. The discount rate used is generally the appropriate cost of capital, and incorporates judgments of the uncertainty (riskiness) of the future cash flows.
FV=PV (1+i)n
DPV=FV/(1+i)n
COST OF CAPITAL
The cost of capital for a firm is a weighted sum of the cost of equity and the cost of debt (see Capital investment decisions). It is also known as the “Hurdle Rate” or “Discount Rate”.
Capital (money) used to fund a business should earn returns for the capital owner who risked his/her saved money. For an investment to be worthwhile the projected return on capital must be greater than the cost of capital. Otherwise stated, the risk-adjusted return on capital (that is, incorporating not just the projected returns, but the probabilities of those projections) must be higher than the cost of capital.
The cost of debt is relatively simple to calculate, as it is composed of the rate of interest paid. In practice, the interest-rate paid by the company will include the risk-free rate plus a risk component, which itself incorporates a probable rate of default (and amount of recovery given default). For companies with similar risk or credit ratings, the interest rate is largely exogenous.
Cost of equity is more challenging to calculate as equity does not pay a set return to its investors. Similar to the cost of debt, the cost of equity is broadly defined as the risk-weighted projected return required by investors, where the return is largely unknown. The cost of equity is therefore inferred by comparing the investment to other investments with similar risk profiles to determine the “market” cost of equity.
The cost of capital is often used as the discount rate, the rate at which projected cash flow will be discounted to give a present value or net present value.
Cost of debt
The cost of debt is computed by taking the rate on a non-defaulting bond whose duration matches the term structure of the corporate debt, then adding a default premium. This default premium will rise as the amount of debt increases (since the risk rises as the amount of debt rises). Since in most cases debt expense is a deductible expense, the cost of debt is computed as an after tax cost to make it comparable with the cost of equity (earnings are after-tax as well). Thus, for profitable firms, debt is discounted by the tax rate. Basically this is used for large corporations only.
Cost of equity
Cost of equity = Risk free rate of return + Premium expected for risk
Expected return
The expected return can be calculated as the “dividend capitalization model”, which is (dividend per share / price per share) + growth rate of dividends (that is, dividend yield + growth rate of dividends).
Capital asset pricing model
The capital asset pricing model (CAPM) is used in finance to determine a theoretically appropriate price of an asset such as a security. The expected return on equity according to the capital asset pricing model. The market risk is normally characterized by the ? parameter. Thus, the investors would expect (or demand) to receive:
WEIGHTED AVERAGE COST OF CAPITAL
The Weighted Average Cost of Capital (WACC) is used in finance to measure a firm’s cost of capital.
The total capital for a firm is the value of its equity (for a firm without outstanding warrants and options, this is the same as the company’s market capitalization) plus the cost of its debt (the cost of debt should be continually updated as the cost of debt changes as a result of interest rate changes). Notice that the “equity” in the debt to equity ratio is the market value of all equity, not the shareholders’ equity on the balance sheet.
Calculation of WACC is an iterative procedure which requires estimation of the fair market value of equity capital
CAPITAL STRUCTURE
Because of tax advantages on debt issuance, it will be cheaper to issue debt rather than new equity (this is only true for profitable firms, tax breaks are available only to profitable firms). At some point, however, the cost of issuing new debt will be greater than the cost of issuing new equity. This is because adding debt increases the default risk – and thus the interest rate that the company must pay in order to borrow money. By utilizing too much debt in its capital structure, this increased default risk can also drive up the costs for other sources (such as retained earnings and preferred stock) as well. Management must identify the “optimal mix” of financing – the capital structure where the cost of capital is minimized so that the firms value can be maximized.
MODIGLIANI-MILLER THEOREM
If there were no tax advantages for issuing debt, and equity could be freely issued, Miller and Modigliani showed that the value of a leveraged firm and the value of an unleveraged firm should be the same.
INTEREST
Interest is a fee paid on borrowed capital. Assets lent include money, shares, consumer goods through hire purchase, major assets such as aircraft, and even entire factories in finance lease arrangements. The interest is calculated upon the value of the assets in the same manner as upon money. Interest can be thought of as “rent on money”.
The fee is compensation to the lender for foregoing other useful investments that could have been made with the loaned money. Instead of the lender using the assets directly, they are advanced to the borrower. The borrower then enjoys the benefit of using the assets ahead of the effort required to obtain them, while the lender enjoys the benefit of the fee paid by the borrower for the privilege. The amount lent, or the value of the assets lent, is called the principal. This principal value is held by the borrower on credit. Interest is therefore the price of credit, not the price of money as it is commonly – and mistakenly – believed to be. The percentage of the principal that is paid as a fee (the interest), over a certain period of time, is called the interest rate.
Interest rates and credit risk
It is increasingly recognized that the business cycle, interest rates and credit risk are tightly interrelated. The Jarrow-Turnbull model was the first model of credit risk which explicitly had random interest rates at its core. Lando (2004), Darrell Duffie and Singleton (2003), and van Deventer and Imai (2003) discuss interest rates when the issuer of the interest-bearing instrument can default.
Money and inflation
Loans, bonds, and shares have some of the characteristics of money and are included in the broad money supply.
By setting i*n, the government institution can affect the markets to alter the total of loans, bonds and shares issued. Generally speaking, a higher real interest rate reduces the broad money supply.
Open market operations in the United States
The Federal Reserve (often referred to as ‘The Fed’) implements monetary policy largely by targeting the federal funds rate. This is the rate that banks charge each other for overnight loans of federal funds. Federal funds are the reserves held by banks at the Fed.
Open market operations are one tool within monetary policy implemented by the Federal Reserve to steer short-term interest rates. Using the power to buy and sell treasury securities, the Open Market Desk at the Federal Reserve Bank of New York can supply the market with dollars by purchasing T-notes, hence increasing the nation’s money supply. By increasing the money supply or Aggregate Supply of Funding (ASF), interest rates will fall due to the excess of dollars banks will end up with in their reserves. Excess reserves may be lent in the Fed funds market to other banks, thus driving down rates.
Credit spread options: credit call spread is a “bearish” call spread, which has more premium on the short call. A credit put spread is a “bullish” put spread and has more premium on the short put.
Credit spread (bond): In finance, a credit spread is the difference in yield between different securities due to different credit quality. The credit spread reflects the additional net yield an investor can earn from a security with more credit risk relative to one with less credit risk. The credit spread of a particular security is often quoted in relation to the yield on a credit risk-free benchmark security or reference rate.
RISK MODELING
Risk modeling refers to the use of formal econometric techniques to determine the aggregate risk in a financial portfolio. Risk modeling is one of many subtasks within the broader area of financial modeling.
Risk modeling uses a variety of techniques including market risk, Value-at-Risk (VaR), Historical Simulation (HS), or Extreme Value Theory (EVT) in order to analyze a portfolio and make forecasts of the likely losses that would be incurred for a variety of risks. Such risks are typically grouped into credit risk, liquidity risk, interest rate risk, and operational risk categories.
Many large financial intermediary firms use risk modeling to help portfolio managers assess the amount of capital reserves to maintain, and to help guide their purchases and sales of various classes of financial assets.
Formal risk modeling is required under the Basel II proposal for all the major international banking institutions by the various national depository institution regulators.
Quantitative risk analysis and modeling have become important in the light of corporate scandals in the past few years (most notably, Enron), Basel II, the revised FAS 123R and the Sarbanes-Oxley Act. In the past, risk analysis was done qualitatively but now with the advent of powerful computing software, quantitative risk analysis can be done quickly and effortlessly.
PORTFOLIO PROBLEMS
In finance, a portfolio is an appropriate mix of or collection of investments held by an institution or a private individual. In building up an investment portfolio a financial institution will typically conduct its own investment analysis, whilst a private individual may make use of the services of a financial advisor or a financial institution which offers portfolio management services. Holding a portfolio is part of an investment and risk-limiting strategy called diversification. By owning several assets, certain types of risk (in particular specific risk) can be reduced. The assets in the portfolio could include stocks, bonds, options, warrants, gold certificates, real estate, futures contracts, production facilities, or any other item that is expected to retain its value.
Portfolio management involves deciding what assets to include in the portfolio, given the goals of the portfolio owner and changing economic conditions. Selection involves deciding what assets to purchase, how many to purchase, when to purchase them, and what assets to divest. These decisions always involve some sort of performance measurement, most typically expected return on the portfolio, and the risk associated with this return (i.e. the standard deviation of the return). Typically the expected return from portfolios of different asset bundles are compared.
Porfolio formation
Many strategies have been developed to form a portfolio.
Ø equally-weighted portfolio
Ø capitalization-weighted portfolio
Ø price-weighted portfolio
Ø optimal portfolio (for which the Sharpe ratio is highest)
VALUATION OF OPTIONS
Black–Scholes:
The term Black–Scholes refers to three closely related concepts:
Ø The Black–Scholes model is a mathematical model of the market for an equity, in which the equity’s price is a stochastic process.
Ø The Black–Scholes PDE is a partial differential equation which (in the model) must be satisfied by the price of a derivative on the equity.
Ø The Black–Scholes formula is the result obtained by solving the Black-Scholes PDE for European put and call options.
Binomial options pricing model: In finance, the binomial options pricing model (BOPM) provides a generalisable numerical method for the valuation of options. The binomial model was first proposed by Cox, Ross and Rubinstein (1979). Essentially, the model uses a “discrete-time” model of the varying price over time of the underlying financial instrument. Option valuation is then computed via application of the risk neutrality assumption over the life of the option, as the price of the underlying instrument evolves.
Monte Carlo option model: In mathematical finance, a Monte Carlo option model uses Monte Carlo methods to calculate the value of an option with multiple sources of uncertainty or with complicated features.
REAL OPTIONS ANALYSIS
In corporate finance, real options analysis or ROA applies put option and call option valuation techniques to capital budgeting decisions.[
A real option is the right, but not the obligation, to undertake some business decision, typically the option to make a capital investment. For example, the opportunity to invest in the expansion of a firm’s factory is a real option. In contrast to financial options, a real option is not often tradeable—e.g. the factory owner cannot sell the right to extend his factory to another party, only he can make this decision; however, some real options can be sold, e.g., ownership of a vacant lot of land is a real option to develop that land in the future. Some real options are proprietory (owned or exercisable by a single individual or a company); others are shared (can be exercised by many parties). Therefore, a project may have a portfolio of embedded real options; some of them can be mutually exclusive.
The terminology “real option” is relatively new, whereas business operators have been making capital investment decisions for centuries. However, the description of such opportunities as real options has occurred at the same time as thinking about such decisions in new, more analytically-based, ways. As such, the terminology “real option” is closely tied to these new methods. The term “real option” was coined by Professor Stewart Myers at the MIT Sloan School of Management; this happened most likely around 1977.
The concept of real options was popularized by Michael J. Mauboussin, the chief U.S. investment strategist for Credit Suisse First Boston and an adjunct professor of finance at the Columbia School of Business. Mauboussin uses real options in part to explain the gap between how the stock market prices some businesses and the “intrinsic value” for those businesses as calculated by traditional financial analysis, specifically discounted cash flows.
Additionally, with real option analysis, uncertainty inherent in investment projects is usually accounted for by risk-adjusting probabilities (a technique known as the equivalent martingale approach). Cash flows can then be discounted at the risk-free rate. With regular DCF analysis, on the other hand, this uncertainty is accounted for by adjusting the discount rate, using e.g. the cost of capital) or the cash flows (using certainty equivalents). These methods normally do not properly account for changes in risk over a project’s lifecycle and fail to appropriately adapt the risk adjustment. More importantly, the real options approach forces decision makers to be more explicit about the assumptions underlying their projections.
Generally, the most widely used methods are: Closed form solutions, partial differential equations, and the binomial lattices. In business strategy, real options have been advanced by the construction of option space, where volatility is compared with value-to-cost, NPVq. Latest advances in real option valuation are models that incorporate fuzzy logic and option valuation in fuzzy real option valuation models.
Real options are a field of academic research, and at the present one of the leading names in academic real options is Professor Lenos Trigeorgis (University of Cyprus). An academic conference on real options is organized yearly (Annual International Conference on Real Options).
This entry was posted on Monday, June 28th, 2010 at 10:54 pm and is filed under term life.
Financial modeling is a process of forecasting performance of a certain asset, using relationships among operating, investing, and financing variables. The central aim of all financial modeling is valuation under uncertainty: how to estimate the value of a security when its future trajectory, or the trajectory of the other securities or economic variables it depends on, is unknown. Usually, financial modeling requires a great deal of spreadsheet work.
Financial Modeling Application
ü Business valuation, especially discounted cash flow
ü Cost of capital or WACC
ü Modeling the term structure of interest rate and credit spread
ü Option pricing
ü Real options
ü Risk modeling
ü Portfolio problems
Standard and Premise of Business Value
Before the value of a business can be measured, the valuation assignment must specify the reason for and circumstances surrounding the business valuation. These are formally known as the business value standard and premise of value.
Business valuation results can vary considerably depending upon the choice of both the standard and premise of value. For example, a business buyer and seller may bargain to establish the value of business assets that approaches the fair market value standard.
However, the value conclusions based on the going concern premise and that of assemblage of business assets may be quite different. One reason is that an operating business creates value by means of its ability to coordinate its capital, human and management resources to produce economic income. The same set of assets not currently used to produce income is generally worth less.
Reasons for Business Valuation
Business people may need to conduct business valuation for a number of reasons including sale, estate tax planning, estate tax valuation, divorce, business purchase price allocation, collateral documentation, litigation and documenting that a sales price is equitable.
Fair market value
“Fair market value”, a central standard of measuring business value, is defined as the price at which 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. See IRS Rev. Rul. 59-60, 1959-1, Cum. Bulletin 237, codified at 26 C.F.R. § 20.2031-1(b).
The fair market value standard incorporates certain assumptions, including the assumptions that the hypothetical purchaser is reasonably prudent and rational but is not motivated by any synergistic or strategic influences; that the business will continue as a going concern and not be liquidated; that the hypothetical transaction will be conducted in cash or equivalents; and that the parties are willing and able to consummate the transaction.
These assumptions might not, and probably do not, reflect the actual conditions of the market in which the subject business might be sold. However, these conditions are assumed because they yield a uniform standard of value, after applying generally-accepted valuation techniques, which allows meaningful comparison between businesses which are similarly situated.
Elements of business valuation
Economic conditions
A business valuation report generally begins with a description of national, regional and local economic conditions existing as of the valuation date, as well as the conditions of the industry in which the subject business operates. A common source of economic information for the first section of the business valuation report is the Federal Reserve Board’s Beige Book, published quarterly by the Federal Reserve Bank. State governments and industry associations often publish useful statistics describing regional and industry conditions.
Financial Analysis
The financial statement analysis generally involves common size analysis, ratio analysis (liquidity, turnover, profitability, etc.), trend analysis and industry comparative analysis. This permits the valuation analyst to compare the subject company to other businesses in the same or similar industry, and to discover trends affecting the company and/or the industry over time. By comparing a company’s financial statements in different time periods, the valuation expert can view growth or decline in revenues or expenses, changes in capital structure, or other financial trends. How the subject company compares to the industry will help with the risk assesment and ultimately help determine the discount rate and the selection of market multiples.
Normalization of financial statements
The most common normalization adjustments fall into the following four categories:
Comparability Adjustments. The valuator may adjust the subject company’s financial statements to facilitate a comparison between the subject company and other businesses in the same industry or geographic location. These adjustments are intended to eliminate differences between the way that published industry data is presented and the way that the subject company’s data is presented in its financial statements.
Non-operating Adjustments. It is reasonable to assume that if a business were sold in a hypothetical sales transaction (which is the underlying premise of the fair market value standard), the seller would retain any assets which were not related to the production of earnings or price those non-operating assets separately. For this reason, non-operating assets (such as excess cash) are usually eliminated from the balance sheet.
Non-recurring Adjustments. The subject company’s financial statements may be affected by events that are not expected to recur, such as the purchase or sale of assets, a lawsuit, or an unusually large revenue or expense. These non-recurring items are adjusted so that the financial statements will better reflect the management’s expectations of future performance.
Discretionary Adjustments. The owners of private companies may be paid at variance from the market level of compensation that similar executives in the industry might command. In order to determine fair market value, the owner’s compensation, benefits, perquisites and distributions must be adjusted to industry standards. Similarly, the rent paid by the subject business for the use of property owned by the company’s owners individually may be scrutinized.
Income, Asset and Market Approaches
Three different approaches are commonly used in business valuation: the income approach, the asset-based approach, and the market approach. Within each of these approaches, there are various techniques for determining the fair market value of a business. Generally, the income approaches determine value by calculating the net present value of the benefit stream generated by the business (discounted cash flow); the asset-based approaches determine value by adding the sum of the parts of the business (net asset value); and the market approaches determine value by comparing the subject company to other companies in the same industry, of the same size, and/or within the same region.
In determining which of these approaches to use, the valuation professional must exercise discretion. Each technique has advantages and drawbacks, which must be considered when applying those techniques to a particular subject company. Most treatises and court decisions encourage the valuator to consider more than one technique, which must be reconciled with each other to arrive at a value conclusion. A measure of common sense and a good grasp of mathematics is helpful.
Income approaches
The income approaches determine fair market value by multiplying the benefit stream generated by the subject company times a discount or capitalization rate. The discount or capitalization rate converts the stream of benefits into present value. There are several different income approaches, including capitalization of earnings or cash flows, discounted future cash flows (“DCF”), and the excess earnings method (which is a hybrid of asset and income approaches). Most of the income approaches consider the subject company’s historical financial data; only the DCF method requires the subject company to provide projected financial data. Most of the income approaches look to the company’s adjusted historical financial data for a single period; only DCF requires data for multiple future periods. The discount or capitalization rate must be matched to the type of benefit stream to which it is applied. The result of a value calculation under the income approach is generally the fair market value of a controlling, marketable interest in the subject company, since the entire benefit stream of the subject company is most often valued, and the capitalization and discount rates are derived from statistics concerning public companies.
Discount or capitalization rates
A discount or capitalization rate is used to determine the present value of the expected returns of a business. The discount rate and capitalization rate are closely related to each other, but distinguishable. Generally speaking, the discount rate or capitalization rate may be defined as the yield necessary to attract investors to a particular investment, given the risks associated with that investment. The discount rate is applied only to discounted cash flow (DCF) valuations, which are based on projected business data over multiple periods of time. In DCF valuations, a series of projected cash flows is divided by the discount rate to derive the present value of the discounted cash flows. The sum of the discounted cash flows is added to a terminal value, which represents the present value of business cash flows into perpetuity. The sum of the discounted cash flows and the terminal value is the value of the business.
On the other hand, a capitalization rate is applied in methods of business valuation that are based on historical business data for a single period of time. The after-tax net cash flow capitalization rate is equal to the discount rate minus the long-term sustainable growth rate. The after-tax net cash flow of a business is divided by the capitalization rate to derive the present value. Capitalization rates may be modified so that they may be applied to after-tax net income or pre-tax cash flows or income. There are several different methods of determining the appropriate discount rates. The discount rate is composed of two elements: (1) the risk-free rate, which is the return that an investor would expect from a secure, practically risk-free investment, such as a government bond; plus (2) a risk premium that compensates an investor for the relative level of risk associated with a particular investment in excess of the risk-free rate. Most importantly, the selected discount or capitalization rate must be consistent with stream of benefits to which it is to be applied.
Build-Up Method
The Build-Up Method is a widely-recognized method of determining the after-tax net cash flow discount rate, which in turn yields the capitalization rate. The figures used in the Build-Up Method are derived from various sources. This method is called a “build-up” method because it is the sum of risks associated with various classes of assets. It is based on the principle that investors would require a greater return on classes of assets that are more risky. The first element of an Build-Up capitalization rate is the risk-free rate, which is the rate of return for long-term government bonds. Investors who buy large-cap equity stocks, which are inherently more risky than long-term government bonds, require a greater return, so the next element of the Build-Up method is the equity risk premium. In determining a company’s value, the long-horizon equity risk premium is used because the Company’s life is assumed to be infinite. The sum of the risk-free rate and the equity risk premium yields the long-term average market rate of return on large public company stocks.
Similarly, investors who invest in small cap stocks, which are riskier than blue-chip stocks, require a greater return, called the “size premium.” Size premium data is generally available from two sources: Morningstars’ (formerly Ibbotson & Associates’) Stocks, Bonds, Bills & Inflation and Duff & Phelps’ Risk Premium Report.
By adding the first three elements of a Build-Up discount rate, we can determine the rate of return that investors would require on their investments in small public company stocks. These three elements of the Build-Up discount rate are known collectively as the “systematic risks.”
In addition to systematic risks, the discount rate must include “unsystematic risks,” which fall into two categories. One of those categories is the “industry risk premium.” Morningstar’s yearbooks contain empirical data to quantify the risks associated with various industries, grouped by SIC industry code.
The other category of unsystematic risk is referred to as “specific company risk.” Historically, no published data has been available to quantify specific company risks. However as of late 2006, new research has been able to quantify, or isolate, this risk for publicly-traded stocks through the use of Total Beta calculations. P. Butler and K. Pinkerton have outlined a procedure using a modified Capital Asset Pricing Model (CAPM) to calculate the company specific risk premium. The model uses an equality between the standard CAPM which relies on the total beta on one side of the equation; and the firm’s beta, size premium and company specific risk premium on the other. The equality is then solved for the company specific risk premium as the only unknown. While this is ground-breaking research, it has yet to be adopted and used by the valuation community at large.
It is important to understand why this capitalization rate for small, privately-held companies is significantly higher than the return that an investor might expect to receive from other common types of investments, such as money market accounts, mutual funds, or even real estate. Those investments involve substantially lower levels of risk than an investment in a closely-held company. Depository accounts are insured by the federal government (up to certain limits); mutual funds are composed of publicly-traded stocks, for which risk can be substantially minimized through portfolio diversification; and real estate almost invariably appreciates in value of long time horizons.
Closely-held companies, on the other hand, frequently fail for a variety of reasons too numerous to name. Examples of the risk can be witnessed in the storefronts on every Main Street in America. There are no federal guarantees. The risk of investing in a private company cannot be reduced through diversification, and most businesses do not own the type of hard assets that can ensure capital appreciation over time. This is why investors demand a much higher return on their investment in closely-held businesses; such investments are inherently much more risky.
Capital Asset Pricing Model (“CAP-M”)
The Capital Asset Pricing Model is another method of determining the appropriate discount rate in business valuations. The CAP-M method originated from the Nobel Prize winning studies of Harry Markowitz, James Tobin and William Sharpe. Like the Ibbotson Build-Up method, the CAP-M method derives the discount rate by adding a risk premium to the risk-free rate. In this instance, however, the risk premium is derived by multiplying the equity risk premium times “beta,” which is a measure of stock price volatility. Beta is published by various sources (including Ibbotson Associates, which was used in this valuation) for particular industries and companies. Beta is associated with the systematic risks of an investment.
One of the criticisms of the CAP-M method is that beta is derived from the volatility of prices of publicly-traded companies, which are likely to differ from private companies in their capital structures, diversification of products and markets, access to credit markets, size, management depth, and many other respects. Where private companies can be shown to be sufficiently similar to public companies, however, the CAP-M model may be appropriate.
Weighted Average Cost of Capital (“WACC”)
The weighted average cost of capital is the third major approach to determining a discount rate. The WACC method determines the subject company’s actual cost of capital by calculating the weighted average of the company’s cost of debt and cost of equity. The WACC capitalization rate must be applied to the subject company’s net cash flow to invested equity. One of the problems with this method is that the valuator may elect to calculate WACC according to the subject company’s existing capital structure, the average industry capital structure, or the optimal capital structure. Such discretion detracts from the objectivity of this approach, in the minds of some critics.
Once the capitalization or discount rate is determined, it must be applied to an appropriate economic income streams: pretax cash flow, aftertax cash flow, pretax net income, after tax net income, excess earnings, projected cash flow, etc. The result of this formula is the indicated value before discounts. Before moving on to calculate discounts, however, the valuation professional must consider the indicated value under the asset and market approaches.
Careful matching of the discount rate to the appropriate measure of economic income is critical to the accuracy of the business valuation results. Net cash flow is a frequent choice in professionally conducted business appraisals. The rationale behind this choice is that this earnings basis corresponds to the equity discount rate derived from the Build-Up or CAP-M models: the returns obtained from investments in publicly traded companies can easily be represented in terms of net cash flows. At the same time, the discount rates are generally also derived from the public capital markets data.
Asset-based approaches
The value of asset-based analysis a business is equal to the sum of its parts. That is the theory underlying the asset-based approaches to business valuation. The asset approach to business valuation is based on the principle of substitution: no rational investor will pay more for the business assets than the cost of procuring assets of similar economic utility. In contrast to the income-based approaches, which require the valuation professional to make subjective judgments about capitalization or discount rates, the adjusted net book value method is relatively objective. Pursuant to accounting convention, most assets are reported on the books of the subject company at their acquisition value, net of depreciation where applicable. These values must be adjusted to fair market value wherever possible. The value of a company’s intangible assets, such as goodwill, is generally impossible to determine apart from the company’s overall enterprise value. For this reason, the asset-based approach is not the most probative method of determining the value of going business concerns. In these cases, the asset-based approach yields a result that is probably lesser than the fair market value of the business. In considering an asset-based approach, the valuation professional must consider whether the shareholder whose interest is being valued would have any authority to access the value of the assets directly. Shareholders own shares in a corporation, but not its assets, which are owned by the corporation. A controlling shareholder may have the authority to direct the corporation to sell all or part of the assets it owns and to distribute the proceeds to the shareholder(s). The non-controlling shareholder, however, lacks this authority and cannot access the value of the assets. As a result, the value of a corporation’s assets is rarely the most relevant indicator of value to a shareholder who cannot avail himself of that value. Adjusted net book value may be the most relevant standard of value where liquidation is imminent or ongoing; where a company earnings or cash flow are nominal, negative or worth less than its assets; or where net book value is standard in the industry in which the company operates. None of these situations applies to the Company which is the subject of this valuation report. However, the adjusted net book value may be used as a “sanity check” when compared to other methods of valuation, such as the income and market approaches.
Market approaches
The market approach to business valuation is rooted in the economic principle of competition: that in a free market the supply and demand forces will drive the price of business assets to a certain equilibrium. Buyers would not pay more for the business, and the sellers will not accept less, than the price of a comparable business enterprise. It is similar in many respects to the “comparable sales” method that is commonly used in real estate appraisal. The market price of the stocks of publicly traded companies engaged in the same or a similar line of business, whose shares are actively traded in a free and open market, can be a valid indicator of value when the transactions in which stocks are traded are sufficiently similar to permit meaningful comparison.
The difficulty lies in identifying public companies that are sufficiently comparable to the subject company for this purpose. Also, as for a private company, the equity is less liquid (in other words its stocks are less easy to buy or sell) than for a public company, its value is considered to be slightly lower than such a market-based valuation would give
Guideline Public Company method
The Guideline Public Company method entails a comparison of the subject company to publicly traded companies. The comparison is generally based on published data regarding the public companies’ stock price and earnings, sales, or revenues, which is expressed as a fraction known as a “multiple.” If the guideline public companies are sufficiently similar to each other and the subject company to permit a meaningful comparison, then their multiples should be nearly equal. The public companies identified for comparison purposes should be similar to the subject company in terms of industry, product lines, market, growth, and risk.
Transaction Method or Direct Market Data Method
Using this method, the valuation analyst may determine market multiples by reviewing published data regarding actual transactions involving either minority or controlling interests in either publicly traded or closely held companies. In judging whether a reasonable basis for comparison exists, the valuation analysis must consider: (1) the similarity of qualitative and quantitative investment and investor characteristics; (2) the extent to which reliable data is known about the transactions in which interests in the guideline companies were bought and sold; and (3) whether or not the price paid for the guideline companies was in an arms-length transaction, or a forced or distressed sale.
The most widely used transactional databases include:
Institute of Business Appraisers (smaller companies)
BIZCOMPS® (smaller companies)
Pratt’s Stats® (smaller to mid-sized companies)
Public Stats™ (larger companies)
DoneDeals® (larger companies)
Alacra (larger companies)
Discounts and premiums
The valuation approaches yield the fair market value of the Company as a whole. In valuing a minority, non-controlling interest in a business, however, the valuation professional must consider the applicability of discounts that affect such interests. Discussions of discounts and premiums frequently begin with a review of the “levels of value.” There are three common levels of value: controlling interest, marketable minority, and non-marketable minority. The intermediate level, marketable minority interest, is lesser than the controlling interest level and higher than the non-marketable minority interest level. The marketable minority interest level represents the perceived value of equity interests that are freely traded without any restrictions. These interests are generally traded on the New York Stock Exchange, AMEX, NASDAQ, and other exchanges where there is a ready market for equity securities. These values represent a minority interest in the subject companies – small blocks of stock that represent less than 50% of the company’s equity, and usually much less than 50%. Controlling interest level is the value that an investor would be willing to pay to acquire more than 50% of a company’s stock, thereby gaining the attendant prerogatives of control. Some of the prerogatives of control include: electing directors, hiring and firing the company’s management and determining their compensation; declaring dividends and distributions, determining the company’s strategy and line of business, and acquiring, selling or liquidating the business. This level of value generally contains a control premium over the intermediate level of value, which typically ranges from 25% to 50%. An additional premium may be paid by strategic investors who are motivated by synergistic motives. Non-marketable, minority level is the lowest level on the chart, representing the level at which non-controlling equity interests in private companies are generally valued or traded. This level of value is discounted because no ready market exists in which to purchase or sell interests. Private companies are less “liquid” than publicly-traded companies, and transactions in private companies take longer and are more uncertain. Between the intermediate and lowest levels of the chart, there are restricted shares of publicly-traded companies. Despite a growing inclination of the IRS and Tax Courts to challenge valuation discounts , Shannon Pratt suggested in a scholarly presentation recently that valuation discounts are actually increasing as the differences between public and private companies is widening . Publicly-traded stocks have grown more liquid in the past decade due to rapid electronic trading, reduced commissions, and governmental deregulation. These developments have not improved the liquidity of interests in private companies, however. Valuation discounts are multiplicative, so they must be considered in order. Control premiums and their inverse, minority interest discounts, are considered before marketability discounts are applied.
Discount for lack of control
The first discount that must be considered is the discount for lack of control, which in this instance is also a minority interest discount. Minority interest discounts are the inverse of control premiums, to which the following mathematical relationship exists: MID = 1 – [ 1 / (1 + CP)] The most common source of data regarding control premiums is the Control Premium Study, published annually by Mergerstat since 1972. Mergerstat compiles data regarding publicly announced mergers, acquisitions and divestitures involving 10% or more of the equity interests in public companies, where the purchase price is $1 million or more and at least one of the parties to the transaction is a U.S. entity. Mergerstat defines the “control premium” as the percentage difference between the acquisition price and the share price of the freely-traded public shares five days prior to the announcement of the M&A transaction. While it is not without valid criticism, Mergerstat control premium data (and the minority interest discount derived therefrom) is widely accepted within the valuation profession.
Discount for lack of marketability
Another factor to be considered in valuing closely held companies is the marketability of an interest in such businesses. Marketability is defined as the ability to convert the business interest into cash quickly, with minimum transaction and administrative costs, and with a high degree of certainty as to the amount of net proceeds. There is usually a cost and a time lag associated with locating interested and capable buyers of interests in privately-held companies, because there is no established market of readily-available buyers and sellers. All other factors being equal, an interest in a publicly traded company is worth more because it is readily marketable. Conversely, an interest in a private-held company is worth less because no established market exists. The IRS Valuation Guide for Income, Estate and Gift Taxes, Valuation Training for Appeals Officers acknowledges the relationship between value and marketability, stating: “Investors prefer an asset which is easy to sell, that is, liquid.” The discount for lack of control is separate and distinguishable from the discount for lack of marketability. It is the valuation professional’s task to quantify the lack of marketability of an interest in a privately-held company. Because, in this case, the subject interest is not a controlling interest in the Company, and the owner of that interest cannot compel liquidation to convert the subject interest to cash quickly, and no established market exists on which that interest could be sold, the discount for lack of marketability is appropriate. Several empirical studies have been published that attempt to quantify the discount for lack of marketability. These studies include the restricted stock studies and the pre-IPO studies. The aggregate of these studies indicate average discounts of 35% and 50%, respectively. Some experts believe the Lack of Control and Marketabilty discounts can aggregate discounts for as much as ninety percent of a Company’s fair market value, specifically with family owned companies.
Restricted stock studies
Restricted stocks are equity securities of public companies that are similar in all respects to the freely traded stocks of those companies except that they carry a restriction that prevents them from being traded on the open market for a certain period of time, which is usually one year (two years prior to 1990). This restriction from active trading, which amounts to a lack of marketability, is the only distinction between the restricted stock and its freely-traded counterpart. Restricted stock can be traded in private transactions and usually do so at a discount. The restricted stock studies attempt to verify the difference in price at which the restricted shares trade versus the price at which the same unrestricted securities trade in the open market as of the same date. The underlying data by which these studies arrived at their conclusions has not been made public. Consequently, it is not possible when valuing a particular company to compare the characteristics of that company to the study data. Still, the existence of a marketability discount has been recognized by valuation professionals and the Courts, and the restricted stock studies are frequently cited as empirical evidence. Notably, the lowest average discount reported by these studies was 26% and the highest average discount was 45%.
Option pricing
In addition to the restricted stock studies, U.S. publicly traded companies are able to sell stock to offshore investors (SEC Regulation S, enacted in 1990) without registering the shares with the Securities and Exchange Commission. The offshore buyers may resell these shares in the United States, still without having to register the shares, after holding them for just 40 days. Typically, these shares are sold for 20% to 30% below the publicly traded share price. Some of these transactions have been reported with discounts of more than 30%, resulting from the lack of marketability. These discounts are similar to the marketability discounts inferred from the restricted and pre-IPO studies, despite the holding period being just 40 days. Studies based on the prices paid for options have also confirmed similar discounts. If one holds restricted stock and purchases an option to sell that stock at the market price (a put), the holder has, in effect, purchased marketability for the shares. The price of the put is equal to the marketability discount. The range of marketability discounts derived by this study was 32% to 49%.
Pre-IPO studies
Another approach to measure the marketability discount is to compare the prices of stock offered in initial public offerings (IPOs) to transactions in the same company’s stocks prior to the IPO. Companies that are going public are required to disclose all transactions in their stocks for a period of three years prior to the IPO. The pre-IPO studies are the leading alternative to the restricted stock stocks in quantifying the marketability discount. The pre-IPO studies are sometimes criticized because the sample size is relatively small, the pre-IPO transactions may not be arm’s length, and the financial structure and product lines of the studied companies may have changed during the three year pre-IPO window.
Applying the studies
The studies confirm what the marketplace knows intuitively: Investors covet liquidity and loathe obstacles that impair liquidity. Prudent investors buy illiquid investments only when there is a sufficient discount in the price to increase the rate of return to a level which brings risk-reward back into balance. The referenced studies establish a reasonable range of valuation discounts from the mid-30%s to the low 50%s. The more recent studies appeared to yield a more conservative range of discounts than older studies, which may have suffered from smaller sample sizes. Another method of quantifying the lack of marketability discount is the Quantifying Marketability Discounts Model (QMDM).
DISCOUNTED CASH FLOW
In finance, the discounted cash flow (or DCF) approach describes a method to value a project, company, or financial asset using the concepts of the time value of money. All future cash flows are estimated and discounted to give them a present value. The discount rate used is generally the appropriate cost of capital, and incorporates judgments of the uncertainty (riskiness) of the future cash flows.
FV=PV (1+i)n
DPV=FV/(1+i)n
COST OF CAPITAL
The cost of capital for a firm is a weighted sum of the cost of equity and the cost of debt (see Capital investment decisions). It is also known as the “Hurdle Rate” or “Discount Rate”.
Capital (money) used to fund a business should earn returns for the capital owner who risked his/her saved money. For an investment to be worthwhile the projected return on capital must be greater than the cost of capital. Otherwise stated, the risk-adjusted return on capital (that is, incorporating not just the projected returns, but the probabilities of those projections) must be higher than the cost of capital.
The cost of debt is relatively simple to calculate, as it is composed of the rate of interest paid. In practice, the interest-rate paid by the company will include the risk-free rate plus a risk component, which itself incorporates a probable rate of default (and amount of recovery given default). For companies with similar risk or credit ratings, the interest rate is largely exogenous.
Cost of equity is more challenging to calculate as equity does not pay a set return to its investors. Similar to the cost of debt, the cost of equity is broadly defined as the risk-weighted projected return required by investors, where the return is largely unknown. The cost of equity is therefore inferred by comparing the investment to other investments with similar risk profiles to determine the “market” cost of equity.
The cost of capital is often used as the discount rate, the rate at which projected cash flow will be discounted to give a present value or net present value.
Cost of debt
The cost of debt is computed by taking the rate on a non-defaulting bond whose duration matches the term structure of the corporate debt, then adding a default premium. This default premium will rise as the amount of debt increases (since the risk rises as the amount of debt rises). Since in most cases debt expense is a deductible expense, the cost of debt is computed as an after tax cost to make it comparable with the cost of equity (earnings are after-tax as well). Thus, for profitable firms, debt is discounted by the tax rate. Basically this is used for large corporations only.
Cost of equity
Cost of equity = Risk free rate of return + Premium expected for risk
Expected return
The expected return can be calculated as the “dividend capitalization model”, which is (dividend per share / price per share) + growth rate of dividends (that is, dividend yield + growth rate of dividends).
Capital asset pricing model
The capital asset pricing model (CAPM) is used in finance to determine a theoretically appropriate price of an asset such as a security. The expected return on equity according to the capital asset pricing model. The market risk is normally characterized by the ? parameter. Thus, the investors would expect (or demand) to receive:
WEIGHTED AVERAGE COST OF CAPITAL
The Weighted Average Cost of Capital (WACC) is used in finance to measure a firm’s cost of capital.
The total capital for a firm is the value of its equity (for a firm without outstanding warrants and options, this is the same as the company’s market capitalization) plus the cost of its debt (the cost of debt should be continually updated as the cost of debt changes as a result of interest rate changes). Notice that the “equity” in the debt to equity ratio is the market value of all equity, not the shareholders’ equity on the balance sheet.
Calculation of WACC is an iterative procedure which requires estimation of the fair market value of equity capital
CAPITAL STRUCTURE
Because of tax advantages on debt issuance, it will be cheaper to issue debt rather than new equity (this is only true for profitable firms, tax breaks are available only to profitable firms). At some point, however, the cost of issuing new debt will be greater than the cost of issuing new equity. This is because adding debt increases the default risk – and thus the interest rate that the company must pay in order to borrow money. By utilizing too much debt in its capital structure, this increased default risk can also drive up the costs for other sources (such as retained earnings and preferred stock) as well. Management must identify the “optimal mix” of financing – the capital structure where the cost of capital is minimized so that the firms value can be maximized.
MODIGLIANI-MILLER THEOREM
If there were no tax advantages for issuing debt, and equity could be freely issued, Miller and Modigliani showed that the value of a leveraged firm and the value of an unleveraged firm should be the same.
INTEREST
Interest is a fee paid on borrowed capital. Assets lent include money, shares, consumer goods through hire purchase, major assets such as aircraft, and even entire factories in finance lease arrangements. The interest is calculated upon the value of the assets in the same manner as upon money. Interest can be thought of as “rent on money”.
The fee is compensation to the lender for foregoing other useful investments that could have been made with the loaned money. Instead of the lender using the assets directly, they are advanced to the borrower. The borrower then enjoys the benefit of using the assets ahead of the effort required to obtain them, while the lender enjoys the benefit of the fee paid by the borrower for the privilege. The amount lent, or the value of the assets lent, is called the principal. This principal value is held by the borrower on credit. Interest is therefore the price of credit, not the price of money as it is commonly – and mistakenly – believed to be. The percentage of the principal that is paid as a fee (the interest), over a certain period of time, is called the interest rate.
Interest rates and credit risk
It is increasingly recognized that the business cycle, interest rates and credit risk are tightly interrelated. The Jarrow-Turnbull model was the first model of credit risk which explicitly had random interest rates at its core. Lando (2004), Darrell Duffie and Singleton (2003), and van Deventer and Imai (2003) discuss interest rates when the issuer of the interest-bearing instrument can default.
Money and inflation
Loans, bonds, and shares have some of the characteristics of money and are included in the broad money supply.
By setting i*n, the government institution can affect the markets to alter the total of loans, bonds and shares issued. Generally speaking, a higher real interest rate reduces the broad money supply.
Open market operations in the United States
The Federal Reserve (often referred to as ‘The Fed’) implements monetary policy largely by targeting the federal funds rate. This is the rate that banks charge each other for overnight loans of federal funds. Federal funds are the reserves held by banks at the Fed.
Open market operations are one tool within monetary policy implemented by the Federal Reserve to steer short-term interest rates. Using the power to buy and sell treasury securities, the Open Market Desk at the Federal Reserve Bank of New York can supply the market with dollars by purchasing T-notes, hence increasing the nation’s money supply. By increasing the money supply or Aggregate Supply of Funding (ASF), interest rates will fall due to the excess of dollars banks will end up with in their reserves. Excess reserves may be lent in the Fed funds market to other banks, thus driving down rates.
Credit spread options: credit call spread is a “bearish” call spread, which has more premium on the short call. A credit put spread is a “bullish” put spread and has more premium on the short put.
Credit spread (bond): In finance, a credit spread is the difference in yield between different securities due to different credit quality. The credit spread reflects the additional net yield an investor can earn from a security with more credit risk relative to one with less credit risk. The credit spread of a particular security is often quoted in relation to the yield on a credit risk-free benchmark security or reference rate.
RISK MODELING
Risk modeling refers to the use of formal econometric techniques to determine the aggregate risk in a financial portfolio. Risk modeling is one of many subtasks within the broader area of financial modeling.
Risk modeling uses a variety of techniques including market risk, Value-at-Risk (VaR), Historical Simulation (HS), or Extreme Value Theory (EVT) in order to analyze a portfolio and make forecasts of the likely losses that would be incurred for a variety of risks. Such risks are typically grouped into credit risk, liquidity risk, interest rate risk, and operational risk categories.
Many large financial intermediary firms use risk modeling to help portfolio managers assess the amount of capital reserves to maintain, and to help guide their purchases and sales of various classes of financial assets.
Formal risk modeling is required under the Basel II proposal for all the major international banking institutions by the various national depository institution regulators.
Quantitative risk analysis and modeling have become important in the light of corporate scandals in the past few years (most notably, Enron), Basel II, the revised FAS 123R and the Sarbanes-Oxley Act. In the past, risk analysis was done qualitatively but now with the advent of powerful computing software, quantitative risk analysis can be done quickly and effortlessly.
PORTFOLIO PROBLEMS
In finance, a portfolio is an appropriate mix of or collection of investments held by an institution or a private individual. In building up an investment portfolio a financial institution will typically conduct its own investment analysis, whilst a private individual may make use of the services of a financial advisor or a financial institution which offers portfolio management services. Holding a portfolio is part of an investment and risk-limiting strategy called diversification. By owning several assets, certain types of risk (in particular specific risk) can be reduced. The assets in the portfolio could include stocks, bonds, options, warrants, gold certificates, real estate, futures contracts, production facilities, or any other item that is expected to retain its value.
Portfolio management involves deciding what assets to include in the portfolio, given the goals of the portfolio owner and changing economic conditions. Selection involves deciding what assets to purchase, how many to purchase, when to purchase them, and what assets to divest. These decisions always involve some sort of performance measurement, most typically expected return on the portfolio, and the risk associated with this return (i.e. the standard deviation of the return). Typically the expected return from portfolios of different asset bundles are compared.
Porfolio formation
Many strategies have been developed to form a portfolio.
Ø equally-weighted portfolio
Ø capitalization-weighted portfolio
Ø price-weighted portfolio
Ø optimal portfolio (for which the Sharpe ratio is highest)
VALUATION OF OPTIONS
Black–Scholes:
The term Black–Scholes refers to three closely related concepts:
Ø The Black–Scholes model is a mathematical model of the market for an equity, in which the equity’s price is a stochastic process.
Ø The Black–Scholes PDE is a partial differential equation which (in the model) must be satisfied by the price of a derivative on the equity.
Ø The Black–Scholes formula is the result obtained by solving the Black-Scholes PDE for European put and call options.
Binomial options pricing model: In finance, the binomial options pricing model (BOPM) provides a generalisable numerical method for the valuation of options. The binomial model was first proposed by Cox, Ross and Rubinstein (1979). Essentially, the model uses a “discrete-time” model of the varying price over time of the underlying financial instrument. Option valuation is then computed via application of the risk neutrality assumption over the life of the option, as the price of the underlying instrument evolves.
Monte Carlo option model: In mathematical finance, a Monte Carlo option model uses Monte Carlo methods to calculate the value of an option with multiple sources of uncertainty or with complicated features.
REAL OPTIONS ANALYSIS
In corporate finance, real options analysis or ROA applies put option and call option valuation techniques to capital budgeting decisions.[
A real option is the right, but not the obligation, to undertake some business decision, typically the option to make a capital investment. For example, the opportunity to invest in the expansion of a firm’s factory is a real option. In contrast to financial options, a real option is not often tradeable—e.g. the factory owner cannot sell the right to extend his factory to another party, only he can make this decision; however, some real options can be sold, e.g., ownership of a vacant lot of land is a real option to develop that land in the future. Some real options are proprietory (owned or exercisable by a single individual or a company); others are shared (can be exercised by many parties). Therefore, a project may have a portfolio of embedded real options; some of them can be mutually exclusive.
The terminology “real option” is relatively new, whereas business operators have been making capital investment decisions for centuries. However, the description of such opportunities as real options has occurred at the same time as thinking about such decisions in new, more analytically-based, ways. As such, the terminology “real option” is closely tied to these new methods. The term “real option” was coined by Professor Stewart Myers at the MIT Sloan School of Management; this happened most likely around 1977.
The concept of real options was popularized by Michael J. Mauboussin, the chief U.S. investment strategist for Credit Suisse First Boston and an adjunct professor of finance at the Columbia School of Business. Mauboussin uses real options in part to explain the gap between how the stock market prices some businesses and the “intrinsic value” for those businesses as calculated by traditional financial analysis, specifically discounted cash flows.
Additionally, with real option analysis, uncertainty inherent in investment projects is usually accounted for by risk-adjusting probabilities (a technique known as the equivalent martingale approach). Cash flows can then be discounted at the risk-free rate. With regular DCF analysis, on the other hand, this uncertainty is accounted for by adjusting the discount rate, using e.g. the cost of capital) or the cash flows (using certainty equivalents). These methods normally do not properly account for changes in risk over a project’s lifecycle and fail to appropriately adapt the risk adjustment. More importantly, the real options approach forces decision makers to be more explicit about the assumptions underlying their projections.
Generally, the most widely used methods are: Closed form solutions, partial differential equations, and the binomial lattices. In business strategy, real options have been advanced by the construction of option space, where volatility is compared with value-to-cost, NPVq. Latest advances in real option valuation are models that incorporate fuzzy logic and option valuation in fuzzy real option valuation models.
Real options are a field of academic research, and at the present one of the leading names in academic real options is Professor Lenos Trigeorgis (University of Cyprus). An academic conference on real options is organized yearly (Annual International Conference on Real Options).
This entry was posted on Monday, June 28th, 2010 at 10:54 pm and is filed under term life.
How to Appraise a Business | Stock Market News
How to Appraise a Business | Stock Market News
There are many different ways to work out the value of a business. For the small to mid-size business, there are 3 main approaches that are used more than others. These are the Income value, Market value and the Asset value.
In brief, these would be described as follows:
Valuation based on income: One is looking at the potential earning power of the business into the future. Past earnings, expected future growth, owner’s compensation adjustments, and specific risk factors, such as customer concentration, weak management and lack of diversification are all taken into account when income based valuations are used.
Market Valuation: This method of valuing a business is similar to the way one values a house when selling it. What is being looked at here is what the market will pay for the business in question. Basically, one collects information on the sale of comparable businesses within the industry that the business is in. “Rule of Thumb” information is just a summary of many businesses sold with a million variations not being taken into consideration.
With both income valuations and market valuations, we will determine two different price multipliers. One is price divided by gross sales and the other is price divided by earnings. The applicable price multiple is selected primarily on the profitability of the business. For example, a business with high profits would have a higher price multiple applied to it. A business with low profits would be assigned a lower price multiple. When using this approach, one gets a more accurate result when one uses a minimum of at least a dozen comparables of similar type businesses.
Asset valuation: This valuation procedure assumes that a business is worth the fair market value of its tangible (physical) assets plus its intangible assets. Then from these total assets, liabilities or debts are deducted. To value a business that has intangibles, several methods are used. The method that is most employed in this area is the 5-step excess earning calculation. We will not go into the details of how this is done; we are only explaining that there is a method and giving a quick explanation. Do not try to use this method without taking classes or seminars training you in the details of this procedure. IBBA has classes on this subject.
This calculation deals with tangible assets, intangible assets, liabilities and adjustments thereof, to arrive at an estimated value for the business. It figures out what the reasonable return, on the assets, of the business, should be. If the profit is greater, than that number, it is an indication that the business has some intangible assets, which are generating the excess profit.
If the company in question is making little or no money then there will be no intangible assets. When this is the case, the asset valuation method is usually used. This is the case because when a business has capital tied up in equipment and other tangible assets the other valuation methods will come up with a price way below the actual asset value, without considering any good will. Goodwill is not considered because there is no goodwill, when the income method shows low profit. It is understandable that even if a business is making no profit or even loosing money that the seller still wants to get at least what the equipment is worth. That is why this method is used.
The Basic Steps of Valuing A Business
Valuing a business has several basic steps. These steps, when done in this exact sequence, result in a valuation of a business that can be sold. The steps are as follows:
1. In order to do any business evaluation we need to establish two numbers. Gross income-regardless of what the financials report and Total Owners Benefits. To do a quick appraisal, for the purpose of getting a listing, we only need the last full year and the current year to date. Then one does an “add-back” sheet based on the Profit and Loss statement (or tax return) to get a preliminary Owners Benefits. It is important to keep in mind that we do not want to spend hours interviewing sellers and filling out forms, at this stage.
2. In order to market a listing, after the seller has signed up, you need to have the Adjusted Net Income of the business for each of the prior two years plus the “year to date” of the current year. This is done exactly as covered below in “How to Work Out Cash Flow /Net Income”. Note: In some cases, financials for body shops will not be available. In the case of body shops, you can still do the valuations. Simply collect the Gross Annual Income and the Total Owners Income and Benefits regardless of how earned and proceed with the valuation as below.
3. Getting various preliminary value based on the “Rule of Thumb” section of the Business Reference Guide and Common Sense. This guide is written and edited by Tom West and published by the Business Brokerage Press. These numbers need to be taken with a light view since everything is given in ranges. “Rule of Thumb” ideas are a starting point, not a hard and fast rule.
An example of how the values are determined, for an Optical Practice, form the “Rule of Thumb guide, is as follows:
a. Determine what sort of business you are doing the valuation for. In this case an Optical Practice.
b. Look up Optical Practice in the index at the back of the guide and turn to the page indicated.
c. In this case you will see that the “Rule of Thumb” guide for an optical practice (in the 2003 guide) is “68% of annual sales”. This is the only valuation method covered in the guide.
d. Based on the above, if the annual sales were $350,000.00, then the valuation of this business would be $350,000 X 68% = $238,000
4. When using the Business Reference Guide for thumbnail valuations you are getting a range of opinions. Do each one separately and see what the result is. These work best when a company is making $250,000 net income (including add backs) or more annually. The smaller the business is the more you go to the lower numbers in the range for practical valuation purposes.
5. Very small businesses, making less than $100,000 net profit, have to be looked at differently. A capable individual can get a 40-hour per week job earning $50,000. That is only $25.00 per hour worked. This is assuming he doesn’t get paid vacation, holidays and medical insurance. As an owner he will work more than 40 hours and this rate will drop accordingly. If a business is making a small profit, then the first $50,000 needs to be looked at as a salary. In truth, “Rule of Thumb” valuations are totally worthless for businesses making less than $50,000 per year in total owner’s benefits.
The question that comes up here is: Why would anyone buy a job at 3 or more times what he could earn by just simply working for someone else? An individual might possibly buy a job for 1 years’ income, because it has the potential of increasing, and he or she gets to work without a boss. If a business is making $100,000 profit, someone would possibly pay 2 times net profit, for the 2nd $50,000 and $50,000 for the first $50,000. This would give a value of $150,000 for a business profit of $100,000.
We are still talking about buying a job at this level, just a better job. Maybe someone would pay $200,000 to earn $100,000 if the potential really looked good. That would be $50,000 for the first $50,000 and 3 times the next $50,000.
6. A business making $250,000 or more looks more attractive even after you deduct $75,000 for a working owner or manager. A buyer might be willing to pay as much as 4 or 5 times for the remaining $175,000 in profit, because his salary is already covered.
7. If a buyer needs to tie up a fortune in inventory then the desire to pay more for the business reduces. Sometimes a buyer pays for the inventory and wants the business for free, especially if it is making less than $50,000 for a working owner.
Judgment: There is some judgment involved in valuing a business. The guidelines above will help you take the financial figures and apply some workable judgment to them.
8. If the valuations done as explained above are within 10% of each other, or if you only have one valid valuation figure to use, after completing the 6 steps above, the valuation is easy.
9. If you have more than one valuation figure and they are NOT WITHIN 10% OF EACH OTHER, do the following, while taking into account the various judgment factors involved in valuing a business:
a. Use the adjusted net income valuation figure
b. If you cannot get a real adjusted net income figure, then use the annual gross sales figure valuation.
10. If you were using several valuation methods, you would tell the seller what the various methods are; what value was arrived at with each; and your final conclusion along with why you reached that conclusion. The “why” part would be based on the various judgment factor and valuations figure that you arrived at from the above ways.
11. You would then ask seller what price he or she would like to list the business for. Our final conclusion would be the number used as the listing price, unless the seller disagreed and wanted to use another figure. We take the sellers listing price but make it clear what the value of the business is and “why that value” in the client notes.
12. Remember, we advise the seller what the valuations are, but take his or her listing price, only if the seller insists on it.
The Comparable Method
It can sometime happen that, even with the different methods outlined above, a business can be difficult to value. When this occurs, we still have the Comparable Method that we can use.
Kismet Business Brokers is a member of http://www.bizbuysell.com and as such we have access to the “For-Sale Comparable Calculator” on the website. This calculator uses the BizBuySell database of 1000’s of sold businesses to perform its analysis. The Calculator can be used to develop a suggested asking price by simply entering the businesses gross income and/or cash flow.
How to Work Out Cash Flow /Net Income
There is a very specific way that cash flow / net income is calculated. The following is how it is done. When net income or cash flow is asked for we use the “owners benefit” figure. This is the net profit on the P & L (profit and loss statement) plus the owners benefits added back. The owner’s benefits are added back because everything one single owner gets, regardless of its form is not considered a business expense and is added back as profit. Note: Any cash that the owner receives and doesn’t report is considered an owners benefit and must also be added; it is labeled other income.
This is calculated by marking the letter “A” beside each of the following items if they show on the P & L. These items are marked and added to the calculation sheet attached. The items are:
Depreciation and Amortization, IRS Taxes, Franchise Taxes, Interest Expense, Donations, Non-Recurring Legal Expenses or Non-essential expenses. Other Expenses, Owners Medical, Life Insurance for Owners, Pension Plan contributions for owner’s family, Non-Essential Salaries, Health insurance (owner’s family portion), Owners vehicle expenses (lease payments, operating expenses, repairs, gas, depreciation and insurance), Magazine subscriptions, Owner’s Travel, Entertainment, Home office expenses and Home telephone expenses. Any other owners benefit that the seller has hidden in some expense account. Real examples include: a) Personal clothing listed as uniforms. b) Family eating out listed under entertainment. c) Children’s education listed under staff training.
Additional clarification on lease payments is as follows: As discussed in the prior paragraph, lease payments made on personal automobiles are not a business expense and are added back. The buyer many times needs to assume a lease payment on leased machinery. If the lease has a $1.00 buy out or any buy out at the end for less than fair market value of the machinery it is called a financing lease. We treat them like a loan payment and add back 100% of the payments and the seller must pay these loans off or the escrow needs to deduct the balance due from buyer’s cash requirement. We also put these assets on the balance sheet. If the buy-out at the end of the lease, at fair market, on the date of the buy-out, then this is a real lease which is really just a rental agreement. The payments are left as a business expense and are not added back. To find out which kind of lease the seller has will require asking the seller or his accountant.
In order to know how much of the financial reports is “owner’s benefits”, it is required that you go through the financials, with the client, and ask him or her to tell you which expenses should be considered personal benefits. You do not need to take the clients opinion as truth; it just needs to make sense. If it doesn’t, do not use it as a benefit.
If the company is a corporation or LLC, mark as with a “B”, the Owners Salary-husband and wife on the P & L statement and put these numbers on the add-back form. . If the business is a partnership or a sole proprietorship we only add-back the “owners/partners draws” amounts if they show up as an expense on the P & L. These salaries and “owner draws” are of interest only if located on the profit and loss sheet. Do not take salary or draw figures off of the balance sheet. The basic decision in adding back salary is this – Add back only one owner’s salary. Other partners or family members salary that will have to be replaced when the business is sold cannot added back. An explanation of what is added back should be included in the business summary.
Finally, where there is other income, this figure is gotten from the owner and added in the “Other Income” section on the attached calculation sheet. Ask the business owner if there is other income or cash that should be noted, get the figure, verify it as much as possible by having the owner supply information that proves the figure is real and how it is calculated. Write it down on the calculation sheet.
Note: Kids salaries are not added back unless they do not work in the business, or they do work in the business and their salary is much more than a non-family employee would be paid. In this case add back, as a separate item – mark it “C”, and put just the excess portion of their salary on the attached calculation sheet. All figures above are annual figures. The attached calculation sheet is used to calculate the various “add backs”. When completed, it is paper clipped on top of the Profit and Loss for the year being worked out.
Also, there are adjustments that reduce the net income of a business. These go under “Other Expenses.”
If the owner of the business also owns the real estate, the P & L will sometimes not properly reflect a fair market rent. Fair market rent is what the landlord/business owner wants from the buyer in rent. Adjust the rent, up or down, on the worksheet, for the difference between the market rent and what shows on the P & L. Property taxes are not an add back because the tenant is usually responsible for the property taxes regardless of who owns the real estate.
Three different adjusted net income work sheets are done, for each business. These are each of the prior two years plus the “year to date” of the current year. “Year to date” is an accounting phrase that means from the first day of the seller’s tax year to the last date available. If that is the 6-month period from January to June then that is the “year to date.” In conclusion, if you have Profit and Loss Statements for 2003, 2004 and 6 months of 2005, you would do an ad-back calculation sheets for the 2 full years of 2003 and 2004 and a 6 months ad-back calculation sheet for the first half of 2005
Finally, add back sheets are signed by the seller to confirm that the add backs are accurate.
What to does the broker or licensed agent do if the seller will not sign the financials as adjusted by us after all corrections are made?
After the finances have been corrected to the seller’s satisfaction he or she may still not wish to sign them. In this case, the following steps are taken:
1) Ask the seller what adjustments would need to be made for him to be able to sign the corrected finances. Advise him that it is essential that we have the financials signed, as they are his report to the buyer as to the financial state of the business. Make the final adjustments and get the signature(s) of the seller(s).
2) If the seller removed the “other income” from the financials, collect the following information so that we can sell the business that is not showing all the income:
a. How much will the seller carry back and at what terms and for how long?
b. Get a statement showing how well he and his family is surviving from the business and what it costs them to live. What they pay for housing, utilities, children’s education, and other expenses will show what it takes to support the family.
Below are the blank “add-Back” sheet and owner confirmation sheet that are used in calculating cash flow and getting seller confirmation of the figures
OWNER’S CASH FLOW ANALYSIS (ADD BACK SHEET)
NAME OF BUSINESS ______________________________________________
For Fiscal Year Ending ______________ 20 _____
Interim Period: Thru __________________________ # of Months ______
Information Source: Tax Returns () Financial Statements ()
NET INCOME FROM OPERATIONS: $______________
(A) ITEMS
Depreciation and Amortization (Except Business Autos)
IRS Federal Income Taxes or Penalties:
State Franchise Taxes or Penalties
Interest Expense
Interest portion of auto lease payments where it is a financing lease.
Donations
Life Insurance for Owners
Pension Plans contribution for owner’s family
Health insurance for owner’s family
Unusual Legal Expenses or Bank overdraft fees
Personal auto lease payments
Auto repair for owner or family auto
Gas for owner or family auto
Insurance for owner or family auto
DMV License for owner or family auto
Travel, clothing
Entertainment
Home telephone expenses
Home office expenses
Other (Name)
(A) TOTAL: $_________________
(B) ITEMS [take only numbers from P & L – not balance sheet]
Owners Salary (If Corporation or LLC)
Owners Draw or Partner #1 “Draw”
Owner #2 or Partner #2 “Draw”
(B) TOTAL: $_________________
(C) ITEMS
Owner’s wife or kids salaries (If not working in the business)
Owner’s wife or kids salaries [excess portion] (If working in the business and getting much more that non-member staff
(C) TOTAL: $_________________
OTHER INCOME: $_________________
OTHER EXPENSES:(A) (Plus or Minus) $_________________
OTHER EXPENSES:(B) (MINUS) $_________________
ESTIMATED CASH FLOW: $_____________________
Seller confirmation of add backs:
OWNER’S CASH FLOW ANALYSIS
“This information is being provided to buyer, by Kismet Business Brokers, as information received from the business owner for such purposes.
The business owner declares that the information herein is based on figures supplied by the owner and that owner intends that Kismet Business Brokers and prospective buyers rely on such information. Owner further declares the owner has documentation supporting such figures and agrees to provide supporting documentation upon request.
Kismet Business Brokers has not independently verified the information provided herein. Further, buyer(s) are advised to obtain appropriate counsel from legal, accounting and other professionals concerning the purchase of this business.”
Business: _____________________________________________
Business Owner’s Signature: __________________________________________________________
Date: __________________________
Willard Michlin is a Business Broker, California Real Estate Broker, Accountant, Well known Public speaker and Administrative/Business Consultant. He can be contacted at his Ventura, California office by calling 805-529-9854 or by e-mail at kismetrei@earthlink.net. See other articles by Willard Michlin at http://www.kismetbusinessbrokers.com
There are many different ways to work out the value of a business. For the small to mid-size business, there are 3 main approaches that are used more than others. These are the Income value, Market value and the Asset value.
In brief, these would be described as follows:
Valuation based on income: One is looking at the potential earning power of the business into the future. Past earnings, expected future growth, owner’s compensation adjustments, and specific risk factors, such as customer concentration, weak management and lack of diversification are all taken into account when income based valuations are used.
Market Valuation: This method of valuing a business is similar to the way one values a house when selling it. What is being looked at here is what the market will pay for the business in question. Basically, one collects information on the sale of comparable businesses within the industry that the business is in. “Rule of Thumb” information is just a summary of many businesses sold with a million variations not being taken into consideration.
With both income valuations and market valuations, we will determine two different price multipliers. One is price divided by gross sales and the other is price divided by earnings. The applicable price multiple is selected primarily on the profitability of the business. For example, a business with high profits would have a higher price multiple applied to it. A business with low profits would be assigned a lower price multiple. When using this approach, one gets a more accurate result when one uses a minimum of at least a dozen comparables of similar type businesses.
Asset valuation: This valuation procedure assumes that a business is worth the fair market value of its tangible (physical) assets plus its intangible assets. Then from these total assets, liabilities or debts are deducted. To value a business that has intangibles, several methods are used. The method that is most employed in this area is the 5-step excess earning calculation. We will not go into the details of how this is done; we are only explaining that there is a method and giving a quick explanation. Do not try to use this method without taking classes or seminars training you in the details of this procedure. IBBA has classes on this subject.
This calculation deals with tangible assets, intangible assets, liabilities and adjustments thereof, to arrive at an estimated value for the business. It figures out what the reasonable return, on the assets, of the business, should be. If the profit is greater, than that number, it is an indication that the business has some intangible assets, which are generating the excess profit.
If the company in question is making little or no money then there will be no intangible assets. When this is the case, the asset valuation method is usually used. This is the case because when a business has capital tied up in equipment and other tangible assets the other valuation methods will come up with a price way below the actual asset value, without considering any good will. Goodwill is not considered because there is no goodwill, when the income method shows low profit. It is understandable that even if a business is making no profit or even loosing money that the seller still wants to get at least what the equipment is worth. That is why this method is used.
The Basic Steps of Valuing A Business
Valuing a business has several basic steps. These steps, when done in this exact sequence, result in a valuation of a business that can be sold. The steps are as follows:
1. In order to do any business evaluation we need to establish two numbers. Gross income-regardless of what the financials report and Total Owners Benefits. To do a quick appraisal, for the purpose of getting a listing, we only need the last full year and the current year to date. Then one does an “add-back” sheet based on the Profit and Loss statement (or tax return) to get a preliminary Owners Benefits. It is important to keep in mind that we do not want to spend hours interviewing sellers and filling out forms, at this stage.
2. In order to market a listing, after the seller has signed up, you need to have the Adjusted Net Income of the business for each of the prior two years plus the “year to date” of the current year. This is done exactly as covered below in “How to Work Out Cash Flow /Net Income”. Note: In some cases, financials for body shops will not be available. In the case of body shops, you can still do the valuations. Simply collect the Gross Annual Income and the Total Owners Income and Benefits regardless of how earned and proceed with the valuation as below.
3. Getting various preliminary value based on the “Rule of Thumb” section of the Business Reference Guide and Common Sense. This guide is written and edited by Tom West and published by the Business Brokerage Press. These numbers need to be taken with a light view since everything is given in ranges. “Rule of Thumb” ideas are a starting point, not a hard and fast rule.
An example of how the values are determined, for an Optical Practice, form the “Rule of Thumb guide, is as follows:
a. Determine what sort of business you are doing the valuation for. In this case an Optical Practice.
b. Look up Optical Practice in the index at the back of the guide and turn to the page indicated.
c. In this case you will see that the “Rule of Thumb” guide for an optical practice (in the 2003 guide) is “68% of annual sales”. This is the only valuation method covered in the guide.
d. Based on the above, if the annual sales were $350,000.00, then the valuation of this business would be $350,000 X 68% = $238,000
4. When using the Business Reference Guide for thumbnail valuations you are getting a range of opinions. Do each one separately and see what the result is. These work best when a company is making $250,000 net income (including add backs) or more annually. The smaller the business is the more you go to the lower numbers in the range for practical valuation purposes.
5. Very small businesses, making less than $100,000 net profit, have to be looked at differently. A capable individual can get a 40-hour per week job earning $50,000. That is only $25.00 per hour worked. This is assuming he doesn’t get paid vacation, holidays and medical insurance. As an owner he will work more than 40 hours and this rate will drop accordingly. If a business is making a small profit, then the first $50,000 needs to be looked at as a salary. In truth, “Rule of Thumb” valuations are totally worthless for businesses making less than $50,000 per year in total owner’s benefits.
The question that comes up here is: Why would anyone buy a job at 3 or more times what he could earn by just simply working for someone else? An individual might possibly buy a job for 1 years’ income, because it has the potential of increasing, and he or she gets to work without a boss. If a business is making $100,000 profit, someone would possibly pay 2 times net profit, for the 2nd $50,000 and $50,000 for the first $50,000. This would give a value of $150,000 for a business profit of $100,000.
We are still talking about buying a job at this level, just a better job. Maybe someone would pay $200,000 to earn $100,000 if the potential really looked good. That would be $50,000 for the first $50,000 and 3 times the next $50,000.
6. A business making $250,000 or more looks more attractive even after you deduct $75,000 for a working owner or manager. A buyer might be willing to pay as much as 4 or 5 times for the remaining $175,000 in profit, because his salary is already covered.
7. If a buyer needs to tie up a fortune in inventory then the desire to pay more for the business reduces. Sometimes a buyer pays for the inventory and wants the business for free, especially if it is making less than $50,000 for a working owner.
Judgment: There is some judgment involved in valuing a business. The guidelines above will help you take the financial figures and apply some workable judgment to them.
8. If the valuations done as explained above are within 10% of each other, or if you only have one valid valuation figure to use, after completing the 6 steps above, the valuation is easy.
9. If you have more than one valuation figure and they are NOT WITHIN 10% OF EACH OTHER, do the following, while taking into account the various judgment factors involved in valuing a business:
a. Use the adjusted net income valuation figure
b. If you cannot get a real adjusted net income figure, then use the annual gross sales figure valuation.
10. If you were using several valuation methods, you would tell the seller what the various methods are; what value was arrived at with each; and your final conclusion along with why you reached that conclusion. The “why” part would be based on the various judgment factor and valuations figure that you arrived at from the above ways.
11. You would then ask seller what price he or she would like to list the business for. Our final conclusion would be the number used as the listing price, unless the seller disagreed and wanted to use another figure. We take the sellers listing price but make it clear what the value of the business is and “why that value” in the client notes.
12. Remember, we advise the seller what the valuations are, but take his or her listing price, only if the seller insists on it.
The Comparable Method
It can sometime happen that, even with the different methods outlined above, a business can be difficult to value. When this occurs, we still have the Comparable Method that we can use.
Kismet Business Brokers is a member of http://www.bizbuysell.com and as such we have access to the “For-Sale Comparable Calculator” on the website. This calculator uses the BizBuySell database of 1000’s of sold businesses to perform its analysis. The Calculator can be used to develop a suggested asking price by simply entering the businesses gross income and/or cash flow.
How to Work Out Cash Flow /Net Income
There is a very specific way that cash flow / net income is calculated. The following is how it is done. When net income or cash flow is asked for we use the “owners benefit” figure. This is the net profit on the P & L (profit and loss statement) plus the owners benefits added back. The owner’s benefits are added back because everything one single owner gets, regardless of its form is not considered a business expense and is added back as profit. Note: Any cash that the owner receives and doesn’t report is considered an owners benefit and must also be added; it is labeled other income.
This is calculated by marking the letter “A” beside each of the following items if they show on the P & L. These items are marked and added to the calculation sheet attached. The items are:
Depreciation and Amortization, IRS Taxes, Franchise Taxes, Interest Expense, Donations, Non-Recurring Legal Expenses or Non-essential expenses. Other Expenses, Owners Medical, Life Insurance for Owners, Pension Plan contributions for owner’s family, Non-Essential Salaries, Health insurance (owner’s family portion), Owners vehicle expenses (lease payments, operating expenses, repairs, gas, depreciation and insurance), Magazine subscriptions, Owner’s Travel, Entertainment, Home office expenses and Home telephone expenses. Any other owners benefit that the seller has hidden in some expense account. Real examples include: a) Personal clothing listed as uniforms. b) Family eating out listed under entertainment. c) Children’s education listed under staff training.
Additional clarification on lease payments is as follows: As discussed in the prior paragraph, lease payments made on personal automobiles are not a business expense and are added back. The buyer many times needs to assume a lease payment on leased machinery. If the lease has a $1.00 buy out or any buy out at the end for less than fair market value of the machinery it is called a financing lease. We treat them like a loan payment and add back 100% of the payments and the seller must pay these loans off or the escrow needs to deduct the balance due from buyer’s cash requirement. We also put these assets on the balance sheet. If the buy-out at the end of the lease, at fair market, on the date of the buy-out, then this is a real lease which is really just a rental agreement. The payments are left as a business expense and are not added back. To find out which kind of lease the seller has will require asking the seller or his accountant.
In order to know how much of the financial reports is “owner’s benefits”, it is required that you go through the financials, with the client, and ask him or her to tell you which expenses should be considered personal benefits. You do not need to take the clients opinion as truth; it just needs to make sense. If it doesn’t, do not use it as a benefit.
If the company is a corporation or LLC, mark as with a “B”, the Owners Salary-husband and wife on the P & L statement and put these numbers on the add-back form. . If the business is a partnership or a sole proprietorship we only add-back the “owners/partners draws” amounts if they show up as an expense on the P & L. These salaries and “owner draws” are of interest only if located on the profit and loss sheet. Do not take salary or draw figures off of the balance sheet. The basic decision in adding back salary is this – Add back only one owner’s salary. Other partners or family members salary that will have to be replaced when the business is sold cannot added back. An explanation of what is added back should be included in the business summary.
Finally, where there is other income, this figure is gotten from the owner and added in the “Other Income” section on the attached calculation sheet. Ask the business owner if there is other income or cash that should be noted, get the figure, verify it as much as possible by having the owner supply information that proves the figure is real and how it is calculated. Write it down on the calculation sheet.
Note: Kids salaries are not added back unless they do not work in the business, or they do work in the business and their salary is much more than a non-family employee would be paid. In this case add back, as a separate item – mark it “C”, and put just the excess portion of their salary on the attached calculation sheet. All figures above are annual figures. The attached calculation sheet is used to calculate the various “add backs”. When completed, it is paper clipped on top of the Profit and Loss for the year being worked out.
Also, there are adjustments that reduce the net income of a business. These go under “Other Expenses.”
If the owner of the business also owns the real estate, the P & L will sometimes not properly reflect a fair market rent. Fair market rent is what the landlord/business owner wants from the buyer in rent. Adjust the rent, up or down, on the worksheet, for the difference between the market rent and what shows on the P & L. Property taxes are not an add back because the tenant is usually responsible for the property taxes regardless of who owns the real estate.
Three different adjusted net income work sheets are done, for each business. These are each of the prior two years plus the “year to date” of the current year. “Year to date” is an accounting phrase that means from the first day of the seller’s tax year to the last date available. If that is the 6-month period from January to June then that is the “year to date.” In conclusion, if you have Profit and Loss Statements for 2003, 2004 and 6 months of 2005, you would do an ad-back calculation sheets for the 2 full years of 2003 and 2004 and a 6 months ad-back calculation sheet for the first half of 2005
Finally, add back sheets are signed by the seller to confirm that the add backs are accurate.
What to does the broker or licensed agent do if the seller will not sign the financials as adjusted by us after all corrections are made?
After the finances have been corrected to the seller’s satisfaction he or she may still not wish to sign them. In this case, the following steps are taken:
1) Ask the seller what adjustments would need to be made for him to be able to sign the corrected finances. Advise him that it is essential that we have the financials signed, as they are his report to the buyer as to the financial state of the business. Make the final adjustments and get the signature(s) of the seller(s).
2) If the seller removed the “other income” from the financials, collect the following information so that we can sell the business that is not showing all the income:
a. How much will the seller carry back and at what terms and for how long?
b. Get a statement showing how well he and his family is surviving from the business and what it costs them to live. What they pay for housing, utilities, children’s education, and other expenses will show what it takes to support the family.
Below are the blank “add-Back” sheet and owner confirmation sheet that are used in calculating cash flow and getting seller confirmation of the figures
OWNER’S CASH FLOW ANALYSIS (ADD BACK SHEET)
NAME OF BUSINESS ______________________________________________
For Fiscal Year Ending ______________ 20 _____
Interim Period: Thru __________________________ # of Months ______
Information Source: Tax Returns () Financial Statements ()
NET INCOME FROM OPERATIONS: $______________
(A) ITEMS
Depreciation and Amortization (Except Business Autos)
IRS Federal Income Taxes or Penalties:
State Franchise Taxes or Penalties
Interest Expense
Interest portion of auto lease payments where it is a financing lease.
Donations
Life Insurance for Owners
Pension Plans contribution for owner’s family
Health insurance for owner’s family
Unusual Legal Expenses or Bank overdraft fees
Personal auto lease payments
Auto repair for owner or family auto
Gas for owner or family auto
Insurance for owner or family auto
DMV License for owner or family auto
Travel, clothing
Entertainment
Home telephone expenses
Home office expenses
Other (Name)
(A) TOTAL: $_________________
(B) ITEMS [take only numbers from P & L – not balance sheet]
Owners Salary (If Corporation or LLC)
Owners Draw or Partner #1 “Draw”
Owner #2 or Partner #2 “Draw”
(B) TOTAL: $_________________
(C) ITEMS
Owner’s wife or kids salaries (If not working in the business)
Owner’s wife or kids salaries [excess portion] (If working in the business and getting much more that non-member staff
(C) TOTAL: $_________________
OTHER INCOME: $_________________
OTHER EXPENSES:(A) (Plus or Minus) $_________________
OTHER EXPENSES:(B) (MINUS) $_________________
ESTIMATED CASH FLOW: $_____________________
Seller confirmation of add backs:
OWNER’S CASH FLOW ANALYSIS
“This information is being provided to buyer, by Kismet Business Brokers, as information received from the business owner for such purposes.
The business owner declares that the information herein is based on figures supplied by the owner and that owner intends that Kismet Business Brokers and prospective buyers rely on such information. Owner further declares the owner has documentation supporting such figures and agrees to provide supporting documentation upon request.
Kismet Business Brokers has not independently verified the information provided herein. Further, buyer(s) are advised to obtain appropriate counsel from legal, accounting and other professionals concerning the purchase of this business.”
Business: _____________________________________________
Business Owner’s Signature: __________________________________________________________
Date: __________________________
Willard Michlin is a Business Broker, California Real Estate Broker, Accountant, Well known Public speaker and Administrative/Business Consultant. He can be contacted at his Ventura, California office by calling 805-529-9854 or by e-mail at kismetrei@earthlink.net. See other articles by Willard Michlin at http://www.kismetbusinessbrokers.com
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