Biz2Credit - Small Business Acquisition Loans and Financing to Buy your own Business
(http://www.biz2credit.com/get-a-loan/business-acquisition-loans/loans-to-buy-a-business.html)
Loans to Buy a Business
If you're looking to buy a business, consult a business valuation expert to help you find appropriate business financing alternatives. Try talking to your accountant or banker or search online for business valuation guides and loans to buy a business.
Use seller financing with a term of 5 to 10 years to buy a business. Lenders feel more confident funding acquisition deals that involve seller financing. Also, seller financing involves less paperwork and does not require an appraisal.
If you're looking to buy a business in a hurry, consolidate the paperwork and keep the following forms ready to speed up the business loan approval process:
* Last 3 years of tax returns and interim financials
* Last 2 years of personal tax returns
* Management structure and business plan for the business you want to buy
Saturday, July 31, 2010
Expectations and Business Valuation | Valtrend
Expectations and Business Valuation | Valtrend
George Steinbrenner (and his partners) purchased the Yankees in 1973 for $10 million. In 2009, Forbes estimated the Yankees value at $1.6 billion. If one does the math, George (ignoring what he paid to buy out his partners later) earned a little more than a 15% compound rate of return on his investment for 36 years.
My hunch is that George probably required (or hoped for) at least this rate of return. However, even he might have been surprised if you told him in 1973 that this investment would be worth $1.6 billion in 2009. (That is the beauty of compound interest) My hunch is that, with the benefit of hindsight, CBS would not have sold the Yankees to him at all or would have sold the team for much for than $10 million in 1973.
This entry was posted on Friday, July 30th, 2010 at 4:17 pm and is filed under Uncategorized.
George Steinbrenner (and his partners) purchased the Yankees in 1973 for $10 million. In 2009, Forbes estimated the Yankees value at $1.6 billion. If one does the math, George (ignoring what he paid to buy out his partners later) earned a little more than a 15% compound rate of return on his investment for 36 years.
My hunch is that George probably required (or hoped for) at least this rate of return. However, even he might have been surprised if you told him in 1973 that this investment would be worth $1.6 billion in 2009. (That is the beauty of compound interest) My hunch is that, with the benefit of hindsight, CBS would not have sold the Yankees to him at all or would have sold the team for much for than $10 million in 1973.
This entry was posted on Friday, July 30th, 2010 at 4:17 pm and is filed under Uncategorized.
The Debate on Fair Value and How it Can Affect Business Valuation Models - christianwire's blog
The Debate on Fair Value and How it Can Affect Business Valuation Models - christianwire's blog
The Debate on Fair Value and How it Can Affect Business Valuation Models
The concept of fair value accounting was driven by the Financial Accounting Standards Board (FASB) and Securities and Exchange Commission (SEC) in an effort to provide greater disclosure, transparency and consistency in financial statements. The objective was to improve the quality, consistency and comparability of financial reporting to provide superior and thorough information to the investment community. Accounting Standard Codification 820, “Fair Value Measurements,” formerly known as Statement of Financial Accounting Standards (SFAS) No. 157, ASC 820, provided a uniform definition for fair value and put an emphasis on the use of market inputs when valuing an asset or liability. This is also referred to as “mark-to-market” accounting since financial statements are now required to clearly state upon which of the three-level hierarchy inputs the reported values are based on.
Defining Fair Value Using Market Inputs
Although ASC 820 was first introduced in 2006, it went into effect for the financial statements of entities classified as “investment companies” with a period beginning January 1, 2008. As the economy began to spiral downward in 2008, and companies were required to start adjusting asset values in accordance with ASC 820, some financial institutions began writing-down the underlying value of certain assets. This brought into question the ability of some institutions to meet regulatory capital requirements and led to a push for emergency remedies – specifically, the suspension of ASC 820.
The debate between the opponents and proponents of fair value continued through the rest of 2008 with opponents blaming mark-to-market accounting for the struggling economy, with proponents favoring increased transparency. In response, Congress directed the SEC to research the issue as part of the Emergency Economic Stabilization Act, which created the Troubled Assets Relief Program (TARP). The SEC issued its report in December 2008, concluding that the credit crisis was not caused by fair value accounting and that it should not be suspended or substantially modified. Ultimately, the first debate swung in favor of FASB and ASC 820, resulting in a few changes being implemented in April 2009 with the issuance of FASB Staff Positions, including No. 115-2 and 124-2, “Recognition and Presentation of Other-Than-Temporary Impairments” and 157-4, “Determining the Fair Value When the Volume and Level of Activity for the Asset or Liability Have Significantly Decreased and Identifying Transactions That Are Not Orderly.”
Expanding Fair Value to Loans
The FASB recently met in August 2009 to discuss additional changes to fair value rules, parallel with the International Accounting Standards Board (IASB), to expand the guidelines. The FASB proposal would require that all financial instruments, including loans, be presented on the balance sheet at fair value. Any changes in value would then be recognized in net income or other comprehensive income. It is anticipated that the revised rule could go into effect as early as 2011. This could require banks to accelerate the recognition of losses, triggering lower earnings and book values. Financial institutions are already beginning to protest, most notably through the American Bankers Association. At the center of the debate is mark-to-market. Financial institutions have been pushing to decrease the use of mark-to-market accounting for assets that are hard to price due to a lack of comparables and the FASB and IASB now want to extend mark-to-market to all financial instruments.
This round of debate over the expansion of fair value accounting is further complicated as the U.S. continues to transition from Generally Accepted Accounting Principles (GAAP) to International Financial Reporting Standards (IFRS). The FASB is working with the IASB, but the two groups have presented different models and deadlines for completion pertaining to the proposed standard. There is concern that the differences between the FASB and the IASB will result in a lack of due process on the part of FASB or a divergence between IFRS and GAAP. And then there is the involvement of the SEC, which has been working with both the FASB and the IASB on the transition to international standards, and is being pressured by members of Congress in response to the initial discourse.
Bottom Line: Companies Should Assess Exposure
Every company should make an assessment of its exposure as it relates to fair value measurement. For many, these measurements will be an integral part of their financial statements and can impact performance. The process is complex and management should have a keen understanding of what inputs are being utilized in the business valuation models and how to interpret the output in order to ensure the reliability of its financial statements. Management should be knowledgeable and have a basic understanding for how amounts were determined by the party providing the pricing information. Addressing the changing landscape of value and learning as much about these changes as possible will benefit companies, boards and advisors.
Thanks To : software cnet accpac accounting software mas90 accounting software
Check it out: The Debate on Fair Value and How it Can Affect Business Valuation Models
30 July 2010 17:30:57
The Debate on Fair Value and How it Can Affect Business Valuation Models
The concept of fair value accounting was driven by the Financial Accounting Standards Board (FASB) and Securities and Exchange Commission (SEC) in an effort to provide greater disclosure, transparency and consistency in financial statements. The objective was to improve the quality, consistency and comparability of financial reporting to provide superior and thorough information to the investment community. Accounting Standard Codification 820, “Fair Value Measurements,” formerly known as Statement of Financial Accounting Standards (SFAS) No. 157, ASC 820, provided a uniform definition for fair value and put an emphasis on the use of market inputs when valuing an asset or liability. This is also referred to as “mark-to-market” accounting since financial statements are now required to clearly state upon which of the three-level hierarchy inputs the reported values are based on.
Defining Fair Value Using Market Inputs
Although ASC 820 was first introduced in 2006, it went into effect for the financial statements of entities classified as “investment companies” with a period beginning January 1, 2008. As the economy began to spiral downward in 2008, and companies were required to start adjusting asset values in accordance with ASC 820, some financial institutions began writing-down the underlying value of certain assets. This brought into question the ability of some institutions to meet regulatory capital requirements and led to a push for emergency remedies – specifically, the suspension of ASC 820.
The debate between the opponents and proponents of fair value continued through the rest of 2008 with opponents blaming mark-to-market accounting for the struggling economy, with proponents favoring increased transparency. In response, Congress directed the SEC to research the issue as part of the Emergency Economic Stabilization Act, which created the Troubled Assets Relief Program (TARP). The SEC issued its report in December 2008, concluding that the credit crisis was not caused by fair value accounting and that it should not be suspended or substantially modified. Ultimately, the first debate swung in favor of FASB and ASC 820, resulting in a few changes being implemented in April 2009 with the issuance of FASB Staff Positions, including No. 115-2 and 124-2, “Recognition and Presentation of Other-Than-Temporary Impairments” and 157-4, “Determining the Fair Value When the Volume and Level of Activity for the Asset or Liability Have Significantly Decreased and Identifying Transactions That Are Not Orderly.”
Expanding Fair Value to Loans
The FASB recently met in August 2009 to discuss additional changes to fair value rules, parallel with the International Accounting Standards Board (IASB), to expand the guidelines. The FASB proposal would require that all financial instruments, including loans, be presented on the balance sheet at fair value. Any changes in value would then be recognized in net income or other comprehensive income. It is anticipated that the revised rule could go into effect as early as 2011. This could require banks to accelerate the recognition of losses, triggering lower earnings and book values. Financial institutions are already beginning to protest, most notably through the American Bankers Association. At the center of the debate is mark-to-market. Financial institutions have been pushing to decrease the use of mark-to-market accounting for assets that are hard to price due to a lack of comparables and the FASB and IASB now want to extend mark-to-market to all financial instruments.
This round of debate over the expansion of fair value accounting is further complicated as the U.S. continues to transition from Generally Accepted Accounting Principles (GAAP) to International Financial Reporting Standards (IFRS). The FASB is working with the IASB, but the two groups have presented different models and deadlines for completion pertaining to the proposed standard. There is concern that the differences between the FASB and the IASB will result in a lack of due process on the part of FASB or a divergence between IFRS and GAAP. And then there is the involvement of the SEC, which has been working with both the FASB and the IASB on the transition to international standards, and is being pressured by members of Congress in response to the initial discourse.
Bottom Line: Companies Should Assess Exposure
Every company should make an assessment of its exposure as it relates to fair value measurement. For many, these measurements will be an integral part of their financial statements and can impact performance. The process is complex and management should have a keen understanding of what inputs are being utilized in the business valuation models and how to interpret the output in order to ensure the reliability of its financial statements. Management should be knowledgeable and have a basic understanding for how amounts were determined by the party providing the pricing information. Addressing the changing landscape of value and learning as much about these changes as possible will benefit companies, boards and advisors.
Thanks To : software cnet accpac accounting software mas90 accounting software
Check it out: The Debate on Fair Value and How it Can Affect Business Valuation Models
30 July 2010 17:30:57
Business Valuation In The Changing Global Economy | Get Unique Articles
Business Valuation In The Changing Global Economy | Get Unique Articles
While many people tend to think of globalization and the current economic recession as factors that have influenced business valuation greatly, the truth is that business valuation has traditionally started with an assessment of national, regional, and local economic conditions. These evaluations are typically made on or around the actual valuation date, and are meant to focus both on all markets in which the business might operate. In the past, all but the largest of businesses operated on a local and/or regional level, but globalization has changed all that in an irrevocable manner.
This makes the global economic situation worth paying attention to, as well as political factors that were once given short shrift when it came to business valuations. Now businesses valuation reports need to take a look at many factors, such as:
* Political and/or economic stability within suppliers – If supply chains are broken due to the development of internal economies or trade barriers being erected between nations, then a business may find itself at a competitive disadvantage.
* Comparative adjustments – While business valuation used to factor competitors within a similar geographic region, this practice is one that needs to be scrutinized more carefully. Entirely new questions have arrived, such a determining the elasticity of the goods and services being offered versus those offered online or by competitors with global reach.
* Different standards for different industries – Some industries are notoriously prone to law suits, which means that any business valuation will need to consider the possibility of actions/decisions taken prior to purchase as potential liabilities at some point in the future. This can be more complex with companies that produce products under the rules and laws of one country and sell/distribute those products elsewhere, even if the manufacturing is outsourced.
* Income and an unstable dollar – While many currencies are pegged to the US Dollar, that has not necessarily proven as stable as many would like when it comes to determining the value of a business. Debts and other obligations, non-recurring or otherwise, in one currency may be difficult to forecast if the purchase is being handled in another currency. This is a common problem for anyone using an income-based business valuation approach when purchasing a business in another country.
With today’s global economies and technologies, the professionals at Global Valuation can credibly analyze any market, anywhere in the world. Our professionals have the talent and resources to deliver your valuation report on time and within budget including business valuation.
While many people tend to think of globalization and the current economic recession as factors that have influenced business valuation greatly, the truth is that business valuation has traditionally started with an assessment of national, regional, and local economic conditions. These evaluations are typically made on or around the actual valuation date, and are meant to focus both on all markets in which the business might operate. In the past, all but the largest of businesses operated on a local and/or regional level, but globalization has changed all that in an irrevocable manner.
This makes the global economic situation worth paying attention to, as well as political factors that were once given short shrift when it came to business valuations. Now businesses valuation reports need to take a look at many factors, such as:
* Political and/or economic stability within suppliers – If supply chains are broken due to the development of internal economies or trade barriers being erected between nations, then a business may find itself at a competitive disadvantage.
* Comparative adjustments – While business valuation used to factor competitors within a similar geographic region, this practice is one that needs to be scrutinized more carefully. Entirely new questions have arrived, such a determining the elasticity of the goods and services being offered versus those offered online or by competitors with global reach.
* Different standards for different industries – Some industries are notoriously prone to law suits, which means that any business valuation will need to consider the possibility of actions/decisions taken prior to purchase as potential liabilities at some point in the future. This can be more complex with companies that produce products under the rules and laws of one country and sell/distribute those products elsewhere, even if the manufacturing is outsourced.
* Income and an unstable dollar – While many currencies are pegged to the US Dollar, that has not necessarily proven as stable as many would like when it comes to determining the value of a business. Debts and other obligations, non-recurring or otherwise, in one currency may be difficult to forecast if the purchase is being handled in another currency. This is a common problem for anyone using an income-based business valuation approach when purchasing a business in another country.
With today’s global economies and technologies, the professionals at Global Valuation can credibly analyze any market, anywhere in the world. Our professionals have the talent and resources to deliver your valuation report on time and within budget including business valuation.
Top Ten Business Valuation Questions for Business Appraisers | VideoArticlePhoto.com
Top Ten Business Valuation Questions for Business Appraisers | VideoArticlePhoto.com
Posted on July 30th, 2010 by admin
Category: Business Articles, Tags: Appraisers, Business, Questions, Valuation
Having performed business valuations for a variety of purposes, I have been asked a number of questions from clients. The following top ten business valuation questions have been compiled in an effort to briefly address some of the most frequent concerns clients have regarding a business appraisal.
1. What approaches do you consider in valuing the business?
Income Approach-The Income Approach derives an indication of value based on the sum of the present value of expected economic benefits associated with the company. Under the Income Approach, the appraiser may select a multi-period discounted future income method or a single period capitalization method.
Market Approach-The market approach derives an indication of value by comparing the company to other similar companies that have been sold in the past. Under the market approach, the appraiser may utilize the guideline publicly traded company method or the direct market data method.
Asset Approach-The Asset Approach adjusts a company’s assets and liabilities to their fair market values and adds to the value of intangible assets and any contingent liabilities.
2. What discounts may be applicable?
The discounts typically used in the valuation of a closely held business interest include a discount for lack of control, discount for lack of marketability, discount for lack of voting rights, blockage discount, portfolio discount, and key person discount. The most common discounts applied in business valuations are discounts for lack of control and discounts for lack of marketability.
3. What are the standards of value?
For most operating businesses, the standard of value will likely be fair market value, fair value, or investment value.
Fair Market Value is the price, expressed in terms of cash equivalents, at which property would change hands between a hypothetical willing and able buyer and a hypothetical willing and able seller, acting at arms length in an open and unrestricted market, when neither is under compulsion to buy or sell and when both have reasonable knowledge of the relevant fact.
Fair Value is a legal standard of value that has been established by the courts for use in issues ranging from marital dissolution to dissenting shareholder suits.
Investment Value is the value to a particular investor based on individual investment requirements and expectations. Investment value is typically used for transactional purposes when an acquirer is assessing the value of the target company, including the potential synergies of the deal.
4. What is the difference between an appraisal and a fairness opinion?
Full/formal business valuations typically consider all relevant approaches and methods that the appraiser considers appropriate in determining a value. These valuation reports typically include research on the subject company’s industry, economic conditions, trends, etc.
Fairness opinions provide the expert’s opinion of whether the proposed value of the transaction is “fair” for the shareholders. Fairness opinions do not typically provide an estimate of value or value range.
5. What are the main credentialing bodies for business valuation, what designations do they offer, and what designations have you earned?
The four main credentialing bodies in the business valuation profession are the National Association of Certified Valuation Analysts (NACVA), the Institute of Business Appraisers (IBA), the American Society of Appraisers (ASA), and the American Institute of Certified Public Accountants (AICPA).
NACVA offers the Certified Valuation Analyst (CVA) designation (for Certified Public Accountants only) and the Accredited Valuation Analyst (AVA) designation.
The IBA offers the Master Certified Business Appraiser (MCBA), the Certified Business Appraisers (CBA), Accredited by IBA (AIBA), Business Valuator Accredited for Litigation (BVAL), and Accredited in Business Appraisal Review (ABAR) designations.
The ASA offers the Accredited Member (AM), the Accredited Senior Appraiser (ASA), and the Fellow Accredited Senior Appraiser (FASA).
The AICPA offers the Accredited in Business Valuation (ABV) designation.
6. Why should a business have an annual valuation?
The most common benefits of an annual business valuation policy include:
Accountability and Performance-An annual business valuation enables the shareholders to see the value that is being consistently created or destroyed by the management of the firm.
Estate Planning Purposes-Many shareholders have on-going estate planning strategies aimed at protecting wealth for heirs.
Buy-sell situations-For those firms that do not have buy-sell agreements in place, annual business valuations are a good way of avoiding disputes that may arise when a shareholder seeks to sell his shares to the other shareholders.
Facilitate Banking-Many firms effectively utilize leverage to invest in value-creating projects. The ability of a firm to borrow based on the value of the goodwill or the value of the company’s shares may expand the universe of value-creating investment options available.
Expands the Investment Options-Closely held firms suffer from a lack of liquidity and the inability to use the company’s shares as currency when seeking acquisitions. An annual business valuation may enable the management of the company to use the shares as acquisition currency.
7. What is the difference between enterprise value and equity value?
Enterprise value is often referred to as the value of the invested capital of the business which includes the value of the equity and the value of the firm’s liabilities. This value represents the total funding of the asset side of the balance sheet for all fixed assets, cash, receivables, inventory, and the goodwill of the business. Equity Value is the enterprise value less all liabilities of the business and represents the value that has accrued to the shareholders through retained earnings, etc.
As various professionals may define these levels of value differently, it is important to understand exactly what a definition of a level of value includes or excludes under the specific circumstances.
8. Do you use rules of thumb when valuing the business?
Rules of thumb are simple pricing techniques that business brokers typically use to approximate the market value of a business. Rules of thumb typically come in the form of a percentage of revenues or a multiple of a level of earnings, such as seller’s discretionary cash flow. For example, a rule of thumb for pricing a widget manufacturer may be 40% of annual revenues plus inventory or two times seller’s discretionary earnings. Rules of thumb fail to consider the specific characteristics of a company as compared to the industry or other similar companies. In addition, rules of thumb do not reflect changes in economic, industry, or competitive factors over time.
Widely-accepted business appraisal theory and practice does not include specific methodology for rules of thumb in developing a value estimate. However, rules of thumb can be useful in testing the value conclusion arrived through the appraiser’s selected approaches and methods.
9. What role do court rulings have in developing an indication of value?
While Tax Court rulings may reflect the proclivity of certain courts to accept various discounts or levels of discounts in case-specific circumstances, these rulings may or may not play a role in the business appraiser’s analysis and value conclusion. The business appraiser must consider the relevant facts in the subject valuation and make a reasoned, informed decision regarding the discounts and level of discounts in developing an indication of value.
With respect to case law, business appraisers should be aware of general issues that may impact a valuation. Often times, the business appraiser consults the client’s legal counsel for their position on specific case law issues. Again, the business appraiser must use reasoned, informed judgment in developing an indication of value, considering the case-specific facts relevant to the valuation.
10. What are the main factors that impact the value of a business?
The value of a business interest is impacted by a number of factors, many of which may change from year to year, including:
• Financial performance-If a business has poor earnings capacity, the value of the business imay be negatively impacted.
• Growth prospects-Just as too high a rate of growth may lead to negative operational and financial consequences, too low a growth rate may also have a negative impact upon the business and its ability to achieve profitability. Revenue growth drives all opportunities for the business to expand.
• Competitive nature of industry-If the industry in which the business is operating has become more competitive due to the entrance of new competitors, the value of a business may be impacted as a result of lost market share, lower revenue growth, shrinking margins, and lower profitability.
• Management-Management of a business influences the value of the firm. A highly experienced management team and an organization with managerial depth is more highly valued by a willing buyer than an organization with only one manager or key executive.
• Economic and industry condition-The strength of the economy impacts all businesses in one way or another. If adverse economic conditions translate into long-term lower growth and profitability for a business, the value may be negatively impacted. Industry conditions are also impacted by the state of the economy but are also influenced by various other factors such as competition, technological change, trends, etc.
Robert M. Clinger III has strong experience in the fields of business valuation and financial analysis, having earned the Accredited Valuation Analyst (AVA) designation from the NACVA and the Certified Business Appraiser (CBA) from the Institute of Business Appraisers.
Posted on July 30th, 2010 by admin
Category: Business Articles, Tags: Appraisers, Business, Questions, Valuation
Having performed business valuations for a variety of purposes, I have been asked a number of questions from clients. The following top ten business valuation questions have been compiled in an effort to briefly address some of the most frequent concerns clients have regarding a business appraisal.
1. What approaches do you consider in valuing the business?
Income Approach-The Income Approach derives an indication of value based on the sum of the present value of expected economic benefits associated with the company. Under the Income Approach, the appraiser may select a multi-period discounted future income method or a single period capitalization method.
Market Approach-The market approach derives an indication of value by comparing the company to other similar companies that have been sold in the past. Under the market approach, the appraiser may utilize the guideline publicly traded company method or the direct market data method.
Asset Approach-The Asset Approach adjusts a company’s assets and liabilities to their fair market values and adds to the value of intangible assets and any contingent liabilities.
2. What discounts may be applicable?
The discounts typically used in the valuation of a closely held business interest include a discount for lack of control, discount for lack of marketability, discount for lack of voting rights, blockage discount, portfolio discount, and key person discount. The most common discounts applied in business valuations are discounts for lack of control and discounts for lack of marketability.
3. What are the standards of value?
For most operating businesses, the standard of value will likely be fair market value, fair value, or investment value.
Fair Market Value is the price, expressed in terms of cash equivalents, at which property would change hands between a hypothetical willing and able buyer and a hypothetical willing and able seller, acting at arms length in an open and unrestricted market, when neither is under compulsion to buy or sell and when both have reasonable knowledge of the relevant fact.
Fair Value is a legal standard of value that has been established by the courts for use in issues ranging from marital dissolution to dissenting shareholder suits.
Investment Value is the value to a particular investor based on individual investment requirements and expectations. Investment value is typically used for transactional purposes when an acquirer is assessing the value of the target company, including the potential synergies of the deal.
4. What is the difference between an appraisal and a fairness opinion?
Full/formal business valuations typically consider all relevant approaches and methods that the appraiser considers appropriate in determining a value. These valuation reports typically include research on the subject company’s industry, economic conditions, trends, etc.
Fairness opinions provide the expert’s opinion of whether the proposed value of the transaction is “fair” for the shareholders. Fairness opinions do not typically provide an estimate of value or value range.
5. What are the main credentialing bodies for business valuation, what designations do they offer, and what designations have you earned?
The four main credentialing bodies in the business valuation profession are the National Association of Certified Valuation Analysts (NACVA), the Institute of Business Appraisers (IBA), the American Society of Appraisers (ASA), and the American Institute of Certified Public Accountants (AICPA).
NACVA offers the Certified Valuation Analyst (CVA) designation (for Certified Public Accountants only) and the Accredited Valuation Analyst (AVA) designation.
The IBA offers the Master Certified Business Appraiser (MCBA), the Certified Business Appraisers (CBA), Accredited by IBA (AIBA), Business Valuator Accredited for Litigation (BVAL), and Accredited in Business Appraisal Review (ABAR) designations.
The ASA offers the Accredited Member (AM), the Accredited Senior Appraiser (ASA), and the Fellow Accredited Senior Appraiser (FASA).
The AICPA offers the Accredited in Business Valuation (ABV) designation.
6. Why should a business have an annual valuation?
The most common benefits of an annual business valuation policy include:
Accountability and Performance-An annual business valuation enables the shareholders to see the value that is being consistently created or destroyed by the management of the firm.
Estate Planning Purposes-Many shareholders have on-going estate planning strategies aimed at protecting wealth for heirs.
Buy-sell situations-For those firms that do not have buy-sell agreements in place, annual business valuations are a good way of avoiding disputes that may arise when a shareholder seeks to sell his shares to the other shareholders.
Facilitate Banking-Many firms effectively utilize leverage to invest in value-creating projects. The ability of a firm to borrow based on the value of the goodwill or the value of the company’s shares may expand the universe of value-creating investment options available.
Expands the Investment Options-Closely held firms suffer from a lack of liquidity and the inability to use the company’s shares as currency when seeking acquisitions. An annual business valuation may enable the management of the company to use the shares as acquisition currency.
7. What is the difference between enterprise value and equity value?
Enterprise value is often referred to as the value of the invested capital of the business which includes the value of the equity and the value of the firm’s liabilities. This value represents the total funding of the asset side of the balance sheet for all fixed assets, cash, receivables, inventory, and the goodwill of the business. Equity Value is the enterprise value less all liabilities of the business and represents the value that has accrued to the shareholders through retained earnings, etc.
As various professionals may define these levels of value differently, it is important to understand exactly what a definition of a level of value includes or excludes under the specific circumstances.
8. Do you use rules of thumb when valuing the business?
Rules of thumb are simple pricing techniques that business brokers typically use to approximate the market value of a business. Rules of thumb typically come in the form of a percentage of revenues or a multiple of a level of earnings, such as seller’s discretionary cash flow. For example, a rule of thumb for pricing a widget manufacturer may be 40% of annual revenues plus inventory or two times seller’s discretionary earnings. Rules of thumb fail to consider the specific characteristics of a company as compared to the industry or other similar companies. In addition, rules of thumb do not reflect changes in economic, industry, or competitive factors over time.
Widely-accepted business appraisal theory and practice does not include specific methodology for rules of thumb in developing a value estimate. However, rules of thumb can be useful in testing the value conclusion arrived through the appraiser’s selected approaches and methods.
9. What role do court rulings have in developing an indication of value?
While Tax Court rulings may reflect the proclivity of certain courts to accept various discounts or levels of discounts in case-specific circumstances, these rulings may or may not play a role in the business appraiser’s analysis and value conclusion. The business appraiser must consider the relevant facts in the subject valuation and make a reasoned, informed decision regarding the discounts and level of discounts in developing an indication of value.
With respect to case law, business appraisers should be aware of general issues that may impact a valuation. Often times, the business appraiser consults the client’s legal counsel for their position on specific case law issues. Again, the business appraiser must use reasoned, informed judgment in developing an indication of value, considering the case-specific facts relevant to the valuation.
10. What are the main factors that impact the value of a business?
The value of a business interest is impacted by a number of factors, many of which may change from year to year, including:
• Financial performance-If a business has poor earnings capacity, the value of the business imay be negatively impacted.
• Growth prospects-Just as too high a rate of growth may lead to negative operational and financial consequences, too low a growth rate may also have a negative impact upon the business and its ability to achieve profitability. Revenue growth drives all opportunities for the business to expand.
• Competitive nature of industry-If the industry in which the business is operating has become more competitive due to the entrance of new competitors, the value of a business may be impacted as a result of lost market share, lower revenue growth, shrinking margins, and lower profitability.
• Management-Management of a business influences the value of the firm. A highly experienced management team and an organization with managerial depth is more highly valued by a willing buyer than an organization with only one manager or key executive.
• Economic and industry condition-The strength of the economy impacts all businesses in one way or another. If adverse economic conditions translate into long-term lower growth and profitability for a business, the value may be negatively impacted. Industry conditions are also impacted by the state of the economy but are also influenced by various other factors such as competition, technological change, trends, etc.
Robert M. Clinger III has strong experience in the fields of business valuation and financial analysis, having earned the Accredited Valuation Analyst (AVA) designation from the NACVA and the Certified Business Appraiser (CBA) from the Institute of Business Appraisers.
Friday, July 30, 2010
Public Relations Blog - GroundFloor Media: Planning for the Inevitable
Public Relations Blog - GroundFloor Media: Planning for the Inevitable
Friday, July 30, 2010
Planning for the Inevitable
Entrepreneurs spend a lot of time talking about the trials and tribulations of trying to build a successful business, but rarely do you hear us espouse on the importance of planning for when we might exit our business. I am not talking about the infamous "exit strategy" and selling for multiples of EBITDA. I am gently referring to the inevitable "exit." I don’t care if you are 40 years old or 80 years young, if you are a business owner you should make sure you have planned for the worst. On average, 45% of a business owner’s net worth is tied up in the business (LIMRA International, Small Business Owners 2005 Report). While it may sound like a grim topic, the death of a small business owner could lead to internal turmoil, customer erosion and disruption in revenue flow. Quite simply -- planning just seems like the smart thing to do, but only 26% of small business owners have some type of succession plan in place. (LIMRA International, Small Business Owners 2005 Report)
So, where do you start? There are several important elements to help you plan for the unexpected and how you go about it depends upon the ownership structure of your business and your intentions. I am a far cry from a lawyer, but my partner and I have spent time talking about the options and putting plans into place. Some options you might consider include:
1. Have you granted a key manager a limited power of attorney so that he or she has the authority to make decisions and continue operating the business?
2. If you have a business partner(s), do you have a buy-sell agreement in place? You can look at a cross-purchase plan, in which each of you owns a life insurance policy on the other so that the partner can use the death benefit to purchase your share of the business. You can also consider an entity purchase or stock redemption plan.
3. Perhaps you should establish an advisory committee to act in the immediate days and months afterward? If your company has several executive level employees, this committee could be given the authority to make key decisions by consensus until a stronger team is in place.
4. Several entrepreneurs I know have established an employee stock ownership plan to insure that a buyer is available when the inevitable happens.
No one likes thinking about their mortality, and entrepreneurs are no exception. But these simple planning tools will ensure the continuation of the company you worked hard to build, while offering your staff, bankers, clients and partners an important sense of security.
Here’s to hoping we never have to put these plans into action.
~ Laura Love
Posted by Kristina at 10:27 AM
Labels: business owner, entrepreneur, exit strategy, GroundFloor Media, Laura Love, small business, succession planning
Friday, July 30, 2010
Planning for the Inevitable
Entrepreneurs spend a lot of time talking about the trials and tribulations of trying to build a successful business, but rarely do you hear us espouse on the importance of planning for when we might exit our business. I am not talking about the infamous "exit strategy" and selling for multiples of EBITDA. I am gently referring to the inevitable "exit." I don’t care if you are 40 years old or 80 years young, if you are a business owner you should make sure you have planned for the worst. On average, 45% of a business owner’s net worth is tied up in the business (LIMRA International, Small Business Owners 2005 Report). While it may sound like a grim topic, the death of a small business owner could lead to internal turmoil, customer erosion and disruption in revenue flow. Quite simply -- planning just seems like the smart thing to do, but only 26% of small business owners have some type of succession plan in place. (LIMRA International, Small Business Owners 2005 Report)
So, where do you start? There are several important elements to help you plan for the unexpected and how you go about it depends upon the ownership structure of your business and your intentions. I am a far cry from a lawyer, but my partner and I have spent time talking about the options and putting plans into place. Some options you might consider include:
1. Have you granted a key manager a limited power of attorney so that he or she has the authority to make decisions and continue operating the business?
2. If you have a business partner(s), do you have a buy-sell agreement in place? You can look at a cross-purchase plan, in which each of you owns a life insurance policy on the other so that the partner can use the death benefit to purchase your share of the business. You can also consider an entity purchase or stock redemption plan.
3. Perhaps you should establish an advisory committee to act in the immediate days and months afterward? If your company has several executive level employees, this committee could be given the authority to make key decisions by consensus until a stronger team is in place.
4. Several entrepreneurs I know have established an employee stock ownership plan to insure that a buyer is available when the inevitable happens.
No one likes thinking about their mortality, and entrepreneurs are no exception. But these simple planning tools will ensure the continuation of the company you worked hard to build, while offering your staff, bankers, clients and partners an important sense of security.
Here’s to hoping we never have to put these plans into action.
~ Laura Love
Posted by Kristina at 10:27 AM
Labels: business owner, entrepreneur, exit strategy, GroundFloor Media, Laura Love, small business, succession planning
What to Do Before You Buy a Biz - FoxSmallBusinessCenter.com
What to Do Before You Buy a Biz - FoxSmallBusinessCenter.com
By Martha Pineda
Published July 29, 2010
Acquiring a business can be an exciting challenge. Unlike starting a business from scratch, when you acquire a business, you have an advantage. Many details, such as equipment, employees and an established customer base, already are set up for you. However, there are still many factors to consider as you work to identify the right opportunity and a fair price.
If you are thinking of acquiring a business, consider these suggestions:
1. Research the market. Try to gain an understanding of the market you are entering. Understand the competition, customers, prospective customers, suppliers and marketing efforts required. Talk to other business owners in the industry who are willing to provide advice. Industry trade shows can also assist you in your research.
2. Consider a business broker. A professional business broker may be able to help you identify a business and navigate the acquisition process. Determine and agree upfront on fees for such services.
3. Know yourself. Know your interests and consider how much time and energy you will need (and are willing) to devote to the new business. Analyze your expertise and skills--you may wish to pursue a business in which you have extensive experience or a general passion for the industry.
4. Review your salary requirements. Consider the type of salary you require. You may also wish to factor your savings or other reserves into your decision to acquire.
5. Assess financing needs. If you have significant cash reserves you can leverage to finance the business, you may not need financing. If you do need financing, consider a bank with a proven track record for lending and supporting small businesses.
6. Assemble a professional team. Contact your banker, accountant and attorney to help you. These advisors can work with you to verify information about the business you are considering purchasing. This team may also help you assess the asking price and make recommendations.
7. Conduct due diligence. Typically, you will have a period in which you can access the company's books and records, including tax records and financial statements. Review them carefully. Enlist your financial team to help you assess the health of the business.
8. Ask questions. Current or former owners may reveal information about the state of the business that could influence your decision.
9. Know the business. Talk to customers or use the service the business provides. If possible, get "inside" the business to observe and track sales transactions. From your observations, you may be able to estimate sales per day or per week and compare your rough data to the seller's report.
10. Determine the price. There are many methods to determine the fair cost to acquire a business. Some industries have formulas they rely on to price a business. A business appraiser can place a value on the business by factoring in assets and liabilities. Also consider the intangibles, such as the status of the current owner's relationships with clients: Are they likely to remain customers after you take over?
Take time to review and research your potential acquisition, and work with advisors to help you make the decision. Your entrepreneurial dream may be within reach.
By Martha Pineda
Published July 29, 2010
Acquiring a business can be an exciting challenge. Unlike starting a business from scratch, when you acquire a business, you have an advantage. Many details, such as equipment, employees and an established customer base, already are set up for you. However, there are still many factors to consider as you work to identify the right opportunity and a fair price.
If you are thinking of acquiring a business, consider these suggestions:
1. Research the market. Try to gain an understanding of the market you are entering. Understand the competition, customers, prospective customers, suppliers and marketing efforts required. Talk to other business owners in the industry who are willing to provide advice. Industry trade shows can also assist you in your research.
2. Consider a business broker. A professional business broker may be able to help you identify a business and navigate the acquisition process. Determine and agree upfront on fees for such services.
3. Know yourself. Know your interests and consider how much time and energy you will need (and are willing) to devote to the new business. Analyze your expertise and skills--you may wish to pursue a business in which you have extensive experience or a general passion for the industry.
4. Review your salary requirements. Consider the type of salary you require. You may also wish to factor your savings or other reserves into your decision to acquire.
5. Assess financing needs. If you have significant cash reserves you can leverage to finance the business, you may not need financing. If you do need financing, consider a bank with a proven track record for lending and supporting small businesses.
6. Assemble a professional team. Contact your banker, accountant and attorney to help you. These advisors can work with you to verify information about the business you are considering purchasing. This team may also help you assess the asking price and make recommendations.
7. Conduct due diligence. Typically, you will have a period in which you can access the company's books and records, including tax records and financial statements. Review them carefully. Enlist your financial team to help you assess the health of the business.
8. Ask questions. Current or former owners may reveal information about the state of the business that could influence your decision.
9. Know the business. Talk to customers or use the service the business provides. If possible, get "inside" the business to observe and track sales transactions. From your observations, you may be able to estimate sales per day or per week and compare your rough data to the seller's report.
10. Determine the price. There are many methods to determine the fair cost to acquire a business. Some industries have formulas they rely on to price a business. A business appraiser can place a value on the business by factoring in assets and liabilities. Also consider the intangibles, such as the status of the current owner's relationships with clients: Are they likely to remain customers after you take over?
Take time to review and research your potential acquisition, and work with advisors to help you make the decision. Your entrepreneurial dream may be within reach.
What is a Business Broker? | TRADER International
What is a Business Broker? | TRADER International
Posted by Ahmadkamal Makrani in Thursday, July 29th 2010
Topics: Brokers
Tags: broker, Business
No Comment
A business broker is an intermediary between a buyer and a seller of a business. In most cases a business broker represents the seller in the sale of a business. It is the business brokers‘ responsibility to find qualified buyers for their clients.
A business broker is similar to a real estate agent who sells homes and earns a commission. But instead of selling homes, business brokers specialize in selling small and midsize companies — everything from your local pizza parlor, dry cleaners and convenience store to larger companies, such as manufacturing and wholesale & distribution companies.
A business broker connects people who are looking to sell a business with people who are looking to buy a business, and helps them to complete the transaction. In most cases a business broker is involved from day one until the actual closing of the business. The business brokers’ responsibility is to be an intermediary between the buyer, the seller, the landlords and the attorneys and make sure it is a smooth process.
Brokers supply numerous benefits to both buyers and sellers. For example, sellers benefit because they do not have to spend time and money searching for buyers. Qualified business brokers have access to people that are in the market to purchase a business, and they know how to attract and screen potential buyers much more quickly then do typical business owners. If you do not have the time to market selling your own business, it may be a good idea to sit down with a local business broker in your area to discuss representing you in the sale of your business.
BusinessMart.com has become the fastest growing businesses for sale search engine, helping buyers and sellers of small businesses and franchises. BusinessMart.com has many resources to help you on your journey to start your own business, sell a business, browse businesses for sale or open a franchise. FranchiseBuyersNetwork.com, which is owned and operated by Business Mart, Inc., helps individuals looking for information on franchise opportunities or business opportunities and guides them on a path to success!
Posted by Ahmadkamal Makrani in Thursday, July 29th 2010
Topics: Brokers
Tags: broker, Business
No Comment
A business broker is an intermediary between a buyer and a seller of a business. In most cases a business broker represents the seller in the sale of a business. It is the business brokers‘ responsibility to find qualified buyers for their clients.
A business broker is similar to a real estate agent who sells homes and earns a commission. But instead of selling homes, business brokers specialize in selling small and midsize companies — everything from your local pizza parlor, dry cleaners and convenience store to larger companies, such as manufacturing and wholesale & distribution companies.
A business broker connects people who are looking to sell a business with people who are looking to buy a business, and helps them to complete the transaction. In most cases a business broker is involved from day one until the actual closing of the business. The business brokers’ responsibility is to be an intermediary between the buyer, the seller, the landlords and the attorneys and make sure it is a smooth process.
Brokers supply numerous benefits to both buyers and sellers. For example, sellers benefit because they do not have to spend time and money searching for buyers. Qualified business brokers have access to people that are in the market to purchase a business, and they know how to attract and screen potential buyers much more quickly then do typical business owners. If you do not have the time to market selling your own business, it may be a good idea to sit down with a local business broker in your area to discuss representing you in the sale of your business.
BusinessMart.com has become the fastest growing businesses for sale search engine, helping buyers and sellers of small businesses and franchises. BusinessMart.com has many resources to help you on your journey to start your own business, sell a business, browse businesses for sale or open a franchise. FranchiseBuyersNetwork.com, which is owned and operated by Business Mart, Inc., helps individuals looking for information on franchise opportunities or business opportunities and guides them on a path to success!
What is a enterprise multiplier for Restaurant or fast food industry? Review - Business FAQs - Business Do Business - Business News, Products Stock Market & Financial Advice
What is a enterprise multiplier for Restaurant or fast food industry? Review - Business FAQs - Business Do Business - Business News, Products Stock Market & Financial Advice
Question:
I am planning to buy fast food joint, popeyes chicken or del Taco.
And I want to know what would be the enterprise multiplier to time it with EBITDA. I have the cash flow and all the information but I just want to make sure I am not over paying for the business.
EBITDA x enterprise multiplier.
Answer:
The Market Approach
Commonly used by real estate professionals, this approach determines the value of a business by using an "industry average" multiplier. This industry average is based on the price at which comparable businesses have sold for. As a result, an industry-specific formula is devised, usually based on a multiple of gross sales. These formulae, often called Rules of Thumb can be troublesome, because they may not focus on bottom line profits, earnings, EBIT or EBITDA. If an industry Rule of Thumb says that companies sell for 50% of annual gross sales, would you pay 50% of sales if the company was not profitable? Probably not.
The appraiser therefore tries to focus on industry formulae where they are applied to a multiple of earnings. This approach is similar to analysing a publicly traded company by its P/E (price to earnings) ratio.The approach, if enough empirical data is available, can very often be the most reliable valuation methodology for many industries. .
Here are a few industry multiplier examples:
Restaurants (Family) 1/3 of annual sales
Car Washes (Tunnel) 5-7 times adjusted earnings
Service Companies (General) 1.7 X annual net profit + inventory + equipment
Manufacturing (Job Shop) 3-5 times EBITDA plus WIP
also -
Rule of Thumb Methods
One of the more common, albeit less exact, approaches to small business valuation is the use of industry rules of thumb. While most financial analysts cringe at the use of these approaches, they are often useful as a cross-check to more well-thought-out calculations.
There are many rules of thumb. Some examples are as follows:
Internet Service Provider $75 to $125 per subscriber plus equipment value
Weekly Newspaper 100% of one year’s gross income
Insurance Agencies 1 to 2 times annual gross commissions
Real Estate Agencies .2 to .3 times annual gross commissions
Restaurants .3 to .5 annual gross sales
Travel Agencies .05 to .1 times annual gross sales
Convenience Stores .5 times annual gross sales
Liquor Stores 2 times owner earnings plus asset value
The good news about rules of thumb is that they can be derived from actual historical sales. They are also usually easy to calculate. The bad news is that they are representative of the average business sold. So it is recommended that they always be tempered with judgment and used in conjunction with other methods
If needed I can supply you with more info – HOWEVER – please note that the financial records of the company and the local economy of the town/city of the business you are looking to buy will yeild more than any equation I can give you.
Question:
I am planning to buy fast food joint, popeyes chicken or del Taco.
And I want to know what would be the enterprise multiplier to time it with EBITDA. I have the cash flow and all the information but I just want to make sure I am not over paying for the business.
EBITDA x enterprise multiplier.
Answer:
The Market Approach
Commonly used by real estate professionals, this approach determines the value of a business by using an "industry average" multiplier. This industry average is based on the price at which comparable businesses have sold for. As a result, an industry-specific formula is devised, usually based on a multiple of gross sales. These formulae, often called Rules of Thumb can be troublesome, because they may not focus on bottom line profits, earnings, EBIT or EBITDA. If an industry Rule of Thumb says that companies sell for 50% of annual gross sales, would you pay 50% of sales if the company was not profitable? Probably not.
The appraiser therefore tries to focus on industry formulae where they are applied to a multiple of earnings. This approach is similar to analysing a publicly traded company by its P/E (price to earnings) ratio.The approach, if enough empirical data is available, can very often be the most reliable valuation methodology for many industries. .
Here are a few industry multiplier examples:
Restaurants (Family) 1/3 of annual sales
Car Washes (Tunnel) 5-7 times adjusted earnings
Service Companies (General) 1.7 X annual net profit + inventory + equipment
Manufacturing (Job Shop) 3-5 times EBITDA plus WIP
also -
Rule of Thumb Methods
One of the more common, albeit less exact, approaches to small business valuation is the use of industry rules of thumb. While most financial analysts cringe at the use of these approaches, they are often useful as a cross-check to more well-thought-out calculations.
There are many rules of thumb. Some examples are as follows:
Internet Service Provider $75 to $125 per subscriber plus equipment value
Weekly Newspaper 100% of one year’s gross income
Insurance Agencies 1 to 2 times annual gross commissions
Real Estate Agencies .2 to .3 times annual gross commissions
Restaurants .3 to .5 annual gross sales
Travel Agencies .05 to .1 times annual gross sales
Convenience Stores .5 times annual gross sales
Liquor Stores 2 times owner earnings plus asset value
The good news about rules of thumb is that they can be derived from actual historical sales. They are also usually easy to calculate. The bad news is that they are representative of the average business sold. So it is recommended that they always be tempered with judgment and used in conjunction with other methods
If needed I can supply you with more info – HOWEVER – please note that the financial records of the company and the local economy of the town/city of the business you are looking to buy will yeild more than any equation I can give you.
Financial Modelling « sudesca.org
Financial Modelling « sudesca.org
Jul 29th, 10 / 0 Comments / Share this Entry
FINANCIAL MODELING
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.[1]
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).
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FINANCIAL MODELING
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.[1]
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).
Does Hourly Billing Hurt Your Bottom Line? « Charting The Course
Does Hourly Billing Hurt Your Bottom Line? « Charting The Course
July 29, 2010 by ulluccilaw
While it’s an article of faith for most lawyers, we are not fans of billing our clients by the hour. We come right out and say it on our firm website: billing by the hour makes clients worried about calling their lawyer and makes lawyers less efficient. Since that is not the kind of relationship we want with our clients, we avoid billing by the hour wherever we can.
Now it’s easy, and fun, to bash lawyers. But, what about all the other businesses that charge by the hour? What about web designers and freelance engineers, or business consultants? Does the same reasoning apply to non-lawyers? “6 Reasons to Stop Charging by the Hour,” an article in yesterday’s Small Business Trends, strongly argues that hourly billing is a bad practice that all businesses should curtail or eliminate.
Some of the author’s reasons match ours: hourly billing erodes the lines of communication and rewards inefficiency. But there were a few other reasons we didn’t touch on:
1. It Limits Your Income Potential: If you bill by the hour, your income will never be greater than the number of hours in the day (unless you raise your rates, which comes with its own backlash).
2. It Creates a Negative Cash Flow Cycle: You have to work the hours before you can send a bill, meaning it could be months between the time you perform the work and time you get paid.
3. It Adversely Affects Your Business’ Valuation: Since an hourly billing business’ profits are nothing more than the hours worked by its employees, the business itself has no predictable future profits. The employees, not the business, have future value. This makes sales, mergers and financing transactions more difficult.
To be fair, there are plenty of folks out there who are hourly billing adherents. We just don’t think their arguments make much sense. What do you think?
Posted in Small Business | Leave a Comment
July 29, 2010 by ulluccilaw
While it’s an article of faith for most lawyers, we are not fans of billing our clients by the hour. We come right out and say it on our firm website: billing by the hour makes clients worried about calling their lawyer and makes lawyers less efficient. Since that is not the kind of relationship we want with our clients, we avoid billing by the hour wherever we can.
Now it’s easy, and fun, to bash lawyers. But, what about all the other businesses that charge by the hour? What about web designers and freelance engineers, or business consultants? Does the same reasoning apply to non-lawyers? “6 Reasons to Stop Charging by the Hour,” an article in yesterday’s Small Business Trends, strongly argues that hourly billing is a bad practice that all businesses should curtail or eliminate.
Some of the author’s reasons match ours: hourly billing erodes the lines of communication and rewards inefficiency. But there were a few other reasons we didn’t touch on:
1. It Limits Your Income Potential: If you bill by the hour, your income will never be greater than the number of hours in the day (unless you raise your rates, which comes with its own backlash).
2. It Creates a Negative Cash Flow Cycle: You have to work the hours before you can send a bill, meaning it could be months between the time you perform the work and time you get paid.
3. It Adversely Affects Your Business’ Valuation: Since an hourly billing business’ profits are nothing more than the hours worked by its employees, the business itself has no predictable future profits. The employees, not the business, have future value. This makes sales, mergers and financing transactions more difficult.
To be fair, there are plenty of folks out there who are hourly billing adherents. We just don’t think their arguments make much sense. What do you think?
Posted in Small Business | Leave a Comment
Thursday, July 29, 2010
Tu-Exito » What Is Your Business Exit Strategy? ? Why having an exit strategy ready is necessary
Tu-Exito » What Is Your Business Exit Strategy? ? Why having an exit strategy ready is necessary
In my experience, it is of the utmost importance for every business owner to have a well thought-out and detailed exit strategy ready should an unexpected event or emergency take place and you need to remove yourself from the business quickly.
In fact, many entrepreneurs are of the same mind and say, planning an exit strategy is just as important as starting the business. If you are fully aware and prepared from the start, your business stands a better chance of success. If your exit strategy is well planned you will maximize the existing value of your business when you have to sell.
You will also find that the time it takes for preparing a business for sale will be significantly reduced and a much smoother process.
“You cannot overestimate the need to plan and prepare. In most of the mistakes I have made, there has been this common theme of inadequate planning beforehand. You really cannot over-prepare in business!” Chris Corrigan
Even though everything may be running fine in the business, you never know when you need to sell your business and move on.
The situations below are examples for when an exit strategy for a business would be advantageous:
1) A sudden change in market conditions, perhaps a much larger competitor moves in next door and you are no longer able to attract customers due to their competitive position
2) An accident, resulting in disability or critical illness – loved ones or yours
3) Loss of customers, suppliers or key employees running the business
4) An offer too good to refuse – Yes, this does happen.
5) Your death – Leaving no relative or options but to sell your business
6) Or simply ready for retirement – In this case it is especially vital to ensure your business is at its maximum value
Should this happen, how long will it take to sell your business?
The time required to sell your business in such circumstances will be specifically related to the complex nature of your business. It also depends on the market conditions and your reasons to exit the business.
A business exit strategy is often a work in progress and can be ever changing, so once you have it in place ensure you keep it up-to-date as needed. Having a well-planned exit strategy ensures the control is maintained with you and you are able to maximize the benefits from the sale of your business.
Your business exit strategy, if planned well, will give you attractive benefits such as:
Your business exit plan should be well documented and reviewed every year. It does not need to be the size of ‘war and peace’, so keep the plan short and precise. You should discuss your business exit plan with your loved ones, business advisors and confidants. A trusted family member or friend should have knowledge of the location of the exit plan so it is quickly and easily sourced.
It is equally important to share the exit plan with a potential buyer. Business buyers are reassured seeing a well planed business, and it will also help them with their future planning for unexpected circumstances.
In my experience, it is of the utmost importance for every business owner to have a well thought-out and detailed exit strategy ready should an unexpected event or emergency take place and you need to remove yourself from the business quickly.
In fact, many entrepreneurs are of the same mind and say, planning an exit strategy is just as important as starting the business. If you are fully aware and prepared from the start, your business stands a better chance of success. If your exit strategy is well planned you will maximize the existing value of your business when you have to sell.
You will also find that the time it takes for preparing a business for sale will be significantly reduced and a much smoother process.
“You cannot overestimate the need to plan and prepare. In most of the mistakes I have made, there has been this common theme of inadequate planning beforehand. You really cannot over-prepare in business!” Chris Corrigan
Even though everything may be running fine in the business, you never know when you need to sell your business and move on.
The situations below are examples for when an exit strategy for a business would be advantageous:
1) A sudden change in market conditions, perhaps a much larger competitor moves in next door and you are no longer able to attract customers due to their competitive position
2) An accident, resulting in disability or critical illness – loved ones or yours
3) Loss of customers, suppliers or key employees running the business
4) An offer too good to refuse – Yes, this does happen.
5) Your death – Leaving no relative or options but to sell your business
6) Or simply ready for retirement – In this case it is especially vital to ensure your business is at its maximum value
Should this happen, how long will it take to sell your business?
The time required to sell your business in such circumstances will be specifically related to the complex nature of your business. It also depends on the market conditions and your reasons to exit the business.
A business exit strategy is often a work in progress and can be ever changing, so once you have it in place ensure you keep it up-to-date as needed. Having a well-planned exit strategy ensures the control is maintained with you and you are able to maximize the benefits from the sale of your business.
Your business exit strategy, if planned well, will give you attractive benefits such as:
Your business exit plan should be well documented and reviewed every year. It does not need to be the size of ‘war and peace’, so keep the plan short and precise. You should discuss your business exit plan with your loved ones, business advisors and confidants. A trusted family member or friend should have knowledge of the location of the exit plan so it is quickly and easily sourced.
It is equally important to share the exit plan with a potential buyer. Business buyers are reassured seeing a well planed business, and it will also help them with their future planning for unexpected circumstances.
A Business Exit Strategy – Why would I need one now, I am not going anywhere? | Succession For Business Group | Succession Planning | Accounting | Small Business | Warrnambool | Melbourne
A Business Exit Strategy – Why would I need one now, I am not going anywhere? | Succession For Business Group | Succession Planning | Accounting | Small Business | Warrnambool | Melbourne
Every business is bound to change hands sooner or later and if you wish to have it happen on your terms you need a plan to cover all circumstances, even on occasions that may be out of your control. I know, you’re saying, we are only just beginning or I am doing exactly what I want to do, I don’t want to leave.
Did you know you must operate your business so that it is ready for your exit at any time? You cannot predict, what may be around the corner:
* Death
* Divorce
* Illness
* Partnership Breakdown
The last thing you want to happen is to be forced to sell your business in a rush and get a fraction of the price you expect you are going to get for it.
We have found that less than 3% of Australian small to medium businesses do not have any form of have Exit Plan. Yet is one of the most important tools you should have in your business. Many serial entrepreneurs have an Exit Strategy, as this is part of their own business model of creating and selling businesses. We all know the kind, but it isn’t just for them.
Putting a Exit Plan in place regardless of whether you have the desire to sell in the near future or at some other time in the future can significantly help to achieve your optimum sales price. An Exiting Strategy or a Succession Plan is a process that includes an analysis of your business, a valuation of your business, the preparation of your business for sale, setting a realistic time frame and many other considerations.
Indeed you should start planning your exit strategy from day one, it should form part of your business plan and be the underlying force which guides the processes of how you operate your business and getting you to where you want to the business to be.
Every business is bound to change hands sooner or later and if you wish to have it happen on your terms you need a plan to cover all circumstances, even on occasions that may be out of your control. I know, you’re saying, we are only just beginning or I am doing exactly what I want to do, I don’t want to leave.
Did you know you must operate your business so that it is ready for your exit at any time? You cannot predict, what may be around the corner:
* Death
* Divorce
* Illness
* Partnership Breakdown
The last thing you want to happen is to be forced to sell your business in a rush and get a fraction of the price you expect you are going to get for it.
We have found that less than 3% of Australian small to medium businesses do not have any form of have Exit Plan. Yet is one of the most important tools you should have in your business. Many serial entrepreneurs have an Exit Strategy, as this is part of their own business model of creating and selling businesses. We all know the kind, but it isn’t just for them.
Putting a Exit Plan in place regardless of whether you have the desire to sell in the near future or at some other time in the future can significantly help to achieve your optimum sales price. An Exiting Strategy or a Succession Plan is a process that includes an analysis of your business, a valuation of your business, the preparation of your business for sale, setting a realistic time frame and many other considerations.
Indeed you should start planning your exit strategy from day one, it should form part of your business plan and be the underlying force which guides the processes of how you operate your business and getting you to where you want to the business to be.
Kids Can’t Find a Job? Buy Them a Business - The Juggle - WSJ
Kids Can’t Find a Job? Buy Them a Business - The Juggle - WSJ
* July 27, 2010, 10:30 PM ET
By Sue Shellenbarger
Associated Press
Would you buy a franchise for your kid to run?
Many parents will readily make a five-figure investment in a college education for their children, usually with the hope that their kids will be able to make a good living. But would you spend as much or more to buy a business for your adult child to run?
Now that many college grads are working for minimum wage — or not at all — a few parents are going the extra mile, and buying a business for them to run, instead of, or in addition to, paying for college. That may seem risky and expensive, and it is; parents risk losing their entire investment, and more. But some of these parents see entrepreneurship as a chance for their kids to reclaim a piece of the American dream –- control of their own destiny and a chance to gain wealth.
For today’s “Work & Family” column, I interviewed 10 parents who had purchased new businesses for this reason. These parents believed that even a startup – as risky as that can be – offered brighter hopes than a corporate job in this rocky economy.
There are some success stories. One dad saw his son, a college athlete with a business degree, unable to find anything but a job selling computer software by phone. Eager to give him a better start, he purchased a business-services franchise for his son to run. The business is doing well. Another couple financed a fast-food restaurant for their son to run; the son sacrificed his social life and worked a lot of 18-hour days for a couple of years, but the restaurant is a success and he will expand to a second restaurant soon.
But these parents know they are taking a big risk. All bought franchise businesses, which research suggests are as risky as any other business startup. All are risking their entire investment, their life savings, or more. Families’ financial arrangements vary widely. Some parents view the investments as a loan, although payback arrangements were flexible, contingent on future profits. A few parents regarded the money as an outright gift. Others, meanwhile, see themselves as silent partners and said they hope to work part-time in the business with their kids after retirement, or expect their kids to support them in old age. Whatever the terms, buying a franchise can expose parents to very large potential losses; some have lost hundreds of thousands of dollars following this path.
The setups can be stressful for parents and children alike. Parents try to strike the right balance between meddling too much and protecting their investment. And adult kids would prefer to be financially independent; some had to move back in with their parents to get their businesses off the ground.
But the parents I interviewed said that so far, the potential rewards justified worth the risk. “As a parent, the best gift you can ever receive is to see your children happy and successful,” one father said.
I found these parents’ dedication and self-sacrifice pretty inspiring. But while I would be delighted if one of my kids wanted to start a business, I wouldn’t, or couldn’t, take the role of their banker. Such a setup seems too potentially stressful, risky and expensive, for parent and child alike.
Readers, what do you think? Are these parents too invested in their adult children’s lives or are they giving them a leg up in the rat race, akin to funding an education? Can you imagine any circumstances that would motivate you to do that? Is business ownership a better investment in your mind than a college degree?
* July 27, 2010, 10:30 PM ET
By Sue Shellenbarger
Associated Press
Would you buy a franchise for your kid to run?
Many parents will readily make a five-figure investment in a college education for their children, usually with the hope that their kids will be able to make a good living. But would you spend as much or more to buy a business for your adult child to run?
Now that many college grads are working for minimum wage — or not at all — a few parents are going the extra mile, and buying a business for them to run, instead of, or in addition to, paying for college. That may seem risky and expensive, and it is; parents risk losing their entire investment, and more. But some of these parents see entrepreneurship as a chance for their kids to reclaim a piece of the American dream –- control of their own destiny and a chance to gain wealth.
For today’s “Work & Family” column, I interviewed 10 parents who had purchased new businesses for this reason. These parents believed that even a startup – as risky as that can be – offered brighter hopes than a corporate job in this rocky economy.
There are some success stories. One dad saw his son, a college athlete with a business degree, unable to find anything but a job selling computer software by phone. Eager to give him a better start, he purchased a business-services franchise for his son to run. The business is doing well. Another couple financed a fast-food restaurant for their son to run; the son sacrificed his social life and worked a lot of 18-hour days for a couple of years, but the restaurant is a success and he will expand to a second restaurant soon.
But these parents know they are taking a big risk. All bought franchise businesses, which research suggests are as risky as any other business startup. All are risking their entire investment, their life savings, or more. Families’ financial arrangements vary widely. Some parents view the investments as a loan, although payback arrangements were flexible, contingent on future profits. A few parents regarded the money as an outright gift. Others, meanwhile, see themselves as silent partners and said they hope to work part-time in the business with their kids after retirement, or expect their kids to support them in old age. Whatever the terms, buying a franchise can expose parents to very large potential losses; some have lost hundreds of thousands of dollars following this path.
The setups can be stressful for parents and children alike. Parents try to strike the right balance between meddling too much and protecting their investment. And adult kids would prefer to be financially independent; some had to move back in with their parents to get their businesses off the ground.
But the parents I interviewed said that so far, the potential rewards justified worth the risk. “As a parent, the best gift you can ever receive is to see your children happy and successful,” one father said.
I found these parents’ dedication and self-sacrifice pretty inspiring. But while I would be delighted if one of my kids wanted to start a business, I wouldn’t, or couldn’t, take the role of their banker. Such a setup seems too potentially stressful, risky and expensive, for parent and child alike.
Readers, what do you think? Are these parents too invested in their adult children’s lives or are they giving them a leg up in the rat race, akin to funding an education? Can you imagine any circumstances that would motivate you to do that? Is business ownership a better investment in your mind than a college degree?
Should You Buy a "Used" Franchise Business? (The Franchise King Blog)
Should You Buy a "Used" Franchise Business? (The Franchise King Blog)
If you're thinking of buying a franchise as a way to secure your future, you're not alone. The US job market is still pretty tough. Competition for high-paying jobs is quite intense.
It's it any wonder that downsized executives and middle management personnel are looking at some career alternatives? Could becoming a franchise owner be a good one?
About a 1/3 of the folks that contact me for a franchise search help ask me if I know of any existing franchise opportunities that may be available. Buying someone else's franchise can be a great way to get into franchising, for sure...
There's certainly some positive aspects to buying a used franchise. Like;
* Immediate cash flow
* An existing base of customers/clients
* A built-in mentor
Of course buying a franchise, whether a start-up, or in this case, an existing franchise business, has many other advantages.
Lowering your risk
Almost everybody looking to buy an existing franchise thinks that it will really lower their risk if they buy a business that already has money coming in. Sometimes, it can.
Anne Barr, A fellow franchise professional , (who also left the same national franchise brokerage franchise that I was a member of) does quite a bit of work in franchise resales, and wrote this short post about purchasing an existing franchise business. Contact her if you're in the Dallas-Fort Worth area. She really knows her stuff.
There's certain steps that you'll have to take in order to purchase any existing business of any type, and some of them even involve a favorite and fun topic of all of ours;
The Law.
Business.Gov
The folks over at Business.Gov lay these steps out nicely;
* Thoroughly research the business and look for legal red flags. Learn as much as you can about how the business's operations from the current owner, including details about existing contracts, insurance policies, licenses, employee agreements, and commercial leases. Leases in particular can be a tricky issue for new buyers - you may need to have the landlord's permission to legally transfer a lease - and you could be held to contractual commitments over employee compensation and benefits.
Here's the rest of "The Legal Steps to Buying a Business," from my friends over at Business.Gov.
**********************************************************************************************************
** (The legal steps that you need to take to buy a franchise or non-franchise business are really important. Don't be cheap. Get a competent attorney.)
Here's a fun recent post that concerns an attorney.(Check out the rather colorful comments)
Read more: http://www.thefranchisekingblog.com/2010/07/should-you-buy-a-used-franchise-business.html#ixzz0v4R9aTcX
From The Franchise King®
Under Creative Commons License: Attribution
If you're thinking of buying a franchise as a way to secure your future, you're not alone. The US job market is still pretty tough. Competition for high-paying jobs is quite intense.
It's it any wonder that downsized executives and middle management personnel are looking at some career alternatives? Could becoming a franchise owner be a good one?
About a 1/3 of the folks that contact me for a franchise search help ask me if I know of any existing franchise opportunities that may be available. Buying someone else's franchise can be a great way to get into franchising, for sure...
There's certainly some positive aspects to buying a used franchise. Like;
* Immediate cash flow
* An existing base of customers/clients
* A built-in mentor
Of course buying a franchise, whether a start-up, or in this case, an existing franchise business, has many other advantages.
Lowering your risk
Almost everybody looking to buy an existing franchise thinks that it will really lower their risk if they buy a business that already has money coming in. Sometimes, it can.
Anne Barr, A fellow franchise professional , (who also left the same national franchise brokerage franchise that I was a member of) does quite a bit of work in franchise resales, and wrote this short post about purchasing an existing franchise business. Contact her if you're in the Dallas-Fort Worth area. She really knows her stuff.
There's certain steps that you'll have to take in order to purchase any existing business of any type, and some of them even involve a favorite and fun topic of all of ours;
The Law.
Business.Gov
The folks over at Business.Gov lay these steps out nicely;
* Thoroughly research the business and look for legal red flags. Learn as much as you can about how the business's operations from the current owner, including details about existing contracts, insurance policies, licenses, employee agreements, and commercial leases. Leases in particular can be a tricky issue for new buyers - you may need to have the landlord's permission to legally transfer a lease - and you could be held to contractual commitments over employee compensation and benefits.
Here's the rest of "The Legal Steps to Buying a Business," from my friends over at Business.Gov.
**********************************************************************************************************
** (The legal steps that you need to take to buy a franchise or non-franchise business are really important. Don't be cheap. Get a competent attorney.)
Here's a fun recent post that concerns an attorney.(Check out the rather colorful comments)
Read more: http://www.thefranchisekingblog.com/2010/07/should-you-buy-a-used-franchise-business.html#ixzz0v4R9aTcX
From The Franchise King®
Under Creative Commons License: Attribution
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