A Basic Guide for valuing a company phần 9 pptx

& Amortization Let’s Assume ⳮ 20,430 Less: Estimated Income Taxes Let’s Assume *Debt service includes an average $54,016 annual principal payment that is traditionally recorded on the b

230 Wholesale Distributor

Seller (8% ⳯ 20 years)

Testing Estimated Business Value

Return: Net Cash Stream to Be Valued $ 93,816

Less: Annual Bank Debt Service (P&I) ⳮ 101,076

Less: Est Dep & Amortization (Let’s Assume) ⳮ 20,430

Less: Estimated Income Taxes (Let’s Assume)

*Debt service includes an average $54,016 annual principal payment that is traditionally recorded

on the balance sheet as a reduction in debt owed This feature recognizes that the ‘‘owned equity’’

in the business increases by this average amount each year.

Return on Equity (ROE):

Pretax Equity Income $ 46,756

Down Payment $225,000

Return on Total Investment (ROI):

Net Operating Income $ 26,326

Sound great? The $54,016 principal gain can’t be spent paying bills!

Buyer’s Potential Cash Benefit

Pretax Cash Flow (Contingency Not Considered) ⳮ 7,260

Discretionary cash flow, by this insertion of bank debt, has been advantaged by nearly 40% (from the seller-financed structure) It doesn’ttake a mathematician to guess that the $892,000 value estimate mightthus be less also In Chapter 10, ‘‘Practicing with an Excess EarningsMethod,’’ we learned of a simple method to ‘‘back into’’ price/valuediscounting Here’s another twist to using this approach:

dis-P&I Payments Under Bank/Seller Blended Financing $101,076

P&I Payments Solely Under Seller Structure 66,949

View the difference as being made up of $251,000 in bank debt, ofwhich 80.7% is just five years in term

(80.7%) ($2,844)⳱ $2,295 per month at 5 years

(19.3%) ($2,844)⳱ $549 per month at 10 years

Using an ‘‘Equal Monthly Loan Amortization Payment’’ table, locatethe page containing 10%, and 5 years, and then 10 years We find that ittakes $2.13 per month to amortize $100 dollars over 5 years, and $1.33

to amortize this amount over 10 years

$2,295 divided by $2.13 (times 100) equals $107,746

$ 549 divided by $1.33 (times 100) equals 41,278

Financing Rationale

232 Wholesale Distributor

Buyer’s New Annual P&I Payments to Seller

($517,000 ⳮ$251,000 ⳱ $266,000)

The scenario that led us to estimate value at $892,000 contained totalP&I payments of $66,949 Under the new presumption, combined P&I

is $86,020 (versus the previous $101,076) I would normally carry thisout through the whole process, but for our purposes, let’s go straight tothe heart of the matter the buyer’s discretionary cash flow

Testing Estimated Business Value

Return: Net Cash Stream to Be Valued $ 93,816

Less: Annual Bank Debt Service (P&I) ⳮ 86,020

Less: Est Dep & Amortization (Let’s Assume) ⳮ 20,430

Less: Estimated Income Taxes (Let’s Assume) ⳮ 2,306*

*Debt service includes an average $50,094 annual principal payment that is traditionally recorded

on the balance sheet as a reduction in debt owed This feature recognizes that the ‘‘owned equity’’

in the business increases by this average amount each year Estimated income taxes might increase slightly because of lower interest write-off.

Return on Equity (ROI):

Pretax Equity Income $ 57,890

Down Payment $225,000

Return on Total Investment (ROI):

Net Operating Income $ 35,154

Total Investment $742,000

Buyer’s Potential Cash Benefit

Pretax Cash Flow (contingency not considered) 7,796

Income Sheltered by Depreciation $ 20,430

Less: Provision for Taxes ⳮ 2,306

This, of course, does not set the equation equal to where the seller wassolely providing financing infrastructure but, then, bank debt rarely

models what sellers might provide to get their deals closed What it doesoffer, however, is an estimate in terms of ‘‘fair purchase value.’’ In thisinstance, if this seller required bank participation in his deal, the buyer’s

$845,000 negotiated price should be reduced to an offering price notexceeding $742,000

I do not believe that valuation formulas should be used as static ments For nearly 30 years I have looked for ways to amend, modify, and/

instru-or restructure these processes to fit other needs of buyers and sellers Tothe best of my knowledge, the amalgamation used herein for ‘‘backinginto’’ another estimate of value will not be found in any other text Ittook several years to develop a mathematical model that resembles whatbuyers and sellers actually do in the marketplace Some may disagree with

my approach, but I can assure you that this neat little trick, if you will,has proven quite reliable, time after time, for many years ‘‘What to offer?’’

is a question most asked by buyers Try the excess earnings method, andplay around with the ‘‘back-into’’ routine outlined here If you know what

you need to earn personally after the purchase, this whole process can lead

to answers for your question, ‘‘What do I offer?’’

Discounted Cash Flow of Future Earnings (The theory is that the value

of a business depends on the future benefits [earnings] it will provide toowners Traditionally, earnings are forecast from a historical performancebase into some number of future years [usually 5 to 10 years] and thendiscounted back to present using present value tables.)

In our wholesale case-business, sales and earnings plod ahead slowlybut predictably History reveals that the seller has been accurate in fore-casting each year’s working budget Future estimates were completed bypurchaser and buyer together, and thus, offer the prospect for levels ofreliability in the use of discounted methods

Establishing Expected Rate of Return (The rate expected as a return

on invested capital) For the loss of liquidity and venture rate of returns inthe range up to 25%, let’s assume 20% as a level of return on risk associatedwith small business ownership We’ll also assume the earnings plateau inthe fifth year at $312,000

(1 Ⳮ 20)

$239,800 Forecast Year 3 3 ⳱ $138,773*

(1 Ⳮ 20)

$295,900 Forecast Year 4 4 ⳱ $142,699*

(1 Ⳮ 20) ($312,000 divided by 20)

(1 Ⳮ 20)

Total Business Value $1,310,468*

*Earnings discounted to present value.

I hope you can now see why I am greatly concerned with the use ofthis so-called model formula in the valuation of small businesses Unlessarbitrarily ‘‘fudging’’ numbers along the way, this method tends nearlyalways to overvalue the smaller business Granted, the formula varies fromuser to user, but this specific case was presented at three graduate businessschools where results calculated by students and professors alike turnedout similar high results I know that I’m beating a dead horse once again,but discount methods of valuation are inappropriate in use with thesmaller business Rates of return used would have to be reduced from 20%

to about 12% to 13% to simulate the results from other formulas Lackingexperienced judgments, most lay users of discounting methods will com-monly overprice businesses

Results

Excess Earnings Method

Combination Bank/Seller Financing 742,000

The buyer did in fact purchase this business for $845,000, and thispresents ample opportunity to show a buyer’s beginning balance sheet.The cash down payment was $178,000.

I suspect that some are wondering why the ‘‘tally’’ balances to

$870,000 and how ‘‘equity’’ stands at $203,000 rather than $178,000.The buyer infused an additional $25,000 into opening balances

$203,000)

This case brings us to the end of my case examples In the next chapter

I provide a working case for your own experimentation My estimates ofthe value in this practice session will be found at the end of the book inAppendix A

21

A Practice Session

A Marina Valuation

One of the most attractive and yet debilitating features for many marinas

is their location Often situated at or in close proximity to recreationalbodies of water, the value of real estate most frequently presents a nemesis

to what otherwise may be adequate cash flows (bear also in mind thatcostly real estate commonly translates into costly leases when such exist inlieu of land ownership) Subsequently, a great many sell at or near ap-praised values of real estate and other hard assets This often presents avery real problem for sellers who have owned their marinas for shorterspans of time As we all know, mortgages amortize ‘‘principal’’ debt veryslowly in the early years Thus, equities in properties held change so little

in under 10 years

Another shortcoming is the rather too frequent replacement costs essary to maintain, especially, in-water assets, such as docks, moorings,and flotation devices Storms and Mother Nature can and do raise havocwith the life spans of these vital assets Exacerbating their replacements orexpansions are a plethora of environmental regulations that rarely gestatefavorable terms for marinas and their owners

nec-Marinas suffer high product-carrying costs similar to automobile erships and retail appliance businesses Floor-plan financing for in-stockboats and other high-ticket items can run 2% to 4% per month Mostmarinas in the United States are seasonal businesses—even in the Sunbeltstates Whereas most recreational products are subjected to the far end ofthe economic whip, marinas also suffer more during downturns that seem,with increasing frequency, to affect family units to a greater degree Poorbuying decisions leading to excess inventory at the end of seasons serve

deal-to dilute profits deal-to what, for many, is already burdening operating costs.Marinas can be quite profitable in season, but the onus of expensive

real estate, asset replacements, and floor-plan carrying costs can frequentlydrain even a robust seasonal ‘‘windfall.’’

There is something, however, that is uniquely magnetic about marinaownership The water, boating sports, fishing, the aroma, the outdoorenvironment itself almost a call of the wild Few persons, especiallymen, can pass through a marina without at least garnering thoughts, en-visioning themselves as owners of this type of small business During myyears as a business broker, I have sold a half dozen marinas between Maine

and Florida None ‘‘went down’’ easy Ads placed in the Wall Street nal, to some extent, prove the charisma of these small businesses After

Jour-the second or third ad, one of my associates proclaimed, ‘‘We will haveanother week of telephone cauliflower ear.’’ During my years of businessbrokerage, I never once handled any other small business that generatedmore ad-calls than marinas

On the supply side of the equation, marinas ‘‘for sale’’ are quite tiful throughout the United States The largest single reason they seem

plen-to be for sale is echoed in this sentiment: I can’t make a living here!However, many marinas, because of their valuable real estate resources,have been transformed into condominium associations; or their real estatenow partially accommodates condominium-living complexes; and/orthey have been replaced entirely by different ventures

Many still do remain solely as marinas Opportunity found, they areone of the great challenges for prospective buyers Successful long-termoperations frequently languish beyond the nature of the present marinaitself Thus, prospective buyers who are shy in net worth, and/or timid

in creativity and risk, might best be advised not to apply

With supply and demand briefly outlined, marinas that modate the values of hard assets and, at the same time, provide minimalwages for new owners tend to sell quickly Often located on real estatevaluable for many other purposes, banks tend willingly to finance consid-erable portions of their purchase prices

cash-accom-Brief Case History

This marina is situated at the outlet of a tributary leading into a acre lake in the mid-Atlantic states The docking and mooring facilitiesare well sheltered along the riverbank, and the river channel provides easy,navigable access to and from the lake Nestled on six wooded acres, a2,000-square-foot modern building houses a retail showroom, service and

32,000-238 A Practice Session

repair facilities, living quarters, and the owner’s office At the riverbank

there is adequate land mass for maneuvering of vehicles and some storage.Fuel, oil, and rental equipment are provided at the dock, where the marinaoffers 68 berthing slips, accommodating boats up to 32 feet Other assetsinclude two metal-clad cold-storage buildings housing between 150 and

170 boats off season; two pickup trucks, a tractor, forklift, and lowbedtandem trailer; and various showroom display fixtures, furniture, tools,and testing equipment Part of the unused land overlooking the rivermight be developed for use as a boat owner’s motel or other such com-mercial development

While two larger and five smaller marinas compete on this lake, thesheltered location of this facility makes it particularly desirable Boat slipscan normally reach 120% occupancy by double-renting less-used seasonaltenants’ slips The marina rents boats and safety regalia as package leases

to five summer youth camps situated on the lake The bulk of revenuescomes from sales of boats, motors, and accessories Fiberglass boat repairand boat upholstering, including boat tops, are also provided

Peak seasons extend just slightly over two months, with gradual and downswings, measuring about four additional months pre- and pos-tseason Off-season is generally limited to boat storage and engine repairs.The marina enjoys a wonderful business reputation, and most customersreturn year after year

up-With the exception of floor-planned inventory, real estate and otherassets are owned by the business The company has been under the presenttenure for 11 years

The valuation problem is in two parts:(a) what value or price should this business be listed for? and (b) what is the most likely sale price? (The owner will NOT provide any seller financing.)

Following are historical balance sheets and reconstructed income ments Also listed are assets included in sale (assume these to be stated atfair market or appraised value) If you choose to complete the ratio analysissection, data for the purpose of these calculations should be taken from

state-historical statements Industry medians relate to the last ‘‘completed’’ year

of business and are provided herein My own responses to ratios and thetwo-part task noted will be found in Appendix A This is not a test; there-fore, feel free to ‘‘cheat’’ open book if you get stuck Better, and easier,

to gain experience with the instruments along the way than to becomefrustrated and give up Don’t be too hard on yourselves; after 30 years,I’m still learning about valuation I don’t believe that anyone has all the

‘‘right’’ answers, if the so-called right answers do in fact exist The

high-light of this case exercise is we had a sale, and you’ll find the line’’ price in Appendix A You may want to purchase an amortization

‘‘punch-table or business calculator for use with this exercise If you’re seriously

in the market to sell or buy a small business, you’ll use these implementsquite often as you search for your lasting transaction Good luck!

Practice Session—Marina Balance Sheets

240 A Practice Session

Practice Session—Marina Reconstructed Income Statements for Valuation

Appraised Value of Assets Held Out for Sale

Land/Buildings/Docks (Includes Improvements) $358,178

*$72,261 of the products are in ‘‘floor plan’’ inventory at a 2% per month carrying cost For a

properly qualified buyer, these may be assumed and, thus, do not require additional financing.

However, bear in mind that a lender would add these costs to other debt-service payments as they consider the extent of other capital they might loan.

Based on the footnote above, total assets held out for sale could, sequently, be reduced to $539,302 Floor-plan interest is already included

sub-in operatsub-ing expenses

Ratio Study

Financial experts will not always agree as to which ratios are particularlygermane to the small and privately owned enterprise I feel that it is es-sential to examine the following:

58.0

This ratio measures the percentage of sales dollars left after goods aresold

It should be noted that ratios for net profit, before and after taxes, can

be most useful ratios But the fact that private owners frequently managetheir businesses to ‘‘minimize’’ bottom lines will often produce littlemeaningful information from these ratios applied to smaller businesses.Therefore, these ratios are not included

The current ratio provides a rough indication of a company’s ability toservice its obligations due within the time frame of one year Progressivelyhigher ratios signify increasing ability to service short-term obligations.Bear in mind that liquidity in a specific business is a critical element ofasset composition Thus the acid test ratio that follows is perhaps a betterindicator of liquidity overall

Total Current Assets

Total Current Liabilities

Industry Median

.8

The quick, or acid test, ratio is a refinement of the current ratio andmore thoroughly measures liquid assets of cash and accounts receivable

A ratio less than 1.0 can suggest a struggle to stay current with gations The median indicates that the industry as a whole may wrestlewith liquidity problems, and even the top 25% of reported companiesreflect only a ratio of 0.5

obli-(Income Statement) Sales

Receivables (Balance Sheet)

Industry Median

11–2 days

This highlights the average time in terms of days that receivables areoutstanding Generally, the longer that receivables are outstanding, thegreater the chance that they may not be collectible Slow-turnover ac-counts merit individual examination for conditions of cause

Generally, the higher their turnover rate, the shorter the time betweenpurchase and payment Lower turnover suggests that companies may fre-quently pay bills from daily in-house cash receipts due to slower receivablecollections This practice may be somewhat misguided in light of invest-ment principles whereby one normally attempts to match collections rela-tively close to payments so that more business income can be directed intothe pockets of owners Some businesses may, however, have little choice.

ⴑ 21.9

*Current assets less liabilities equals working capital.

A low ratio may indicate an inefficient use of working capital, whereas

a very high ratio often signals a vulnerable position for creditors This

minus industry median indicates that working capital is scarce or that

in-efficient uses of working capital prevail throughout this industry

To analyze how well inventory is being managed, the cost of sales toinventory ratio can identify important potential shortsightedness

3.8

A higher inventory turnover can signify a more liquid position and/orbetter skills at marketing, whereas a lower turnover of inventory may in-dicate shortages of merchandise for sale, overstocking, or obsolescence

The Valuation Exercise

Book Value Method

Total Liabilities

244 A Practice Session

Adjusted Book Value Method

Assets

Balance Sheet Cost

Fair Market Value

Weighted Average Cash Flow

The flip-side nature of three years of sales and income suggests thepossibility that revenues might have peaked and that income is now largelydependent upon each year’s economy However, to assure oneself of suchassumptions, several other years’ performance should be examined Youcan take this assumption for granted in our case