A Basic Guide for VALUING a Company phần 9 pps

The valuation problem is in two parts:a what value or price should this business be listed for?. Total Current Assets Current Ratio ⳱ or Total Current Liabilities Industry Median .8 The

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

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

Current Ratio ⳱ or

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

in the sense of ability to pay off current obligations Higher ratios indicategreater liquidity as a general rule.

Cash and Equivalents Ⳮ Receivables

Total Current Liabilities

Industry Median

.2

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

Sales/Receivable Ratio ⳱ or

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

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

Hybrid Method

(This is a form of the capitalization method.)

1⳱ High amount of dollars in assets and low-risk business venture

2⳱ Medium amount of dollars in assets and medium-risk business

venture

3⳱ Low amount of dollars in assets and high-risk business venture

Yield on Risk-Free Investments Such as

Risk Premium on Nonmanagerial Investments a

Risk Premium on Personal Management a 7.5% 14.5% 22.5%

Add: Appreciation in Assets

Excess Earnings Method

(This method considers cash flow and values in hard assets, estimates tangible values, and superimposes tax considerations and financing struc-tures to prove the most-likely equation.)

Less: Comparable Salary (provided) ⳮ27,000

Cost of Money

Market Value of Tangible Assets

(see reconstructed balance sheet) $

Excess of Cost of Earnings

Return Net Cash Stream to Be Valued $

Intangible Business Value

Times: Intangible Net Multiplier Assigned* $

Add: Tangible Asset Value

TOTAL BUSINESS VALUE (Prior to Proof) $

Furniture/Equip ($ ) at % of FMV

Vehicles ($ ) at % of FMV

Inventory ($ ) at % of Book Value

Bank ( % ⳯ years)

Annual Principal/Interest Payment ⳮ

Testing Estimated Business Value

Return: Net Cash Stream to Be Valued $

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

Add: Principal Reduction*

Less: Est Dep & Amortization ⳮ

*Debt service includes annual principal payments that are traditionally recorded on the balance sheet as a reduction in debt owed (I use an average of the first five or six years.) Unless you have use of a business calculator or an amortization table, you may have to obtain this answer from your accountant or banker.

Return on Equity:

Pretax Equity Income $

Down Payment $

Return on Total Investment:

Net Operating Income $

*This number should not include dollars set aside in the contingency and replacement reserves.

At this time we have taken our first shot at estimating business value.The following is provided for the benefit of those who wish to experimentfurther with their own estimates of value Although I conditioned thiscase in the beginning that the seller would not provide owner financing(all sellers say that), this does not mean such should not be figured A tip:Few businesses in America sell without it

Financing Rationale

Annual Principal/Interest Payment ⳮ

Testing Estimated Business Value

Return: Net Cash Stream to Be Valued $

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

Add: Principal Reduction

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

Less: Estimated Income Taxes (Let’s Assume) ⳮ

Return on Equity:

Pretax Equity Income $

Return on Total Investment:

Net Operating Income $

Total Investment $ Buyer’s Potential Cash Benefit

Pretax Cash Flow (contingency not considered)

Income Sheltered by Depreciation

Add: Equity Buildup

Discretionary and Nondiscretionary Cash $

Seller’s Potential Cash Benefit in Sale

Bank Financing Receipts

*From which must be deducted capital gains and other taxes Structured appropriately, the deal qualifies as an ‘‘installment’’ sale with taxes on the proceeds in seller financing put off until later periods.

Projected Cash to Seller by End of 10th Year

Add: Principal and Interest Payments

Considerations for Fairness in Pricing:

1. Asking price is not greater than 150% of net worth (except wherereconstructed profits are 40% of asking price)

2. At least 10% sales growth per year being realized

3. Down payment is approximately the amount of one year’s structed profits

recon-4. Terms of payment of balance of purchase price (including interest)should not exceed 40% of annual reconstructed profit

Results

Hybrid (capitalization) Method $

Well, how did you do? They say that business valuators are the mostindependent, nonconforming individuals on earth They never agree onanything Frankly, they say that about writers, too Personally, I believeboth can find things to agree upon If you haven’t already, you can nowturn to the Appendix A to see how you scored Don’t get upset withyourself if you ‘‘mushed’’ it a bit It’s like a lot of things in life youoften have to screw it up to learn Quite honestly, I believe you did justfine

Questions:

1. What should this business be listed for?

2. What is the most-likely sale price?

3 Would you pay this amount?

22

Concluding Thoughts about

Value and Price

In this and my other books, I describe prices being paid for small nesses as fair or acceptable as long as those prices can be paid back to thepurchaser from business earnings within a reasonable period of time Theessence or key to ‘‘acceptable price’’ within this thought rests in ‘‘paidback’’ and in ‘‘reasonable time.’’ In early chapters I covered theory andpersonal perceptions associated with such academic definition I’d nowlike to break this down into real terms

busi-Down Payments

Purchase prices paid for businesses generally include a combination of cashdown payment and secured and/or unsecured debt instruments coveringnoncash balances for these prices being paid Nothing startling about this.However, buyers far too frequently fail to consider the impacts on value

that down payments create Whatever prevailing rates of return one can

normally expect to achieve from ‘‘safer’’ investments, such as stocks,bonds, CDs, or savings, must be considered, as a minimum, as one cal-culates estimated values By my way of thinking, regardless of where mycash may be temporarily invested or stored, I prefer to use the market ratefor bonds as the minimal standard since this choice is both stable andavailable to most people At the time of this writing, for example, 8% could

be a generally expected return from ‘‘savings’’ invested in bonds Cash

invested in these instruments provides (a) above-average safety of principaland (b) ‘‘no physical work’’ associated with earnings In other words, risk

is low and earnings are achieved without physical effort

The question then becomes: What additional return on these fundsmight be fair and reasonable to put them at risk in small-business own-

ership? The basis for no risk/no work is 8% (or whatever prevails at thetime) return The problem gets a bit fuzzy at this stage because in buying

a small company we expect to work and be paid for that work Thus, theonly real consideration for earnings beyond a basis-return has to do with

risk If I can get 8% without much risk to my capital, and don’t have to

work for a profit, then what amount ‘‘extra’’ will justify my putting thiscapital into greater risk? The answer to this, of course, is a very personalone, but I’ve found that prudent and ardent small-company buyers tend

to place the premium expected at between 4% and 6% Subsequently, if

8% is the ‘‘safe’’ rate, then to get prudent and ardent buyers to unleashcash for business purchase, we might generally expect that these individ-uals will not buy until the prices for purchase allow business cash flows to

throw off returns on equity in the range of 12% to 14%.

We can build an economic model to help us work this through Let’ssay that I want a down payment of $100,000 to return 12%:

Return on Equity:

Pretax Equity Income ?

Down Payment $100,000 ($100,000) (12%) ⳱ $12,000 per year equity incomeLet’s now assume that the business we are considering is throwing off

a reliable $70,000 reconstructed (owner’s ‘‘perks,’’ depreciation, and

in-terest removed) earnings per year Using this as a starting point, we canbegin our process of evaluating the ‘‘offering price’’ by saying that

$12,000 of business cash flow is not available in our calculations Before

proceeding further, however, we must examine the element of ‘‘pay forexpected work.’’

Salary or Wage

Personal perception plagues what we ‘‘believe’’ we should be able to earn.Personal yardsticks often ensue from past experiences We ‘‘were’’ earningX; therefore, to go into business for ourselves we want X plus Y Subse-quently, this too has two parts: (a) a fair amount that might be paid to

‘‘anybody’’ doing comparable work and (b) something ‘‘extra’’ for theskills we bring to the business that the present owner might not have had.Factor ‘‘a’’ can be ascertained through local employment agencies, per-sonal knowledge, and/or government labor data Pay rates for ‘‘similar’’

work must be the standard used at this stage in the calculation For

ex-ample, let us assume the ‘‘going rate’’ to be $35,000 to manage this type

of business By setting this standard, we are accepting that we could hire

a qualified manager to run the business for this amount, and that $35,000might have nothing to do with what we want or need to earn Part ‘‘b’’above cannot be answered at this point because we have yet to run the

business and apply our skills to obtain this extra amount What we have

historically earned, or believe we should earn, has nothing—nothing—to do with the value of a particular business To meet personal want/need earn-

ings objectives we must ‘‘find’’ appropriate small businesses where down

payments are within the reach of our pocketbooks or take chances that

we can perform feats within the allocated time frame established by ourearning objectives We have now added the second element leading tovalue or offering price

Cash Flow Available for Debt Servicing the Purchase Price $ 23,000

The Rest of the Story

We don’t need to know what the seller is asking for his or her business to

complete our assignment, because all we are interested in is what we

would be willing to pay The answer, once again, relies on two questions:(a) What principal amount can be amortized with $23,000 and (b) whenadded to a down payment of $100,000, what total amount is the projectedoffering price? Since we have used 10% as the commercial rate throughoutthis book, we will also use this in our example

$23,000 divided by 12 equals approximately $1,917 per month The

‘‘face amount’’ these payments will service over 10, 15, or 20 years can

be estimated using amortization tables readily available through mostbookstores, or by the use of business calculators The following are ex-amples for three different periods at 10%:

Using $1,917 per month available for debt service:

(10% over 20 years)