1. Where is that Reasonable Range of Value?
Key Concepts to Consider in the Valuation of Closely-Held Companies
Presented by:
Andrew K. Lowe, ASA, CEIV MAFF, ABAR
&
Jordan C. Enix, CPA, ABV, CEIV, CFF
LBMC, PC
Valuation & Litigation Support Services Group

2. Business Valuation Considerations
Type of entity to be valued
Purpose of valuation (Estate planning, transaction, other)
Valuation date
Standard of value
Premise of value
Level of value

3. Standard of Value “Value to whom?”
The standard of value answers the question:
“Value to whom?”
Fair Market Value
Investment Value
Intrinsic or Fundamental Value (applies to options)
Fair Value under State Statutes
Fair Value for Financial Reporting

4. Date of Valuation
Subsequent events that were not foreseeable as of the date of valuation
Subsequent transactions may assist in valuation if the factors impacting the business have not changed significantly from the date of valuation to the date of the subsequent transaction

5. What are we Valuing? We must first understand our subject interest:
Equity Interest
100% Equity interest
51% Equity interest
A single share or unit
Other
Total Invested Capital of the Company

6. What is a Valuation?
For the valuation of a company, interest in a company
or other asset, we are trying to estimate two
components:
The future expected benefits
The risk related to receiving the future expected benefits
Amount of benefits
Timing of benefits (e.g. a dollar today is worth more than a dollar in one year)

7. General Approaches to Valuing a Closely Held Company

8. Business Valuation Approaches
Three basic approaches to determining business value:
Asset (also referred to as Cost Approach)
Income
Market
Under each approach, there are multiple methods
The use of one or several approaches (or methods) may be appropriate

9. Asset Approach
Particularly useful for the valuation of holding companies (e.g., real estate holding companies and companies holding marketable securities) and operating companies facing an uncertain future.
Net book value
Total Assets – Total Liabilities = Stockholders’ Equity
Typically results in a control-level valuation so valuation adjustments may be needed

10. Net Book Value

11. Asset Approach
Net Asset Value (NAV) Method – all assets and liabilities are adjusted to current market values. Also referred to as the Adjusted Book Value Method.
NAV = Assets less liabilities
Pitfall – If done incorrectly fails to capture intangible and other unrecorded assets
Minority owners typically cannot compel a liquidation

12. Adjusted Book Value

13. Income Approach
Value is based on the present value of expected future benefits to be derived from ownership
Expected benefit = net cash flow or other measure
Forecasted benefits
Normalized historical benefits
Earnings stream dictates level of valuation (controlling v. non-controlling)

14. Income Approach Two methods generally used under the income approach:
Discounted Cash Flow (DCF) Method
Projects future cash flows for a number of years
Terminal value
Capitalized Income Method
Estimated future cash flow is capitalized
Used for companies with stable growth rates and debt structure

15. Present Value Computations
Rate of return = 15%
$1 million next year is worth $869,565 today
$1,000,000/(1+.15)^1 = $869,565
$1 million in two years is worth $756,144 today
$1,000,000/(1+.15)^2 = $756,144

16. Weighted Average Cost of Capital

17. Discounted Cash Flow Method

18. Capitalization of Cash Flow Method

19. Market Approach Based on the principal of substitution
A buyer would pay no more than the cost to acquire a substitute property with the same utility
Earnings stream dictates level of valuation (controlling v. non-controlling)

20. Market Approach Two methods generally used:
Guideline public company method; based on sales of similar publicly traded company shares
Can be difficult to use for small and medium sized companies due to size, capital structure, and other differences
Guideline company transaction method; based on acquisitions of similar privately held or publicly traded companies
Works best when companies are sufficiently similar to the subject business
Exercise caution with dated transactions

21. Market Approach
Expected benefit = some level of earnings (revenue, net income, EBIT, EBITDA, EBITDAR, gross profit, etc.)
Expected risk and growth are measured by a market multiple (P/E, MVIC/R, MVIC/EBIT, MVIC/EBITDA)
Market multiples are obtained from public companies, from sales of similar companies, or prior sales of the subject company or interests in the subject company

22. EBITDA EBITDA Earnings Before Interest Taxes Depreciation Amortization
“…Trumpeting EBITDA (earnings before interest, taxes, depreciation and amortization) is a particularly pernicious practice. Doing so implies that depreciation is not truly an expense, given that it is a “non-cash” charge. That's nonsense. In truth, depreciation is a particularly unattractive expense because the cash outlay it represents is paid up front, before the asset acquired has delivered any benefits to the business.“ - Warren Buffet
“… every time you saw the word EBITDA [earnings], you should substitute the word “_______” earnings.”  - Charlie Munger
“… if some officer connected with a prospective investee starts talking about EBITDA, it “is time to zip up the purse.” The officer is trying to be too optimistic about his company's prospects. The problem is not so much that he is trying to kid the investor, but far worse, that he may well be successful in kidding himself.”
– Charlie Munger

23. Market Approach

24. Application of Excess or Non-Operating Assets
Excess or non-operating assets represent the value of resources the company owns but are not required to operate the business. Examples are excess cash on hand, non-operating real estate or other securities. The fair market value of any excess and/or non-operating assets must be added to the valuation and any non-operating liabilities must be subtracted from the valuation.

25. Valuation Adjustments

26. Valuation Adjustments
Discount for lack of control (“DLOC”)
Discount for lack of marketability (“DLOM”)
Discount for lack of voting rights (“DLOVR”)
Control premium
Other

27. Valuation Process

28. Sources of Information
Management interviews
Business and industry questionnaire completed by management
Financial statements for three to five years
Income tax returns for three to five years
Schedule of owners’ compensation
Accounts receivable aging summary
Accounts payable aging summary
Summary of fixed assets and depreciation schedule
Real estate appraisals and/or property tax assessments
Summary of customer contracts and annual sales by customer
Organization chart
Shareholder, partnership or operating agreement

29. Key Considerations History of the company including;
Expansions
Relocations
New product or service offerings
Acquisitions
Operations of the company including;
Products
Services
Customer base
Key suppliers
Distribution methods
Marketing and advertising
Regulatory issues

30. Key Considerations Facilities Management and staff;
Owned or Leased
Related party or third party
Management and staff;
Employment and/or non-compete agreements
Key executives
Market and competition
Size of the market
Types of customers
Uses of products and services
Number, quality and size of competitors
History of distributions to owners
Economic and Industry conditions

31. Financial Analysis Trend Analysis (covering three to five years)
Comparison of revenue and expense line items in nominal amounts as well as common-sized percentages.
Ratio Analysis (covering three to five years)
Liquidity ratios
Coverage ratios
Leverage ratios
Operating ratios
Future business plans and expectations
Extensive forecast analysis
Capitalization and ownership of interests in the company
Common stock
Preferred stock
Normalization adjustments
Balance sheet
Income statements

32. Reason to Obtain a Valuation
Corporate
Transactions (business acquisitions, mergers and dispositions)
Employee stock option plans
Buy-Sell agreements
Clearly define appraiser (ABV, ASA, CBA, etc. for business valuation; MAI, etc. for real estate appraisal)
Clearly define standard of value
Caution against use of formulas

33. Reason to Obtain a Valuation
Tax
Gift and estate tax (planning and compliance)
Interests in closely-held businesses
Intellectual property
Income tax (planning and compliance)
Charitable contributions
Personal goodwill
Transfer pricing

34. Reason to Obtain a Valuation
Financial reporting
ASC Topic 820– Fair Value Measurements and Disclosures
ASC Topic 805– Business Combinations
Purchase price allocations
Valuation of intangible assets such as trade names, trademarks, assembled work force, internally-developed software, in-process research and development, customer relationships and contracts, non-compete agreements, etc.
ASC Topic 350 – Intangibles - Goodwill and Other
ASC Topic 718 – Compensation – Stock Compensation

35. Reason to Obtain a Valuation
Litigation
Shareholder disputes and dissenting shareholder actions
Commercial litigation involving claim for lost business value
Marital dissolution
Business or business interest disputes
Intellectual property disputes

36. Contact Information
Andrew K. Lowe, ASA, CEIV, MAFF, ABAR
LBMC, PC
2095 Lakeside Centre Way, Suite 220
Knoxville, Tennessee 37922
(865)
Jordan C. Enix, CPA, ABV, CEIV, CFF
LBMC, PC
2095 Lakeside Centre Way, Suite 220
Knoxville, Tennessee 37922
(865)