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Succession Planning   Esop Assoc. 2008
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Succession Planning Esop Assoc. 2008


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  • 1. Vine Valuations Inc. Christine Minelli CA•CBV, CFI (905) 549-8463 or (905)517-3741 Offices in Hamilton, Burlington and Kitchener
  • 2.  Transfer to Family  Sell to Third Party Members  Refinance or  Sell to Recapitalize Shareholders  Go Public  Sell to  Liquidate the Management Business  Sell to Employees (Stock Ownership Plan) Business needs to be valued 2
  • 3.  Business valuation is a critical component of a well planned exit strategy: For benchmarking/planning exit strategy For negotiating the sale For maximizing wealth Independent & objective 3
  • 4. Business Valuation: “the act or process of determining the value of a business enterprise or ownership interest therein” Value: the desirability or worth of a thing; the rate at which a commodity is potentially exchangeable for others Webster’s International Dictionary 4
  • 5. Business Owner: “What’s the value of my business?” Business Valuator: “ It depends…” 5
  • 6.  Price and Value are not the same. “Price is what you pay. Value is what you get”.. Warren Buffett  Each business is unique and will command a different price for different reasons.  Buyer/Seller - different perspectives  Toconclude a transaction, both parties must be satisfied with Price and understand how it was determined  Valuation is a starting point in exit planning, not an end unto itself 6
  • 7.  Price = Value + Terms negotiated between buyer and seller  FMV = a notional or intrinsic value estimate  Business Valuation = an Art, not a Science! 7
  • 8. “The highest 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 arm’s length in an open and unrestricted market, when neither is under compulsion to buy or sell and when both have a reasonable knowledge of the relevant facts.” Not the real world, but a starting point 8
  • 9.  Recent profit history  General condition of the company (facilities, books & records, technology, processes, employees, proprietary rights, contracts, etc.)  Market demand for particular type of business  Economic conditions (cost/availability of capital and factors directly affecting the business)  Ability to transfer goodwill or other intangibles  Future profit/cash flow potential: Cash is KING! But: Businesses rarely change hands at fair market value 9
  • 10. Transaction Value : Price + Deal Terms  Negotiated between seller and a specific buyer  Tradeoff between cash & terms  May not be the same as fair market value but FMV a reasonable starting point  Value unknown until business exposed for sale 10
  • 11. Transaction Value is affected by:  Timing of sale: Value is time-specific. Price today not the same as Price next year.  Economic outlook and outlook for specific industry: the market dictates investor’s required rate of return.  Earnings capacity. Value is prospective, present value future benefits measured in cash flows. Owner selling business but the buyer is buying a business opportunity. Nature and history of business. S.W.O.T. assessment part of buyer due diligence.  Comparable market transactions/prices – a benchmark. Pay no more than would pay for similar investment. 11
  • 12. Transaction Price is affected by:  Liquidity of investment – size of market/existence of more than one special purchaser  Level of the business’ net tangible assets. The higher the value of net tangible assets, the lower the buyer’s risk, and the higher the price (usually).  Intangibles: sometimes the only valuable assets  Goodwill: Commercial or personal? Transferable?  Size of interest being sold: controlling interest or minority interest? Exit planning tip: Find the right buyers, more than one. 12
  • 13. Transaction Price is also affected by: Negotiating strengths of buyer and seller Personal reasons (distress or planned) Available leverage (wait for proceeds/earn-out) Who the owner is actually prepared to sell to:  Sale to third parties  Intergenerational sale to family  Sale to management  Sale to employees Price & Terms may be different 13
  • 14. Buyer to owner: “You tell me your price, I’ll tell you the terms” Possible Deal Terms -  Hold-back of sale proceeds, buyer has recourse if info wrong  Seller financing helps close deal, risk on the seller  Performance payouts/earn-outs can bridge the “price gap”, but risk transfers to seller. Timing of cash flow to consider.  Non-competition agreements, protect the buyer. Exit Planning : What terms will owner consider? What terms can owner afford? 14
  • 15. Buyer to owner: “You tell me your price, I’ll tell you the terms” Possible Deal Terms –  Employment contracts. Normally favour buyer. 100% tax deductible and buyer gets extended terms. Retiring? Can be a deal-breaker.  Price adjustments made post-closing: contingent and unknown liabilities, i.e. estimates, provisions, bad debts, warranty claims, similar. Need to consider. 15
  • 16.  Income Approach: - Focus on profits/cash flow produced by assets - Capitalized earnings/cash flow method (single period) - Discounted cash flow method (multiple period)  Market Approach: - Guideline Company method - Transactional method - Industry method: “rules of thumb”  Asset Approach: - Adjusted book value (assumes going concern) - Liquidation value (forced/orderly) 16
  • 17.  Assumes the business is a going concern, expected to generate adequate return on investment  FMV equal to present value of expected future earnings/cash flow (earnings, EBIT, EBITDA) Requires:  Assessing future maintainable cash flows  Determining appropriate (buyer) tax rate  Determining capitalization rate (& multiple)  Assessing discounts for control & illiquidity Exit Planning Tip: Consider ways to increase business cash flow to exit date in order to increase exit price 17
  • 18. Business net profit or loss +/- ◦ Non-operating/non-recurring revenue & expense ◦ Interest & non-cash expenses (depends) ◦ Equipment replacements/additions (depends) ◦ Discretionary items, adjust to market: •Owner's compensation & benefits •Meals & entertainment expenses •Automobile expenses & allowances •Compensation of non-working family members •Rent and other non-arm’s length expenses Exit Planning Tip: Should ‘clean-up’ discretionary items before sale 18
  • 19.  Adjust assets/liabilities to fair market value (real estate, receivables, inventory, F&E …)  Identify redundant assets (non-operating assets: excess cash, ATV, house, trailer, boat, etc.)  Related party amounts: buyer does not want to buy  Remove purchased goodwill – valuing goodwill  Identify liabilities buyer does not want to assume Exit Planning Tip: Consider removing redundant assets before  Unusual May affect QSBC status seller’s tax planning, sale. items related to and CGE. bonuses/advances, etc. 19
  • 20. Adjusted earnings** $ 1,000,000 Forecasted growth** x 1.05 Estimated future earnings $ 1,050,000 Capitalization rate** 25.0 % P/E multiple (1 ÷ capitalization rate) 4.0 Indicated Value from Operations $ 4,200,000 Add: Net redundant assets ** 357,350 Total Enterprise Value of equity only, interest cost$in Cost 4,557,350 earnings 20
  • 21.  Investor’s risk adjusted rate of return on equity  Reasonable capital structure (debt/equity)  Expected growth 21
  • 22. Cost of Equity  Risk free rate of return (GOC long-term bond)  Equity risk premium (range 4% to 6%)  Small company (size) premium (up to 10%)  Industry risk premium ( +/-)  Company specific risk premium ( +/-)  Long-term growth in excess of inflation reduces risk The higher the capitalization rate, the lower the Price. Multiple of earnings/cash flow = 1 ÷ capitalization rate 22
  • 23.  Economic risk  Business risk  Operating risks  Financial risks  Asset risks  Product risks  Market risks  Technological risks  Regulatory risks  Legal risks 23
  • 24. High Risk/Lower Multiple Low Risk/Higher Multiple = Lower Price =Higher Price  New business, no  Established earnings history base  Weak balance sheet  Strong balance sheet  Weak growth trend  Strong growth trend  Weak industry/position  Strong industry/position  Significant barriers  Few entry barriers  Not price dependent  Competes on price  Not tied to personal  Customer loyalty is to goodwill the business owner  Asset purchase  Share purchase 24
  • 25. High Risk/Lower Multiple Low Risk/Higher Multiple = Lower Price =Higher Price  Seller not staying on  Seller stays long period  No vendor take back  Vendor financing & financing good terms  Price not tied to post-  Vendor earn-out, closing, no ‘earn-out’ shares in post-closing  No proprietary assets risks or competitive  Valuable intellectual advantage property/other rights  Minimal synergy for  Significant synergies buyer This is not an all-inclusive list of risk identified factors 25
  • 26.  Uses multiples derived from market prices of public companies engaged in same or similar lines of business  Market prices of public companies reflect minority interest positions and high liquidity  Selected companies should share characteristics such as markets, products, growth and cyclical variability to the business  Valuator analyzes financial and operating performance, compares to the business being valued  Adjustments are made to multiples for differences identified and for private co illiquidity of investment 26
  • 27. GUIDELINE CO. DATE P/E P/Sales P/Book Apple Company, Inc. 12/31/07 8.70 55.30% 2.85 Bananas R Us, Inc. 10/31/07 9.30 47.43% 4.65 Fruits, Inc. 12/31/07 8.50 35.25% 3.65 Cherry Corp. 10/31/07 6.60 54.80% 3.90 Grapes Corp. 11/30/07 7.80 48.20% 4.25 **Adjusted to normalize to business being valued Median Multiple 8.50 48.20% 27 3.90
  • 28. Market Approach: Guideline Company Example PRICE TO EARNINGS After-tax earnings $ 959,446 Selected Multiple x 6.20 Operating Entity Value $ 5,948,565 Net Non-operating assets + 250,000 Total Entity Value $ 6,198,565 Rounded $ 6,200,000 28
  • 29. A rule of thumb is a mathematical formula developed from the relationship between price and certain variables based on experience, observation, hearsay, or a combination of these; usually industry specific. Rules of thumb arise from observation of market transactions Expressed as multiples of revenue, cash flow, etc. A multiple of revenues implicitly assumes there is a reasonably constant relationship between gross revenues, maintainable earnings (or cash flow) and Value. Rules of thumb assumes “one size fits all”. But each business is unique. Good as a secondary check, not as primary valuation method 29
  • 30. Multiples of:  Price/net earnings  Price/pre-tax earnings  Price/cash flow  Price/revenues  Price/gross profit  Price/book value  Price/EBIT  Price/EBITDA  Price/SDE 30
  • 31. Restate assets & liabilities to FMV:  Adjusted Book Value Method • Going concern basis • FMV is in net assets owned, not in cash flow (i.e. real estate or other investment holding co.)  Liquidation Value Method • Worth more dead than alive • Forced vs. orderly 31
  • 32. Business Owner: “What’s the value of my business?” Business valuator: “ It depends…” 32
  • 33.  Successful deal takes time and planning. Usually need 3 to 5 years track record of profits & good FS.  Takes between 6 – 18 months to sell  Business Valuator can: ◦ Find ‘hidden assets’ ◦ Provide a baseline value now ◦ Identify weaknesses & areas of improvement 33
  • 34.  Business Valuator can: ◦ Identify value drivers to maximize sale value ◦ Assess business risks and opportunities ◦ Help target buyers / best sale process ◦ Evaluate offers/assist in negotiations and give the owner an edge!  Integrating a business valuator into exit planning team can translate into a higher value when the owner ultimately retires. 34
  • 35. Vine Valuations Inc. Christine Minelli CA•CBV, CFI (905) 549-8463 or (905)517-3741 Offices in Hamilton, Burlington and Kitchener