Business Valuation and Exit Planning. Aaron J. Pryor, CFA, ASA

Transcription

1 Business Valuation and Exit Planning Aaron J. Pryor, CFA, ASA

2 Phases of a Business Valuation Assignment Define the valuation assignment What exactly is the subject of the valuation What is the purpose Valuation date Engagement letter Gather/analyze the pertinent facts Request for information form sent Preliminary analysis Site visit and management interviews

3 Phases of a Business Valuation Assignment Apply valuation approaches and methods Determine relevant valuation methods Earnings and risk assessment Determine the final estimate of value Reconciliation of results from relevant methods Sanity check / Test of reasonableness Draft Valuation Report Management review and comment Finalize Valuation Report

4 Define the Valuation Assignment Assets vs. invested capital vs. equity Control -- minority Degree of control depends on ownership structure; existence of other shareholders Premium or discount is based on comparison Marketable -- Non-marketable Closely-held vs. as if freely traded Degree of illiquidity varies Discount is based on comparison

5 Standards of Value Fair market value Fair value (statutory) Fair value (GAAP) Investment (strategic) value Intrinsic (fundamental) value

6 Premises of value Going concern (most common) Assemblage of assets Orderly disposition (liquidation) Forced liquidation

7 Revenue Ruling Eight Factors The nature of the business and the history of the enterprise from its inception. The economic outlook in general and the condition and outlook of the specific industry in particular. The book value of the stock and the financial condition of the business. The earning capacity of the company

8 Revenue Ruling Eight Factors The dividend-paying capacity. Whether or not the enterprise has goodwill or other intangible value. Sales of the stock and the size of the block of stock to be valued. The market price of stocks of corporations engaged in the same or similar line of business having their stocks actively traded in a free and open market, either on an exchange or over-thecounter.

9 Gather/Analyze the Facts Conduct independent research Economic conditions and outlook Industry conditions and outlook Guideline companies Comparable transactions Discount and capitalization rate Review company information Analyze financial information/ratio analysis Adjust for GAAP adjustments, non-operating, nonrecurring, excessive discretionary, and related-party items Review company operating data Plant tour and management interviews

10 Approaches and Methods Asset Approach Asset Accumulation Excess Earnings Market Approach Guideline Companies Comparable Transactions Income Approach Capitalization of Earnings Discounted Future Earnings

11 Asset-Based Approach: Asset Accumulation Method Can be complex and rigorous Adjust underlying assets and liabilities to market values Consideration of built-in capital gain taxes if C corp May require assistance of other appraisers (real estate, machinery and equipment, and personal property) Result is controlling-interest basis Apply DLOM and DLOC, if appropriate

12 Market Approach: Guideline Companies Method Value multiples: Equity Price / Revenue Price / Earnings Price / Gross Cash Flow Invested Capital Market Value of Invested Capital (MVIC)/ Revenue MVIC/Earnings before Interest Taxes Depreciation and Amortization (EBITDA) MVIC/Book Value of Invested Capital

13 Market Approach: Comparable Transactions Sources : IBA Done Deals Bizcomps Pratt s Stats Mergerstat Review Securities Data Corporation - Acquisition/Divestiture Weekly Report - Merger & Acquisition Source Book - Mergers & Acquisitions Magazine - The Merger Yearbook

14 Market Approach: Comparable Transactions Important to understand what was exchanged in the transaction as different sources measure different items Result is controlling-interest basis DLOM is controversial

15 Earnings Approach: Discounted Future Earnings Based on the present value of expected future earnings Use when historical earnings are not reflective of expected future earnings and reliable forecasts of future operations can be prepared Assumes all operational assets and liabilities in normal amounts are acquired by the purchaser

16 Earnings Approach: Discounted Future Earnings Discount Rate = Risk-free rate (20 yr. Treasury Bond) + Equity risk premium +\- Industry risk adjustment +\- Size adjustment +\- Company specific risk adjustment Weighted Average Cost of Capital = (Ke X Wd) + (Kd(1-t) X Wd)

17 Earnings Approach: Capitalization of Earnings Based on present value of expected future earnings Use when historical earnings are reflective of expected future earnings Capitalization rate Discount rate long-term sustainable growth rate Result may be either a controlling-interest or minority interest depending on earnings measure used and adjustments made Apply DLOM and DLOC, if appropriate

18 Valuation Discounts and Premiums Reflect additional risks not already considered in the valuation process Meaningless unless base to which it applies is clearly defined Measured as a percent of some base amount Minority-control issue is addressed first, then marketability Multiplicative not additive

19 Valuation Discounts and Premiums Most common: Discount for lack of control (DLOC) Discount for lack of marketability (DLOM) Others: Voting vs. non-voting Blockage/market absorption Key person Portfolio or conglomerate Environmental/litigation Built-in capital gains tax

20 Discount for Lack of Control Deals with shareholder rights Various degrees of control Reflects the inability of the minority stockholder to exercise the common prerogatives of control Sources: Mergerstat Review HLHZ Control Premium Studies

21 Discounts for Lack of Marketability Deals with ability to liquidate an interest quickly, at low cost, and for a relatively certain price Various degrees of marketability Factors: Potential pool of buyers Restrictions on transfer Prospects of IPO or sale Dividend paying history/intentions Information access/reliability

22 Discounts for Lack of Marketability Comparison to of empirical studies Two types: Restricted stock Initial public offering Quantification of Marketability Discount Model Controversial Based on following factors: Length of expected holding period (EHP) Growth in underlying assets during EHP Return of capital and income returns during EHP Required rate of return during EHP

23 Reconciliation and Synthesis of Valuation Conclusion Judgment, not mechanical Industry norms important Prospective earnings important Discuss strengths and weaknesses of each method

24 Private Capital Markets

25 What is an ESOP? Qualified, defined contribution employee benefit plan designed to invest primarily in the stock of the sponsoring company. Governed by the Internal Revenue Code (enforced by the Internal Revenue Service) and Employee Retirement Income Security Act (ERISA) - Enforced by the Department of Labor. As with other qualified retirement plans, ESOPs must meet general rules concerning eligibility to participate, vesting, and non-discrimination. 25

26 What is an ESOP? However, unlike other qualified retirement plans, ESOPs may borrow funds to purchase stock of the sponsoring company. An ESOP allows the employees of the sponsoring company to acquire a beneficial interest in the sponsoring company s stock. Because of certain tax benefits associated with an ESOP, it is commonly used to finance acquisitions of businesses in a tax-advantaged manner. 26

27 How Does an ESOP Work? To set up an ESOP, the sponsoring company creates a trust for its employees. The sponsoring company funds the trust in one of the following ways: Contribute shares of the company stock; Contribute cash to enable the ESOP to acquire shares of company stock; or Provide a loan guarantee that enables the ESOP to borrow money to buy the shares. The Company then makes ESOP contributions to the ESOP to enable the ESOP to make the loan payments. 27

28 How Does an ESOP Work? The Plan trustee buys and/or holds the shares of the company s stock in the trust s name for the benefit of the employees. The shares of the company s stock are allocated to individual participants accounts, subject to vesting requirements. When the participants retire or otherwise leave the company, they receive either shares of the company s stock or cash equal to the value of the stock. 28

29 How Does an ESOP Work? The shares of company stock issued to departing participants have a put option attached to them that requires the trust (or the company) to repurchase the shares at their fair market value. 29

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31 Benefits of an ESOP - Stockholders Diversifies personal wealth. Creates liquidity for the stock (including non-esop shares) by providing a ready market at fair market value. The owner(s) may sell to the ESOP partially, or in stages over a period of years so they can gradually ease out of the company -particularly important for sellers with management responsibilities. Maintains control. In a C corporation, the selling owner(s) may defer taxation on the gains by using the Section 1042 "rollover if the sales proceeds are reinvested in Qualified Replacement Property (QRP). 31

32 Section 1042 Rollovers Capital gain taxes on sale of stock to ESOP can be deferred or excluded: Owner sells stock issued by a domestic closely held C corporation to the ESOP. ESOP must own at least 30% of stock after sale. Seller must reinvest proceeds in QRP, which are securities of domestic operating companies. Seller, seller s family, and 25% owners cannot receive allocations of 1042 stock in the ESOP (for 10 years as to seller and family members). Tax deferral can be permanent if QRP transferred by gift, death of seller, or corporate reorganization. 32

33 Benefits of an ESOP Company Increased cash flow through tax savings. Corporate continuity and perpetuation. In a C corporation, the company can fund the transaction with pretax dollars by paying the principal on the ESOP loan with tax-deductible contributions to ESOP or dividends paid on ESOP stock. In an S corporation, distributions that would otherwise be used for stockholders to pay taxes on S corporation income may be used to fund a portion of the ESOP share purchase. Research indicates that ESOP-owned companies may perform better than non-esop-owned companies. To create an additional employee benefit and spread corporate ownership among all employees. 33

34 S Corporation ESOPs The ESOP is a tax-exempt stockholder of the sponsoring company. If 100% of the sponsoring company s stock is held by the ESOP, the S corporation pays no United States income taxes on its income. Company can retain tax savings. If retained, value of sponsoring company s stock increases rapidly. 34

35 Benefits of an ESOP - Employees Share in growth of equity in the company. Motivation can help to build unity and team spirit. To build a stronger corporate culture: Research has shown that ESOPs enhance corporate performance and job satisfaction by creating a corporate ownership culture. Especially effective when combined with participative open-book style of management. 35

36 Who is a Candidate for a Leveraged ESOP? Company Characteristics: C corporation (IRC 1042 rollover) Increasing earnings / cash flow expectations Company expects to pay income taxes Fair market value of $2 million employees and stable employment base Strong management team in place Sufficient level of underlying assets and eligible compensation to support ESOP debt Participative management style 36

37 Who is a Candidate for a Leveraged ESOP? Selling Stockholder Characteristics: Owns at least 30% of all outstanding shares of the stock of the company Has low basis in stock Investment in company s stock represents significant portion of personal net worth Willing to transfer a beneficial ownership interest in a portion of the company s stock to the company s employees 37

38 Illustration of 100% S Corp ESOP Transaction 38

39 Questions? Aaron Pryor, CFA, ASA Acclaro Valuation Advisors