PricewaterhouseCoopers Page 3 Valuation Primer When are Valuations Used? Financial Reporting Mergers & Acquisitions/ Transaction Support Reorganizations Tax Purposes Income Tax & Estate Planning Tax Disputes Disputes Live Buy and Sell Transactions Family Law Strategy & Succession Planning
PricewaterhouseCoopers Page 4 Valuation Primer Value Concepts and Considerations Value definition sets parameters of the valuation assignment Hypothetical Fair market value (“FMV”) is defined as -Highest price -Expressed in terms of money or money’s worth -Obtainable in an open and unrestricted market -Between informed and prudent parties -Acting at arm’s length -Under no compulsion to transact Other value terms – fair value, value to owner
PricewaterhouseCoopers Page 5 Valuation Primer Price is not the same as Fair Market Value! Price is the consideration paid in a negotiated open market transaction involving the purchase and sale of an asset Parties often do not have equal information, equal bargaining positions, or equal negotiation experience Often impossible, in the absence of an actual transaction, to identify and quantify the synergies that a potential buyer may perceive to exist and for which they are willing to pay
PricewaterhouseCoopers Page 6 Somewhat Comparable Transactions Moving and Storage Industry Recent actual transactions suggest price multiples in the moving and storage industry to be in the range of 0.1 to 2.6 of revenue with a median of 0.5 (See attached slides). Price Multiples of Cash flow (unadjusted) ranged from 2.3 to 7.5, with a median of 2.9. Price Multiples of actual reported earnings (unadjusted) ranged from 2.6 to 17.1 with a mean of 10.1.
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PricewaterhouseCoopers Page 10 Valuation Primer Value Definitions and Principals Value -Is at a point in time -Does not consider hindsight -Is a function of future expected earnings -Is the greater of future earnings potential or the underlying net asset value Higher tangible asset backing equates to higher value – greater downside risk protection Some level of discount premium may be appropriate in considering value of a specific ownership interest / shareholding - lack of control / marketability / minority Value concept applies equally to purchase of assets or purchase of shares – although purchaser / vendor may have different preferences for deal structure (unique to each deal / owner)
PricewaterhouseCoopers Page 11 Valuation Primer Shanlock, Inc. Facts Location – Fort Lauderdale Years in Business – 10 Business Description – Moving and Storage Income Statement Date – 12/31/2005 Sales – $4.4 Million Net Income (unadjusted) – $1.15 Million Book-value (unadjusted) – $1.2 Million Cash Flow (unadjusted) – $1.236 Million What is it Worth?
PricewaterhouseCoopers Page 12 Valuation Primer Example – Actual Price Paid Shanlock, Inc. – Purchase Price of $3.0 Million Price to Revenue Multiple0.7 Price to Earnings Multiple2.6 Price to Book Multiple2.5 Price to Cash Flow Multiple2.4
PricewaterhouseCoopers Page 14 Valuation Approaches Overview of Valuation Approaches Is the Business Enterprise a viable, operating entity? NoYes Liquidation Approach Asset-Based Methodology Income-Based Methodology Capitalized cash flow / earnings Capitalized EBIT / EBITDA Market comparables Other multiples based approaches (Rules of Thumb) Going Concern Approach Asset-Based Methodology Orderly vs. forced
PricewaterhouseCoopers Page 15 Valuation Approaches Valuations – Asset Based Methodologies Asset based methodologies are most commonly used to value holding companies, real estate and equipment Most common asset based techniques: -Liquidation Value Consider using if business is not a going concern Orderly vs. Forced Tax considerations -Adjusted Net Book Value Commonly used to value holding companies Tax considerations -Replacement Cost
PricewaterhouseCoopers Page 16 Valuation Approaches Valuations – Asset Based Methodologies Example Book Value vs. Going Concern Value vs. Liquidation Value
PricewaterhouseCoopers Page 17 Valuation Approaches Income Based Methodologies – What are they and When are they Appropriate? Underlying premise: -Profitable company earns a reasonable rate of return on the invested assets -Value is calculated in relation to the cash flow or earnings available to the stakeholders -Value determined by converting anticipated future benefits to a present single amount Separate consideration of excess or redundant assets that may be extracted from operating business without impairing operations
PricewaterhouseCoopers Page 18 Valuation Approaches Income Based Methodologies Some possible methodologies: -Capitalized Earnings / Cash Flow -Capitalized EBIT or EBITDA -Discounted Cash Flow -Other multiples – revenue, book value, etc. Appropriate multiples or rates of return developed through: -Traditional financial market models Capital Asset Pricing Model, Weighted Average Cost of Capital, Build-Up Approach -Public company comparables – trading and transactional information -Analysis, experience and judgment
PricewaterhouseCoopers Page 19 Valuation Approaches Income Based Methodologies – Earnings Based Earnings based methodologies are most commonly used to value operating and going concern businesses Most common earnings based techniques: -Capitalized Earnings or cash flow method Bases include EBITDA / EBIT / After tax earnings / Cash flow (i.e. Shanlock had an unadjusted earnings multiple of 2.6) Use multiple to convert constant stream of earnings or cash flow to a value -Discounted Cash Flow (“DCF”) Present value forecast cash flows
PricewaterhouseCoopers Page 20 Valuation Approaches Income Based Methodologies – Potential Normalization Adjustments Non-arm’s length transactions Discretionary compensation Earnings level – tax minimization incentive versus profit motive Unusual/non-recurring expenses Other non-business assets (redundancies) Existence of related companies / planning vehicles / services businesses Owner/Manager Remuneration
PricewaterhouseCoopers Page 21 Valuation Approaches Income Based Methodologies – Factors Impacting Selection of Capitalization Rate. External Factors -General economic conditions -Opportunities and threats facing company Industry Factors -Outlook -Barriers to entry Internal Factors -Strengths and weaknesses facing company -Management -Dependency on key customers or individuals
PricewaterhouseCoopers Page 22 Valuation Approaches Earnings Multiple Inverse of the Capitalization Rate Applied to earnings – either historical or future Cap Rate = Discount Rate – Growth Rate High risk = High return = Low multiple Selection of an appropriate earnings multiple requires professional judgement
PricewaterhouseCoopers Page 23 Valuation Approaches Determination of an Appropriate Multiple Build Up Method – small closely held companies -Risk free rate + risk premium (subjective) Capital Asset Pricing Method (CAPM) -Large businesses that are comparable to public companies -Based on target company’s risk profile against an average public company -Discount Rate = Rf + (Beta x Equity risk premium)
PricewaterhouseCoopers Page 24 Valuation Approaches Income Based Methodologies – Example
PricewaterhouseCoopers Page 25 Valuation Approaches Valuations – Market Based Methodologies Market based methodologies are most commonly used to value operating and going concern businesses Review multiples of comparable companies and transactions in the marketplace Difficult to find an exact comparable company Application of public equity market multiples
PricewaterhouseCoopers Page 26 Valuation Approaches Other Multiple Based Approaches – Rules of Thumb Advantages: -Simple to apply -Relevant if widely publicized and used Disadvantages: -No empirical evidence that market actually follows -How to apply (i.e. before debt?) -Wide range of values -Too general for specific company -Sometimes not earnings based (i.e. multiple of sales) Conclusion -Used as a reasonability check most often
PricewaterhouseCoopers Page 28 Valuation Issues Estate and Tax Planning For documenting corporate reorganizations, CRA requires reasonable effort to determine valuation Valuation estimate by expert valuator who is independent and has relevant industry expertise would meet criteria Company’s accountants may not qualify as independent expert valuators CRA concept of family control – applying a discount on individual family shareholding generally not appropriate Better to obtain valuation upfront rather than disputing later as penalties and interest costs can be quite high
PricewaterhouseCoopers Page 29 Valuation Issues Size of Interests/Shareholdings For example, a 20% interest in the equity of a company that is controlled by a person or group of persons dealing at arm’s length (through direct ownership of more than 50% of the voting equity. It is not likely to have a value equal to 20% of the total value of the company. Premium values (more than a proportionate share of the value of the whole) have historically been considered in valuing the holdings of a controlling shareholder or group. The sum of the values of all the various equity interests in a business, each valued on their specific merits, will not always equate with the total value of the business.
PricewaterhouseCoopers Page 30 Valuation Issues Marketability/Minority Discounts Key in succession based valuations, there are often issues relating to various sized holdings of possibly different classes of equity shares, often with varying rights. Discounts from the per share total value to account for disadvantages arising from marketability and minority issues must be established. A key issue in many private company valuations is the determination of an appropriate minority/marketability discount to apply to a specific minority holding. Substantial discounts based on fact may become more commonplace in the future, particularly in family law matters.
PricewaterhouseCoopers Page 31 Valuation Issues Redundant Assets assets that are not necessary to its business operations. these excess or redundant assets, which might be in the form of cash, real estate, or other investments, can be distributed to the shareholders or converted to cash and used for other purposes without affecting the business’ operations. after considering disposal costs, if any, can constitute a value in addition to the earnings value of the operations. examples include: real estate, investments, cars, boats, art.
PricewaterhouseCoopers Page 32 Valuation Issues Value Drivers and Diminishers Positive Track records and growth expectations Contractual relationships vs. handshakes Higher tangible asset value Proprietary technology / intangibles Niche markets Barriers to entry Strength / depth of management Negative Declining earnings Business based on handshakes Reliance on key customers / employees Union issues / contingencies Outstanding litigation Other contingencies Business risks Economic / industry risks
PricewaterhouseCoopers Page 33 Valuation Issues Shareholder Agreement Formulas Pros and cons of the valuation formula -Avoid trying to boil it down to a specific formula – differences can cause problems Valuation issues to address include: -Formula definition – how detailed -Clear definitions of valuation terms are key – what is “value”? -Agreeing on valuation date -Addressing minority discounts -Designate the valuator(s) up front -Dealing with major assumptions regarding on-going business, personal / commercial goodwill, treatment of insurance proceeds -Inclusion of clauses to protect each in event of transfer of ownership -Ensure agreement is vetted by valuator
Specialty Issues – Succession Planning
PricewaterhouseCoopers Page 35 Specialty Issues – Succession Planning Valuation Issues in a Family Owned Business Goodwill Quantification Non-arms length transactions Discretionary compensation Earnings levels – tax minimization incentive versus profit motive Other non-business assets (redundancies) Use of publicly available data Family Owners (50% each) Opco
PricewaterhouseCoopers Page 36 Specialty Issues – Succession Planning Valuation Issues in a Family Owned Business – Goodwill Definition: -Intangible Value (Value in Excess of Net Assets) -Ability to earn “super profits” in excess of a normal return on assets. Sources: -Goodwill of location; -Goodwill of product; -Goodwill of service; -Personal Goodwill; -Personal relationships and work of owner/manager; and -Non-Commercial (Value to Owner)
PricewaterhouseCoopers Page 37 Specialty Issues – Succession Planning Valuation Issues for a Business Interest Held Through a Holding Company Holding company Asset based approach Latent tax liabilities Selling costs Tax planning opportunities in realizing the value of the interest Business interest Form of interest (instrument, terms of preference shares, restrictions) Value of interest (public vs. private) Minority discount/control premium Owner X 20% Opco 100% Holdco Owner Y Children X Trust 50% 30%
PricewaterhouseCoopers Page 38 Specialty Issues – Succession Planning Valuation Formula Buyout Clauses – Do They Work? Pros and Cons of the valuation formula Valuation issues to address include: -Formula definition – how detailed -Valuation date -Addressing minority discounts -Agreeing the valuator(s) up front -Dealing with major assumptions regarding on-going business, personal/commercial goodwill, treatment of insurance proceeds
PricewaterhouseCoopers Page 39 Specialty Issues – Succession Planning Conclusion Ensure key valuation issues are addressed in the valuation formula of your Shareholders Agreement. Negotiating the transaction goes beyond price.