1. Copyright C&S Associates, July 20070 How to Value a Small Business Pete Smith C&S Associates Professional Development Seminar South Carolina Small Business Development Center

2. Copyright C&S Associates, July 20071 Introduction Business Valuation: Estimating the Fair Market Value of a business entity Business Valuation: Estimating the Fair Market Value of a business entity Principles are consistent Principles are consistent Application of principles is diverse Application of principles is diverse Objectives of a Business Valuation Objectives of a Business Valuation Accuracy Accuracy Fairness - Objectivity Fairness - Objectivity Defend-ability Defend-ability

3. Copyright C&S Associates, July 20072 Seminar Objectives Understanding of the basic Principles Understanding of the basic Principles Understanding of the basic Terms used Understanding of the basic Terms used Understanding of the basic Methods used Understanding of the basic Methods used With a hands-on example, gain the: With a hands-on example, gain the: Ability to apply to appropriate client situations Ability to apply to appropriate client situations Ability to know when not to apply!!! Ability to know when not to apply!!!

4. Copyright C&S Associates, July 20073 Fair Market Value “Fair Market Value is defined as the value that a willing seller and a willing buyer, both being informed of the relevant facts about the company, could reasonably conduct a buy-sell transaction, neither party under any compulsion to do so.”

5. Copyright C&S Associates, July 20074 PURPOSES Business Sale Business Sale Business Purchase Business Purchase Bank Financing Bank Financing Estate Planning Estate Planning Estate Taxes Estate Taxes Gifting Gifting Divorce Partner Buy In/Out Report Card ESOP Inter-Generation Other Always dealing with two sides – someone wants a higher valuation, someone wants a lower valuation. One side is frequently the IRS.

6. Copyright C&S Associates, July 20075 SMALL BUSINESS CHARACTERISTICS Size & Business Model Size & Business Model Markets Markets People People

7. Copyright C&S Associates, July 20076 Market Evaluation Size of Market in area Size of Market in area Growth in area Growth in area Company’s Position Company’s Position Top Customers Top Customers Concentration Company Growth Desire-ability of product/service Location, Location, Location

8. Copyright C&S Associates, July 20077 Business Valuation Steps - 1 Define Purpose Define Purpose Understand size & characteristics of Client Understand size & characteristics of Client Assessment of People and Markets Assessment of People and Markets ---------------------------------------------- ---------------------------------------------- Gather Additional Data Gather Additional Data Recast Financial Statements Recast Financial Statements Ratio Analysis / Industry Comparison Ratio Analysis / Industry Comparison

9. Copyright C&S Associates, July 20078 Business Valuation Steps - 2 Application of Valuation Methods Application of Valuation Methods Reconciliation Reconciliation Adjustments Adjustments Valuation Report Valuation Report

10. Copyright C&S Associates, July 20079 GLOSSARY -1 Pro Forma Adjustments Pro Forma Adjustments Reflect Nature of Deal Reflect Nature of Deal Adjust for Real Estate Adjust for Real Estate Adjust for discretionary and one-time items Adjust for discretionary and one-time items Book Value of Stockholder’s Equity Book Value of Stockholder’s Equity Book Value of Total Capital Book Value of Total Capital Goodwill Goodwill

11. Copyright C&S Associates, July 200710 GLOSSARY – 2 Income Measures Sales Sales Contribution Value Contribution Value Prime Gross Profit Prime Gross Profit Gross Profit Gross Profit SDE – Seller’s Discretionary Earnings SDE – Seller’s Discretionary Earnings PBITDA, EBITDA, IBITDA PBIT, EBIT, IBIT PBT, EBT, IBT PAT, EAT, IAT

12. Copyright C&S Associates, July 200711 Glossary - 3 Arm’s Length Arm’s Length Date of Valuation Date of Valuation Discretionary Expenses Discretionary Expenses Materiality Materiality One-time events One-time events Control / Minority Interest Control / Minority Interest Ranges of Values Ranges of Values

13. Copyright C&S Associates, July 200712 Discretionary Expenses Owner’s Bonus Owner’s Bonus Management’s Bonus Management’s Bonus Country/Golf Club Country/Golf Club Airplane Airplane Director’s Fees Director’s Fees Guaranty Fees Guaranty Fees Family Salaries Family Salaries Car Expenses Life Insurance Interest Earned NASCAR tickets London Travel Trade Show Training Class

14. Copyright C&S Associates, July 200713 Valuation Methods - 1 Income Methods Income Methods Cost Methods Cost Methods Comparable Value Methods Comparable Value Methods

15. Copyright C&S Associates, July 200714 Valuation Methods - 2 Income Methods* Income Methods* ROI ROI Cash Flow Cash Flow Excess Income (IRS) Excess Income (IRS) SDE SDE DCF – Ugly! DCF – Ugly! Other Multiples Other Multiples Others Others * Can’t use many income methods if there is no income ! Cost Methods Book Depreciation add back Replacement – new Replacement – used Cost plus 1x GP Multiple of Book Others

16. Copyright C&S Associates, July 200715 Valuation Methods - 3 Comparable Value Methods Comparable Value Methods Deals Done – tough finding sources – privately held businesses, definition of price. Deals Done – tough finding sources – privately held businesses, definition of price. Publicly held – minority vs. majority, liquidity? Publicly held – minority vs. majority, liquidity? Industry Rules-of-Thumb Industry Rules-of-Thumb

17. Copyright C&S Associates, July 200716 BUSINESS VALUATION EZ ELECTRIC Purpose: Joe would like to retire sometime in his mid- 50’s. Wants to get an idea of the value of the business to plan ahead. Make sure he has enough life insurance to cover the value, knowing that much of the value is gone in the event of his death.

18. Copyright C&S Associates, July 200717 EZ ELECTRIC – Size /Other 20 Employees including Joe 20 Employees including Joe Sales $3m Sales $3m 100% owned by Joe 100% owned by Joe Founded, Dad 1970 Founded, Dad 1970 Joe took over 1997 Joe took over 1997 Dad passed 2000 Dad passed 2000 Key Man Life Insur. Key Man Life Insur. Joe’s Mom in Florida Comes to annual meeting at Xmas. She owns building Lease to EZ Son and Daughter work at EZ

19. Copyright C&S Associates, July 200718 Markets Apparatus service market in area $10m Apparatus service market in area $10m 1 competitor same size, 3 smaller 1 competitor same size, 3 smaller Industry Growth: Flat Industry Growth: Flat Top Four Customers Top Four Customers Mining 15% Mining 15% Automotive10% Automotive10% Manufacturing10% Manufacturing10% Health Care10% Health Care10%

20. Copyright C&S Associates, July 200719 Adjustments - 1 Joe bought out Mom’s stock at the then fair market value, balance is part of Long Term Debt. Payments of $3k per month for principal and interest on 8% note. Pays her an additional $10k at year end to for attending board meeting to supplement her income. Joe bought out Mom’s stock at the then fair market value, balance is part of Long Term Debt. Payments of $3k per month for principal and interest on 8% note. Pays her an additional $10k at year end to for attending board meeting to supplement her income. Any discretionary? Any one time? Any discretionary? Any one time?

21. Copyright C&S Associates, July 200720 Adjustments - 2 Joe’s only sister is an attorney. Keeps track of the corporate records, member of the board of directors, handles collection letters and other minor legal matters. Joe pays her $1k per month. Joe’s only sister is an attorney. Keeps track of the corporate records, member of the board of directors, handles collection letters and other minor legal matters. Joe pays her $1k per month. Any discretionary? Any one time? Any discretionary? Any one time?

22. Copyright C&S Associates, July 200721 Method/Calculate Lower Higher Notes 1. 4 to 6 x 160 640 960 Total Equity* 2. 3 to 5 x 250 750 1250 Total Capital less debt(375) (375) 375 875 Total Equity* 375 875 Total Equity* 3. 40% to 60% 180 270 Acc. Depre. Book Equity 375 375 555 645 Total Equity* 555 645 Total Equity* 4. No Information * Valuation of Total Equity is the objective Apply Methods 1-4

23. Copyright C&S Associates, July 200722 Method/Calculate Lower Higher Notes 5. 1.5 to 2.5 SDE 600 1,000 FA+GW+Inv** Cash, A/R, OCA 310 310 Cash, A/R, OCA 310 310 Total Liab. (525) (525) Total Liab. (525) (525) 385 785 Total Equity* 385 785 Total Equity* 6. 25% to 40% 525 840 FA+ GW only All Tot. CA 550 550 Current Assets Total Liab. (525) (525) 550 865 Total Equity* 550 865 Total Equity* *Valuation of total equity is the objective ** Typical Small Business Sale Apply Methods 5-6

24. Copyright C&S Associates, July 200723

25. Copyright C&S Associates, July 200724 THANK YOU Please complete the feedback form. Other Questions?