VALUATION OF A SYSTEMS INTEGRATION COMPANY 5408Woodway Drive Fort Worth, Texas 76133 817-698-9999 WWW.Reitman.US

General Accounting, Tax Preparation and Representation Valuation Services Brokerage Due Diligence

Valuation is a Profession Valuators are not required to be licensed. Valuation Professionals should adopt and follow a set of Standards.

Examples of Professional Standards American Society of Appraisers The National Association of Certified Valuators and Analysts American Institute of Certified Public Accountants (AICPA)

AICPA Statement on Valuation Standards This statement establishes standards for AICPA members who are engaged to estimate the value of a business, business ownership interest, security, or intangible asset.

There is little statutory law governing valuations: - IRS Code - IRS Revenue Ruling 59-60 There is case law: - Federal Income Tax Cases - Divorce Cases 

defines Fair Market Value IRS Revenue Ruling 59-60 defines Fair Market Value Fair market value is defined as the price at which property would change hands between a hypothetical willing buyer and a hypothetical willing seller, both being adequately informed of the relevant facts and neither being under any compulsion to buy or to sell.

Valuation vs. Calculation Valuation engagement: Estimate of the value of a subject interest using the valuation approaches and methods the Valuator deems appropriate in the circumstances. The Valuator expresses the results of the valuation as a conclusion of value. The conclusion may be either a single amount or a range.

Valuation vs. Calculation Calculation engagement: Valuator and the client agree on the valuation approaches and methods the Valuator will use and the extent of procedures the valuator will perform in the process of calculating the value of a subject interest. The valuator expresses the results of these procedures as a calculated value.

Valuation vs. Calculation The calculated value is expressed as a range or as a single amount. A calculation engagement does not include all of the procedures required for a valuation engagement.

Valuation vs. Calculation Valuation Analyst: Applies the valuation approaches and methods he or she deems appropriate in the circumstances. The valuation analyst expresses the results of the valuation as a conclusion of value; the conclusion may be either a single amount or a range.

Valuation Approaches Income Approach Asset Approach or Cost Approach Market Approach

Income Approach Two frequently used valuation methods: Capitalization of earnings method (e.g., earnings or cash flows) Discounted future benefits method (e.g., earnings or cash flows)

Capitalization of Earnings Method Best suited for a stable company with consistent earnings. Focused on historical earnings

Discounted Future Benefits Method Best suited for a dynamic or fast growing company or a company without a stable earnings history. Predicts future cash flows

 Asset Approach Measurement of the net assets

Market Approach Guideline public company method Guideline company transactions method Guideline sales of interests in the subject entity, such as business ownership interests or securities

Valuations of Typical RMR Based Security Companies Usually calculations using the Asset Approach Occasionally a blended Income and Asset Approach can be used

Valuing an Integrator Integrators typically have some RMR, which has stand-alone value Most successful integrators also have Earnings Before Interest, Taxes, Depreciation, and Amortization (EBITDA)

Valuation Components Value of RMR (Asset Approach) Value of Adjusted EBITDA (Income Approach)

Valuation Methodology Determine the Value of RMR Determine the Adjusted EBITDA

Prepare an RMR Rollforward RMR Rollforward Analysis - Alarm 2016   Jan-15 Feb-15 Mar-15 Apr-15 May-15 Jun-15 Jul-15 Aug-15 Sep-15 Oct-15 Nov-15 Dec-15 RMR Rollforward and the Attrition Trend Previous Month Ending $ 277,819 $ 282,587 $ 285,981 $ 287,173 $ 289,396 $ 290,393 $ 291,488 $ 292,686 $ 293,025 $ 294,588 $ 295,728 $ 297,546 Prince Increases 1,679 1,670 1,410 1,641 1,206 1,933 1,433 (5,501) 1,948 1,777 1,865 1,339 RMR Added 5,343 3,337 2,248 2,944 1,540 1,776 2,075 9,267 1,585 1,856 1,448 1,521 RMR Cancelled (1,872) (1,390) (2,419) (2,214) (1,701) (2,440) (2,151) (3,182) (1,683) (1,969) (1,508) (1,796) Moves and Reconnects (382) (222) (47) (148) (48) (173) (160) (245) (288) (524) 13 (186) Adjusted Attrtiion (change in RMR) - Net Attrition $ (1,872) $ (1,390) $ (2,419) $ (2,214) $ (1,701) $ (2,440) $ (2,151) $ (3,182) $ (1,683) $ (1,969) $ (1,508) $ (1,796) Ending RMR $ 287,173 $ 294,588 $ 297,546 $ 298,423 BOM past due RMR $ - EOM past due RMR Variance in past due RMR $ - Gross Attrition $ 1,872 $ 1,390 $ 2,419 $ 2,214 $ 1,701 $ 2,440 $ 2,151 $ 3,182 $ 1,683 $ 1,969 $ 1,508 $ 1,796 1,872 Beginning RMR (see note below) 277,819 Annualized Gross Attrition 8.1% 5.9% 10.2% 9.3% 7.1% 10.1% 8.9% 13.0% 6.9% 8.0% 6.1% 7.2% Annualized Net Attrition 3 Month Gross Attrition===================================================== $ 5,681 $ 6,023 $ 6,334 $ 6,355 $ 6,292 $ 7,773 $ 7,016 $ 6,834 $ 5,160 $ 5,273 3 Month Net Attrition============================================== 5,681 6,023 6,334 6,355 6,292 7,773 7,016 6,834 5,160 5,273 Average beginning RMR - Last three months======================================== 282,129 285,247 287,517 288,987 290,426 291,522 292,400 293,433 294,447 295,954 Annualized Attrition from last three months==================================================== 8.4% 8.8% 8.7% 10.7% 9.6% 7.0% Annualized Net Attrition from last three months=============================================== 6 Month Gross Attrition====================================================================================================== $ 12,036 $ 12,315 $ 14,107 $ 13,371 $ 13,126 $ 12,933 $ 12,289 6 Month Net Attrition===================================================================================================== 12,036 12,315 14,107 13,371 13,126 12,933 12,289 Average beginning RMR - Last 6 months============================================================================================== 285,558 287,836 289,520 290,693 291,929 292,985 294,177 Annualized Attrition from last 6 months=============================================================================================== 8.6% 9.7% 9.2% 9.0% Annualized Net Attrition from last 6 months========================================================================================= 12 Month Gross Attrition================================================================================================================================ $ 24,325 12 Month Net Attrition================================================================================================================================== 24,325 Average beginning RMR - Last 12 months======================================================================================================================== 289,867.42 Annualized Attrition from last 12 months============================================================================================================================ Annualized Net Attrition from last 12 months=========================================================================================================================

Valuation of RMR (Asset Approach) Determine Net Present Value of Cash Flow from RMR Apply Market Limitations Judgmentally determine value of RMR

Determine Net Present Value of RMR (NPV = {C for Period 1 / (1 + R) ^ 1} + {C for Period 2 / (1 + R) ^ 2} ... – Initial Investment

Apply Market Limitations Adjust the NPV to reflect adjustments due to Quality of account base Contract impairments Other impairments (geographic, account type, etc…) The result is the Value of the RMR (accounts)

Determine Non RMR Cash Flow Non RMR Cash Flow includes: Adjusted EBITDA less: Cash Flow From RMR plus: Creation Cost adjustment (if any)

Determine RMR Added and Net RMR Added Some integrators have Creation Cost. If an integrator installs systems below cost, a creation cost factor should be added back to EBITDA to compensate for Creation Cost expensed.

“Gross Up” EBITDA for ‘Add Backs’ Add Backs include: Excessive owner compensation Owner benefits Over market rent or charges Any expenditures that are not necessary to operate the Company Determine if there is net cash flow from sources other than RMR.

Determine Net Assets Discount assets with impairments Accounts receivable Other Receivables Inventory Fixed Assets (may be marked up over NBV) Other Impaired Assets

Consider Undisclosed Liabilities Deferred Revenue Unaccrued Expenses Deposits and Retainers “Off Balance Sheet” debt Convertible Equity Contingent Payments Other Undisclosed Liabilities

Determine Earnings Multiplier Judgmentally determined based upon expectation of future earnings Applied to non-RMR EBITDA

Enterprise Value Value of Non RMR Cash Flow XXX NPV of RMR XXX Market Value of RMR XXX (Judgmentally select the most reasonable amount) XXX RMR Creation Adjustment (if any) XXX Net Assets XXX  Any other judgmental adjustments XXX (reasonableness, enterprise, brand awareness, etc.) __ Total Enterprise Value XXX

Other Considerations In Place Workforce Secondary Meaning Repetitive Revenue Exclusive Relationships

Adjustments for Lack of Control and Marketability The Standards (AICPA Statement on Standards for Valuation Services, Section 40) require that the valuation analyst consider whether valuation adjustments should be made to a pre-adjustment value.

Lack of Control Discount A Lack of Control Discount is a reduction in the value of an interest in an entity in order to recognize the absence of certain powers of control of the entity. These powers generally include the ability to: Set policy Enter into transactions or agreements Pay dividends or distributions Offer services of the entity Guarantee the financial obligations of others or of other entities Invest or reinvest the property or income of the entity Manage the day to day affairs of the entity

Discount Amount for Lack of Control In Holman v. Commissioner (130 T.C. 170 (2008) 105AFTR 2d 2010-721), the IRS contended and the Court affirmed that a minority interest discount of 14.4% was reasonable. Apply a 14.4% Lack of Control Discount to the previously determined valuation to determine the value net of Lack of Control Discount but before Lack of Marketability Discount.

Lack of Marketability Lack of Marketability Discount: Recognizes that an owner of a business interest cannot convert his/her interest into cash as easily and as quickly as a shareholder in a publicly traded company.

Determining the Discount Interests in a closely held entity closely resemble shares of restricted stock. In 1990 the Securities and Exchange Commission adopted Rule 144a which provided limited access to a resale market for restricted stock. Prior to the adoption of Rule 144a restricted stock discounts were an average of 34%, after the adoption of Rule 144a discounts on many of those same stocks were an average of 22%. When Rule 144a was amended average discounts dropped to 13%.

The IRS has contended (in Holman) that there are two components that influence investors in restricted stock: (1) limited liquidity and (2) the holding period. For private holding companies which are not subject to any legally imposed holding periods or the risks attendant to restricted stock, the discount for lack of marketability should be close to 12%. A reasonable buyer would request (and likely receive) a discount ranging from 10% to 15% for a restricted interest.

A Lack of Marketability Discount of 12.5% is reasonable. This, when applied to the net value of after the Lack of Control Discount, yields a value net of Lack of Control Discount and Lack of Marketability Discount.