ADA -Las Vegas Nov 8,2008 1 Presented By JAMES M. RAMSEY BUYING AND SELLING AN AUDIOLOGY PRACTICE 1...
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Transcript of ADA -Las Vegas Nov 8,2008 1 Presented By JAMES M. RAMSEY BUYING AND SELLING AN AUDIOLOGY PRACTICE 1...
ADA -Las Vegas Nov 8,20081
Presented By
JAMES M. RAMSEY
BUYING AND SELLING AN BUYING AND SELLING AN AUDIOLOGY PRACTICEAUDIOLOGY PRACTICE
1
ADA Convention ~ November 8, 2008
ADA -Las Vegas Nov 8,20082
Introduction
Objectives
To provide the framework for valuing and purchasing/selling an Audiology practice
To incorporate Effective Negotiating Skills in an effort to achieve an optimal outcome
2
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Introduction
Outline of Program Review Basic Accounting Concepts Valuation of an Audiology Practice Effective Negotiating to Optimize the
Outcome
3
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Accounting 101
Basic Accounting Equation (Balance Sheet)
Assets = Liabilities + Equity
4
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Sources of Funding
Debt (liability)
Equity Capital (Yours – Others) Retained Earnings - Profits
5
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Financial Statements
Balance Sheet (Single Date Valuation)
Assets = Liability(Debt) + Equity
Profit and Loss Statement (Income Statement) Stated Period of Time Profits or <Losses> = Revenue - Expenses
6
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Accounting Terms/Concepts
Accrual vs. Cash Basis of Accounting
“Matching Principle” Double Entry Bookkeeping System
Personal Checkbook Vs Using QuickBooks
Fiscal Year vs. Calendar Year Reporting
7
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Accounting Terms/Concepts
Current Assets – Working Capital Current vs. Long Term Debt Expense vs. Depreciable or Non-Depreciable
Assets Section 179 Depreciation
8
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Forms of Doing Business
Distinction Focuses on Tax Consequences Liability Protection Flexibility
9
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Forms of Doing Business
Most Frequent Legal / Tax Structure Sole Proprietorship (1040 Schedule C) General Partnership (1065 – Schedule K-1) C-Corporation (Form 1120, W-2 Income) S-Corporation (11205 – Taxed Like Partnership) LLC/P – Limited Liability Corporation-Partnership (1065) LP-Limited Partnership Entities to Reduce Payroll Taxes
10
ADA -Las Vegas Nov 8,200811
BUSINESS VALUATIONBUSINESS VALUATION
11
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Business Valuation
Define – Based on Reason for Valuation Liquidation – Focus on Value of Assets and Debt Not
Profits Company Operating at a Loss Divorce – “Equitable Distribution” Intrinsic Value – Not Necessarily Reflected on
Financial Statement Fair Market Value – Rev. Ruling 59-60
The Price a Willing Buyer Would Pay or Accept Neither Being Under the Obligation to Buy or Sell
12
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Basic Valuation Models
Adjusted Net Asset Method Income / Cash Flow Methodology
Capitalization of Earnings Rule of Thumb Methods(Multiple of EBIDTA) Discounted Cash Flow
13
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Adjusted Net Asset Method
Usually the Lowest Value The Whole Equals the Sum of the Parts Limited Applicability
Not Suitable for a “Going Concern” Liquidation
14
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Income/Cash Approach
An Audiology practice is worth the amount you would pay today to receive a stream of earnings (Cash Flow) in the future
Looks at Two Components (Time – Risk) Timing – Money you Receive in 5 Years is Worth less
than Cash in Hand The Amount Received & Likelihood of Receiving–
The Riskier the Future Cash Flow – Lower Value
15
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CAPITALIZATION OF EARNINGSCAPITALIZATION OF EARNINGS
16
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Capitalization of Earnings
EarningsHow much money you will receive on your investments (E = Annual Profits for One Year)
17
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Capitalization of Earnings
Capitalization Rate (R) The rate of return you want to receive based
on your assessment of risk The safer the investment (i.e. likelihood that
you will realize the projected earnings) the lower the rate of return you will need to justify the amount you will invest
The Valuation FormulaValue = Earnings / Capitalization Rate
18
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Capitalization of Earnings
Capitalization Rate (R) Example of two businesses earn $100,000
per year – Firm A is high risk where investor wants 25% return and the second is low risk and the investor wants 10% return Low Risk – $100,000/10% = $1,000,000 High Risk – $100,000/25% = $400,000
A Reasonable Approach where Earnings are Stable
19
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DISCOUNTED CASH FLOW (DCF)DISCOUNTED CASH FLOW (DCF)
20
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Discounted Cash Flow
Based on the value of a stream of future cash flow taking into account both the timing of the receipts and the cost of capital. The value of a business is the amount you would pay today for a future stream of cash.
21
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Discounted Cash Flow
The Cost of Capital (Financing) Percentage Financed by Debt x Cost of Debt Percentage Financed by Equity x Cost of
Equity WACC – The Weighted Average
Cost of Capital Using Debt and/or Capital
22
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Discounted Cash Flow
Computing Cost of Debt
Cost to borrow from a lender to the Firm based on lender’s assessment of the Company’s creditworthiness
23
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Key Terms
WACC – Weighted Average Cost of Capital The cost of financing using
debt and or capital
CAPM – Capital Asset Pricing Mode A mathematical calculation
to compute the Cost of Equity
24
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EBIDTA – Earnings Before Interest, Depreciation Taxes and
Amortization
A financial term used in business to reflect the cash flow of a business
The “Starting Point” in computing
“Free Cash Flow” to the Firm (FCF)
25
Key Terms
ADA -Las Vegas Nov 8,200826
Key Terms
FREE CASH FLOW (FCF)
The amount of cash generated each year that is available to either the creditors or owners
Equals
EBIDTA – Income Taxes – Changes in Working Capital – Capital Expenditures
26
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Key Terms
DISCOUNT RATE WACC The rate of return you require based on
actual financing using both debt and capital
Methodology• Comparable• WACC / CAPM• Schilt or Ibottson Table
27
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Methodology
Start with current P&L Normalize P&L (remove/adjust personal,
discretionary/non-business related items) Expenses of owner charged to
business Compensation above “norm” Charitable expense
Project 5 – 7 Years FCF
28
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Methodology
Compute the Present Value (PV) Years 1 – 5 Terminal Value
• Compute Terminal Value• Convert to Present Value
Result in the Total Value of the Company (Enterprise Value) Deduct Debt Balance of Equity Holder (Value)
29
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Present Value Years 1-5
Year Present Value Cash Flow Discount Factor
1 90,845 105,000 (1+.1558)
2 79,534 106,250 (1+.1558)2
3 72,253 111,563 (1+.1558)3
4 65,638 117,411 (1+.1558)4
5 59,629 122,998 (1+.1558)5
Total 367,899 563,222 - 30
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Computing the Present Value of the Terminal Value
Terminal Value(TV) 5th years earnings Divided By DF-Gwth Rate
905,642 122,998 =15.58% -2%=13.58%
Present Value of TV Terminal Value Discount Factor
379,867 905,642
(1+.1558)6
31
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Present Value of cash Flows & The Terminal Value
Period of Time Present Value
Years 1-5 367,900
Terminal Value After 5 Years 379,867
Total-Enterprise Value(Value to be Allocated between Debt Holders & Equity Holders)
747,767
32
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Computing Enterprise ValueStart Year 1 Year 2 Year 3 Year 4 Year 5
Terminal Value Total
EBITDA160,00
0168,00
0 176,400185,22
0194,48
1884,10
1
Taxes on Earnings
-45,000 -47,250 -49,613 -52,093 -54,698
-248,65
4
Chg in WC 0 -4,000 -4,200 -4,410 -4,631 -17,241
Capex-
10,000 -10,500 -11,025 -11,576 -12,155 -55,256
CF105,00
0106,25
0 111,563117,14
1122,99
8 905,6421,468,593
Disc. Factor 115.58% 133.59% 154.41% 178.46% 206.27% 238.41%
Discounted CF 90,845 79,534 72,253 65,638 59,629 379,867747,76
7
33
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Simplified Method For Computing Discount Rate (Cap Rate)
James H. Schilt updated and published his theories in the June 1991 edition of the American Society of Appraisers publication, Business Valuation Review, in an article entitled “Selection of Capitalization Rates – Revisited”. He categorizes companies into one of the following five categories and assigns a risk premium accordingly.
ADA -Las Vegas Nov 8,20083535
Simplified Method for Computing Discount Rate-Cap Rate
Established businesses with a strong trade position that are well financed, have depth and management, whose past earnings have been stable, and whose future is highly predictable (6-10%)
Established businesses in a more competitive industry that are well financed, have depth and management, have stable past earnings, and whose future is fairly predictable (11-15%)
ADA -Las Vegas Nov 8,20083636
Simplified Method for Computing Discount Rate-Cap Rate
Businesses in a highly competitive industry that require little capital to enter, no management depth, and have a high element of risk, although the past record may be good. (16-20%)
Small businesses that depend upon the special skills of one or two people, or larger established businesses that are highly cyclical in nature. In both cases, future earnings may be expected to deviate widely from projections (21-25%)
ADA -Las Vegas Nov 8,20083737
Simplified Method for Computing Discount Rate-Cap Rate
Small “one-man” businesses of a personal service nature, where transferability of the income stream is in question. (26-30)
ADA -Las Vegas Nov 8,20083838
Simplified Method for Computing Discount Rate-Cap Rate
You add the risk premium, calculated above to the risk-free rate, just as with the Ibbotson Method. The calculation of the discount rate for a privately held company in the 35% tax bracket using the Schilt’s Build-Up Method is as follows:
ADA -Las Vegas Nov 8,20083939
Simplified Method for Computing Discount Rate-Cap Rate
Risk-free long-term government bond rate 6.7%
Risk premium for category 4 company 25%
Pretax discount rate 31.7%
Convert pretax rate to after-tax rate
(31.7% x (1-35%)) 20.61%
(31.7% x (1 – 35%))
ADA -Las Vegas Nov 8,200840
RULES OF THUMBRULES OF THUMB
40
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Multiple of EBIDTA
3-6 Times EBIDTA (Earnings Before Interest, Depreciation, Taxes and Amortization
41
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Summary
Net Asset Method-Not Valid Capitalization-Simple & valid for Stable
Earnings DCF-Best for Valuing a steam of Cash Flow Multiple Of EBIDTA- Over simplified but
viewed with credibility
42
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NEGOTIATIONNEGOTIATION
43
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Objective
To enhance your ability to achieve an optimal outcome that is devised with a sense of fairness with a sensitivity for maintaining and/or enhancing the long term relationship.
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Overview
How People Typically Negotiate – Descriptive
How People Should Negotiate – Prescriptive
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DescriptiveDescriptive
How People Negotiate
Descriptive Negotiating Focusing on Positions Trade off between substantive outcome and
importance of relationship Possible Scenarios:
Soft-Soft Soft-Hard Hard-Hard
…ultimate challenge: to effectively negotiate with a sociopath!
ADA -Las Vegas Nov 8,200847
Research Finding on Distributive Bargaining
The final price is usually close to halfway between the two opening offers.
People who have high targets usually do better.
Many cultures accepted exaggerated opening offers.
There’s a “deadline effect”: most deals will close during the last minutes or hours if you impose a deadline – e.g. labor negotiations and class negotiating exercises.
Lying can be a Problem
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Prescriptive(“Getting To Yes” Roger Fisher)
Shift from zero sum to integrative(e.g Follet Sisters split Orange)
The Harvard model of principled negotiating
Separate people from problem. Focus on interests, not positions.
“If you would persuade, appeal to interests not reason.” –Ben Franklin
Look for options for mutual gain. Insist on using objective criteria, fair standards and fair
procedures.
“Never yield to pressure, only to principle.”
ADA -Las Vegas Nov 8,200849
What is Theory Structured Negotiating?
A system of negotiating whereby we base our assessment, recommendations, and strategic planning on definitive theories, principles and guidelines. Obviously, the quality of these “principles” will dictate the outcome. If you use “The Prince”, by Machiavelli, you will get a different outcome than if you used The Book of Proverbs.
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Theory Structured Negotiating“Blueprinting The Negotiation”
The Components Each Side’s “Consequences of No
Agreement” (CNA) or “Best Alternative To A Negotiated Agreement (BATNA).
Each side’s desired outcome based on the issues and priorities. (Each sides wish list)
ADA -Las Vegas Nov 8,200851
The Process (Blueprint)
Estimating/Predicting/Identifying each side’s CNA/BATNA Wish List
Validating the accuracy of each side’s CNA and wish list
Creating value (Lax and Sebenius) Claiming value (Lax and Sebenius)
ADA -Las Vegas Nov 8,200852
The Blueprint of the Negotiating The Blueprint of the Negotiating ProcessProcess
ADA -Las Vegas Nov 8,200853
Cap Gains Rate 15% Interest Rate 8%
Tax Rate-Ord Inc 40% Stock( Assets) 650,000
Def Comp 0
BATNAYear 1 2 Total
Stock
Cash At closing 650,000 650,000
Financing 0
Capital Assets 1 2 Total
Cash at Closing 650,000 0 650,000
Annual payment 0 0 0
Total 650,000 0 650,000
Less Taxes (97,500) 0 (97,500)
After Tax 552,500 0 552,500
PV Factor 1.00 1.08
Present Value 552,500 0 552,500 After Tax PV Total Cash
Stock 552,500 650,000 53
ADA -Las Vegas Nov 8,200854
MEO # 1 $800,000 with 50% at closing & 25% per year in 2nd & 3rd year
Year 1 2 3 Total
Cash at Closing 400,000 400,000
Annual payment 0 200,000 200,000 400,000
Capital Gains 400,000 200,000 200,000 800,000
Interest Income 32,000 16,000 0 48,000
Less Taxes (72,800) (36,400) (30,000) (139,200)
After Tax 359,200 179,600 170,000 708,800
PV Factor 1.00 1.08 1.17
Present Value 359,200 166,296 145,748 671,244 After Tax PV Total Cash
Stock 800,000
Interest 48,000
Def Comp 0 0
Total 671,244 848,000 54
ADA -Las Vegas Nov 8,200855
MEO # 2 $400,000 cash +10% of grossYear 1 2 3 4 5 Total
Cash At closing 200,000 100,000 100,000 400,000 Interest 16,000 8,000 0 0 24,000
Prin 200,000 100,000 100,000 400,000 Total 216,000 108,000 100,000 0 0 424,000
Less Taxes Cap Gains (30,000) (15,000) (15,000) (60,000)Net After
Taxes 170,000 85,000 85,000 340,000 Ordinary Inc
Interest Income 16,000 8,000 0 0 0 24,000
Def Comp 80,000 84,000 88,200 92,610 97,241 442,051 Total 96,000 92,000 88,200 92,610 97,241 466,051
Less Taxes (38,400) (36,800) (35,280) (37,044) (38,896) (186,420)Net After Tax 57,600 55,200 52,920 55,566 58,344 279,630
Total After Tax 227,600 140,200 137,920 55,566 58,344 619,630
PV Factor 1.00 1.08 1.17 1.26 1.36
Present Value 227,600 129,815 118,244 44,110 42,885 562,654 PV Total Cash
Stock 400,000 Interest 24,000
Def Comp 442,051
Total 562,654 866,051 55
ADA -Las Vegas Nov 8,200856
Cap Gains Rate 15% MEO # 3 $600,000 cash +2.3% of grossStock( Assets) 600,000 Est Revenue 800,000
Def Comp 18,644 Percent of Gross 2.3%
Year 1 2 3 4 5 Total
Cash 300,000 150,000 150,000 600,000
Interest 24,000 12,000 36,000
Total 324,000 162,000 150,000 0 0 636,000
Less Taxes
Cap Gains (45,000) (22,500) (22,500) (90,000)
Net After Taxes 255,000 127,500 127,500 0 0 510,000
Ordinary Inc
Interest Income 24,000 12,000 0 0 0 36,000
Def Comp 18,644 19,576 20,555 21,583 22,662 103,019
Total 42,644 31,576 20,555 21,583 22,662 139,019
Less Taxes (17,058) (12,630) (8,222) (8,633) (9,065) (55,608)
After Tax 25,586 18,946 12,333 12,950 13,597 83,411
Total After Taxes 280,586 146,446 139,833 12,950 13,597
PV Factor 1.00 1.08 1.17 1.26 1.36
Present Value 280,586 135,598 119,884 10,280 9,994 556,342 PV Total Cash
Stock 600,000
Interest 36,000
Def Comp 103,019
Total 556,342 739,019 56
ADA -Las Vegas Nov 8,200857
BATNA MEO # 1 MEO # 2 MEO # 3
Stock 650,000 800,000 400,000 600,000
At Closing 650,000 400,000 200,000 300,000
Balance 0 2 years 200,000 300,000
DC 0 0 442,051 103,019
DC -Years 5 5
After Tax PV 552,500 671,244 562,654 556,342
Total Cash 650,000 848,000 739,019 739,019
EBIDTA 160,000 160,000 160,000 160,000
multiple 4.06 5.30 4.62 4.62 57
ADA -Las Vegas Nov 8,200858
Tips – Techniques – ConventionsJudgmental Errors in Negotiating
Define: “The errors in our thinking or cognitive
processes that result in our not negotiating rationally or not doing what’s in our own best interest.”
Consequences:We don’t see flaws or adequately
evaluate alternatives.
ADA -Las Vegas Nov 8,200859
Judgmental Errors in NegotiatingTips-Techniques-Conventions
(Assess from both Descriptive and Prescriptive perspectives)
Non-Rational escalation-(Endowment Factor)
Mythical Fixed Pie Anchoring and Adjustment Framing the negotiation – e.g. how
people view gains/losses
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Tips – Techniques - Conventions
Give your logic before conclusions Importance of understanding the concept of
organizational negotiating Negotiating one item at a time vs. multiple items Keys to Success:
Accurate emotional and intellectual empathy You’re not ready to negotiate until you can present
the other side’s point of view more articulately and persuasively than they can and then give an “appropriate” response”
ADA -Las Vegas Nov 8,200861
Tips – Techniques - Conventions
The 3rd Movement (Wharton) Opening Offer/Position Response Rebuttal
Never concede, only trade Value creating vs. value claiming – Pareto
curve/Efficient frontier Role Playing(Preparation Most Important factor in
your success) Not Optional Behavioral rehearsal Discovering “integrative” solutions Accurate empathy You’ll only appear to be extemporaneous
ADA -Las Vegas Nov 8,200862
Tips – Techniques - Conventions
The Negotiating Team Spokesperson Back up Observer
The People Factor The “Dale Carnegie” component Cognitive dissonance – hard on the problem – soft
on the people Principle of the “State of Disequilibrium”
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Tips – Techniques - Conventions
Anger/handling criticism Anger is one letter away from danger The most difficult emotion to control Disarming the critic
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Tips – Techniques - Conventions
Munger: “The standard antidote to one’s overactive hostility is to train oneself to defer reaction. As my smart friend Tom Murphy so frequently says, ‘you can always tell someone off tomorrow, if it is such a good idea.’”
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Tips – Techniques - Conventions
Communication Skills Listen more – Talk Less (20/80 Rule) – “Even a fool
is thought wise if he keeps silent and discerning if he holds his tongue” –Proverbs 17:28
Using “I” messages vs. “You” messages Feeling Behavior Consequences
The first sign you are communicating more effectively is when you do not follow your instincts.