Understanding and Increasing Business Value Understanding and Increasing Business Value American...

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Transcript of Understanding and Increasing Business Value Understanding and Increasing Business Value American...

  • --Working ON your Business, not just IN your Business--

    Understanding and Increasing Business Value

    American Cheese Society July 30, 2016


    • What really matters in business valuation?

    • Is your business transferable? • Why every business has more than one value. • Can’t I just use an industry rule of thumb? • Why a company’s financial statements do not

    indicate the value of the business. • How is a business valued? • How can value be increased?

  • But I’m Not Ready to Sell…

    • Investment vs. Employment

    • Identifying your successor is a fundamental objective

    • Value can be increased if you have time and understand the drivers

    In Madison: (608) 257-2757

  • Is the business actually a transferable entity, or is it a career with the

    “tools of the trade”?

  • The Transferable Business Has Two Key Characteristics*

    • The business is not dependent on a specific individual with skills or relationships that cannot be transferred.

    • The business generates sufficient cash flow for BOTH market compensation and return on investment.

    Presenter Presentation Notes Don’t become synonymous with your company. Buyers need to be confident the business can run without you.

  • Is it Transferable?


    Year 1 Year 15

  • What about……

    Those handy rules of thumb?

    •Multiple of Revenue? •Multiple of EBIT? •Multiple of EBITDA?

    Presenter Presentation Notes

    Not only do businesses have more than one value but the value is dynamic and changes over time Some factors are controllable by the owner, some are not Is the industry’s outlook similar to the subject company’s?

    Impact of interest rates, bank lending, real estate

  • ABC Cheese v. XYZ Cheese 4.35 x EBITDA

    • ABC Company • High employee turnover • 26% of revenues from one

    customer • No contracts for future work • Facilities at capacity • Contracts do not allow for

    surcharges • New competitor just came

    to town

    • XYZ Company • Low-no employee turnover • 4% of revenues from one

    customer • Contracts in place for future

    work • Facilities at 60% of capacity • Contracts do allow for

    surcharges • Competitive landscape


  • Fair Market Value

    The cash or cash-equivalent price at which the security would change hands between a willing buyer and a willing seller, neither being under any compulsion to buy or sell and both having reasonable knowledge of the relevant facts.

    Article 20.2031-1(b) of the Estate Tax Regulations and Revenue Ruling 59-60, 1959-1 C.B. 237

  • Prospect Ranking Chart Buyers of a Business Enterprise

    Highest Enterprise Value 9 Strategically Positioned Businesses 8 Diversifying Businesses 7 Competing Businesses 6 ESOPs 5 Outside Investors/Managers 4 Insider Management Group 3 Diversified Passive Investors 2 Investor/Job Seeker 1 Undiversified Passive Investors

    Lowest Enterprise Value

    Presenter Presentation Notes Who are these people or companies in your industry? Consolidation within industry

  • Business Valuation Approaches

    Income Approach

    Market Approach

    Asset Approach

  • Asset Approach • Determines value based on the current market

    value of underlying assets

    • Seldom used for operating companies

    • Relied upon for real estate or investment holding companies

    • May not be applicable if business is a going concern or minority interest is being valued

    Presenter Presentation Notes Let’s take the balance sheet and reprice at market values—assumes we’re selling assets and paying liabilities

    Rarely applicable --going concern --minority?

  • Balance Sheet Adjustment To Restated As Reported Market Value Balance Sheet

    Cash 50,000$ 50,000$ Accounts Receivable 200,000 (25,000) 175,000 Inventory 450,000 (50,000) 400,000

    Plant & Equipment 750,000 1,000,000 1,750,000

    Land 250,000 1,000,000 1,250,000

    TOTAL ASSETS 1,700,000 1,925,000 3,625,000

    Accounts Payable 100,000 100,000

    Interest-Bearing Debt 500,000 500,000

    Built-In Capital Gain Tax 350,000 350,000 -

    TOTAL LIABILITIES 600,000 950,000 -

    NET EQUITY 1,100,000$ 1,575,000$ 2,675,000$

    Asset Approach to ValueAsset Approach to Value

  • Market Approach Are there any comparable transactions whose data we could apply to our subject company?

     Guideline public companies

    Comparable private transactions

    Prior transactions in the subject company

    Presenter Presentation Notes PRIVATE transactions—hinders access Private transactions are often a reflection of the values and personalities of the principals involved. Difficult to determine whether the transaction was arm’s length or if other issues were involved Quality of data is subject to questions—no standards re: the reporting of this info—does report accurately represent the actual transaction?


    Closely held transactions\

    Prior Transfers: Kohler case study comparing fair value to fmv estate and fmv of actual transaction (most valuable blocks)

  • Income Approach

    Value today is the present value of future

    economic benefits

    Presenter Presentation Notes This is where the real work happens in closely held business valuation and the most mis-application Capitalization of Earnings—backward looking DCF—forward looking

  • Income Approach Two methods—

    • Capitalization of earnings—only if future will look like most recent year(s)

    • Discounted future cash flows—most detailed method for reflecting the specific company’s expected future

    Presenter Presentation Notes This is where the real work happens in closely held business valuation and the most mis-application Capitalization of Earnings—backward looking DCF—forward looking

  • Income Approach

    Capitalization of Earnings

    • Involves a numerator • A single number intended to represent the future economic


    • Involves a denominator • Represents the rate of return required by the investor

    Presenter Presentation Notes Only appropriate when the company’s past is a good reflection of its long term future growth prospects.

  • What’s the Problem? • Based solely on the income statement

    • Past performance

    • No allowance for future capital expenditures

    • No allowance for future working capital needs

    • Cash • Accounts Receivable • Inventory

    • Capital Structure: relies on cost of equity only

  • GAAP Accounting Was Never Intended to Reflect Value

    • GAAP accounting captures utilization of assets and capital at work

    • Value is based on capacity, not utilization

    • Accounting is backward looking • Value is forward looking

    Presenter Presentation Notes END: So what pieces of information are we needing?

  • Analyzing the Business Enterprise

    Presenter Presentation Notes Personnel: Develop healthy culture—hire the best talent available and build your organization around what that talent wants– keep and motivate good people Products/Services: Consumables? Management: consistent chart of accounts; compiled, reviewed or audited statements; no discretionary items; stop tax planning; remove personal assets/liabilities Share of Market: develop large number of independent customers Systems: Document them!

  • What’s Different? The DCF Method reflects the future business plan for the business:

    • Models the business’s future expected performance

    • More detailed cash flows • Allows for varying capital expenditures • Allows for varying working capital needs • Allows for cost of capital that includes debt

    and equity (weighted average cost of capital)

  • Discounted Cash Flow Projections Projections

    Normalized Year 1 Year 2 Year 3


    Revenues $7,600,000 $8,512,000 $9,873,920 $9,478,963 12% 16% -4%

    Cost of Goods Sold 6,080,000 6,809,600 7,899,136 7,583,171

    Gross Profit 1,520,000 1,702,400 1,974,784 1,895,793

    Operating Expenses Payroll 760,000 775,200 790,704 866,518 Payroll Taxes 68,400 69,768 71,163 78,587 Rent 38,000 38,760 39,535 40,326 Utilities 12,000 12,240 12,485 12,734 Telephone 12,000 12,240 12,485 12,734 Professional Fees 34,000 34,680 35,374 36,081 Interest Expense 46,000 43,384 39,743 35,915 Depreciation 24,000 26,143 30,429 34,714 Total Operating Expenses 994,400 1,012,415 1,031,917 1,117,610

    Net Operating Income $525,600 $689,985 $942,867 $778,183 EBITDA 595,600 759,512 1,013,038 848,812

  • Developing Equity Capitalization Rate

    Risk Free Rate 4.00 Equity Risk Premium 5.00 Industry Risk Premium 4.20 Size Premium 9.00 Specific Company Risk 4.00 Total Expected Return 26.20

    Less long-term growth (3.0