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August 26, 2014

New Orleans, Louisiana

Presented By: Vanessa Brown Claiborne, CPA/ABV, ASA

How to Value a Good Small Business for a Great Big Price

A Presentation For:

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Table of Contents

I. Introduction to Business Valuation

II. Valuation Examples

III. Payment Methods

IV. How to Achieve a Great Big Price

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I. Introduction to Business Valuations

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Business Valuation

1. Reasons for a Business Valuation2. Analyzing Qualitative Factors3. Valuation Process

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1. Reasons for a Business Valuation

• Merger/Acquisition/Fairness Opinions• Family Succession Planning/Estate and

Gift Taxes• Employee Share Ownership Plans (ESOP)• Buy-Sell Agreements• Executive Compensation (Options/SARS)• Stock Repurchase or Recapitalization• Fair Value Accounting• Income Tax

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2. Analyzing Qualitative Factors

• Relevant economic data (Global, National, Local)• Industry factors• Competition• Regulation• Product or service lines• Supplier relationships• Market position• Management and employees• Adequacy of physical facility• Operating efficiencies and inefficiencies

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Relevant Economic Data

• National Economic Data

• Regional and Local Economic Data

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Industry Factors

• Markets• Channels of Distribution• Technology• Sources of Industry Information

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Competition

• Existing Competition

• Potential Competition

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Regulation

• Present Regulation

• Potential Changes in Regulatory Environment

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Product or Service Lines

• Existing Lines• Opportunities for Related Lines• Patents, Copyrights, Trademarks• Relative Profitability of Lines• Service or Warranty Obligations

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Supplier Relationships

• Continuity• Degree of Exclusivity• Contractual Relationships

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Market Position

• Reputation• Geographic Scope• Method of Marketing and Distribution• Pricing Policies• Customer Base• Customer Relationships• Market Continuity, Growth

Opportunities and Weaknesses

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Management and Employees

• Size and Composition of Work Force• Key Employees– Noncompete agreements– Employment contracts

• Other Employees• Compensation• Personnel Policies, Satisfaction,

Conflict, and Turnover• Management Depth

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Adequacy of Physical Facility

• Condition• Heat, Light, Plumbing, and Other

Systems• Size• Continuity of Occupancy

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Operating Efficiencies and Inefficiencies

• Physical Plant

• Accounting and Other Controls

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3. Valuation Process

• Gather company data• Site visit• Research economic and industry

information• Analyze company financial

statements• Tests of valuation• Discounts, premiums, and value

conclusion

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Standards of Value

1. Fair Market Value2. Fair Value3. Investment Value4. Intrinsic Value

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1. Fair Market Value

• The price, expressed in terms of cash equivalents, at which property would change hands between a hypothetical willing and able buyer and a hypothetical willing and able seller acting at arm’s length in an open and unrestricted market, when neither is under compulsion to buy or sell and when both have reasonable knowledge of the relevant facts (ASA BVS definition)

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2. Fair Value

• Has two different contexts:– Fair value for legal purposes• Usually defined by various authorities an

statutes

– Fair value for financial reporting purposes• The price that would be received to sell an

asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date (FASB ASC 820, formerly SFAS 157)

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3. Investment Value

• Specific value to a particular investor based on individual investment requirements– This extremely small and limited market

is typically characterized by a premium because of the unique synergies the perceived particular buyer would realize as a result of acquiring the asset

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4. Intrinsic Value

• Amount an investor considers to be “real” worth of an item based on evaluation of available facts; may be above or below fair market value

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Valuation Definitions

1. Earnings before Interest, Depreciation and Amortization (“EBITDA”)

2. Sellers Discretionary Earnings (“SDE”)

3. Enterprise Value

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EBITDA

Earnings before interest expense, taxes, depreciation and amortization

(cash flow available to all capital providers)

Net income+interest expense on long term debt+ income taxes+depreciation and amortizationEBITDA

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SDE

Seller’s Discretionary Earnings: The earnings of a business enterprise prior to the following items:• Income taxes• Depreciation and amortization• Interest expense or income• Owners total compensation for one

owner/manager after adjusting the total compensation of all owners to market value

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Total Enterprise Value

• (“TEV”) = equity + long term debt

• Pricing multiple = (Equity + LT debt)/EBITDA

• Equity = pricing multiple x EBITDA – LT debt.

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Methods and Approaches

• There are several valuation approaches in valuing a company:1. Market approach2. Income approach3. Asset approach

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1. Market Approach

• Previous sales of or offers for the Company’s stock

• Sales of similar companies• Sales of stock of publicly traded

companies• Rules of thumb

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2. Income Approach

• Discounted cash flow method

• Capitalization of earnings method

• Excess earnings method

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3. Asset Approach

• Liquidation model• Net asset value

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II. Valuation Examples

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Valuation Examples

I. Retail Boutique

II. Professional Consulting Practice

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I. Retail BoutiqueNAWBO's Couture StoreIncome Statement

Year 1 % Year 2 % Year 3 % Year 4 % Year 5 %Sales 300,000$ 103.09% 375,000$ 103.09% 431,250$ 103.09% 474,375$ 103.09% 379,500$ 103.09%

Less: Sales Returns 9,000 3.00% 11,250 3.00% 12,938 3.00% 14,231 3.00% 11,385 3.00%Net Sales 291,000 100.00% 363,750 100.00% 418,313 100.00% 460,144 100.00% 368,115 100.00%

Cost of Goods Sold 116,400 40.00% 145,500 40.00% 167,325 40.00% 184,058 40.00% 147,246 40.00%

Gross Profit 174,600 60.00% 218,250 60.00% 250,988 60.00% 276,086 60.00% 220,869 60.00%

Expenses:Advertising 6,000 2.06% 6,000 1.65% 6,000 1.43% 6,000 1.30% 6,000 1.63%Owner Salary 60,000 20.62% 60,000 16.49% 60,000 14.34% 60,000 13.04% 60,000 16.30%Clerk Salaries 9,000 3.09% 12,000 3.30% 15,000 3.59% 18,000 3.91% 21,000 5.70%Other Expenses 80,000 27.49% 85,000 23.37% 90,000 21.52% 95,000 20.65% 100,000 27.17%Rent 5,000 1.72% 5,000 1.37% 5,000 1.20% 5,000 1.09% 5,000 1.36%

Total Expenses 160,000 54.98% 168,000 46.19% 176,000 42.07% 184,000 39.99% 192,000 52.16%Net Income 14,600 5.02% 50,250 13.81% 74,987 17.93% 92,086 20.01% 28,869 7.84%

Growth in Sales. 25% 15% 10% -20%Introduce a Very Popular New Line of Clothing

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Income Approach

Year1 14,600 2 50,250 3 74,987 4 92,086 5 28,869

Terminal Value 222,069

Net Present Value $236,479

Discount Rate 18%LT Growth Rate 5%

Present Value of Cash Flows

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Market Approach

Company Multiple Mkt. MinorityPrice/Earnings 14,600 10.00 146,000 Forward PE 50,250 8.00 402,000 MV/EBITDA 50,000 6.00 300,000

(100,000) 200,000 Conclusion 249,333

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Rules of Thumb

• Rules of Thumb for Small Specialty Retail Stores– 15-20% of annual sales plus inventory– 1.8 to 2.2 times SDE plus inventory

Rule 1 Rule 2Annual Sales 291,000$ SDE 50,000 Times 20% 58,200 Times 2x 100,000

Plus Inventory 145,500 Plus Inventory 145,500 Value Indication 203,700 Value Indication 245,500

Average 224,600

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Summary Conclusion

WeightIncome Approach $236,479 45% $106,415Market Approach 249,333 35% 87,267 Rules of Thumb 203,700 20% 40,740

100%

Conclusion $234,400

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Sanity Check

• Buyer receives a loan for 60% and 80% of the purchase price with a 5 year term, and a 5% rate.Purchase Price $234,400

Loan Amt. 140,640 Equity 93,760

Year 1 Year 2 Year 3 Year 4 Year 5 Year 6EBITDA 50,000 62,500 71,875 79,063 63,250 63,250 Less Loan Pmt 32,484 32,484 32,484 32,484 32,484 - Amt for Equity 17,516 30,016 39,391 46,578 30,766 63,250

Purchase Price $234,400Loan Amt. 187,520 Equity 46,880

Year 1 Year 2 Year 3 Year 4 Year 5 Year 6EBITDA 50,000 62,500 71,875 79,063 63,250 63,250 Less Loan Pmt 43,312 43,312 43,312 43,312 43,312 - Amt for Equity 6,688 19,188 28,563 35,750 19,938 63,250

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Loan

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I. Professional Consulting PracticeNAWBO's Business ConsultingIncome Statement

Year 1 % Year 2 Year 3 Year 4 Year 5Revenue

Client Service Revenue 700,000$ 87.50% 770,000$ 88.00% 847,000$ 88.48% 931,700$ 88.95% 1,024,870$ 89.40%Professional Consultation 100,000 12.50% 105,000 12.00% 110,250 11.52% 115,763 11.05% 121,551 10.60%

Total Sales 800,000 100.00% 875,000 100.00% 957,250 100.00% 1,047,463 100.00% 1,146,421 100.00%

Expenses:Owners Comp. 250,000 31.25% 275,000 31.43% 302,500 31.60% 332,750 31.77% 366,025 31.93%Professional Comp. 150,000 18.75% 157,500 18.00% 165,375 17.28% 173,644 16.58% 182,326 15.90%Admin Comp 75,000 9.38% 82,031 9.38% 89,742 9.38% 98,200 9.38% 107,477 9.38%Marketing and Advertising 80,000 10.00% 87,500 10.00% 95,725 10.00% 104,746 10.00% 114,642 10.00%Rent 30,000 3.75% 30,000 3.43% 30,000 3.13% 30,000 2.86% 30,000 2.62%Utilities 10,000 1.25% 10,000 1.14% 10,000 1.04% 10,000 0.95% 10,000 0.87%Memberships 6,000 0.75% 6,000 0.69% 6,000 0.63% 6,000 0.57% 6,000 0.52%Consultant Bonuses 100,000 12.50% 110,000 12.57% 121,000 12.64% 133,100 12.71% 146,410 12.77%Office Supplies 10,000 1.25% 10,000 1.14% 10,000 1.04% 10,000 0.95% 10,000 0.87%

Total Expenses 711,000 88.88% 768,031 87.78% 830,342 86.74% 898,440 85.77% 972,880 84.86%Net Income 89,000 11.13% 106,969 12.23% 126,908 13.26% 149,023 14.23% 173,541 15.14%

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Income Approach

Cash Flow 150,000

Cap Rate 15.0%

Net Present Value $1,000,000

Capitalization of Earnings

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Market Approach

Company Multiple Mkt. MinorityPrice/Earnings 89,000 9.00 801,000 Forward PE 106,969 7.50 802,266 MV/EBITDA 150,000 6.00 900,000

(100,000) 800,000

Conclusion 801,089

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Rules of Thumb• Rules of Thumb for Consulting

Practice– 60.00% of annual sales

• Many consulting businesses are one-man operations or are headed by someone who has the contacts and may basically be “the business.”

• This person may be the goodwill, and without her presence the business may not be worth much.

• If this person stays while the business is slowly being transferred and an earnout is in place, the value may still be there.

Rule 1Annual Sales 800,000$ Times 60.00%Value Indication 480,000

Source: 2014 Business Reference Guide

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Summary Conclusion

WeightIncome Approach $1,000,000 45% 450,000 Market Approach 801,089 35% 280,381 Rule of Thumb 480,000 20% 96,000

100%

Conclusion $826,400

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III. Payment Methods

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Payment Methods

• Cash

• Percentage of Retained Revenue/Earnout

• Seller Note

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Example of Earnout

• Receive 33% of Retained Revenue each of the next 3 years.

Year 1 Year 2 Year 3Revenue 600,000 480,000 450,000 Payment 198,000 158,400 148,500 Total Payout $504,900

Present Value @ 18% $307,298

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IIII. How to Achieve a Great Big Price

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Big Value

• Keywords: Predictability & Growth• Business can run without the seller or seller can

stay on and successfully train buyer• Reliable financial statements• Customer contracts or long-term relationships• Secure, exclusive supply agreements• Location-ownership of property or long-term

lease• Ability to increase future cash flow by

– Expanding product line, hiring more employees, expanding geographic market, etc.

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Vanessa Brown Claiborne, CPA/ABV, ASAvbrown@chaffe-associates.com

Chaffe & Associates, Inc.201 St. Charles Ave.

Suite 1410New Orleans, LA 70170

www.chaffe-associates.com