Business Valuation Case Studies & Hot Topics Steve Mize – GCF Valuation Neal Patel – Reliant Business Valuation March 13, 2014
Steve Mize, ASA – GCF Valuation • Steve Mize, ASA is managing partner of GCF Valuation – a family owned and operated company specializing in business valuations to SBA lenders since 1997. • Steve’s experience includes valuation engagements for mergers/acquisitions, estate and gift tax purposes, feasibility analysis and consulting related to fairness opinions and value improvement. • Steve is a member of the American Society of Appraisers (ASA), the Institute of Business Appraisers (IBA) and the National Association of Government Guaranteed Lenders (NAGGL) and regularly conducts training through NAGGL at various national and regional conferences for SBA lenders.
• GCF Valuation is the leading provider of 3rd party business valuations to SBA lenders, performing over hundreds of business valuations to the nation’s top SBA lenders.
Neal Patel, CBA, CVA – Reliant Business Valuation •
Neal Patel, CBA, CVA is the Principal of Reliant Business Valuation, a business valuation and equipment appraisal firm specialized in SBA related valuations nationwide.
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He is a Certified Business Appraiser through the Institute of Business Appraisers (IBA) and a Certified Valuation Analyst through the National Association of Certified Valuators and Analysts (NACVA).
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Neal has extensive experience with small business valuations and financing, and firsthand ownership experience of multiple small businesses. This comprehensive experience helps him understand the intricacies of the businesses he appraises, while enabling him to add unique value to a nationwide roster of clients.
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Reliant Business Valuation is a leading business valuation and equipment appraisal firm for SBA lenders and currently works with over 100 of the nation’s top SBA lenders.
Hot Topics in Business Valuation • Changes in SOP regarding business valuation • What if the appraised value is lower than the purchase price? • Financial Statements vs Tax Returns…what to use?
Changes in SOP – Business Valuation • SOP 50 10 5(f) – Effective January 1, 2014 • Removal of CPA as a “qualified source”;
• Removal of the BV requirement for loans being used for refinance purposes (even if refinancing a seller note or private note); • Real estate appraisers also have to fall under the BV “qualified source” to appraise special use properties.
Valuation Requirements for Refinancing • NEW: A business valuation is not required when refinancing debt originally used to finance a change of ownership.
• However, “prudent lender policy” is still in effect, and lenders may still choose to request a 3rd party business valuation on larger loans. • Seller and Private notes will always be a concern.
What if the Appraised Value is Lower than Purchase Price? • A loan can still be processed under delegated authority (PLP) • SOP states: – Any amount in excess of the business valuation may not be financed with the SBA guaranteed loan • Reasons why a buyer would overpay for a business: – Buyout of an inefficient or disgruntled partner – Strategic transaction
Is the Business Appraiser Required to use Tax Returns? • The SOP uses the words “IRS Transcripts” in their direction with regards to business valuations. • However, the appraiser can choose to use whatever financials best represent the company's financial performance. • The significant point here really is to be able to determine whether the financials used in the business valuation accurately depict the operations/performance of the business for the periods in question. • Example – cash tax returns vs. accrual internal financials: – A reconciliation report between the two should be requested and should reflect marginal differences.
The Valuation Process • Cash Flow for Lenders vs. Valuations • Add-Backs & Normalizing Adjustments • Finding the SDE (Case study: Dental Practice) • Reasonable Valuation Multiples • Red Flags • Frequently Asked Questions
Cash Flow for Lending • Specific to the deal terms and the borrower’s requirements • Typically uses tax returns • Cash flow in underwriting often stated as: – Adjusted EBITDA – UCA (direct or indirect) – Cash flow available to service debt
Cash Flow for Business Valuations • Based on a hypothetical transaction • Will use most accurate financial statements available • Cash flow in valuations often stated as: – Normalized EBITDA – Seller’s Discretionary Earnings – Net cash flow
Cash Flow – Lending
Cash Flow – Valuations
Treatment of Add-backs • • • •
Add-back must be fully explained and documented; Can be discretionary in nature (an owner benefit); Can be non-recurring or “excess” for that period; Can be non-operating or not related to business being valued; • Should not be strategic; • Should not be based on “industry averages”.
Dental Practice Case Study: Calculate the EBITDA
Amortization $50,000
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Example – Calculate the EBITDA
EBITDA Calculation Net income (loss) from financials
$ 166,570
Add: Interest Add: Taxes Add: Depreciation Add: Amortization EBITDA (unadjusted)
$ 63,773 $ $ 14,790 $ 50,000 $ 295,133
Amortization $50,000
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Example – Calculate the SDE
EBITDA + Owner's Compensation + Normalizing Adjustments* = Normalized SDE *Normalizing Adjustments
Amortization $50,000
Non-Recurring Expenses Non-Business Expenses Owner's Perks Rent Adjustment
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Example – Calculate the SDE
Spouse’s Salary - $25,000
Amortization $50,00
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Example – Calculate the SDE
Appraiser's Cash Flow for Liquor Store EBITDA
$ 295,133
Add: Owner's Compensation Add: Non-Business / Owner's "Perks" Less: Non-Recurring Gain on Sale (Equipment) Add: Non-working Spouse's Salary (W2 proof) Seller's Discretionary Earnings (SDE)
$ 185,150 $ 7,024 $ (6,842) $ 25,000 $ 505,465
SDE
Spouse’s Salary - $25,000
Sales
Amortization $50,00
Margin
$ 505,465 / $ 1,328,318 = 38.1% 2014 SESBLC
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Which Multiple is Reasonable? Normalized SDE (rounded) Chosen Price / Earnings Multiple x Estimated Value (rule of thumb)
500,000 1.0 500,000
1 year return 100% ROI
Normalized SDE (rounded) Chosen Price / Earnings Multiple x Estimated Value (rule of thumb)
500,000 2.0 1,000,000
2 year return 50% ROI
Normalized SDE (rounded) Chosen Price / Earnings Multiple x Estimated Value (rule of thumb)
500,000 3.0 1,500,000
3 year return 33% ROI
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Factors that Influence the Multiple • • • • • • • •
Owner’s involvement Financial Strength Transferability of Revenues Size of Potential Buyer Pool Customer Concentration Size of Company / Revenues Growth Prospects Marketability
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Brand recognition Industry and company risk Management depth Employee retention Ease of operations Quality of clients Product mix
Which Multiple is Reasonable? Normalized SDE (rounded) Chosen Price / Earnings Multiple x Estimated Value (rule of thumb)
500,000 1.0 500,000
1 year return 100% ROI
Normalized SDE (rounded) Chosen Price / Earnings Multiple x Estimated Value (rule of thumb)
500,000 2.0 1,000,000
2 year return 50% ROI
Normalized SDE (rounded) Chosen Price / Earnings Multiple x Estimated Value (rule of thumb)
500,000 3.0 1,500,000
3 year return 33% ROI
Recognizing Red Flags and Other Considerations • Is the deal price in excess of 4x adjusted Seller’s Discretionary Earnings (SDE) or 5x adjusted EBITDA? • Is the price of the business based solely upon one year of financial statements (typically the most profitable year)? • What are quality of the financial statements? (Tax Returns, Compiled/Audited, Internal)
Recognizing Red Flags and Other Considerations • Are there any significant capital expenditure requirements that will impact cash flow? (Income approach is only method that factors in capital expenditures!) • If valuing a division or one of several locations, did you look to see if the seller “loaded up” other divisions to make the division to be sold more profitable? • If sold above high end of the range (SDE and EBITDA), look for high growth, proprietary product, management in place, and within an industry that may attract “synergistic” or strategic buyers.
Frequently Asked Questions Q: The SOP states that I need a valuation if the loan amount (minus the appraised value of the equipment and real estate) is greater than $250,000….what about working capital (cash, A/R, inventory, etc.)? A: Unfortunately, if taking the literal interpretation of the SOP, only equipment and real estate are allowed to be considered.
Frequently Asked Questions Q: How do you calculate intangible assets? A: The value of the business as per the business valuation minus the sum of the working capital and the book value of fixed assets. "intangible assets = business value – (working capital + fixed assets)“
If a USPAP compliant equipment appraisal is available, the appraised equipment can be used in lieu of the net book value of equipment.
Frequently Asked Questions Q: The seller's files a Schedule C and does not have balance sheets. How will you treat tangible vs intangible assets? A: For purposes of calculating intangible assets, if an internal balance sheet cannot be produced, the appraiser must assign the entire value of the business to intangible assets.
Frequently Asked Questions Q: The buyer is purchasing three different businesses (for example restaurants), all owned by separate companies. Can you combine them into one report? A: Yes, as long as there is one loan and the businesses are similar in nature (or the same franchise). If there are three separate loans, you need three separate valuations.
Contact Information Neal Patel, CBA, CVA Reliant Business Valuation 908.248.4658
[email protected] www.reliantvalue.com
Steve Mize, ASA GCF Valuation 813.658.3501
[email protected] www.gvalue.com
