BUSINESS VALUATION - Nuts and Bolts
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1 BUSINESS VALUATION - Nuts and Bolts CA RAJIV SINGH FCA, LIFA(USA),CISA(USA) CO-FOUNDER EXPLICO CONSULTING rajivsinghfca@gmail.com
2 AGENDA Business valuation introduction Valuation-Art or Science? Business Valuation how to define? Valuation standards Business Valuation Process Valuation Purpose Standard of Value Valuation Case Laws Valuation Myths
3 BUSINESS VALUATION Introduction Some men know the price of everything and the value of nothing - Oscar Wilde It s better to be roughly right than to be precisely wrong - J.M. Keynes It s stupid the way people extrapolate the past and not slightly stupid, but massively stupid -Charlie Munger
4 BUSINESS VALUATION Introduction Appraisers have a value in mind before they start the process and try to back into it Aswath Damaodaran, Jan 14,2009 There is a vast difference between understanding something well enough to buy it as opposed to understanding it well enough to sell it. Zig Ziglar, Secrets of Closing the Sale, 1984 The numbers are never a whole story, only a starting point. We must always remember that market research, no matter how well done, is based on the past. We are always susceptible to discovering a truth whose time has gone. Mark A. Johnson, The Random Walk and Beyond, 1988
5 BUSINESS VALUATION: Arts or Science BV is promoted as more Art than Science. The art is professional judgement and science is statistics. Art is nebulous and synonyms with subjective judgement. Valuation conclusions are susceptible to challenge when based mainly on professional judgement. Professional judgement should be the method applied to evaluate relevance & reliability of data, applied methodology and the inference derived thereon. Professional judgement is not a substitute for properly applied statistical methods analysis and logical reasoning.
6 BUSINESS VALUATION: Arts or Science A judicious man uses statistics, not to get knowledge, but to save himself from having ignorance foisted upon him. [ Thomas Carlyle ] A relevant and reliable valuation conclusion is the product of the analysis of historical financial data, economic, industry and comparative data. The requisite financial analysis can not be performed absent applied statistical method. The analysis is most important how you took the data, analysed it, and wed it to your conclusion. I want transparency; I want to see your thinking because that s what appellant courts want to see from me - [ Judge David Laro ]
7 BUSINESS VALUATION - how to define? Business Valuation An act or process of determining the value of a business, business ownership interest, security or intangible assets {The International Glossary of Business Valuation Terms} Alternative Definition Business Valuation is a logical, defendable process of arriving at the opinion as to the worth of a business given the information available, assumption & limiting conditions as on the valuation date
8 Bus ines s Valuation s tandards BVS are basically codes of practice that are used in business valuation The standards are very similar in terms of content and terminology, including a dependence on the eight factors to consider in business valuation which are listed and discussed in IRS Revenue Ruling 59-60
9 Bus ines s Valuation s tandards Need To promote best practices and fairness in valuation services To promote credibility, relevancy & transparency of valuation information. To enhance quality, consistency, comparability and uniformity of valuation practice To enhance reliance on the valuation amongst stakeholder To improve corporate governance To improve public confidence in valuation To improve market efficiency Enhance market knowledge and understanding
10 Valuatio n s tandards
11 Valuatio n s tandards
12 Valuatio n s tandards
13 BUSINESS VALUATION PROCESS Define Valuation Assignment Information Collection Subject interest to be valued Ownership characteristics Valuation date Site visits & Entrance conference Environmental Scan Global Economy Domestic Economy Industry overview Company overview & historical financial analysis Purpose Standard of value Premise of value Deliverables Limitations Special instructions.
14 BUSINESS VALUATION PROCESS Company strategy & risk analysis Selection of approaches & methods Prospective analysis Income approach Market approach. Asset based approach Discounts & Premiums Value calculation & sanity check Value Conclusion
15 PURPOSE OF VALUATION Purpose of valuation Examples Valuation for transactions Business purchase, Business sale, M&A (Mergers & Acquisition), Reverse merger, Recapitalization, Restructuring, LBO (Leverage Buy Out), MBO (Management Buy Out), MBI (Management Buy In), BSA (Buy Sell Agreement), IPO, ESOPs, Buy back of shares, Project financing and others Valuation for court cases Bankruptcy, Contractual disputes, Ownership disputes, Dissenting and Oppressive shareholder cases, Divorces cases, Intellectual property disputes and other Valuation for compliances Valuation for planning Fair value accounting, Tax Issues, DCF valuation under FEMA Estate planning, Personal financial planning, M&A planning, strategic planning
16 STANDARD OF VALUE a definition of type of value being sought The identification of the type of value being utilised in a specific engagement The International Glossary of Business Valuation Terms Types of Standards of Value Fair Market Value (FMV) Investment Value Intrinsic Value Fair Value Market Value
17 STANDARD OF VALUE Selecting Standard of Value Subject matter of Valuation Purpose of Valuation Statute Contracts Case Laws Circumstances Professional judgement & Experience
18 Fair Market Value (FMV) As defined by Statement on Standards for Valuation Services Issued by the AICPA 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 arms 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.
19 Fair Market Value (FMV) As defined by Revenue Ruling 59-60, the price at which the property would change hands between a willing buyer and a willing seller when the former is not under any compulsion to buy and the latter is not under any compulsion to sell, both parties having reasonable knowledge of the relevant facts.
20 Fair Market Value (FMV) Cash or Cash equivalent: Price without any financing support or special concession and contemplates prevalent economic & market condition on the valuation date. Hypothetical: does not contemplate real but refer Potential Willingness: motivated and assets would be exposed to the market for a reasonable period Arm s length: third Party
21 Fair Market Value (FMV) Open & unrestricted market: excludes specific buyer One transaction involving a willing buyer & seller can not establish a market price Able : pushes value downward No Compulsion: Forced conditional transactions excluded Reasonable Knowledge of facts: Average knowledge & not specific knowledge
22 Fair Market Value (FMV) What Hypothetical Sale Transaction Contemplate Does not contemplate Price is cash or cash equivalents at the prevailing economic condition Willingness and ability to buy sell exist No compulsion to accept the deal Potential buyers of similar assets exist Reasonable time and knowledge exist No separate price for not to compete Plan to sell to a particular buyer and adopting a planned strategy Buyer have specific knowledge Engagement of experienced and well connected negotiator get a favorable deal Other benefits attached with the deal like making available finance or key persons
23 INVESTMENT VALUE Value to a particular investor based on individual investment requirements & expectations The International Glossary of Business Valuation Terms Investment value may be more than FMV or less than FMV
24 FMV VS. INVESTMENT VALUE FMV Consensus opinion of market participants Investment Value Opinion of a specific investor Sale is always contemplated Sale is not necessary Hypothetical investor Specific investor Impersonal Personal DLOC & DLOM may apply Control premium & synergy premium apply
25 Factors creating difference between FMV and Investment Value Estimation of cash flows Risk Tax Product synergy & cannibalisation Other strategic advantages
26 VALUATION CASE LAWS Before 1983 Delaware Block method (DBM) A mechanical combination of three approaches net asset, market and earning Step I: determine the value under three approaches. Step II: assign a percentage weight to the values derived in step I considering nature of the business. Step III: calculate the weighted average of the three valuations -this is the fair value or appraised value of the business.
27 After 1983 Weinberger VALUATION CASE LAWS Judicial birth of DCF & demise of DBM more liberal approach must include proof of value by any technique or methods that are generally considered acceptable to financial community Did not prohibits DBM but allowed other methods
28 Valuation case laws India 1.Mahadev Jalan, Wealth Tax, 1972 (SC) Break-up value for going concern is nor correct. Court laid down principles of valuation 2.Kusumben Mahadevia, Gift Tax 1979(SC) Reinforced principles laid down in the Mahadev Jalan
29 Valuation case laws India 3.Bharat Hari Singhania, wealth tax, 1994 (SC) Court recognised practical difficulties in application of principles of Mahadev Jalan 4.HLL, Companies Act 1994(SC) All or combination of methods can be applied for fair value
30 Valuation case laws India 5.Miheer Mafat Lal, Companies Act, 1996 (SC) Fair exchange ratio based on manageable profit method, net worth or break up method and market value accepted 6.Mrs Renuka Datla, Companies Act 2003(SC) DCF is acceptable Combination of methods accepted Intrinsic value cannot include control premium
31 Valuation Myths Valuation is objective Valuation is a science Valuation gives precise number A single valuation serves more than one purpose A complex financial model gives better valuation Growth in earning increases value Valuation is worthless as it involves lot of assumptions All valuation approaches and methods apply in all situations There is single definition of value
32 Send feedback & suggestions at
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