Francisco Frank Rosillo, CPA/ABV, ABAR, CBA, CVA, MAFF, CFE, CFF. The Valuations & Forensics Advisory, LLC. Miami, Florida Frosillo@valfor.

Transcription

1 Francisco Frank Rosillo, CPA/ABV, ABAR, CBA, CVA, MAFF, CFE, CFF The Valuations & Forensics Advisory, LLC. Miami, Florida

2 DISCLAIMER All rights reserved. No part of this work covered by the copyrights herein may be reproduced or copied in any form or by any means graphically, electronically, or mechanically, including photocopying, audio/video recording, or information storage and retrieval of any kind without the express written permission of the Consultants Training Institute (CTI ), the National Association of Certified Valuators and Analysts (NACVA ), the Institute of Business Appraisers (IBA ), and the presenter. The information contained in this presentation is only intended for general purposes. It is designed to provide authoritative and accurate information about the subject covered. It is sold with the understanding that the copyright holder is not engaged in rendering legal, accounting, or other professional service or advice. If legal or other expert advice is required, the services of an appropriate professional person should be sought. The material may not be applicable or suitable for the reader s specific needs or circumstances. Readers/viewers may not use this information as a substitute for consultation with qualified professionals in the subject matter presented here. Although information contained in this publication has been carefully compiled from sources believed to be reliable, the accuracy of the information is not guaranteed. It is neither intended nor should it be construed as either legal, accounting, and/or tax advice, nor as an opinion provided by the Consultants Training Institute (CTI), the National Association of Certified Valuators and Analysts (NACVA), the Institute of Business Appraisers (IBA), the presenter, or the presenter s firm. The authors specifically disclaim any personal liability, loss, or risk incurred as a consequence of the use, either directly or indirectly, of any information or advice given in these materials. The instructor s opinion may not reflect those of the CTI, NACVA, IBA, their policies, other instructors, or materials. Each occurrence and the facts of each occurrence are different. Changes in facts and/or policy terms may result in conclusions different than those stated herein. It is not intended to reflect the opinions or positions of the authors and instructors in relation to any specific case, but, rather, to be illustrative for educational purposes. The user is cautioned that this course is not all inclusive National Association of Certified Valuators and Analysts (NACVA). All rights reserved South State Street, Suite 400, SLC, UT, The Consultants' Training Institute (CTI) is registered with the National Association of State Boards of Accountancy (NASBA) as a sponsor of continuing professional education on the National Registry of CPE Sponsors. State boards of accountancy have final authority on the acceptance of individual courses for CPE credit. Complaints regarding registered sponsors may be submitted through its web site: learningmarket.org National Association of Certified Valuators and Analysts (NACVA) 2

3 The objectives of this presentation are: To help you make better use of Market Data in your valuation reports To help you articulate key Market Data concepts to stakeholders in the valuation of Privately Held Companies 2015 National Association of Certified Valuators and Analysts (NACVA) 3

4 Market Income Asset Indications of Value 2015 National Association of Certified Valuators and Analysts (NACVA) 4

5 Value Conclusion Methodology 1- Indication of Value Methodology 2 - Indication of Value Methodology 3- Indication of Value Methodology 4 - Indication of Value 2015 National Association of Certified Valuators and Analysts (NACVA) 5

6 According to Dr. Shannon P. Pratt: The market approach is especially relevant if the standard of value is fair market value. The Market Approach is relevant because it uses observable factual evidence of actual sales of other properties to derive indications of value. It is, of course, important to insure that the transactions used for guidance are sales on an arm s length basis, assuming that the buyers and sellers are each acting in their own self-interest. (*) The theoretical application of the market approach is to allow the valuation analyst to use a group of surrogate companies to determine valuation relationships applicable to the appraisal Subject. (*) Pratt, Shannon P. The Market Approach to Valuing Businesses. Wiley and Sons N.Y., N.Y National Association of Certified Valuators and Analysts (NACVA) 6

7 These surrogate comparisons are grounded on the economic principle of substitution. Namely, that an investor would not pay more for an investment than what an equally desirable substitute investment would sell for. In the application of the Market Approach, the valuation analyst analyzes a group of similar surrogate companies, either publicly traded or privately owned. Surrogate comparisons can be made using either Subject Based Methods, such as the Guideline Company Method, where a subject company is compared to a group of guideline companies used as a proxy for the marketplace for similar interests, or Market Based Methods, such as the Direct Market Data Method, where the market valuation inferences are based on the market of available surrogate transactions taken as a whole, i.e., as a representative sample of the market where similar interests are sold National Association of Certified Valuators and Analysts (NACVA) 7

8 Court Case Digests Lost Opportunity Damages Calculated Using Direct- Market- Data Method Date of decision: 2/20/2002 State or Federal: State Type of action: Contract Sourced from: This abstract originally appeared in Valuation Case Digest, authored by John J. Stockdale, Jr. In Patricia Stevens, et al. v. Robert Levi Wilmoth, Jr., No. CA (Ark. App. February 20, 2002), unpublished, the Arkansas Court of Appeals considered an award of damages flowing from a breach of contract. Stevens owned Best Care Health Services, a hospice. She entered into an employment agreement with Wilmoth. Under the agreement, Stevens agreed to employ Wilmoth for two years at an annual salary of $48,000 and provide health insurance coverage for his family. The court also received testimony from a CPA, accredited in business valuation, as to the monetary damages. The expert calculated the amount of lost insurance premiums, based on Wilmoth's pay stubs, to be $3, The court also awarded Wilmoth $10,917 for his lost income. The court lastly received evidence of Wilmoth's damages for the lost opportunity of operating the hospice during The CPA expert calculated Wilmoth s damages for lost business opportunity using the direct-market-data method. Under the method, he determined the value of the business using a market approach. On appeal, Stevens argued, among other issues, that the damages for lost opportunity were improperly calculated. She specifically claimed that the damage award should have considered the business's gross revenues, expenses, and net profits. The appellate court disagreed. It noted that the expert "stated that using [the direct-marketdata] method gives one a realistic appraisal of the business's value, and that expenses and net profits have no relevance to it." 2015 National Association of Certified Valuators and Analysts (NACVA) 8

9 In a well developed Valuation Report, Market Data is Everywhere!!! 2015 National Association of Certified Valuators and Analysts (NACVA) 9

10 Economic Data is full of market data Industry Data is based on market metrics Market Data is used in one form or another in the Methodologies selected under any of the Approaches to Valuation Many Key Valuation Concepts are also based on Market Derived inputs 2015 National Association of Certified Valuators and Analysts (NACVA) 10

11 We need to go beyond the traditional valuation thought process, and appropriately assess market data, wherever it appears and not just in the application of a market approach methodology National Association of Certified Valuators and Analysts (NACVA) 11

12 Sec. 4. Factors To Consider..01 It is advisable to emphasize that in the valuation of the stock of closely held corporations or the stock of corporations where market quotations are either lacking or too scarce to be recognized, all available financial data, as well as all relevant factors affecting the fair market value, should be considered. The following factors, although not all-inclusive are fundamental and require careful analysis in each case: (h) The market price of stocks of corporations engaged in the same or a similar line of business having their stocks actively traded in a free and open market, either on an exchange or over-the-counter National Association of Certified Valuators and Analysts (NACVA) 12

13 We must know enough information about the Market, before we can intelligently make a decision to use market data. The market experience of freely tradable securities of the same class as the restricted securities is also significant in determining the amount of discount. Whether the shares are privately held or publicly traded affects the worth of the shares to the holder. Securities traded on a public market generally are worth more to investors than those that are not traded on a public market. Moreover, the type of public market in which the unrestricted securities are traded is to be given consideration. (Emphasis added) (Sourced from Revenue Ruling , Sec. 6. Weighing Facts and Circumstances Material to Restricted Stock Valuation, Paragraph 4) 2015 National Association of Certified Valuators and Analysts (NACVA) 13

14 Now that you have an appreciation that market data may appear throughout a valuation report, and not just in the application of a market approach methodology, the next step is to understand when and how market data should be utilized. Two Basic Requirements can be gleaned from Revenue Ruling and Revenue Ruling Namely, if market data is used, whenever appropriate, the following criteria should be established: 1) Similarity 2) Relevancy-(Note: As part of establishing relevancy, you must also Understand the attributes of the Markets from which inferences are drawn, and/or where guideline transactions originate.) 2015 National Association of Certified Valuators and Analysts (NACVA) 14

15 According to the Institute of Business Appraisers (Underlined Italics added by Presenter): 1. "Similar" refers to the nature of the business being appraised. It encompasses business attributes, (factors affecting a Company), such as: a. business size b. markets served and related demographics c. depth of management d. information processing systems e. level of technology utilization f. probable future earnings growth, etc. 2. "Relevant" refers to the desires and expectations of the probable "willing buyer" or investor (i.e., how markets respond to trends). This includes: a. risk tolerance (degree of risk assumed) b. liquidity of investment c. degree of management involvement d. probable holding period, etc National Association of Certified Valuators and Analysts (NACVA) 15

16 IBISWorld Domestic Airlines Market Research Report NAICS 48111b Dec 2014: IBISWorld s Domestic Airlines market research report is a comprehensive guide to market size and growth prospects. Our industry reports offer strategic industry analysis of the factors influencing companies, including: new product developments, economic, lifestyle and demographic influences, distribution and supply chain factors, and pricing issues. Full analysis accompanies our data forecasts to illustrate how the market responds to emerging industry trends National Association of Certified Valuators and Analysts (NACVA) 16

17 The D6 Factor (Sixth District Common Economic Factor) is an index of the trends common to 48 distinct monthly series of economic data for the six states that lie entirely (Alabama, Florida, Georgia) or partly (Louisiana, Mississippi, and Tennessee) within the Sixth Federal Reserve District. (This indicator was introduced and described in detail in a 2007 Economic Review article. A revised methodology for the index, with an expanded data set and sample estimation period, was introduced in a 2009 Economic Review article.) The D6 Factor provides a broad measure of the Southeast's economic conditions that is timelier and available at a higher frequency than estimates of gross domestic product (GDP) for Sixth District states made by the U.S. Bureau of Economic Analysis. Moreover, unlike an average of state-level GDPs or other factors, the D6 Factor is able to filter out idiosyncratic shocks that disproportionately affect individual states. The D6 utilizes monthly composites of: Employment. The employment statistics used include total nonfarm payroll employment and the unemployment rate for all six southeastern states. Housing. The housing statistics employed include the number of housing starts as well as the number of housing permits awarded per month per covered state. Income. States sales tax receipts and personal income are the series used to account for variations in disposable income throughout the business cycle. Industrial Activity. The average number of hours worked in manufacturing and the industrial electrical consumption per state National Association of Certified Valuators and Analysts (NACVA) 17

18 Note: The growth rate is normalized to zero. Source: Federal Reserve Bankof Atlanta 2015 National Association of Certified Valuators and Analysts (NACVA) 18

19 Market Data is used in all Approaches to Valuation and in one form or another, in the Methodologies selected. Adjusted Book Value Method a method within the asset approach whereby all assets and liabilities (including off-balance sheet, intangible, and contingent) are adjusted to their fair market values, if under the FMV standard. Guideline Public Company Method a method within the market approach whereby market multiples are derived from market prices of stocks of companies that are engaged in the same or similar lines of business and that are actively traded on a free and open market. Discounted Cash Flows and Capitalization Methodologies income approach methods typically relying on some form of/or derivation from Cost of Capital metrics which are based on the expected rate of return that the market requires in order to attract funds to a particular investment National Association of Certified Valuators and Analysts (NACVA) 19

20 Equity Risk Premium a rate of return added to a risk-free rate to reflect the additional risk of equity instruments over risk free instruments (a component of the cost of equity capital or equity discount rate). Financial Risk the degree of uncertainty of realizing expected future returns of the business resulting from financial leverage. Investment Risk the degree of uncertainty as to the realization of expected returns. Price/Earnings Multiple the price of a share of stock divided by its earnings per share. Required Rate of Return the minimum rate of return acceptable by investors before they will commit money to an investment at a given level of risk. Systematic Risk the risk that is common to all risky securities and cannot be eliminated through diversification. The measure of systematic risk in stocks is the beta coefficient. Unsystematic Risk the risk specific to an individual security that can be avoided through diversification. Weighted Average Cost of Capital (WACC) the cost of capital (discount rate) determined by the weighted average, at market value, of the cost of all financing sources in the business enterprise's capital structure National Association of Certified Valuators and Analysts (NACVA) 20

21 Valuation Adjustments, must also meet the Similar & Relevant criteria: Discount for Lack of Marketability (DLOM)* an amount or percentage deducted from the value of an ownership interest to reflect the relative absence of marketability. Discount for Lack of Control (DLOC)* an amount or percentage deducted from the pro rata share of value of 100% of an equity interest in a business to reflect the absence of some or all of the powers of control. Note: Pre-IPO, Restricted Stock Studies and Mergerstat get their data from the Markets. *Source: International Glossary of Business Valuation Terms 2015 National Association of Certified Valuators and Analysts (NACVA) 21

22 A Capitalization Rate is an inverse of a Price/Earnings Multiple P/E Ratios are affected by economic and industry outlooks, as well as a subject s operating results Market Derived Growth Rates affect all approaches Terminal Values may be assessed for reasonableness on the basis of projected market multiples 2015 National Association of Certified Valuators and Analysts (NACVA) 22

23 Income Market Asset 2015 National Association of Certified Valuators and Analysts (NACVA) 23

24 We must know enough information about the Market, before we can intelligently make a decision to use market data. 1) Identify the Market Place from which the data is derived 2) Defining the Attributes of those Markets 3) Establishing the Relevancy of the Criteria to be used for Comparisons 2015 National Association of Certified Valuators and Analysts (NACVA) 24

25 Beware of Differences in Business Cycles, Differences in Demographics, Regulatory Issues Inadequate Sample Sizes Adjustments to Market Multiples i.e., Effect of Non-Compete Agreements, Non-Recurring items Beware of Market Multiple sensitivities due to Size in terms of Revenue Levels, Asset Size, Number of Employees When using Market Data, Size does Matter!! Be sure to compute and use Coefficients of Variation (CV) as an aid in selecting multiples Limitation of Historical Market Multiples applied to Forecasted Benefit Streams 2015 National Association of Certified Valuators and Analysts (NACVA) 25

26 Markets provide a means to price and monetize accumulated wealth. Markets provide the liquidity necessary to effect transactions. Markets publish metrics to assess investment performance. Standards and Premises of Value are conditioned on specified market attributes assumed throughout the valuation process National Association of Certified Valuators and Analysts (NACVA) 26

27 To properly use Market Data, you should go beyond the simple selection of an overall Mean or Median Metric. Ask yourself the question: A Mean or Median of What? At the very least you should be able to stratify your market data into Upper, Middle, and Lower performance brackets and then use the appropriate multiple. Then proceed to calculate a Median, or Mean for each strata of market data National Association of Certified Valuators and Analysts (NACVA) 27

28 Index Metric Measures Trend Industry Average Company Average Growth Sales Growth Annual Compound Growth Rate Positive 4.3% 6.8% Efficiency Sales to Net Fixed Assets Ability to generate revenues Positive Efficiency Efficiency Operating Expenses to Sales Pre Tax Earnings to Total Assets Management s ability to control operating expenses Positive Profitability generated by asset base Positive Liquidity Quick Assets Management s ability to maintain adequate liquidity Negative.7.5 Liquidity Current Assets to Current Liabilities Management s ability to maintain adequate liquidity to fund operations Positive Liquidity Sales to Working Capital Management s ability to sustain operations and achieve future growth Negative Profitability Pre-Tax Profit to Sales Percentage of Pretax Income generated from each sale Positive Profitability Gross Profit from Sales to Sales Percentage of Gross Profitability generated from each sale Negative Debt & Risk Total Debt to Net Worth Company s ability to meet its obligations Positive National Association of Certified Valuators and Analysts (NACVA) 28

29 Direct Market Data Method 2015 National Association of Certified Valuators and Analysts (NACVA) 29

30 According to the Institute of Business Appraisers, when utilizing Transactional Market Data (Private Guideline Companies): There is relatively little change in the range of uncertainty as the size of the sample decreases from more than 20 to about 10. As the number of transactions falls below 10, however, the range of uncertainty becomes greater. Then, below about five transactions, the range of uncertainty begins to increase rapidly until, with only a single guideline transaction, the range of uncertainty is infinite. (1) (1) Sourced from How to Use the IBA Market Data Base, Part VIII, IBA News, Volume 17, no National Association of Certified Valuators and Analysts (NACVA) 30

31 Minimum of four to seven "good" guideline companies. (1) My recommendation: Try whenever possible to use at least ten. Why? Statistical theory says that for small sample sizes of less than 10, the range of uncertainty rises dramatically, negatively affecting a valuator s ability to derive value from the sample of guideline companies (Public or Private) (1) Sourced from Shannon P. Pratt, Robert F. Reilly, and Robert P. Schweihs, Valuing a Business - The Analysis and Appraisal of Closely Held Companies, third edition, page National Association of Certified Valuators and Analysts (NACVA) 31

32 The Market Multiples in the following example would only be appropriate if your Subject Company is operating at or near the Average Operating Levels of the 570 selected Guideline Companies. Otherwise, you may have violated the Similar & Relevant Criteria for the use of Market Data National Association of Certified Valuators and Analysts (NACVA) 32

33 All Transactions Sales DE Price Price / Sales Price / DE Low $0 ($136) $ High $8,000 $516 $13, Mean $494 $53 $ Median $365 $37 $ Harmonic Mean NA NA $ Standard Deviation $583 $71 $ Coefficient of Variation Count 1, ,934 1, Transactions Selected Sales DE Price Price / Sales Price / DE Low $24 $3 $ High $3,400 $516 $1, Mean $472 $85 $ Median $332 $68 $ Harmonic Mean $261 $44 $ Standard Deviation $455 $72 $ Coefficient of Variation Count National Association of Certified Valuators and Analysts (NACVA) 33

34 Look at the Differences in the Market Multiples of the selected transactions below, after stratifying the Market Data into four ratio limits (strata). The range of ratios: From a low Price to Sales (Price/Sales) Market Multiple of.24 to a high of National Association of Certified Valuators and Analysts (NACVA) 34

35 Price / Sales Price / DE Number of Transactions Number of Transactions Total 570 Total % Rounded to Integer 57 10% Rounded to Integer 57 25% Rounded to Integer % Rounded to Integer 143 Ratio Limits Ratio Limits 10% Upper Limit % Upper Limit % Lower Limit % Lower Limit % Upper Limit % Upper Limit % Lower Limit % Lower Limit National Association of Certified Valuators and Analysts (NACVA) 35

36 Which would be the most appropriate market metric to derive a meaningful indication of value? 2015 National Association of Certified Valuators and Analysts (NACVA) 36

37 Critical Consideration: In addition to establishing and assessing your Subject Company performance versus that of its industry peers and industry trends, you must also establish how the Subject Company compares to its market peers in order to select the appropriate corresponding market multiple. Otherwise your application of market data may be tantamount to no more than using rules of thumb National Association of Certified Valuators and Analysts (NACVA) 37

38 Price / Sales Transact 2,000 1,800 1,600 1,400 1,200 Price 1, ,000 1,500 2,000 2,500 3,000 Sales 2015 National Association of Certified Valuators and Analysts (NACVA) 38

39 Price / Sales Transact 2,000 1,800 1,600 1,400 1,200 Price 1, ,000 1,500 2,000 2,500 3,000 Sales (1) Subject Company = Annual Net Sales of $2,000,000; Derived DMDM Indication of Value of $980,000, resulting in a Price to Sales Ratio of.49 placing the Subject in the Upper 25 Strata 2015 National Association of Certified Valuators and Analysts (NACVA) 39

40 Another Illustration 2015 National Association of Certified Valuators and Analysts (NACVA) 40

41 (Another Illustration) S U B J E C T'S R E P O R T E D M E T R I C S Market Metric A n a l y t i c a l R e s u l t s Analytical Index Net Sales Reported EBITDA Reported EBITDA as a % of Sales Reported Operating Income Reported Operating Profit as a % of Net Sales Reported Return on Assets Revenue Per Employee Private Guideline Companies Sourced from Pratt's Stats Difference Difference as a % of Guideline Metric (Rounded) Statistical Index Used for Comparison Last Years' Net Sales $7,300,000 $6,900,000 $400,000 6% Harmonic Mean Last Years' EBITDA $915,000 $670,000 $245,000 37% Harmonic Mean Last Years' EBITDA As a % of Net Sales Last Year's Operating Income Last Year's Operating Income As a % of Net Sales Last Years' Return on Assets 13% 10% 3% 25% Harmonic Mean $375,000 $278,000 $97,000 35% Harmonic Mean 5% 10% -5% 50% Harmonic Mean 35% 25% 10% 40% Harmonic Mean Revenue per Employee $97,000 $77,000 $20,000 26% Harmonic Mean 2015 National Association of Certified Valuators and Analysts (NACVA) 41

42 Be sure to establish a nexus between the attending standard of value required by the engagement and the respective markets places wherein the valuation process is undertaken. Provide reasonableness testing to establish the required nexus between the market place and the application of the attending standard of value i.e., consider an Internal Rate of Return (IRR) approximation to your calculated cost of capital National Association of Certified Valuators and Analysts (NACVA) 42

43 The most common standard of value, Fair Market Value (FMV), calls for the market attributes within which the fair market valuation is to be performed: 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 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.* *Source: International Glossary of Business Valuation Terms 2015 National Association of Certified Valuators and Analysts (NACVA) 43

44 Value is the aggregate amount that best reflects the pricing and monetizing trends in the market place(s) in which the item valued participates, derived under an applicable standard of value (1) (1) Copyrighted 2015 All Rights Reserved Francisco Frank Rosillo National Association of Certified Valuators and Analysts (NACVA) 44

45 When using Market Data in your Valuation Reports: Use an appropriate sample size Make sure that the Market Data is Similar and Relevant to your Subject, as reflected in your derivation of the appropriate market multiples Know the Attributes of the Underlying Markets Beware of Limiting Factors to Consider when Assessing the Reliability of Market Data Be sure to perform an analysis that places your Subject within its Market Peers 2015 National Association of Certified Valuators and Analysts (NACVA) 45

46 Francisco Frank Rosillo, CPA/ABV, ABAR, CBA, CVA, MAFF, CFE, CFF The Valuations & Forensics Advisory, LLC. Miami, Florida