How to Value Your Business in 20 Minutes November 5, 2013

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2 November 5, 2013

3 Overview This Webinar + DCF Template = Fast and Simple Company Valuation What is this webinar designed to do? Give you a crash course on how to use the discounted cash Dlow ( DCF ) valuation template to determine the value of your business This goes hand- in- hand with Axial s 20 Minute DCF Excel Template Provide a quick, easy, simple calculation of your company s value Rely on the minimum number of inputs necessary to arrive at an answer Involves 12 inputs Allow you to run sensitivities around the inputs Who is this webinar for? Business owners CEOs, CFOs, COOs, VP Finance, Treasurers, Partners, Owners, etc. Anyone that is curious about the value of their business Beginning Dinance professionals Those curious about business valuation from a very tactical (i.e., not theoretical perspective) 3

4 Leading the Webinar Kateri Y. Zhu Kateri Zhu leads inbound marketing to investment bankers, advisors, private equity funds, mezzanine capital providers, and commercial lenders for Axial. Prior to Axial, she was a private equity associate responsible for evaluating and executing take- private transactions at Mill Road Capital. Previously, Kateri worked as an investment banker in the Healthcare group at Morgan Stanley in New York City. She holds a B.A., phi beta kappa, cum laude, in Political Science and Economics from Duke University. 4

5 What is a Discounted Cash Flow Analysis? The DCF is one of the most commonly- used methods to value a business Used by investment bankers, private equity funds, venture capital, hedge funds, asset managers, equity research, corporate Dinance professionals, etc. What is a Discounted Cash Flow ( DCF ) analysis? One of the most fundamental, popular, and broadly used methods to determine the value of a company Developed and supported in academia and very widely utilized in practice Based on the concept that the value of a business is the sum of its expected future free cash Dlows, discounted to the present day at an appropriate rate Thus the valuation requires (a) a projection of future cash Dlows and (a) a determination of this discount rate for your business How does a DCF work? Takes all the projected future cash Dlows from your business and determines what an investor would pay for the aggregate sum of these cash Dlows today (e.g., by buying your company) These cash Dlows are discounted back to the present based on the: Time value of money (i.e., a sum of money received today is worth more than the same amount received in the future due to its potential earning capacity) The risk in the cash Dlows 5

6 Word of Warning: Power of Assumptions The DCF is a very powerful tool Based on the intrinsic value of a company Less vulnerable to market conditions and non- economic factors Thus theoretically the most defensible valuation methodology Highly useful for valuing whole businesses, parts of businesses, or projects with Dinite lives However the output is very sensitive to assumptions: Long term growth rate Discount rate Moreover it works best with realistic Dinancial projections over at least one business cycle, i.e., 7 to 10 years, or until cash Dlows are normalized In this template, you re only asked for one year of Dinancials However, the greater the years of accurate projections you include, the more sound your valuation 6

7 What it Means: Power of Assumptions The quality of the output is dependent on the accuracy of the inputs Your Forecast + Your Assumptions = Your Value The number you get is only as reasonable as the forecast and assumptions used to build it Small differences in assumptions will have exponential effects on the outcome E.g., Overstatement of the steady state growth rate of your business will erroneously and dramatically indlate your answer Avoid this pitfall by being conservative Be conservative on all assumptions: Operating Dinancials (Revenue, EBITDA, Depreciation, etc.) Long term growth rate Discount rate 7

8 Inputs: Step-by-Step Valuation Date The date of your valuation This determines the period of time over which the template will discount your future cash Dlows; the further in the future the cash Dlows are received, the less they re worth today End of Last Fiscal Year This is the end of the last complete Discal year For most of us this is December 31 st, which would mean an input of 12/31/2012 However given that it is November 5 th most of us have a solid sense of how our 2013 Dinancials will come in and can therefore start with 12/31/2013 For those of us in industries with heavy selling in certain months, it may not be December 31 st E.g., retailers often close their books at the end of January This affects both the future years and the discount periods 8

9 Inputs: Step-by-Step (continued) Revenue The amount of money that your company actually received in the most recent Discal year, including discounts and deductions for returned merchandise Revenue = Price per good or service x Number of units sold Also referred to as your topline or gross income From which all costs are subtracted to determine net income EBITDA Your earnings before interest, taxes, depreciation, and amortization EBITDA = Revenue Expenses (excluding interest, taxes, depreciation, amortization) Common measure of proditability between companies and industries because it backs out the effects of Dinancing and accounting differences 9

10 Inputs: Step-by-Step (continued) Depreciation and amortization are added back to Net Operating ProDit After Tax ( NOPAT ) to get FCF because they are non- cash charges; i.e., do not actually detract from your cash Dlow Depreciation The annual deduction in value of your long term tangible assets based on their useful value Used to spread, or smooth, the value of an asset as a business expense over the life of the asset Important in a DCF because it is a non- cash charge Examples: Equipment, machinery, etc. Not examples: Supplies, accounts receivable, etc. Amortization The annual deduction in value of your long term intangibles assets based on the asset s life Examples: Patents, copyrights, etc. 10

11 Inputs: Step-by-Step (continued) Capital Expenditures The amount of money spent on buying or upgrading tangible, i.e., physical, assets in the last year Funds spent on maintaining assets at the current condition are not capital expenditures Examples: property, facilities, buildings, industrial machinery, etc. Can include everything from repairing a roof to building a factory from the ground up Net Working Capital Working Capital = Current Assets Current Liabilities Represents operating liquidity available to a business or, in other words, the short term assets your company has to cover its short term capital needs Highly relevant because an increase in working capital has a negative impact on free cash Dlow ( FCF ) 11

12 Inputs: Step-by-Step (continued) Discount Rate Important element of the DCF given the impact on valuation The weighted average percentage rate a which a company can borrow money How much money a company has to pay for every dollar it Dinances Basis of the discount rate: In order to run a business, companies often need to borrow capital and put it to work The two primary providers of capital are equity and debt investors However these providers require a certain return on their investment Therefore the discount rate is based on the fact that an investor whether debt or equity contributes capital with the expectation that the riskiness of cash Dlows will be offset by an commensurate return ReDlects the rate of return on an investment required by capital providers, taking into account the risks accompanying the investment and the opportunity cost associated with putting their dollars elsewhere All else equal, equity investors expect a higher return than debt investors Typically estimated by analyzing capital costs of investments with similar industry attributes, business characteristics, operating prodiles, and risk prodiles relative to your business 12

13 Inputs: Step-by-Step (continued) Short Term Revenue Growth Rate How much you expect your sales to grow on an annual basis over the short term (i.e., the next 5 to 10 years) For the purpose of this template, how much you expect your sales to grow next year on a percentage basis Long Term Revenue Growth Rate How much you expect your sales to grow on an annual basis after it reaches steady state growth, i.e., after the business has normalized In steady state, growth typically slows to below the nominal GDP growth rate but above indlation (unless the industry as a whole - - is declining) Thus, your Digure should be above indlation and below the nominal GDP growth rate A classic input error is assuming Long Term Growth equal to or above nominal GDP growth A business is not going to grow faster than the economy into perpetuity Tax Rate The percentage at which your corporate earnings are taxed For most of us this will be 35% 13

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