COMMUNICATING THE VALUATION REPORT

Transcription

1 COMMUNICATING THE VALUATION REPORT Dave Diehl, CFA Prairie Capital Advisors, Inc. Chieoke Moore, CPA Prairie Capital Advisors, Inc. OUTLINE OF TODAY S PRESENTATION Introduction Hiring an Independent Financial Advisor Valuation Report Basics Basic Valuation Concepts Common ESOP-Related Valuation Issues Synthetic Equity Communication Tips 2 INTRODUCTION -DETERMINING VALUE OF STOCK IN THE ESOP WORLD Valuation is at the core of all succession planning decisions including ESOPs Value and value trajectory are both relevant ESOPs exist in a regulated world An ESOPs fiduciaries may engage in purchase and sale transactions and/or set the value at least annually Independent valuations in the ESOP world require specialization 3

2 HIRING AN INDEPENDENT FINANCIAL ADVISOR What should you be looking for when hiring an independent financial advisor? Qualifications and Education Some professional credentials include: Chartered Financial Analyst (CFA) Accredited Senior Appraiser (ASA) Certified Valuation Analyst (CVA) Accredited in Business Valuation (ABV) for Certified Public Accountants (CPA) Certified Business Appraiser (CBA) 4 HIRING AN INDEPENDENT FINANCIAL ADVISOR (CONT D) What should you be looking for when hiring an independent financial advisor? Qualifications and Education (Cont d) At least a college degree or equivalent experience in a subject related to valuation, such as finance, accounting, economics or business Industry specific experience ESOP specific valuation experience Standing and reputation of the appraiser s firm 5 VALUATION REPORT BASICS Valuation opinions can be communicated to a fiduciary in the form of a business valuation report What information should be included in a business valuation report? Description of the assignment Definition of value Fair Market Value Revenue Ruling Purpose of the report (annual ESOP update for example) Level or basis of value (controlling, minority, 100%) Premise of value (going concern business) Identification of the securities to be valued 6

3 VALUATION REPORT BASICS (CONT'D) What information should be included in a valuation report? (Cont d) Name of company Form of ownership (C-corp, S-corp, etc.) Name and standing of the party hiring the appraiser Is the appraiser working for the fiduciary, or the company, or some other party? Is there a conflict? Valuation date Report preparation date 7 VALUATION REPORT BASICS (CONT'D) What information should be included in a valuation report? (Cont d) Description of the company and its position History Description of products/services Competition Strengths, weaknesses, opportunities, threats Management depth / capabilities (any weaknesses?) Employees Capital structure Board structure 8 VALUATION REPORT BASICS (CONT'D) What information should be included in a valuation report? (Cont d) General economic background Industry specific information Sources of information used Due diligence procedures used (did the appraiser perform a site visit?) Financial statement analysis Analysis of financial projections Valuation methodologies Discounts / Premiums Synthesis and Conclusion Contingent and Limiting Conditions Statement of Independence Appraisal Certification 9

4 BASIC VALUATION CONCEPTS - SOME VALUATION LANGUAGE Assets = Liabilities + Equity Invested Capital = Interest Bearing Debt + Equity + Preferred Equity + Minority Interest Net Working Capital All Other Fixed and Intangible Assets Long Term Liabilities Equity Invested Capital Value Stockholders Equity Value 10 BASIC VALUATION CONCEPTS (CONT D) Valuation is a carefully scrutinized component of many ESOPs Valuation comes down to expectations of cash Profits provide a return on your investment The more return, the more valuable the investment Profit streams can be risky that is, they may not happen Value is also impacted by external market factors The Income Approach Discounted Cash Flow Method (DCF) Capitalized Cash Flow Method Potential weakness: Are the projections reasonable and/or reliable? The discount or cap rate used The Market Approach Guideline Publicly-Traded Company Method Guideline Merged and Acquired Company Method Potential weakness: Are the comparables truly comparable? The Asset-Based Approach 11 BASIC VALUATION CONCEPTS (CONT'D) What do we look for We want to reflect the economics of The Company itself Its competitive marketplace The general economy and capital markets Our goal is to think like investors As such, we must look inside and outside of the Company 12

5 BASIC VALUATION CONCEPTS (CONT'D) What do we look for This is how the market prices stock Research analysts developing recommendations Investment bankers considering mergers and acquisitions Corporate development professionals evaluating acquisitions Sub-debt/mezzanine lenders pricing warrants on their facilities We want to MIMIC the marketplace 13 BASIC VALUATION CONCEPTS (CONT'D) What drives value? 14 BASIC VALUATION CONCEPTS -LEVEL OR BASIS OF VALUE Non-Marketable Minority Illiquid Minority Interest Gift and estate valuation Internal stock transfers Marketable Minority Value as if Publicly Traded PCA Starting Point No discounts or premiums Controlling Interest Change of control Control premium applied Synergistic premium possible Premise of Value in Valuation Non-Marketable, Controlling Interest Factors Affecting Marketability Likelihood of achieving liquidity Provisions of ESOP (put right) Financial strength and solvency Company risk Factors Affecting Premium Size Degree of control Empirical evidence of premiums Value enhancements of control Future prospects of the Company 15

6 BASIC VALUATION CONCEPTS -INCOME APPROACH DCF method is most common Modeling can vary in duration Single or multiple-year models are used All future years are valued Typically, a discrete period (usually 5 years) and a terminal value are used Revenue, expenses, reinvestment and other assumptions are reflected in the DCF What causes value change? Value changes directly as revenue and profitability expectations rise and fall Value also changes as risks and costs of capital fluctuate 16 BASIC VALUATION CONCEPTS -INCOME APPROACH (CONT D) The discount rate is used to discount future cash flow streams back to present value Time value of money Risk It is common to project the cash flow of the Company on a debt-free basis In doing so, use the weighted average cost of capital (WACC) to calculate the discount rate Projected rate of return that debt and equity holders would require to invest in this particular business 17 BASIC VALUATION CONCEPTS -INCOME APPROACH (CONT D) The WACC involves: The cost of equity The cost of debt capital Calculating the WACC by multiplying the returns required for each component of capital by its contribution to total capital Determination of an appropriate discount rate cannot be reduced to a simple mathematical formula It requires judgment and knowledge developed from experience in securities valuation 18

7 BASIC VALUATION CONCEPTS -MARKET APPROACH Guideline Publicly Traded Company Method is most common Guideline Merged and Acquired Company Method also can be useful Comparative public companies (or comparative private transactions) are selected as a representative group of alternate investments Issue in today s market: Is our company on the same path? Value may be a significant function of the company s economics Valuation multiples may include: Net Income, Cash Flow, EBIT, EBITDA, Revenue, Book Value, etc. EBIT = Earnings Before Interest and Taxes EBITDA = Earnings Before Interest, Taxes, Depreciation and Amortization 19 BASIC VALUATION CONCEPTS -EARNINGS ADJUSTMENTS In order to reflect an accurate representation of the Company s true earnings, certain items may be adjusted Income/expenses deemed to be one-time in nature Expenses that are in excess of normal market levels Expenses that will no longer occur in the future 20 BASIC VALUATION CONCEPTS -EARNINGS ADJUSTMENTS (CONT D) Examples of Adjustments/Add-backs to Earnings Excess compensation Non-continuing compensation Personal (entertainment) expenses (cars, plane, etc.) Extraordinary legal or professional fees Income / expense from discontinued operations Environmental litigation/ remediation Gain on sale of assets Investment income 21

8 COMMON ESOP-RELATED VALUATION ISSUES -ESOP VALUATION SUBTLETIES Whole companies are worth more than parts and many ESOPs own parts Entire enterprises Fractional controlling blocks of ownership Fractional minority interests Small companies are worth less than big companies Multiple of Pretax Earnings Size, public market, high growth, high visibility, etc. 22 COMMON ESOP-RELATED VALUATION ISSUES -REPURCHASE OBLIGATION ISSUES Greater ESOP % + Value = Greater Repurchase Obligation (RO) Many ESOP companies have seen this occur There are choices Redemption vs. recycle or both Pay out of corporate cash Use borrowed funds Deferred payouts Has a formal analysis been completed or been considered? 23 COMMON ESOP-RELATED VALUATION ISSUES RO GUIDING QUESTIONS How does repurchase obligation affect valuation? As an employee benefit expense As something that increases risk to the Company As something that can crowd out other important expenditures Will the Company have the operating cash flow to fund expected repurchase obligations? Will funds be saved or borrowed? If the Company saves for the future where will that money be housed? There are different tax and valuation impacts, depending on the answer! 24

9 SYNTHETIC EQUITY Common types of synthetic equity Options Warrants As financing incentive or equity participation? Stock Appreciation Rights (SARs) Phantom Stock Valuation impacts The details matter Common rules of thumb 25 COMMUNICATION TIPS Guessing Game Contests ESOP Committee Education (e.g., Appraiser Valuation Visit and Presentation) Employee Impact Discussion Others? 26 Questions? 27

10 DAVE DIEHL S BIO As Chief Operating Officer, Mr. Diehl oversees the day to day operations of Prairie Capital Advisors and the Company s Fairness Opinion Committee. On a project basis, Mr. Diehl provides closely held businesses a complete understanding of the best available options for their ownership transition needs. He expertly executes projects for mergers and acquisitions (M&A), management buyouts (MBO), Employee Stock Ownership Plans (ESOPs), estate planning and other corporate finance purposes. Mr. Diehl serves as a trusted advisor to a diverse range of clients nationwide delivering highly strategic consultation. With extensive end-to-end management experience and a focus on his clients success, Mr. Diehl helps ensure an exceptional ownership transition experience. Mr. Diehl is a CFA Charterholder and is on the board of directors of two companies a manufacturer of plastic parts and a financial consulting firm. He is also a frequent speaker in forums around the country on topics including ownership transition, valuation, capital management and business sale. Before joining Prairie Capital Advisors, Mr. Diehl was Relationship Manager/Senior Administrator in the Northern Trust Company s Wealth Management Group, specializing in advising and administering individual family relationships for families with liquid net worth in excess of one hundred million dollars. Services provided included structured equity, financial reporting, investment management, asset allocation, lending, family partnership administration, performance analysis and tax-related work. Prior to that, Mr. Diehl worked for Harris Trust and Savings Bank, providing financial reporting and performance analysis for the bank s largest relationship, a twelve billion dollar pension trust. Mr. Diehl holds a Master of Business Administration Degree in Finance from Northwestern University s J.L. Kellogg Graduate School of Management and a Bachelor of Science Degree in Marketing from Indiana University. He is a member of the ESOP Association, Business Valuation Association, National Center for Employee Ownership. In addition, he is a candidate member for the American Society of Appraisers. 28 CHIEOKE MOORE S BIO Mr. Moore operates out of Prairie Capital Advisors Atlanta office. As an Analyst, Mr. Moore performs financial analysis and modeling services, as well as analyzes the business dynamics and trends of publicly traded companies. In addition, he performs merger and acquisition (M&A) research and prepares narrative reports in support of a wide variety of valuation projects, including Employee Stock Ownership Plans (ESOP), leveraged buyouts (LBO), management buyouts (MBO) and other capital structuring projects for clients nationwide. Prior to joining Prairie, Mr. Moore was an associate in the Private Company Services (PCS) Tax group at PricewaterhouseCoopers LLP. Mr. Moore holds a Master of Taxation Degree from Georgia State University and a Bachelor of Arts Degree in Business Administration Accounting from Morehouse College in Atlanta, Georgia. He is a Level III candidate in the Chartered Financial Analyst (CFA) program of the CFA Institute. 29