Business Valuations for SBA Lending

Transcription

1 Business Valuations for SBA Lending 2 nd Annual Lenders Conference Minnesota District SBA Office September 4, 2014 Chuck Miller, CBA cmiller@affirmedvaluation.com

2 Appraiser s Professional Bio Chuck Miller, CBA is the founder of Affirmed Valuation Services, a Minnesota based business valuation firm specializing in SBA related valuations. He is a Certified Business Appraiser (CBA) through the Institute of Business Appraisers (IBA). He has provided valuation advisory services for closely held companies since 2005 in addition to possessing several more years of financial and valuation experience. Chuck has conducted hundreds of business valuations for companies across a wide range of industries with annual revenues ranging from startup to over $700 million including main street businesses to publicly traded companies.

3 Overview SBA Requirements When is a Valuation Required? Other Business Valuation Requirements What if the Appraised Value is Lower than the Purchase Price? 100% Control or Minority Interest? Recent SOP Changes Major Screen Out Reasons The Valuation Process The Engagement Business Valuation Basics Fair Market Value versus Investment Value Three Approaches to Value: Income, Market, Asset/Cost Using the Income Approach Income Normalization Adjustments Using the Market Approach Valuation Rules of Thumb

4 When is a business valuation required? Per the SOP (pages ): If the amount being financed (including any 7(a), 504, seller, or other financing) minus the appraised value of real estate and/or equipment is greater than $250,000; or If there is a close relationship between the buyer and seller (for example, transactions between family members or business partners), the lender must obtain an independent business valuation from a qualified source. Then: The lender must obtain an independent business valuation from a qualified source.

5 When is a business valuation required? EXAMPLE: 1 2 Total Deal Purchase Price $1,000,000 $1,000,000 Buyer/Borrower Equity $250,000 $250,000 Financing/Loan Amount $750,000 $750,000 Real Estate & Equipment Value $450,000 $550,000 Remaining Business Financed $300,000 $200,000 BV Required? Yes No

6 What is a Qualified Source? Per the SOP: A qualified source is an individual who regularly receives compensation for business valuations and is accredited by one of the following recognized organizations: Accredited Senior Appraiser (ASA) accredited through the American Society of Appraisers; Certified Business Appraiser (CBA) accredited through the Institute of Business Appraisers; Accredited in Business Valuation (ABV) accredited through the American Institute of Certified Public Accountants; and Certified Valuation Analyst (CVA) or Accredited Valuation Analyst (AVA) accredited through the National Association of Certified Valuation Analysts.

7 Other SBA Requirements for Bus. Val. Requested by and prepared for the lender. Lender may not use a business valuation prepared for the applicant or seller. Valuation must identify whether stock or asset purchase and specific enough to know what is included in the sale. Must include the appraiser s: Opinion of value Qualifications of appraiser Certification with signature

8 Other SBA Requirements for Bus. Val. Lender may use a going concern appraisal if financing a special use property (e.g. hotel, carwash, gas station, golf course). Note: the appraiser must still be certified in business valuation and the values must be allocated between land, building, equipment, intangibles. Lender must verify business valuation financial data (have copies and compare accuracy against IRS transcripts). If going through the LGPC, business valuation must be submitted with package.

9 What if the business valuation comes in less than purchase price? SOP states: Any amount in excess of the business valuation may not be financed with the SBA guaranteed loan. In other words, the appraised value of the business must be greater than the lender's loan amount.

10 What if the valuation comes in less than purchase price? EXAMPLE: Purchased Asset Loan Amount Buyer/ Borrower Equity Total Purchase Business $375,000 $125,000 $500,000 Purchase Comm. Real Estate $400,000 $100,000 $500,000 $775,000 $225,000 $1,000,000 If the business valuation is less than the purchase price, say $380,000, can the lender still process the loan?

11 Recent Changes in 2014 SOP for Business Valuations Eliminated the requirement for business valuations for the refinance of change of ownership transactions. A CPA is no longer qualified to provide a business valuation (unless the CPA has a qualifying business valuation designation).

12 100% or Partial/Minority Interest Appraised? Perform Business Valuation for a 100% Interest SBA loan proceeds can be used in a small business acquisition if: The buyer is purchasing a 100% ownership interest; or One or more existing owners purchase of a seller s interest would result in the buyer(s) owning a 100% interest.

13 Major Screen Out Reasons Related to Business Valuation Failure to include a valid business valuation: Per the SOP: If the application will be submitted to the LGPC, the business valuation must be submitted as part of the loan application. If under delegated authority, business valuation can be obtained after approval. SBA Express: Amount being financed may be less than $250,000, but if there is a close relationship between buyer/seller, a third party business valuation is required. Failing to include allocations of sale in a Purchase and Sale Agreement (intangible asset amounts are important). Note: allocations in business valuations may be different from the allocations stated in the PSA or other lender documents.

14 Typical Business Valuation Process Engagement (discuss, agree, retain, sign); Information gathering (sometimes most tedious part); Initial interviews, discussions with parties involved; Conduct industry/economic research; Analyze relevant financial data & descriptive information; Identify relevant valuation methodologies; Normalize income statements & balance sheets; Estimate ongoing earning power; Search for market comparables; Conduct valuation analysis (asset, income & market approach); Analyze any non-operating or excess assets; Apply applicable discounts/premiums; Reconciliation & conclusion of value; Write report (summary or comprehensive); Finalize invoice, engagement & delivery method.

15 Engagement The engagement hiring a business appraiser Accredited business appraiser (per SBA SOP) Get firm fee quote and turnaround time Engagement letter Understand type of report provided and methods used. Does appraiser use multiple valuation methods? If unsure of appraiser s work, get a sample report Will appraiser personally visit site or will it be a desk appraisal?

16 Business Valuation Report Type Report Type Examples Price Detailed Report - Business Valuation Opinion IRS matters, Litigation, ESOPs, etc. $$$ Summary Report - Business Valuation Opinion SBA lending, holding companies, consulting $$ Calculation Report - Calculation of Value (limited scope) Consulting, specific client requested situations $

17 Standard of Value Fair Market Value (most common): Willing buyer & willing seller No compulsion to buy or sell Both knowledgeable of the facts Acting at arm s length Investment Value (value can be higher): Value of an asset/investment to a specific buyer Based on individual investment objectives Includes potential synergies Neither specified in the SBA SOP

18 Standard of Value Fair Market Value More conservative Values the current business as it is expected to be operated Example: A print/mailing shop would be valued based on its existing revenues, operations, expenses, employees, etc. Owner discretionary expenses are still add-backs when valuing a control interest. Investment Value Can take into account specific improvements/synergies only available to the buyer. Example: Buyer owns several print/mail shops, saves on bulk purchases, delivery and marketing, has existing special equipment, and has less expensive management and admin.

19 Business Valuation Methods Small Businesses Income Approach Single Period Income Capitalization Multiple Period Discounted Cash Flow Market Approach Private Company Transactions Rule of Thumb Asset/Cost Approach Economic Adjusted Balance Sheet

20 Income Approach to Value Estimates value of the business by applying appropriate cost of capital rates to normalized projected earnings. This method considers the company s ability to cover debt service and provide a reasonable equity return to the owner.

21 Income Approach - Steps Normalize earnings/cash flow Project earnings/cash flow Estimate an appropriate cost of capital Single period capitalization rate Multi period discount rate Apply cap rate or discount rate to cash flow Make any required adjustments: nonoperating assets, excess working capital, debt, etc.

22 Income Approach Example Income Capitalization Method Pre-tax WACC Discount Rate 23.0% Less Long Term Growth -3.0% WACC Capitalization Rate 20.0% Projected Cash Flow (normalized NOI/EBIT) $200,000 Divide by capitalization rate 20.0% Estimated Business Value - Before Debt $1,000,000

23 Normalize Earnings/Cash Flow Owner compensation to economic value How much would non-owner need to be paid? Use industry publications (e.g. RMA) and public occupation/wage data Related benefits (e.g. life ins.) and payroll taxes Rent normalize to projected rent or market rent if related entity Discretionary expenses Auto Travel/meals/entertainment Cell phone plans Family members on payroll Non-recurring items Legal and consulting fees Unrelated income and/or expense Depreciation/Amortization

24 Example: Normalized & Projected Earnings-Cash Flow Historical Operating Income Plus/(Minus) Adjustments Excess officer compensation Depreciation Capital Reserves/Economic Deprec. (5.0) (5.0) (5.0) Non-recurring legal 30.0 Total Adjustments Adjusted Earnings Weight Each Year 15.0% 35.0% 50.0% Weighted Earnings Normalized Earnings-Cash Flow Long Term Growth 3% Projected Earnings (Normalized) 200.0

25 Cost of Capital by Asset Class/Size IRR/Discount Rates Long Term Asset Class Total Returns Source Total Return Inflation SBBI 3.1% Treasury Bills SBBI 3.6% Intermediate Term Government Bonds SBBI 5.5% Long Term Government Bonds SBBI 6.1% Long Term Corporate Bonds SBBI 6.4% Large Company Stocks - Publicy Traded SBBI 11.8% Micro Cap Stocks - Publicy Traded SBBI 18.0% Small Private Companies (pre-tax WACC) BVR 19.7% SBBI - Stocks Bonds Bills and Inflation Valuation Yearbook BVR - Business Valuation Resources, Mar 2014 Business Valuation Update IPCPM

26 Cost of Capital Primary Components Cost of equity Cost of debt Long term growth Weighted Average Cost of Capital (WACC) Pre-Tax Discount Rate Mix Debt 6.0% x 0.30 = 1.8% Equity 30.0% x 0.70 = 21.0% Pre-Tax Discount Rate 22.8% Less: Long-term Growth Rate -3.0% Invested Capital Capitalization Rate 19.8%

27 Cap Rate Factors to Consider (this also applies to market approach multiples) Expected growth in business and/or industry Debt capacity and/or ability to obtain financing History of the business (established/new) Reputation Dependence on Key Employees/Relationships Customer concentration Size Historical profitability and cash flow Location Etc.

28 Income Approach Example Income Capitalization Method Pre-tax WACC Discount Rate 23.0% Less Long Term Growth -3.0% WACC Capitalization Rate 20.0% Projected Cash Flow (normalized NOI/EBIT) $200,000 Divide by capitalization rate 20.0% Estimated Business Value - Before Debt $1,000,000

29 Income Approach Example Discounted Cash Flow Method Pre-tax WACC Discount Rate 23.0% Cash Flow Factor Present Value Year 1 $200, $162,602 Year 2 $206, $136,162 Year 3 $212, $114,022 Year 4 $218, $95,482 Year 5 $225, $79,956 Terminal Year $1,159, $411,776 Estimated Business Value - Before Debt $1,000,000

30 Market Approach Private Company Transaction Method Compares subject business to sale transactions of other comparable privately held businesses (similar industry, size, etc.). Similar to real estate Sales Comparison Method Market transaction databases: Pratt s Stats IBA Market Transaction Database BizComps

31 Market Approach Private Company Transaction Method Analyze transaction multiples Price to Sales Price to EBIT/EBITDA (use the most consistent earnings multiple) Price to Discretionary Earnings (smaller businesses) Find any relevant trends in the multiples Adjust/select multiples and apply to subject company

32 Market Approach Example Private Company Transaction Method Indicated Subject's Adjusted: Multiple Value Revenue $500, $400,000 EBITDA $100, $450,000 Plus Owner's Comp $70,000 Discretionary Earnings $170, $425,000

33 Market Approach Private Company Transaction Method Pratt s Stats Data

34 Market Approach Private Company Transaction Method Pratt s Stats Data

35 MVIC Price to Revenue Transaction Example: Sandwich Shops Price to Sales Trend by Profitability % 10.0% 20.0% 30.0% EBITDA % to Revenue

36 MVIC Price to Revenue Transaction Example: Sandwich Shops Price to Sales Trend by Size Annual Revenue

37 MVIC Price to EBITDA Transaction Example: Sandwich Shops Price to EBITDA Trend by % Profitability % 10.0% 20.0% 30.0% EBITDA % to Revenue

38 Market Approach Rules of Thumb Method Same use of business pricing multiples as the Private Transaction Method Uses published or commonly known Rules of Thumb instead of market evidence/transactions Popular with business brokers to obtain a quick check on value Used as a reasonable test: a business valuation will not rely heavily on the method

39 Asset/Cost Approach Adjusted Book Value Method Relies on adjusting the balance sheet to estimated market value. Most appropriate for very asset intensive businesses (e.g. real estate holding company) Not as useful for businesses with substantial intangible assets Represents a floor value for most businesses as a going concern.

40 What Report Should Include Report opinion letter/executive summary Engagement basics (client, purpose, value date, scope) Interest appraised (%, invested capital, stock, etc.) Definition and type of value used Company background Economic and Industry background Financial analysis (make sure historical financials square with your data) Valuation methods explained Value method reconciliation and opinion Assumptions, hypothetical, and/or limiting conditions Signed appraiser Certification and Qualifications

41 Questions? Chuck Miller, CBA