Discounts and Premiums
Based on research that will be discussed in the Appraisal Report, the determination of value shall be subject to certain discounts and premiums. Once a valuation amount is determined, a Business Appraiser considers premiums and discounts. Issues of majority and minority interest deal with the relationship between the interest being valued and the total enterprise. The primary factor bearing on the value of the minority interest in relation to the value of the total entity is how much control the minority interest has over that entity. The concept of marketability deals with the liquidity of the interest, that is, how quickly and certainly it can be converted to cash at the owner’s discretion. Also, combined premiums or discounts are multiplicative and not additive.
To obtain a professionally prepared business valuation, there is a process that usually includes the following:
A Business Appraiser will use a methodology based on his or her experience, drawn from a multitude of useful valuation models used in many industries for various size companies. What works best for the entire professional team, i.e., lawyer, accountant, banker, financial advisor and others, should have clarity while reflecting the businesses unique attributes that differentiate it, all businesses have certain common factors. The Business Appraiser should take those factors, plus elements that create a premium or a discount, into consideration, without getting bogged down in esoteric theories that are not necessities to creating a valuation opinion. The process will begin with a confidential questionnaire that seeks to capture and integrate into a Business Valuation Report – encapsulating all the key value drivers, which are crucial in order to achieve a realistic determination of value.
For example, if you are interested in selling your family business, the questionnaire should be tailored to your business and industry, for you and your professional advisors. Most business owners complete the questionnaire with internal resources, if need be, the Business Appraiser would be available to advise and direct the process so that your valuation incorporates the latest and most accurate measures of your company’s many aspects. In the meantime, the Business Appraiser would begin a comprehensive survey of your industry that covers recent sales, acquisitions, startups, overall profitability, competition, and public and private company ratios and unique attributes. And the health of the marketplace – is it growing, mature, or in decline?
• Consider the characteristics (nature, history and outlook) of your business, including rights, privileges and conditions, quantity, factors affecting control and agreements restricting sale or transfer.
• Review selected information from trade associations and other sources regarding your company’s particular industry, markets and the economy.
• Analyze your company’s financial statements and tax returns with a view to recast amounts to reflect values not otherwise apparent in the historical or prospective financial statements.
• Review appropriate capital markets information, such as available rates of return on alternative investments, relevant public stock transactions and applicable mergers and acquisitions.
• Evaluate prior transactions involving your company.
• Forecast prospective information.
• Determination of the Fair Market Value.
Financial statements of the business are analyzed and adjusted to reflect the actual financial benefits of business ownership. This normalization is similar to what happens when a company is being sold or going public, to determine the key value driver is based on a multiple of normalized EBITDA. (Earnings before Interest, Taxes, Depreciation, and Amortization). EBITDA is the approximate measure of a company’s operating cash flow based on the company’s financial statements, before charging, interest, income taxes, depreciation and amortization, plus all other normalizing adjustments.
Financial analysis helps in assessing Your Company’s financial performance over time. Past sales and earnings, while not a guarantee of future performance, can provide an indication of future growth potential and can put Your Company’s current performance into a historical context. For example, a company with steadily rising sales and earnings is worth more than one with little or no growth.
Trends and key factors impact results, and comparing financial performance and financial statement ratios with available industry performance measures also provides an indication of the attainability of future results.
Risk factors are reflected in discount rates and capitalization rates – they both reflect the percentage return appropriate to a business as of the valuation date. The amount of the percentage return is considered to be the appropriate applied to the income stream for the business for the period. The percentage of return should be the percentage prevailing in the industry based on the risk factors involved at the date of valuation.
A business with stable and regular earnings is of less risk and will have a lower rate, as contrasted with a lack of stability and losses which would result in higher rates.
Your Industry’s Outlook
Industry trends, such as expansion and consolidation, and factors, such as industry demand and the regulatory environment, impact the participants.
Consideration should be given to both positive and negative factors impacting the industry, short and long-term growth forecasts, industry participants, how your company compares to other participants, and other similar issues.
As part of estimating the fair market value of a business interest or an intangible asset, it is important to relate the key economic factors that impact the subject property. These analyses aid in the development of the appropriate valuation variables and considerations.
Generally, business performance varies in relation to the economy. Usually, a strong economy can improve overall business performance and value, and a declining economy can have the opposite effect. Depending on the size and scope of a business, it can be affected by global, national, and local events. Changes in regulatory environments, political climate, and market and competitive forces can also have a significant impact on a business. For these reasons, it is important to analyze and understand the prevailing economic environment when valuing a closely held business or intellectual property. Since a material consideration in the appraisal process is prospective in nature, a Business Appraiser reviews the economic outlook as it would impact the appraisal subject.
Part II Written By Michael Gilburd