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Business Valuation Presentation

Recent Presentations Delivered to the following groups:

Waddell & Reed
Waltham, Massachusetts
July, 2000
Contact:  Kristie Lohrum, Division Manager

Commonwealth Financial Group
Waltham, Massachusetts
June, 2000
Contact:  Charles C. Woodward, MBA


Readers of this presentation will come away with  the following:

  •  An improved awareness of some of the key concepts, principles and definitions that are the foundation of the business valuation process.

  •  An appreciation of the complexity of the Valuation Process, and

  •  An improved ability to advise your clients on the applications and potential benefits of the Formal Business Valuation Process.



1.     Why is a Formal Valuation by a Professional necessary?

2.     How are Business Valuations Governed?

3.     What are the different Approaches and Methods of Business Valuation?

4.     What are the Major Determinants of the Value of a Business?

5.     What are the Benefits my Client may receive from a Business Valuation?

6.     What’s Involved in a Complete Business Valuation?

7.     What will my Client Receive?

8.    What will it Cost my Client for a Business Valuation?


1)   Why is a Formal Valuation by a Professional necessary?

a)     Why a Formal Valuation?

i)       First, Two Important Definitions:

(1)  What is a “Closely Held Business?”

(a)   A business that is owned by relatively few stockholders

(b)  Not publicly traded

(c)   May be any size

(2)  What is “Value?”

(a)   Value is an imprecise term because it varies with the situation

(i)     Fair Market Value

(ii)  Fair Value

(iii)  Investment Value

(iv) Intrinsic Value

(v)    Going Concern Value

(vi) Liquidation Value

(vii)  Book Value

(b)  Fair Market Value is defined in Revenue Ruling 59-60 as ….the amount at which the property would change hands between a willing buyer and a willing seller when the former is not under compulsion to buy and the latter is not under any compulsion to sell, both parties having reasonable knowledge of the relevant facts.

ii)     Common Reasons For Formal Valuation

(1)  Selling or Buying a Business

(2)  Buy/Sell Agreements

(3)  Gift, Estate and Inheritance Taxes

(4)  Charitable contributions

(5)  Divorce

(6)  Bankruptcy

(7)  Litigation

(8)  Determining need for Life Insurance

(9)  Estate and Succession Planning

iii)  Alternatives To Formal Valuation

(1)  Rules of Thumb

(a)   Problem

(2)  Limited Valuation

b)     Why a Professional?

i)       Role Of The Professional?

(1)  Independent consultant

(2)  Advisor

ii)     Complexity

(1)  Expertise

(2)  Education and experience

iii)  Creditability

(1)  Standards of the American Institute of Certified Public Accountants (AICPA)

(2)  Standards of the National Association of Certified Valuation Analysts (NACVA)

(3) Standards of the Business Valuation Committee of the American Society of Appraisers (ASA)


2)   How are Business Valuations Governed?

a)     Overview

i)       Professional Associations’ Standards

ii)     Uniform Standards of Professional Appraisal  Practice of The Appraisal Foundation

iii)  Revenue Ruling 59-60

iv)    Court Decisions

b)     Uniform Standards of Professional Appraisal Practice Require that:

i)       Standard 9 - Business Appraisal Development

ii)     Standard 10 -Business Appraisal Reporting

(i)     (For the complete text of Standards 9 and 10, please click here.)

c)      Revenue Ruling 59-60

i)       Overview

(1)  Outlines the approaches, methods and factors

(2)  Applies to business valuations performed for estate, gift and income tax

ii)     The following eight factors are fundamental and require careful consideration

(1)  The nature and history of the business from inception

(2)  Economic outlook in general and the condition and outlook of the industry

(3)  The book value of the stock and the financial condition of the business

(4)  The earning capacity of the company

(5)  The company’s dividend-paying capacity

(6)  Whether or not the enterprise has goodwill or other intangible value

(7)  Sales of the stock and the size of the block of stock to be valued

(8)  The market price of stocks of corporations engaged in the same or similar line of business having their stocks actively traded

iii)  RR 59-60: A Cornerstone of the valuation process.  (For the complete text of Revenue Ruling 59-60, please click here.)


3)   What are the Different Approaches and Methods of Business Valuation?

a)     Approaches

i)       Income approach

ii)     Market approach

iii)  Asset based approach

b)     Methods

i)       Income Approach Methods

(1)  Overview

(a)   Basic Valuation Principle is, “the value of an ownership interest in a company is equal to the present worth of the future benefits of ownership.”

(b)  The Methods most commonly used are the Discounted Net Cash Flow and the Capitalization of Earnings Methods.

(2)  Discounted future returns methods

(a)   A discount rate represents the total expected rate of return that a buyer (or investor) would demand on the purchase price of an ownership interest in an asset, given the level of risk inherent in that ownership interest.

(b)  Appropriate when future returns are expected to be “substantially different” from current operations.

(3)  Capitalized return methods

(a)   A company’s cap rate is usually derived by subtracting the company’s expected average annual compound growth rate from its discount rate.

(b)  Appropriate when it appears that a company’s current operations are indicative of its future operations.

ii)     Market Approach Methods

1)  Overview

a)      An asset’s value can sometimes be determined based on what similar or comparable assets have recently been sold for in cash transactions.

2)       Difficulty is in identifying valid comparable companies.

3)     Most applicable for companies that have public company counterparts.

4)  Most feasible when the company being valued is relatively large.

5)    Value multiples are derived from comparative company data

a)     Most common: price/earnings multiples

iii)       Asset Based Approach Methods

(1)  Overview

(a)   In using these methods, the company’s assets and liabilities are adjusted to their appraised values, and the net result is an indication of the value of the company’s equity.

(b)  This method is appropriate only in limited circumstances

(2)  Two Primary Underlying Assets Methods

(a)   Net Asset Value Method

(b)  Liquidation Value Method

iv)     Selecting Valuation Methods

(1)  The Selection Process is important because valuation consultants may be asked to defend their choices of methods if the valuation is challenged.


4)   What are the Major Determinants of the Value of a business?

a)     Overview

i)       A look at strengths and weaknesses from a valuation point of view

ii)     Owners often get too close to the business and lose sight of important trends and industry standards

iii)  Financial Advisors frequently have the opportunity to identify strengths and weaknesses and propose strategy

b)     Major Determinants

i)       History of stable growth and profits

ii)     Product Cycle point

iii)  Size; Market share

iv)    Industry: Infancy or Mature?

v)      Customer base, Diversification

vi)    Growth potential; Revenue and Profit Trends

vii) Competitive positioning

viii)  Product mix; Uniqueness

ix)   The value of similar companies

x)     Strategy for continued growth and profitability

xi)   Timing

c)      Example: Optimizing For Sale of Business:

i)       Positioning your “House” For Sale

ii)     Comprehensive “Health” Examination

iii)  Restructure financial statements

iv)    Lead time is Critical


5)   What are the Benefits my Client may receive from a Business Valuation?

a)     Clients may benefit from business valuation in any of the following areas:

i)       Business Transactions

ii)     Estate, Gift and Income Taxes

iii)  Estate Planning

iv)    Succession Planning

v)      Divorce/Bankruptcy

b)     Timely Business Valuations, performed in anticipation of the following, will result in benefits to your client:

i)       Business Transactions

(1)  Buying or selling a business

(2)  Buy-sell Agreements

(3)  Life Insurance determination

ii)     Estate, Gift and Income Taxes

(1)  Avoiding IRS audit

(2)  Heading off IRS challenge, if audited

(3)  Early resolution of disputes with IRS

(4)  Burden of proof, if “credible evidence” submitted (IRC Sec 7491)

iii)  Estate & Succession Planning

(1)  Knowledge of estimated range of values

(2)  Avoid unnecessary taxes

(3)  Facilitate ownership transfer

iv)    Divorce/Bankruptcy

(1)  Avoid protracted legal costs

(2)  Achieve favorable settlement

(3)  Win expedient resolution of dispute


6)   What is involved in a Complete Business Valuation?

a)     Overview

i)       Pre-engagement Procedures

ii)     Data Gathering

iii)  Analysis

iv)    Selection of Valuation Methods

v)      Determining Final Value

vi)    Report Preparation

vii) Wrap-up Procedures

b)     Pre-engagement Procedures

i)       Evaluate whether to accept engagement

ii)     Prepare work program

iii)  Develop time & fee estimate

iv)    Prepare Proposal Letter

v)      Obtain Engagement Letter

c)      Data Gathering

i)       Internal Company Data

(1)  Historical Financial Statements

(2)  Income Tax Returns

(3)  Prospective Financial Statements

(4)  Documents

ii)     External Information

(1)  Economic Conditions

(2)  Industry Trends

(3)  Examples of Key External Factors:

(a)   Interest Rates

(b)  Inflation

(c)   Competition

(d)  Technological Changes

(e)   Dependence of Natural Resources

d)     Analysis

i)       Completeness of Information

ii)     Usability

iii)  Departures from GAAP

iv)    Normalization of financial statements

v)      Legal Documents

vi)    Operational Data

e)     Selection of Valuation Methods

i)       Consider Requirements of Engagement

ii)     Consider Industry and Company Factors

iii)  Decide Whether Asset-Based Methods and/or Earnings-Based Methods Apply

iv)    Consider Whether Adequate Comparative Data is Available

v)      If Asset-Based Methods are Used:

(1)  Determine if Company More Valuable as Going Concern or In Liquidation

(2)  Then Select Appropriate Methods

vi)    If Earnings-Based Methods are Used:

(1)  Identify the Benefit Streams to be used

(2)  Assess Whether future Earnings/Cash Flow is expected to differ significantly from Current or Historical Earnings/Cash Flow

(3)  Based on that, Select Appropriate Valuation Methods

f)       Determine Final Value

i)       Weight the Methods

ii)     Apply “sanity checks” to the estimates of value

iii)  Apply Premiums and/or Discounts

g)     Wrap-up Procedures

i)       Document work performed and conclusions reached

ii)     Obtain Representation Letter

iii)  Draft Valuation Report


7)   What Will My Client Receive?

a)     Overview

i)       Full Written Report

ii)     Summary Report

iii)  Oral Report

b)     Full Written Report

i)       For Use By Third Parties

(1)  Tax-related Matters

(2)  Filings with Governmental Agencies

(3)  Negotiations with Lenders, Investment Bankers or Potential Purchasers

(4)  Litigation

ii)     Table of Contents

(1)  Introduction

(2)  Company Background

(3)  Economic and Industry Data

(4)  Financial Analysis of the Company

(5)  Search for Comparatives

(6)  Valuation Methods Considered and Used

(7)  Valuation Calculations

(8)  Conclusion

(9)  Addenda, with Appraiser Qualifications, Statement of Independence, Assumptions and Limiting Conditions

c)      Summary Reports

i)       Narrative is summarized rather than fully explained

ii)     For only the “sophisticated user”

d)     Oral Reports

i)       Advisory engagements

ii)     Informal report to client


8)   What is the Cost to my Client for a Business Valuation?

a)     Overview

i)       Non-public companies

ii)     Related party transactions

iii)  Exposure and scrutiny

iv)    Tight Deadlines

b)     Relevant Points:

i)       Business valuation is a complex process

ii)     Time consuming

iii)  Collecting information

iv)    Analyzing documents and financial statements

v)      Adjusting

vi)    Selecting valuation methods

vii) Determining final value

viii) Writing report

ix)   Documenting

c)      Records and Statements

i)       Availability and condition

ii)     Financial Statements not audited

iii)  Documents not properly recorded

iv)    Weak accounting and financial staff

v)      Deficient financial advisors

d)     Need to educate Client

e)     Cost Range




·        We now have time for a few questions.

·        I invite you to visit our Web site


·        Email your business valuations questions to me and I will respond within 24 to 48 hours.

o       Describe the relevant facts and circumstances surrounding your situation and ask your question.

·        If you would like general information on some facet or area of business valuation, please let me know and I will post it on our Web site for the benefit of others, also.

·        I would like to thank you again for coming this morning and I hope that it has been worthwhile for you.




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