How to Value a Small Business

1. How to Value aSmall Business Professional Development Seminar South Carolina Small Business Development Center Pete Smith C&S Associates Copyright C&S Associates, July 2007

2. Introduction • Business Valuation: Estimating the Fair Market Value of a business entity • Principles are consistent • Application of principles is diverse • Objectives of a Business Valuation • Accuracy • Fairness - Objectivity • Defend-ability Copyright C&S Associates, July 2007

3. Seminar Objectives • Understanding of the basic Principles • Understanding of the basic Terms used • Understanding of the basic Methods used • With a hands-on example, gain the: • Ability to apply to appropriate client situations • Ability to know when not to apply!!! Copyright C&S Associates, July 2007

4. Fair Market Value “Fair Market Value is defined as the value that a willing seller and a willing buyer, both being informed of the relevant facts about the company, could reasonably conduct a buy-sell transaction, neither party under any compulsion to do so.” Copyright C&S Associates, July 2007

5. Business Sale Business Purchase Bank Financing Estate Planning Estate Taxes Gifting Divorce Partner Buy In/Out Report Card ESOP Inter-Generation Other PURPOSES Always dealing with two sides – someone wants a higher valuation, someone wants a lower valuation. One side is frequently the IRS. Copyright C&S Associates, July 2007

6. SMALL BUSINESS CHARACTERISTICS • Size & Business Model • Markets • People Copyright C&S Associates, July 2007

7. Size of Market in area Growth in area Company’s Position Top Customers Concentration Company Growth Desire-ability of product/service Location, Location, Location Market Evaluation Copyright C&S Associates, July 2007

8. Business Valuation Steps - 1 • Define Purpose • Understand size & characteristics of Client • Assessment of People and Markets • ---------------------------------------------- • Gather Additional Data • Recast Financial Statements • Ratio Analysis / Industry Comparison Copyright C&S Associates, July 2007

9. Business Valuation Steps - 2 • Application of Valuation Methods • Reconciliation • Adjustments • Valuation Report Copyright C&S Associates, July 2007

10. GLOSSARY -1 • Pro Forma Adjustments • Reflect Nature of Deal • Adjust for Real Estate • Adjust for discretionary and one-time items • Book Value of Stockholder’s Equity • Book Value of Total Capital • Goodwill Copyright C&S Associates, July 2007

11. Sales Contribution Value Prime Gross Profit Gross Profit SDE – Seller’s Discretionary Earnings PBITDA, EBITDA, IBITDA PBIT, EBIT, IBIT PBT, EBT, IBT PAT, EAT, IAT GLOSSARY – 2Income Measures Copyright C&S Associates, July 2007

12. Glossary - 3 • Arm’s Length • Date of Valuation • Discretionary Expenses • Materiality • One-time events • Control / Minority Interest • Ranges of Values Copyright C&S Associates, July 2007

13. Owner’s Bonus Management’s Bonus Country/Golf Club Airplane Director’s Fees Guaranty Fees Family Salaries Car Expenses Life Insurance Interest Earned NASCAR tickets London Travel Trade Show Training Class Discretionary Expenses Copyright C&S Associates, July 2007

14. Valuation Methods - 1 • Income Methods • Cost Methods • Comparable Value Methods Copyright C&S Associates, July 2007

15. Income Methods* ROI Cash Flow Excess Income (IRS) SDE DCF – Ugly! Other Multiples Others * Can’t use many income methods if there is no income! Cost Methods Book Depreciation add back Replacement – new Replacement – used Cost plus 1x GP Multiple of Book Others Valuation Methods - 2 Copyright C&S Associates, July 2007

16. Valuation Methods - 3 • Comparable Value Methods • Deals Done – tough finding sources – privately held businesses, definition of price. • Publicly held – minority vs. majority, liquidity? • Industry Rules-of-Thumb Copyright C&S Associates, July 2007

17. BUSINESS VALUATION EZ ELECTRIC Purpose: Joe would like to retire sometime in his mid-50’s. Wants to get an idea of the value of the business to plan ahead. Make sure he has enough life insurance to cover the value, knowing that much of the value is gone in the event of his death. Copyright C&S Associates, July 2007

18. 20 Employees including Joe Sales $3m 100% owned by Joe Founded, Dad 1970 Joe took over 1997 Dad passed 2000 Key Man Life Insur. Joe’s Mom in Florida Comes to annual meeting at Xmas. She owns building Lease to EZ Son and Daughter work at EZ EZ ELECTRIC – Size /Other Copyright C&S Associates, July 2007

19. Markets • Apparatus service market in area $10m • 1 competitor same size, 3 smaller • Industry Growth: Flat • Top Four Customers • Mining 15% • Automotive 10% • Manufacturing 10% • Health Care 10% Copyright C&S Associates, July 2007

20. Adjustments - 1 • Joe bought out Mom’s stock at the then fair market value, balance is part of Long Term Debt. Payments of $3k per month for principal and interest on 8% note. Pays her an additional $10k at year end to for attending board meeting to supplement her income. • Any discretionary? Any one time? Copyright C&S Associates, July 2007

21. Adjustments - 2 • Joe’s only sister is an attorney. Keeps track of the corporate records, member of the board of directors, handles collection letters and other minor legal matters. Joe pays her $1k per month. • Any discretionary? Any one time? Copyright C&S Associates, July 2007

22. Apply Methods 1-4 Method/Calculate Lower Higher Notes • 4 to 6 x 160 640 960 Total Equity* • 3 to 5 x 250 750 1250 Total Capital less debt (375)(375) 375 875 Total Equity* • 40% to 60% 180 270 Acc. Depre. Book Equity 375375 555 645 Total Equity* 4. No Information * Valuation of Total Equity is the objective Copyright C&S Associates, July 2007

23. Apply Methods 5-6 Method/Calculate Lower Higher Notes 5. 1.5 to 2.5 SDE 600 1,000 FA+GW+Inv** Cash, A/R, OCA 310 310 Total Liab. (525)(525) 385 785 Total Equity* 6. 25% to 40% 525 840 FA+ GW only All Tot. CA 550 550 Current Assets Total Liab. (525)(525) 550 865 Total Equity* *Valuation of total equity is the objective ** Typical Small Business Sale Copyright C&S Associates, July 2007

24. Copyright C&S Associates, July 2007

25. THANK YOU Please complete the feedback form. Other Questions? Copyright C&S Associates, July 2007