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AMC Owners as Buyers and Sellers – Two Perspectives 2013 AMC Institute Loews Don Cesar Beach Resort Thursday, February 14, 2013 St. Petersburg Beach, Florida. Overview of Today’s Topics. Gregory Cowhey Pots of Gold – Help for Sellers Basic Overview of Valuation Concepts & Principles

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AMC Owners as Buyers and Sellers – Two Perspectives2013 AMC Institute Loews Don Cesar Beach ResortThursday, February 14, 2013St. Petersburg Beach, Florida

overview of today s topics
Overview of Today’s Topics
  • Gregory Cowhey
    • Pots of Gold – Help for Sellers
      • Basic Overview of Valuation Concepts & Principles
      • Current Observations of the Private Equity Market
  • Scott Hermansen
    • Skeltons in the Closet – Buyer Beware
      • Pricing, Due Diligence, Relationships & Deal Structure
  • Questions & Answers
business valuation issues and considerations
Standards of Value

Fair Market Value

Willing Buyer

Willing Seller

No Compulsion To Act

Knowledgeable Parties

Hypothetical Buyer/ Seller

Transaction Based

Business Valuation Issues and Considerations
business valuation issues and considerations1
Standards of Value

Investment Value

Specific Buyer Strategic

Value to A Specific Investor Based on Individual Investment

Fair Value

Specific Use – Legal Concept

Dissenters’ Shareholders suits

Intrinsic Value

Analytical Judgment

Perceived Characteristics of the Investment

Business Valuation Issues and Considerations
business valuation issues and considerations2
Premise of Value

Going Concern

Assemblage of Assets

Orderly Liquidation

Forced Liquidation

Business Valuation Issues and Considerations
business valuation issues and considerations3

Asset Approach

Market Approach

Income Approach

Capitalization of Cash Flow Method

Discounted Cash Flow

Business Valuation Issues and Considerations

Asset Accumulation Method




Comparable Transactions

Treasury Method

business valuation issues and considerations4
Intangible Assets Seen in Most Businesses


Customer related intangible assets

Contract related intangible assets

Human capital related intangible assets

Location related intangible assets

Goodwill related intangible assets

Patents and other intellectual property

Below Market Leases

Business Valuation Issues and Considerations
valuing intangible assets
Income Approach

Direct Capitalization

Yield Capitalization


Replacement Cost

Reproduction Cost

Research and Development

Market Approach

Relief from Royalty Method

Valuing Intangible Assets
adjusting reported income statements
Type 1 – Unusual/Non-Recurring Adjustments

The first type are adjustments that eliminate one-time gains or losses, other unusual items, non-recurring business elements, expenses of non-operating assets and the like.

Type 2 - Discretionary (Control) Expense Adjustments

The second type of normalization adjustment involves adjustments that normalize officer/owner compensation and other discretionary expenses that may be eliminated by an owner motivated to maximize profits and provide the greatest return to its stockholders.

Adjusting Reported Income Statements
type 2 control adjustments
Must consider the size of, and level of control associated with, the Subject Interest in determining whether to make Type 2 Control Adjustments.

The use of minority cash flows in the income approach produces a minority interest value.

Minority cash flows are those cash flows without any adjustments for prerogatives of control by the controlling shareholder (e.g. excess compensation and perquisites)

Type 2 Control Adjustments
examples of type 2 normalizing adjustments
Remove Non-Operating Income

Analyze Cost of Goods Sold/Inventory Considerations

Excessive or Understated Officer’s Compensation

Family Members/Related Party Transactions

Travel and Entertainment

Related Party Rent

Professional Fees

Examples of Type 2 Normalizing Adjustments
replacement compensation
By definition, is a Type 2 Control Adjustment

Often referred to as “normalized compensation” or “reasonable compensation allowance”

Pertains to replacement compensation to replace (or retain) the owner/operator for the services performed.

Separate and distinct from the owner’s return on investment in the form of dividends/distributions

Trading current income (ordinary tax) for capital gains income (Cap gains tax)

Replacement Compensation
measuring risk in business valuations
Discount and Capitalization Rate Calculation

The Bigger The Risk – The Bigger The Required Return

Rate Reflective of the Risk of The Investment

Rate Must Match Economic Income Stream

Build Up Method - Example

Risk Free Rate 4.92%

Equity Risk Premium 6.14

Small Stock Premium 6.41

Industry Risk Premium 1.43

Other Risk Considerations 2.00

Discount Rate 20.90%

Capitalization Rate = Discount Rate Less Long Term Growth Rate

Measuring Risk in Business Valuations
levels of value
Levels of Value

Synergistic (Strategic) Value

Value of Control Shares *



Minority or


Value of minority shares if freely traded on an active public market (“Publicly traded equivalent value or Stock Market Value

Discount for Lack of


Value of non-marketable minority (lack of control) shares

trapped in gains tig in business valuations
Underlying Theory Applied to Business Valuation

A hypothetical willing buyer would discount the price which would be paid for a stock in a corporation with trapped in gains (TIG). Similarly, a hypothetical seller will accept a lower price for a stock that is subject to trapped in gains.

ABC Corporation holds $5 million worth of assets and has no trapped in capital gains. XYZ Corporation holds $5 million of identical classes of assets, but has trapped in capital gains of $3 million due to depreciation recapture and market appreciation of its assets. All other things being equal, a hypothetical buyer would pay less for an interest in XYZ Corporation than in ABC Corporation due to the trapped in capital gains.

Trapped In Gains (TIG) in Business Valuations
record levels of dry powder 400b capital overhang for us focused funds raised by us investors
Record Levels of Dry Powder; $400BCapital Overhang for US-Focused Funds Raised by US Investors
recent performance for 10 250 mm deal range
GF Data Resources Survey

Private sponsored deals reported by 174 PE firms and 1,431 deals since 2003Q1

Reporting data for 1,147 transactions that exhibited pricing multiples of 3-10x EBITDA [80% of total universe]

Size of transaction

Smaller deals $10-$25 M value trade at 5.0-5.4x EBITDA

Larger deals $100-$250M value trade at 7.0-8.5x EBITDA

Leverage model turned upside down

Pre-2006: typical model was 20% “real money” by PE firm with 80% bank debt

Post-2007: “new model” has averaged 50/50, with Seller taking back debt

Flight to quality

Inferior performers command lower pricing multiples

Recent Performance for $10-$250 MM Deal Range
recent performance for 10 250 mm deal range1
GF Data Resources Survey

2010-2012 Statistics

2010-H1 – 60 deals at pricing multiples in the 5.5x EBITDA range

2010-H2 – 102 deals at pricing multiples in the 6.1x EBITDA range

2012-Q1 – 29 deals, still in the 6.1x EBITDA range

Election results – Democrats could not pass tax legislation

P/E Firms have “Dry Powder”

Need to invest or return

GP paid on %AUM and carried interest

Lack of success from 2007-2009 creates cautionary approach

Above average performance needed to attract attention

Financing Deals

Deal multiples – 6.1x EBITDA

Senior Debt – 2.2x EBITDA

Total Debt – 3.0x EBITDA --- Sellers need to keep “skin in the game”

P/E Firm Equity – 3.1x EBITDA

Recent Performance for $10-$250 MM Deal Range
median valuation continues 2009 trend pe deal activity count and median valuations by year
Median Valuation Continues 2009 TrendPE Deal Activity (count) and Median Valuations by Year
secondary deals return strategics dominant us pe exit activity exit type percentage
Secondary Deals Return, Strategics DominantUS PE Exit Activity (Exit Type Percentage)




exits up ipos reemerge in 4q quarterly pe exits by corporate acquisition ipo and secondary sale
Exits Up, IPOs Reemerge in 4QQuarterly PE Exits by Corporate Acquisition, IPO and Secondary Sale

Percentage of capital invested by industry

Buyer beware – there are skeletons everywhere.

Seller will give a great song and dance.

Independent appraisal is good, but need to determine what you think it’s worth.

Remember, most appraisals are MAI (made as instructed).

If deal sounds too good to be true---watch out.

Everyone uses data rooms these days --- they don’t tell the whole story

What is presented can be very filtered.

There’s nothing like hearing someone explain something.

Determine if asking price is FV.

Look at 5 year history of earnings.

Do 1 or 2 clients make up the total book of business?

Prepare pro-forma statements:

Staffing costs/savings

Overhead savings vs. overhead increases

Cost to relocate

Determine worst case/best case

Reasonable return on investment

Depends on the deal structure – will be discussed later.

Can end up with less business than projected.

Value of business can go down.

due diligence
You need a NDA, LOI and/or contract in place first.

Not always objective, can be very subjective.

Review client contracts:

Assignability of contracts

Out clauses of contracts

Have most clients been around awhile or do they turn

What is likelihood clients will stay.

What synergies can be realized.

Due Diligence
What is the current ownership structure?

Are the current owners active in organization?


Does office need to be in a certain city

How hard is it to relocate/consolidate

Relationship between staff and clients

Relocation of current key players

Why does current ownership want out?

deal structure
Stock – sellers love them, buyer beware

Sellers get easy capital gain treatment for taxes

Buyer gets very limited ability to deduct anything for taxes

Since no deductions to help fund deal, want lower asking price

Assume any and all Corporate liabilities, including staff issues

Pure merger

New ownership

Consolidate locations

Consolidate staffing

Book of business – contracts

Contingency payments

Deal Structure
You may need to kiss a bunch of frogs before you find a prince.

Determine what you are really buying

Do you really want all the clients?

Are you just getting the inside track when the RFP goes out?

This could be an easy way to increase client base.

Factor in tax consequences, but don’t let them drive the deal.

Not every deal is priced right or a good fit

Don’t fall in love

Be willing to work

Don’t settle

contact data
Contact Data

Gregory Cowhey

Managing Director – Forensic & Financial Services


401 Plymouth Road, Suite 200

Plymouth Meeting, PA 19462

Direct: 610-862-2227

contact data1
Contact Data

Scott M. Hermansen, CPA

Chief Financial Officer

Applied Measurement Professionals, Inc.

Phone: 913-895-4600