VALUATION METHODOLOGY



Edison Business Advisors offer two levels of valuation services:

1.  Broker's Price Opinion
2.  Certified Business Appraisal

Broker's Price Opinion

Edison Business Advisors will prepare an opinion of the Fair Market Value (FMV) of the business.  The FMV is an opinion of the amount the business will change hands between a willing seller and a willing buyer when neither is acting under compulsion and when both have a reasonable knowledge of the relevant facts.  The term Most Probable Selling Price (MPSP) is used interchangeably with FMV.  


Purpose 

The purpose of the Broker's Price Opinion is to prepare an opinion of value calculations with the understanding a prospective seller will use the opinion of value calculations in conjunction with other information in consideration of a possible sale of the whole business.  Edison Business Advisors understands these opinions of value calculations will not be used for any other purposes.  Edison Business Advisors offers no guarantees the FMV will be realized in the open market. 


Principle Sources of Information

Information and data relied on to produce an opinion of value includes:

  • Federal Corporate Tax Returns and reviewed financial statements for the past three fiscal years as well as any interim financial statements if the current fiscal year is beyond the first quarter.
  • Information about the business including non-cash, non-operating, and non-business expenses included in the fore-mentioned financial statements.
  • Research and use of private company transactional data provided by Business Broker of Florida, PeerComps, BizComps, and DealStats.


Scope and Calculations and Limitations of Calculations

The scope of the analytical process and reporting will include:

  • Information related to the business's history, management, strategies, asset management, and outlook.
  • Being informed about internal and external factors affecting the financial performance of the business including expected adjustments and reductions in operating and discretionary expenses if a sale takes place.
  • Consideration of other factors deemed necessary for the assignment.
  • Preparation of the valuation model in the attached exhibits.
  • Preparation of this summary report.

Limitations of the Calculations include, but are not limited to:

  • Limited analysis and information deemed necessary to perform this specific consulting assignment.
  • Analysis and services not specifically described above are not included in the client engagement letter and are not covered by the engagement fees.
  • Edison Business Advisors is not engaged to and did not prepare an appraisal as defined by professional appraisal standards; appraisal analysis and reporting are comprehensive, in-depth, and far beyond the scope of these limited analyses and reporting; accordingly, our level of assurance is lower than in a Certified Business Appraisal.
  • Rather than limited analysis, if the business owner engaged Edison Avenue to prepare an appraisal and comprehensive, formal appraisal reporting, the appraisal conclusions may have varied from the limited analysis opinion of value conclusions, and the variances may have been material.
  • Limited information and data used to calculate the opinion of value were obtained from sources assumed to be reliable; the scope of limited services does not permit Edison Avenue to independently verify such information, and Edison Avenue is not liable for the accuracy, completeness, or fairness of such information.

Formula Valuations

Formula Valuations are calculated using five different valuation methods:  1) Asset/Earnings Method, 2) Capitalized Earnings Method, 3) Excess Earnings & Net Asset Value Method, 4) Cap Rate Attribute Method, and 5) Direct Market Data Method:

  • Asset/Earnings Method – Value is estimated based on adding the value of the Fixed Assets (FA), the Net Working Capital (NWC or accounts receivable less accounts payable), and a multiple of the weighted average of the historical Discretionary Earnings (DE). The multiple is always between 1 and 2 times the DE.
  • Capitalized Earnings Method – Value is calculated based on the assumptions only the DE changes over time and the DE changes at a uniform rate of growth. The net present value of forecasted DE is calculated using a discount rate calculated by summing a risk-free investment return, equity risk, business size risk, industry risk, and, other general risk factors.  
  • Excess Earnings & Net Asset Value Method – Value is calculated based on a multiple of two times the DE less a fair return generated from the FA plus the FA plus the NWC.
  • Cap Rate Attribute Method (CRAM) – Value is calculated based on discounting the DE by a capitalization rate derived by formulas attached to ten attributes. The formulas for each attribute were provided to Edison Business Advisors by multiple certified appraisers who use the Cap Rate Attribute Method in their valuations.
  • Direct Market Data Method (DMDM) – Two values are calculated by taking the sold history of similar businesses and calculating the multiple of sold price vs. sales and sold price vs. adjusted net (or DE). These multiples are then applied to the business's sales and DE to calculate the value to generate a DMDM Comparable to DE and a DMDM Comparable to sales.

Fair Market Value is then calculated by weighting each of the five valuations methods according to Edison Business Advisors's opinion of merit.  DMDM Comparable to DE is always the heaviest weighted method followed by CRAM.  Accounting methods generally carry the least weight.  Price is calculated by uplifting the FMV or MPSP by 15%.


Reasonableness of Price Test

The reasonableness of a price test is used to determine how a Small Business Administration (SBA) lender will view the business and approve or reject a typical SBA loan request.  SBA loan assumptions are:

  • Industry-standard compensation package for the buyer to manage the business,
  • Sufficient working capital required to operate the business (based on historical NWC), and a
  • 20% down payment on the business sale price.
The estimated cash flow to the buyer is calculated by taking the Seller's Discretionary Earnings (SDE) and subtracting the buyer's compensation package.  If the estimated cash flow is greater than 1.25 times the annual debt service, an SBA lender will likely accept the loan assuming the buyer has relevant business experience and a strong financial history.

A final test is performed to ensure a sufficient Return on Investment (ROI) commensurate with the risk accepted by the buyer is achieved.  Understand if the buyer finances the deal through a lender, their risk is significantly higher as they are putting their personal assets at risk.  Typically, we like to see an ROI no less than 25% on a cash deal and no less than 50% on a financed deal.


Certified Business Appraisal

Under development