VALUATION METHODOLOGY



Edison Business Advisors offer two levels of valuation services:
 
1.  Broker's Price Opinion
2.  Certified Business Appraisal


BROKER'S PRICE OPINIONS (BPO)


Edison Business Advisors will prepare a BPO of the Fair Market Value (FMV) of the business.  The term Most Probable Selling Price (MPSP) is used interchangeably with FMV and will be used in this document.  MPSP 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.  
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PURPOSE

The purpose of the BPO is to calculate an MPSP with the understanding a prospective seller will use the MPSP in conjunction with other information in considering the possible sale of the business.  


PRINCIPLE SOURCE OF INFORMATION

Information and data relied on to produce a BPO include:

  • 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 business transaction data provided by Business Brokers of Florida, PeerComps, BizComps, DealStats, and any other sources of business transaction data.


SCOPE AND CALCULATIONS & 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 opinion of value.

  • Preparation of the valuation model.

  • Preparation of a summary report.

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

  • Limited analysis and information deemed necessary to perform this specific BPO.
  • A BPO is not an appraisal as defined by professional appraisal standards.  Professional (certified) appraisal analysis and reporting is a comprehensive and in-depth analysis of value beyond the scope of the limited BPO.

  • Although the information and data used to calculate the BPO are generally obtained from sources assumed to be reliable; the scope of limited services does not permit verification of such information.


FORMULA VALUATIONS

Formula valuations are calculated using five to six (out of eight) different valuation methods:  1) Asset/Earnings Method, 2) Capitalized Earnings Method, 3) Excess Earnings & Net Asset Value Method, 4) Cap Rate Attribute Method, 5) Direct Market Data Method, and if a reliable forecast is available, 6) Net Present Value of Future Cash Flows:

  1. Asset/Earnings Method – Value is estimated based on adding the value of the Fixed Assets (FA), the Net Working Capital included in the sale (NWC or cash, inventory and 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.

  2. Capitalized Earnings Method – Value is calculated based on the assumption only the DE changes at a uniform rate of growth. The net present value (NPV) 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.  The NWC is then added to the NPV of forecasted DE to determine value. 

  3. 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.

  4. 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.

  5. 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.

  6. Net Present Value of Future Cash Flows (NPVCF) - If a business plan exists with forecasted revenues, expenses, and cash flows that are based on specified actions, the NPVCF can be used to determine value.  The NPVCF is calculated by discounting the future cash flows based on an industry cost of capital discount rate derived from any number of acceptable methods.

MPSP is then calculated by weighting each of the five to six valuations methods according to Edison Business Advisors' opinion of merit.  DMDM Comparable to DE and NPVCF are always the heaviest weighted methods followed by CRAM.  Methods 1, 2, and 3 generally carry the least weight.  Price is calculated by uplifting the MPSP by 10 to 15%.


REASONABLENESS OF PRICE TESTS

Reasonableness of price tests is used to confirm the price.  The first test is to evaluate if a Small Business Administration (SBA) lender will approve or reject a typical SBA loan request.  SBA loan assumptions are:

  1. Industry-standard compensation package for the buyer to manage the business,

  2. Sufficient working capital required to operate the business (based on historical NWC), 

  3. 20% down payment on the business sale price, and 

  4. The loan amount will include 80% of the sales price plus fees and NWC.
The estimated cash flow to the buyer is calculated by taking the DE 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 second test is performed to ensure a sufficient Return on Investment (ROI) commensurate with the risk accepted by the buyer.  Return is calculated by taking the DE and subtracting the buyer's compensation package and annual debt service.  The investment is the amount of personal funds put down by the buyer at closing to acquire the business.  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.

If you have questions about our valuation process, please contact us for a complimentary, confidential consultation.



CERTIFIED BUSINESS APPRAISALS

Certified business appraisals can only be performed by credentialed business appraisal professionals. Certified appraisers are required to adhere to the professional standards of the credentialing entity, and in most circumstances, the Uniform Standards of Professional Appraisal Practice (USPSP) promulgated by the Appraisal Standards Board of the Appraisal Foundation. The credentialing entities include the National Association of Certified Valuators and Analysts (NACVA), the American Society of Appraisers (ASA), and the Institute of Business Appraisers (IBA). Certified Public Accountants may also achieve the Accredited in Business Valuation credential.

A certified business appraisal may be required for a number of reasons including, bank financing, gift, and estate tax returns, and litigation support. Certified appraisals are often required by the courts for divorce, damages determination, dissenting shareholder actions, and disability calculations. They are also recommended for business transactions and for the general knowledge of management in order to measure the change in business value over time.

Certified business appraisals range from a brief calculation of value based on agreed-upon terms between the business owner and the appraiser to a full appraisal with a comprehensive report. A calculation does not adhere to the strict guidelines of a full appraisal, but they can be useful in planning. A full appraisal requires a deep dive into the business's financial performance, structure and operations, industry and market in which it operates, competition, and the economy.  The opinion of value may be communicated in a comprehensive report, a summary report, or even orally.

There are generally three approaches to establish an opinion of value for a business:

  • Income approach
  • Asset approach
  • Market approach

The income approach estimates future cash flow and discounts it into today’s dollars.

The asset approach attempts to determine the fair market value of the underlying assets owned by the business. The asset approach is most appropriate for asset-heavy businesses such as transportation or manufacturing businesses. The biggest challenge with the asset approach is it requires a separate determination of the goodwill. 

The market approach compares the subject business with similar and relevant businesses that have already been sold, or to comparable publicly traded businesses.  A “multiple” of revenue or a selected earnings stream is multiplied by the average or adjusted average derived from the dataset to estimate the value of the subject. The market approach generally produces a range of value and the appraiser must determine where the subject fits into the range.

The appraiser must consider all three approaches and decide which is most appropriate, or which combination of the three is appropriate. In many cases, the appraiser will reconcile the difference between two or more approaches to arrive at an opinion of value.

Value only exists in the future and the appraiser attempts to determine the expected future earnings and the likelihood of achieving those earnings. The likelihood is affected by risk factors common among small to medium-sized businesses. Risk factors include depth of management (or lack thereof), reliance on key personnel, reliance on a limited number of vendors, the concentration of sales in one or a small number of customers, historical performance, environmental and/or legal issues, government regulation, target market, and how susceptible the industry is to technological obsolescence.  Reducing any of these risks tends to increase value.

To determine if a certified business appraisal is appropriate for your needs, please contact us for a complimentary, confidential consultation.

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