Business Valuation

Week 1: Introduction to Business Valuation

Business Valuation Evolution
• What is Business?
• Why valuing business?
• How much is this business interest worth?
• Economic factors – local, regional, national and international
• Premise or standard of value selected
• The application of appropriate valuation method
• Interest being value; etc…etc..etc..
• How business valuation been accepted in Malaysia?
• Any local regulatory body to govern the profession?
• No. Business Valuer Association Malaysia is only an association.
• Why you have to take this course???? Other than part of program structure.
Professional Organisation
• The National Association of Certified Valuators and Analysts (NACVA)
• The Institute of Business Appraisers (IBA)
• International Association of Consultants, Valuators and Analysts (IACVA)
• Canadian Institute of Chartered Business Valuators (CICBV)
• Malaysia???
• Business Valuers Association Malaysia (BVAM) member of the International
Association of Certified Valuation Specialists.
• Is property valuer capable of doing business valuation?
• Do they have knowledge that mostly accountant or financial professionals has?
Why Need Business Valuation?
• Economic instability
• Lead to Merger & Acquisition: companies consider merging with or acquiring another company mainly due to
• Help ensure economic stability in recessing economy through overhead sharing.
• Maintain or increase market share.
• Establish strategic alliance for growth and diversification
• Age demographics
• Older, retire group of individuals is cash rich: Plan for succession may include transferring business through;
• Gift the business to their heirs
• Sell the business to their heirs
• Sell the business to third parties
• Establish a charitable trust
• Establish an ESOP (Employee Stock Ownership Plan)
• Issue options to key employee

• Litigation engagements
• Dissolution or break up amongst key employees/partner require business valuation.
• The situation involving
• Partner disputes
• Dissenting shareholders actions
• Fairness opinions
• Divorces
• Valuation may also needed when it involves economic loss, such as;
• Wrongful death
• Wrongful injuries
• Wrongful loss of property
• Patent infringement
• Tax Planning
• Associated with rights/restriction of ownership interest in non-traditional
legal liabilities
• Family Limited Partnership and Family Limited Liability Companies
• Limited Liability Companies
• Financial Reporting
• New but important changes in business valuation practices.
• In Financial Accounting Standards requires goodwill to be tested for
impairment at least annually.
• Therefore, in order to test for impairment it is necessary to estimate the Fair
Value of the acquired company or business unit.
Purposes of Valuations
• Merger and acquisitions
• Sales and divestures
• Buy/sell agreements
• Fairness opinions
• Shareholder transactions
• Capital infusions
• Employee Stock Ownership Plans (ESOPs)
• Employee Benefit Plans
• Expert testimony/litigation support
• Estate planning and taxation
• Gift taxes
• Solvency opinions
• Insolvency opinions
• Collateral valuations
• Purchase price allocations
• GAAP valuations
• Charitable contributions
• Determination of net operating loss in
bankruptcy
• Determination of liquidation value in
bankruptcy
• Banks – loan applications
• Marital dissolution
Valuation Concepts
• Valuation
• Appraisal
• Value of a particular business
• Theoretical basis of value
• Premise of Value
Valuation
• A process taken to establish a value for entire or partial interest,
taking into consideration both qualitative and quantitative tangible
and intangible factors associated with the specific business being
valued.
• Definition:
• The act or process of determining the value of a business, business ownership
interest, security, or intangible asset. (International Glossary of Business
Valuation Terms)
Appraisal
• In the process of performing a business valuation, the valuation
analyst may require appraisal of various asset owned by the company
such as:-
• Art (from a reputable art dealer)
• Coins (from a reputable coin dealer)
• Real estate
• Machinery and equipment (from a reputable appraiser)
• Jewellery (from a reputable gemologist or dealer)
• Antiques (from a reputable dealer)
• Other collectibles (from other reputable dealer)
Value of a Particular Business
• The value of a business interest is equal to the future benefits that will
be received from the business.
• Discounted to the present.
• At an appropriate discount rate.
• However, this simple definition poses several challenges:
• Whose definition of “benefits” applies?
• Future projection are extremely difficult to made (absent a crystal ball) and very
difficult to get two opposing parties to agree to.
• What is an appropriate discount rate?
• How long a stream of benefits should be included in the determination of value?
Theoretical Basis of Value
• The term “value” means different things to different people.
• In business valuation, there are 3 standards of value
• Fair Market Value
• Fair Value
• Strategic/investment value
Fair Market Value
• The price, expressed in terms of cash equivalents, at which property
would change hands between a hypothetical willing and able buyer
and a hypothetical willing and able seller, acting at arms length in an
open and unrestricted market, when neither is under compulsion to
buy or sell and when both have reasonable knowledge of the relevant
facts. (International Glossary of Business Valuation Terms)
Fair Value
• Fair value has several meaning, depending on the purpose of
valuation.
• Fair value is the statutory standard of value applicable in cases of dissenting
stockholders’ valuation right.
• Ibbotson Associates SBBI Valuation Edition 2005 define fair value as “…the
amount that will compensate an owner involuntarily deprived of property.“ -
A case of willing buyer but not willing seller.
• FASB define fair value as “…the price that would be received for an asset or
paid to transfer a liability in a transaction between marketplace participants
at the measurement date”
• Fair value may also relate to value in divorce – marital dissolution.
Strategic/Investment Value
• Value to a particular investor based on individual investment
requirement and expectation.
• It reflects the subjective relationship between a particular investor
and a given investment.
• There are reasons why investment value may differ substantially from
fair market value and some of the reason are
• Differences in estimates of future earning power
• Differences in perception of the degree of risk and the require rate of return.
• Differences in financing costs and tax status.
• Synergies with other operations owned or controlled.
Premise of Value
• In the valuation context, once standard of value is determined,
appropriate premise of value must be selected.
• Premise of value can be further broken down into various categories:
• Book Value
• Going Concern Value
• Liquidation Value
• Replacement Value
Book Value
• With regard to business enterprise: Book value is the difference between total asset
(net of accumulated depreciation, depletion, and amortisation) and total liabilities as
the appear on the balance sheet.
• With regard to a specific asset: book value is the capitalised cost less accumulated
amortisation or depreciation as it appears on the books of account of the business
enterprise.
• Asset are generally recorded at historical cost (net of accumulated depreciation or
value allowance)
• Liability are normally recorded at face value.
• Book value is not an appropriate measure of business value.
• The longer a particular asset or liability is carried on book, the greater the potential of
difference between book value and fair market value.
Going Concern Value
• The value of a business enterprise that is expected to continue to
operate into the future. The intangible elements of Going Concern
Value result from factors such as having a trained work force, an
operational plant, and the necessary licenses, systems and procedures
in place.
• A trained and assembled work force is a valuable intangible asset
because of substantial costs involved in developing a new work force.
• Going concern value can be particularly relevant to service firm.
Liquidation Value and Replacement Value
• Liquidation value
• The net amount of what would be realized if the business is terminated and
the asset are sold piecemeal.
• Liquidation could be orderly or force.
• Replacement value
• Current cost of a new similar asset having the nearest equivalent utility to the
asset being valued.
Valuation Purpose and Its Value Impact
• Before conducting valuation analysis, purpose of valuation must first be
determined.
• Different purpose require different valuation methods and approaches and
usually generate different value.
• NACVA valuation standards require valuation analyst specifically and carefully
define the purpose of each valuation
• “No single valuation method is universally applicable to all appraisal purposes. The
context in which appraisal to be used is critical factor. Many business appraisal failed to
reach a number representing the appropriate definition of value because the appraiser
failed to match the valuation methods to the purpose for which it was being performed.
The result of a particular appraisal can also be inappropriate if the client attempts to use
the valuation conclusion for some purpose other than the intended one”
Valuators versus Advocate
• Fundamental concept that must be understood.
• A Valuator –
• Relies heavily on quantifiable, objective data and attempts to remove as much
as subjectivity as possible.
• An Advocate –
• Introduces subjective factors and attempts to rely heavily on qualitative
factors in providing valuation services.
• “To advocate is to attempt to make an argument on behalf of an idea or a
person. The purpose of advocacy is persuasion. The advocate wants to instil
an idea in order to bring about a change in thinking or behaviour. The primary
tools of an advocate are words and tact.”
The Equity Interest as An Investment
• The purchase of an equity interest should be treated no differently
than the purchase of any investment.
• Investor should be expect to receive not only the investment back,
but expect to receive fair return.
• Return should be commensurate with the risk involved.
• When purchase equity interest as an investment, certain principles
need to be observed.
Principles in Purchase Equity Interest
• The alternative principle
• Applies to valuing business in the context of buying and selling
• Valuation involved a business that is being offered for sale, it must be realized
that both; buyer and seller have alternatives, and do not necessarily to enter
or proceed with a proposed purchase/sale transaction.
• The principle of substitution
• The value of an asset tends to be determined by the cost of acquiring an
equally desirable substitute.
• The investment value principle
• Valuation of a business sometime is a very difficult process due to lack of
active trading market (for small business) – therefore valuation is based on
investment value principle.
• Value = benefit stream/required rate of return.
Rate of Return/Level of Risk Principle
• A fundamental relationship between rate of return and the amount of
risk associated in the investment.
• Direct relationship between risk and return – the greater the risk the
higher the return expected.
• There are various investment that carry different levels of risk and
different potential return.
Key Financial Variables
• Whether one focuses on historical data or future projections, there
are three key variables that are important.
• Each of these variables are equally important in estimating value
• The three key financial variables are:
• Identification and definition of appropriate benefit stream;
• Measurement of appropriate benefit stream
• Determination of an appropriate capitalisation/discount rate.