Private firms linger longer on the selling block

Dear Clients and Colleagues:

It’s taking longer for private companies to sell and this could have an impact on Marketability Discounts.

A newly updated analysis of data from BVR’s Pratt’s Stats reveals that the time needed to market and sell a privately held business is 211 days, up from 200 days in the previous analysis.

The latest annual update of an ongoing study, Marketing Period of Private Sales Transactions, examines a database of 7,928 private company sale transactions from BVR’s Pratt’s Stats database. The population of the transactions occurred from February 1992 through the end of 2011.

The business valuation concept of marketability deals with the liquidity of the ownership interest; that is how quickly and with what certainty an owner can convert an investment to cash. It is appropriate in the valuation of most privately held businesses to discount the total enterprise value for this lack of liquidity in order to arrive at the company’s fair market value.

The uncertainty involved with liquidity is reflected in business valuations by the Discount for Lack of Marketability (DLOM). The DLOM can be substantial, ranging at times from 30% – 40%, and many factors contribute independently to its determination.

At Stevenson Valuation Group we explore and have experience in analyzing the key contributors to Marketability. For more information, please contact us.

If you have any questions about this article, please don’t hesitate to contact me.

Sincerely,

Thomas G Stevenson, CPA, CVA

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Building Value is a Process–Part Three

Under the Income Approach to valuation, maximizing value becomes a function of increasing net cash flow , decreasing an investor’s perception of risk or a combination of both.  Last month we discussed various ways to increase net flow and this month we’ll review various ways to reduce investor’s risk.  In valuation terms, investor’s risk is also referred to as an investor’s required rate of return or, capitalization rate, and it is expressed as a percentage.

A key component in determining the value of a going concern is the strength and transferability of the business’ cash flow.  An investor is likely to pay more for a cash flow that’s predictable than one that is subject to various internal and/or external sources of risk. 

The general rule of thumb is “the lower the risk the higher the value.” 

Below is a sample of some of the factors we commonly consider when evaluating the strength and transferability of cash flow.       

·         Company operating history and volatility of cash flow

·         Depth and quality of management

·         Competition and barriers to entry

·         Access to capital resources

·         Reliance on key person(s)

·         Size and geographic diversification

·         Concentration in customer base

·         Market resources in light of competition

·         Purchasing power and other economies of scale

·         Product and market development resources

·         Technological obsolescence

·         Reliance on vendors

·         Distribution system

·         Financial reporting and controls

·         Long term contracts with customers or unique products or

            market niche

·         Patents, copyrights, franchise rights, proprietary products

·         Operating facilities and capital investment needs

·         Industry and economic conditions

Broadly speaking, capitalization rates range from 17% at the low risk end of the spectrum to over 30% at the high end of the spectrum.  

By working with management, Stevenson Valuation Group has, over time, assisted management in increasing value by enhancing the quality of the company’s cash flow.

Building Value Is A Process

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Building Value Is a Process

Part One of a three part series.

 Part One

The process of building value in a company starts with a basic understanding of how value is determined.

There are three appraisal principles that constitute the foundation of valuation theory. These principles are (1) the principle of alternatives, (2) the principle of substitution, and (3) the principle of future benefits.

The principle of alternatives states that in any contemplated transaction both buyer and seller have choices and do not necessarily need to enter or proceed with a proposed transaction.

The principle of substitution states that value tends to be determined by the cost of an equally desirable substitute. In other words, if two items are identical, except for price, a willing buyer will gravitate to the item with the lower price. Or, in terms of an investment, if two investments have equal risk an investor will invest in the item that provides the greatest return.

Finally, the principle of future benefits tells us that economic value reflects anticipated future benefits. Basically, there are three reasons that investors will invest in a certain stock: (1) dividends (future cash flows to the investor), (2) capital appreciation (future cash flows to the investor upon sale), or (3) a combination of the two.

Since there is no ready market for closely held stock, an experienced valuator, keeping in mind the three principles above, will analyze and examine a vast array of information before selecting an appropriate valuation method or methods. The valuation method selected will fall within three general approaches:

Asset Approach

Market Approach

Income Approach

 In the asset approach emphasis is placed on the current value of the assets less liabilities. It is typically used for companies with volatile or low earnings, holding companies, companies that will soon be liquidated and capital intensive operations. It does not provide a value for goodwill which must be computed separately if it exists.

The market approach employs the valuation principle of substitution. The substitution theory states that similar assets have similar values. Therefore, by comparing the subject company to other comparable companies a reasonable estimation of value is obtained. The market method is a highly regarded method for valuing a going concern because value is derived directly from the marketplace. However, finding suitable comparable companies is extremely difficult and often time consuming.

For profitable, non-public companies, the Income Approach is often favored. The income approach measures value based on the principle that the value of a business is equal to the present value of the future benefits of ownership. The benefits of ownership are most often expressed in terms of net cash flow. The present value factor is usually referred to as a capitalization or discount rate and is generally considered to be a measurement of investor risk expressed as a percentage.

The income approach employs a simple formula to determine value:

Value = Benefit/Risk

 Therefore, maximizing value is a function of increasing net cash flow, decreasing risk or a combination of both.

Next month, in Part Two of this article, we will discuss ways to increase cash flow and minimize investor risk.
Sincerely,

Thomas G Stevenson, CPA, CVA