Business valuation

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Business valuation is the process and set of procedures used to estimate the economic value of the owner's interest in a business. Valuations are used by financial market participants to determine the price they are willing to pay or receive to influence a business's sales. In addition to estimating the selling price of a business, the same valuation tool is often used by business appraisers to resolve disputes related to property and prize taxes, divorce litigation, allocate the purchase price of business among business assets, establish a formula to estimate the value of ownership of partners for sale agreement -buy, and many other business and legal purposes such as in shareholder deadlock, divorce litigation, and property contests. In some cases, the court will appoint a forensic accountant as a joint expert who conducts business appraisals.

Video Business valuation

Standard and premise value

Before a business's value can be measured, the appraisal assignment should mention the reasons and circumstances surrounding the business valuation. It is formally known as the standard of business value and the premise of value.

The standard of value is a hypothetical condition in which the business will be judged. Premise values â€‹â€‹relate to assumptions, such as the assumption that the business will continue in its current form (going concern), or that the value of the business lies in the proceeds from the sale of all its assets minus the related debt. (number of parts or bundles of business assets).

Maps Business valuation

Standard value

Fair market value - the value of a business enterprise determined between a willing buyer and a willing seller both have full knowledge of all relevant facts and are not compelled to conclude the transaction.
Investment value - the value the company has for a particular investor. Note that the effect of synergies is included in the valuation below the investment value standard.
Intrinsic value - a measure of business value that reflects the investor's deep understanding of the company's economic potential.

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Location value

Survival - Value in sustainable use as a running business enterprise.
Assets collection - the value of the asset in place but not used for conducting business operations.
Order sharing - the value of a business asset in exchange, where an asset should be disposed individually and not used for business operations.
Liquidation - a value in exchange when a business asset must be disposed of in a forced liquidation.

The premise value for Fair value calculation

Used - If the asset will give the market a maximum value primarily through its use in combination with other assets as a group.
In Exchange - If the asset will give the marketer a maximum value in principle on a stand-alone basis.

The results of business valuations can vary greatly depending on the choice of standards and the premise of value. In actual business sales, it is expected that buyers and sellers, each with an incentive to achieve optimal results, will determine fair market value of the business assets that will compete in the market for such acquisitions. If the synergy is specific to the company being assessed, they may not be considered. Fair value also excludes discounts due to lack of control or selling power.

Note, however, that it is possible to achieve fair market value for business assets that are being liquidated in the secondary market. It underlines the difference between standard and premise value.

These assumptions may not, and may not, reflect actual market conditions in which the subject business can be sold. However, these conditions are assumed because they result in a uniform standard of value, after applying a generally accepted assessment technique, which allows a meaningful comparison between the same business.

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Business rating element

Economic condition

The business valuation report generally begins with a summary of the purpose and scope of the business assessment as well as the stated date and audience. The following is a description of the national, regional and local economic conditions that existed from the assessment date, as well as the industrial conditions in which the subject business operates. The general source of economic information for the first part of the business valuation report is the Federal Reserve Board's Beige Book, published eight times a year by the Federal Reserve Bank. State governments and industry associations also publish useful statistics describing regional and industrial conditions.

Financial analysis

Financial statement analysis generally involves general size analysis, ratio analysis (liquidity, turnover, profitability, etc.), trend analysis and industry comparative analysis. This allows assessment analysts to compare subject firms with other businesses in the same or similar industry, and to find trends affecting companies and/or industries over time. By comparing the company's financial statements over different time periods, the assessment expert can see growth or decrease in revenues or expenses, changes in capital structure, or other financial trends. How the company's subject is compared to the industry will help with risk assessment and ultimately help determine the discount rate and the selection of multiples of the market.

It is important to mention that among the financial statements, the main statement to show the company's liquidity is cash flow. Cash flow shows cash inflows and outflows.

Normalization of financial statements

The primary goal of normalization is to identify the business's ability to generate revenue for its owners. The size of revenue is the amount of cash flow that an owner can remove from a business without affecting its operations. The most common normalization adjustments fall into the following four categories:

Comparative Adjustment. Valuers may adjust the subject's financial statements to facilitate comparisons between subject firms and other businesses in the same industry or geographic location. This adjustment is intended to eliminate the distinction between the way in which the publication of industry data and the way in which the subject data is presented in its financial statements.
Non-operating Adjustments. It makes sense to assume that if a business is sold in a hypothetical sale transaction (which is the basic premise of fair market value standards), the seller will retain any assets not related to the production of income or prices that do not operate the asset separately. For this reason, non-operating assets (such as excess cash) are usually removed from the balance sheet.
Non-recurring Adjustments. The subject company's financial statements may be affected by unexpected events, such as the purchase or sale of a tremendous asset, suit, or income or expense. These non-repetitive items are adjusted so that the financial statements will better reflect management's expectations for future performance.
Discretionary Adjustment. Owners of private companies can be paid for with variations of the level of market compensation that may be owned by similar executives in the industry. To determine fair market value, the owner's compensation, benefits, additional income and distribution must be adjusted to industry standards. Similarly, the rent paid by the subject business for the use of property owned by individual company owners can be examined.

Revenue, assets, and market approach

Three different approaches are commonly used in business valuations: income approaches, asset-based approaches, and market approaches. In each of these approaches, there are various techniques for determining business value using the exact definition of value for assignment assessment. Generally, the revenue approach determines the value by calculating the net present value of the business benefit stream (discounted cash flow); an asset-based approach determines value by adding the number of parts of the business (net asset value); and a market approach determines value by comparing subject firms with other firms in the same industry, of equal size, and/or within the same territory. A number of business valuation models can be built that utilize various methods under three business valuation approaches. Venture Capitalists and Private Equity professionals have long used the First chicago method that essentially combines income approaches with a market approach.

In certain cases, equity can also be assessed by applying techniques and frameworks developed for financial options, through a real-life option framework, as discussed below.

In determining which approach to use, assessment professionals should apply discretion. Each technique has its own advantages and disadvantages, which should be considered when applying these techniques to a particular subject company. Most treatises and court decisions encourage appraisers to consider more than one technique, which must be reconciled with each other to reach a value conclusion. The size of common sense and a good understanding of mathematics are helpful.

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Income approach

The income approach depends on the economic principle of expectation: business value is based on expected economic benefits and the level of risks associated with investments. The revenue-based valuation method determines fair market value by dividing the flow of benefits generated by the subject or target company multiplied by the discount or capitalization rate. The discount rate or capitalization changes the flow of benefits into present value. There are different revenue methods, including profit capitalization or cash flow, future cashflow deductions ("DCF"), and over-income methods (which are a combination of asset and revenue approaches). The result of the computation of values â€‹â€‹under the income approach is generally the fair market value of a controlling interest, which can be marketed in the subject enterprise, since all beneficiary flows are most frequently assessed, and the capitalization and discount rates are derived from statistics on public companies. The IRS 59-60 Revenue Rule states that earnings are superior to the firm's closely held appraisals.

However, revenue valuation methods can also be used to set the value of disconnected business assets as long as the revenue stream can be attributed to them. An example is a licensed intellectual property rights whose value needs to be established to achieve a royalty structure that can be supported.

Discount or capitalization rate

The discount rate or capitalization rate is used to determine the present value of the expected outcome of a business. The discount rate and capitalization rate are closely related to each other, but can be differentiated. In general, the discount rate or the capitalization rate can be defined as the result required to attract investors to a particular investment, given the risks associated with the investment.

In the DCF valuation, the discount rate, often an estimate of the cost of capital for a business, is used to calculate the net present value of a set of projected cash flows. The discount rate can also be seen as the requested rate of return that investors would expect to receive from business firms, given the level of risk they make.
On the other hand, the capitalization rate is applied in a business valuation method based on business data for a period of time. For example, in a real estate valuation for a property that generates cash flow, the capitalization rate can be applied to net operating income (NOI) (ie, income before depreciation and interest cost) of the property for trailing twelve months.

There are different methods to determine the exact discount rate. The discount rate consists of two elements: (1) the risk-free level, which is the expected return of investors from safe, risk-free investment, such as high-quality government bonds; plus (2) risk premiums that compensate investors for relative risk levels associated with certain investments that exceed risk-free levels. Most importantly, the discount or selected capitalization rate must be consistent with the flow of benefits to be applied.

Capitalization and calculation of discount valuations become mathematically equivalent assuming that business income grows at a constant rate.

Capital Asset Pricing Model (CAPM)

The capital asset pricing model (CAPM) provides a method for determining the discount rate in a business valuation. CAPM comes from the study of Nobel Prize winners Harry Markowitz, James Tobin, and William Sharpe. This method obtains a discount rate by adding a risk premium to a risk-free rate. The risk premium is derived by multiplying the equity risk premium by "beta", the stock price volatility measure. Beta is compiled by various researchers for specific industries and companies, and measures the systematic risk of investment.

One criticism of CAPM is that beta comes from the volatility of public company prices, which differs from non-public companies in liquidity, marketing, capital structure and control. Other aspects such as access to credit markets, size, and depth of management in general are also different. Rate-raising methods also require a corporate risk assessment, which provides the assessment itself. Where private companies can be shown to be quite similar to a public company, CAPM might be appropriate. However, this requires knowledge of stock market prices for calculations. For private companies that do not sell shares in the public capital market, this information is not available. Therefore, the beta calculation for private companies is problematic. The cost of building a capital model is a common option in such cases.

Modified Modified Capital Assets

Justice Costs (Ke) are calculated using the Modified Capital Asset Pricing Model (Mod CAPM)

${\ displaystyle k_ {e} = R_ {f} \ beta (R_ {m} -R_ {f}) SCRP CSRP} Ã‚Â Ã‚Â$

Where:

${\ displaystyle R_ {f}} Ã‚Â Ã‚Â$ = Tingkat pengembalian bebas risiko (Umumnya diambil sebagai imbal hasil obligasi pemerintah 10-tahun)

${\ displaystyle \ beta} Ã‚Â Ã‚Â$ = Nilai Beta (Sensitivitas pengembalian saham terhadap pengembalian pasar)

${\ displaystyle k_ {e}} Ã‚Â Ã‚Â$ = Biaya Ekuitas

${\ displaystyle R_ {m}} Ã‚Â Ã‚Â$ = Tingkat Pengembalian Pasar

SCRP = Small Enterprise Risk Premium

CSRP = Company specific Risk premium

The weighted average cost of capital ("WACC")

The weighted average cost of capital is the approach to determine the discount rate. The WACC method determines the actual firm capital cost by calculating the weighted average cost of debt and the cost of the company's equity. WACC should be applied to the company's net cash flow to the total capital invested.

One of the problems with this method is that the assessor may choose to calculate WACC according to the company's existing structure, the average industry capital structure, or the optimal capital structure. Such wisdom reduces the objectivity of this approach, in the minds of some critics.

Indeed, since WACC captures the subject's business risk itself, the existing or contemplated capital structure, rather than the industry average, is the right choice for business valuation.

Once the capitalization rate or discount rate is determined, it must be applied to the appropriate stream of economic income: pre-tax cash flow, aftertax cash flow, net profit before tax, after tax net profit, excess income, cash flow projection, The result of this formula is the value indicated before the discount. Before proceeding to calculate discounts, however, assessment professionals should consider the value shown under the assets and market approach.

A careful matching of the discount rate to measure the right economic income is critical to the accuracy of business valuation results. Net cash flows are a frequently used option in professionally conducted business valuations. The rationale behind this option is that this revenue base corresponds to the equity discount rate derived from the Build-Up or CAPM model: returns generated from investments in public companies can easily be represented in terms of net cash flows. At the same time, the discount rate in general also comes from public capital market data.

Setup Method

The Build-Up method is a widely recognized method for determining the discount rate of net after-tax net cash flows, which in turn results in a capitalization rate. The numbers used in the Build-Up Method come from various sources. This method is called the "build-up" method because it is the number of risks associated with different asset classes. This is based on the principle that investors will need a greater return on a more risky asset class. The first element of the Build-Up capitalization rate is the risk-free rate, which is the rate of return for long-term government bonds. Investors who buy large capitalized equity shares, which are inherently more risky than long-term government bonds, require greater returns, so the next element of the Build-Up method is the equity risk premium. In determining the value of the company, the long-term equity risk premium is used because the life of the Company is assumed to be unlimited. The amount of risk-free rate and equity risk premium resulted in a long-term average rate of return on the stock of large public corporations.

Similarly, investors who invest in small cap stocks, which are more risky than blue-chip stocks, require greater returns, called "premium sizes." Premium data sizes are generally available from two sources: Stocks, Bonds, Bills & amp; from Morningstar (formerly Ibbotson & Associates'); Inflation and Duff & amp; Phelps Risk Premium Report.

By adding the first three elements of the Build-Up discount rate, we can determine the rate of return that investors will need on their investments in the stock of small public companies. The three elements of the Build-Up discount rate are known collectively as "systematic risk." This type of investment risk can not be avoided through portfolio diversification. It arises from external factors and affects every type of investment in the economy. As a result, investors who take systematic risk are rewarded by additional premiums.

In addition to systematic risk, the discount rate should include "systematic risk" which represents a portion of total investment risk that can be avoided through diversification. The public capital market does not provide any evidence of systematic risk because investors who fail to diversify can not expect additional returns.

Unsystematic risks fall into two categories. One such category is "industry risk premium". This is also known as idiosyncratic risk and can be observed by studying the return of a group of companies operating in the same industry sector. Morningstar's annual book contains empirical data for measuring risks associated with various industries, grouped by SIC industry code.

Another category of systemic risk is referred to as "enterprise-specific risk." Historically, no published data were available to measure a particular company's risk. However, by the end of 2006, new research has been able to measure, or isolate, this risk to public stock through the use of Total Beta calculations. P. Butler and K. Pinkerton have outlined a procedure that sets the following two equations together:

Total Equity Cost (TCOE) = total risk-free rate beta * TCOE equity risk premium = beta risk-free rate * premium equity risk premium size of company-specific risk premium

The only unknown in the two equations is the specific risk premium of the firm.

While it may be possible to isolate the company's specific risk premium as indicated above, many assessors only include the total equity cost (TCOE) provided by the following equation: TCOE = risk-free rate Total beta * equity risk premium.

This is similar to using a market approach in revenue approaches rather than adding separate (and potentially redundant) risk measures in the build-up approach. The total beta use (developed by Aswath Damodaran) is a relatively new concept. Nevertheless, gaining acceptance in the business valuation community because it is based on modern portfolio theory. Total beta can help the appraiser develop a satisfactory capital cost to use their own intuition when it previously added a purely subjective corporate risk premium in the build-up approach.

It is important to understand why this level of capitalization for privately owned small firms is significantly higher than earnings that might be expected by investors of other types of general investments, such as money market accounts, mutual funds, or even real estate. The investment involves a much lower level of risk than investing in a closely held company. Storage accounts are insured by the federal government (to some extent); Mutual funds consist of publicly traded stocks, where risk can be substantially minimized through portfolio diversification.

Companies held tightly, on the other hand, often fail for too many reasons to be named. Examples of risks can be seen in shop windows on every Main Street in America. There is no federal guarantee. The risk of investing in a private company can not be reduced through diversification, and most businesses do not have the kind of hard assets that can ensure capital appreciation over time. This is why investors demand a much higher return on their investment in tightly held businesses; Such investments are inherently much more risky. (This paragraph is biased, assuming that with the fact that a company is held tightly, it is vulnerable to failure.)

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Asset-based approach

The value of an asset-based analysis of a business is equal to the sum of its parts. That's the theory that underlies an asset-based approach to business valuation. The asset approach to business valuation is reported on books of subject firms on their acquisition value, net of depreciation where applicable. These values â€‹â€‹must be adjusted to fair market value wherever possible. The value of the company's intangible assets, such as goodwill, is generally impossible to determine apart from the company's overall corporate value. For this reason, an asset-based approach is not the most probable method of determining the value of an ongoing business problem. In this case, an asset-based approach produces results that may be lower than the fair market value of the business. In considering an asset-based approach, assessment professionals must consider whether shareholders whose interests are assessed will have the authority to access asset value directly. Shareholders own shares in a company, but not its assets, owned by the company. The controlling shareholder may have the authority to direct the company to sell all or part of its assets and to distribute the proceeds to the shareholder (s). The non-controlling shareholder, however, does not have this authority and can not access the asset value. As a result, the value of the company's assets is not a true value indicator for shareholders who can not take advantage of that value. An asset-based approach is an entry barrier value and should be used in businesses that have mature or declining growth cycles and are more suitable for capital-intensive industries.

Adjusted book value may be the most relevant value standard where liquidation is near or in progress; in which the company's revenue or cash flow is nominal, negative or of lesser value than its assets; or where net book value is the standard in the industry where the company operates. The adjusted net book value can also be used as a "sanity check" when compared to other valuation methods, such as revenue and market approaches...

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Market Approach

The market approach to business valuation is rooted in the principle of a competitive economy: that in a free market, the power of supply and demand will push the price of a business asset to a certain equilibrium. The buyer will not pay more for the business, and the seller will not receive less, than the price of a comparable business enterprise. Buyers and sellers are assumed to be equally informed and act on their own behalf to complete the transaction. This is similar in many ways to the "comparable selling" method commonly used in real estate valuations. Stock market prices of publicly traded companies operating in the same or similar business field, whose shares are actively traded in free and open markets, may be a valid value indicator when transactions in which shares are traded are similar enough to allow meaningful comparison.

The difficulty lies in identifying public companies that are quite comparable to the subject companies for this purpose. Also, as for a private company, equity is less liquid (in other words its shares are less easy to buy or sell) than for a public company, its value is considered to be slightly lower than the market-based valuation as it would deliver.

When there is a lack of comparison with direct competition, a meaningful alternative can be a vertical value chain approach in which the subject company is compared to, for example, a downstream industry known to have a good sense of value by building a useful correlation with its downstream firm. Such comparisons often reveal useful insights that help business analysts better understand the performance relationship between the subject company and its downstream industry. For example, if a developing subject company is in a more concentrated industry than its downstream industry with a high degree of interdependence, one should logically expect the subject company to perform better than the downstream industry in terms of growth, margins and risk.

Company Methods Public Guide

The Guideline Public Company method requires comparison of subject firms with publicly traded companies. This comparison is generally based on published data on the stock price of a public company and its revenue, sales, or income, expressed as fractions known as "multiples". If the guidelines of a public company are quite similar to each other and the subject company to allow meaningful comparison, then its multiples must be similar. Public companies identified for comparative purposes should be similar to subject firms in terms of industry, product lines, markets, growth, margins, and risk.

However, if the subject company is privately owned, its value should be adjusted for lack of marketing. This is usually represented by a discount, or a percentage reduction in the value of a company when compared to its publicly traded counterparts. This reflects a higher risk associated with ownership of shares in private companies. The difference in value can be quantified by applying a discount due to lack of marketing. These discounts are determined by studying the price paid for the ownership stake in a private company that eventually offers their shares in a public offering. Alternatively, the lack of marketing can be assessed by comparing the price paid for the limited stock with the shares of a fully marketable public company.

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Option pricing approach

As above, in certain cases equity can be assessed by applying techniques and frameworks developed for financial options, through a realistic option framework. For a general discussion of the context, see "Valuation flexibility" under corporate finance and the assessment of Contingent claims; for details on implementation and other considerations, see "Limitations" under the assessment of real options.

In general, equity can be seen as a call option at a company, and this allows for valuation of problematic companies that may be difficult to analyze; see Depressed securities. Here, because the principle of limited liability protects equity investors, shareholders will choose not to pay corporate debt where the value of the firm (as perceived) is less than the value of unpaid debt; see bond assessment. Of course, where the value of the company is greater than the value of the debt, the shareholders will choose to pay back (ie use their options) and not to liquidate. So analogously with a value-for-money option, equity will (probably) have a value even if the value of the firm falls (well) below the nominal value of the unpaid debt - and this value can (should) be determined using appropriate optional valuation techniques. (The further application of this principle is the analysis of principal-agent problems: see contract design under principal-agent issues.)

Certain business situations, and parent companies in such cases, are also logically analyzed under the framework of choice; see "Applications" under real-time option assessment reference. Just as the financial option gives the owner the right, but not the obligation, to buy or sell securities at a certain price, the company that makes the strategic investment has the right, but not the obligation, to take advantage of future opportunities. Thus, for a company facing this type of uncertainty, the stock price may (should) be seen as the sum of the value of the existing business (i.e., the discounted cash flow value) plus any real value option. An equity valuation here, perhaps (should) be likewise resumed. Compare PVGO.

A common application is the investment of natural resources. Here, the underlying asset is the resource itself; asset value is a function of both the quantity of available resources and the price of the commodity concerned. The value of the resource is then the difference between the asset value and the costs associated with the development of the resource. Where positive ("in money") management will do development, and will not do it otherwise, and the resource project is thus effectively a call option. A resource company may (should) therefore also be analyzed using the option approach. Specifically, the value of the firm consists of the value of an already active project determined through a DCF assessment (or any other standard technique) and undeveloped reserves as analyzed using a realistic option framework. See the Mineral economy.

Product patents can also be assessed as options, and the value of companies holding this patent - usually companies in the bio-sciences, technology, and pharmaceutical sectors - can be equally seen as the amount of product value in place and the patent portfolio has not been deployed. Regarding option analysis, since the patent grants the company the right to develop the product, it will do so only if the present value of the expected cash flow of the product exceeds the development cost, and the patent corresponds to a call option. See Patent Rating Ãƒ, Ã‚Â§ Option based method. Similar analyzes may be applied to options on film (or other works of intellectual property) and movie studio appraisals.

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Discounts and premiums

The appraisal approach generates fair market value from the Company as a whole. In assessing minorities, non-controlling interests in business, however, assessment professionals should consider the application of discounts that affect those interests. Discussions on discounts and premiums often begin with reviews of "grade level". There are three common values: controlling interest, marketable minority, and non-marketable minority. Medium-sized, marketable minority, less than the controlling interest rate and higher than the non-marketable minority rates. Marketable minority rates represent the perceived value of free trading equity interests without any restriction. These interests are generally traded on the New York Stock Exchange, AMEX, NASDAQ, and other exchanges where there is a ready market for equity securities. These values â€‹â€‹represent minority interests in subject firms - small blocks of shares representing less than 50% of the firm's equity, and usually less than 50%. Controlling the interest rate is the value that the investor is willing to pay to acquire more than 50% of the company's shares, thereby gaining controlling prerogative rights. Some of the prerogatives of control include: selecting directors, hiring and firing company management and determining their compensation; declare dividends and distributions, determine the company's strategy and lines of business, and acquire, sell or liquidate business. This level of value generally contains a control premium above the intermediate level, which typically ranges from 25% to 50%. Additional premiums can be paid by strategic investors motivated by synergistic motives. Non-marketable, the minority level is the lowest level on the chart, representing the rate at which non-controlling equity interests in private companies are generally valued or traded. This level of value is discounted because there is no market ready to buy or sell interest. Private companies are less "liquid" than publicly traded companies, and transactions in private companies take longer and more uncertain. Among the middle and low levels of the charts, there are limited stocks of public companies. Despite the increasing tendency of the IRS and Tax Court to challenge the assessment discounts, Shannon Pratt suggested in a recent scientific presentation that valuation discounts actually increased as the differences between public and private companies widened. Publicly traded stocks have grown more fluid in the last decade due to rapid electronic commerce, commission cuts, and government deregulation. This development has not increased liquidity of interest in private companies. The assessment discount is multiplication, so it should be considered in sequence. Premium and reverse controls, minority interest discounts, are considered before marketing discounts are applied.

Discount for lack of control

The first discount to consider is a discount due to lack of control, which in this case is also a discount of minority rights. Minority interest discount is the inverse of the control premium, which has the following mathematical relationship: MID = 1 - [1/(1 CP)] The most common source of data on control premiums is the Premium Control Study, published annually by Mergerstat since 1972. Mergerstat collects data on publicly traded mergers, acquisitions and divestments involving 10% or more of equity interests in public companies, where the purchase price is $ 1 million or more and at least one of the parties to the transaction is a US entity. Mergerstat defines "control premium" as a percentage difference between the acquisition price and the stock price of a freely traded public stock five days before the announcement of the M & amp; A. Though not without valid criticism, Mergerstat's premium control data (and minority interest discounts derived from it) are widely accepted in the assessment profession.

Discount for lack of marketing capabilities

"Discounts due to lack of marketing" (DLOM) can be applied to minority share blocks to change the block's rating.

Another factor to consider in assessing a closely held company is the selling power of interest in the business. Marketing ability is defined as the ability to turn business interest into cash quickly, with minimal transaction and administrative costs, and with a high degree of certainty about the amount of net proceeds. There is usually a fee and time lag associated with the location of interest of interested and capable buyers in privately held companies, as there is no established market of available buyers and sellers.

All other factors are equal, interest in publicly traded companies is more valuable because it is easy to market. Conversely, interest in private companies is more valuable because there is no established market. "The IRS Valuation Guide for Revenue, Property Taxes and Gifts, Assessment Training for Appeals Officers" recognizes the relationship between value and marketing, stating: "Investors prefer easy-to-sell assets, that is, liquid."

Discounts due to lack of separate control and can be distinguished from discounts due to lack of marketing. It is a professional assessment task to gauge the lack of selling power of an interest in a private company. Because, in this case, the interest of the subject is not a controlling interest in the Company, and the owner of that interest can not force liquidation to turn the subject's interest into cash quickly, and there is no established market where the interest can be sold, a discount due to lack of marketing is just right.

Several empirical studies have been published that attempt to measure discounts due to lack of marketing. These studies include limited stock studies and pre-IPO studies. The overall study showed average discounts of 35% and 50% respectively. Some experts believe that Lack of Control and Marketability discounts may collect a discount of ninety percent of the fair market value of the Company, in particular with family-owned companies.

Limited stock studies

Restricted shares are equity securities of public companies which are similar in all respects to free traded shares of such companies except that they carry a restriction that prevents them from being traded on the open market for a specified period of time, usually one year (two years before 1990). This restriction of active trade, which means lack of marketing, is the only difference between limited stocks and freely traded partners. Restricted shares may be traded in private transactions and usually do so at a discount. Limited stock studies try to verify the price difference where stock trading is limited versus the price at which the same unlimited securities trade in the open market on the same date. The underlying data on which this study came to their conclusions has not been published. Consequently, it is not possible when assessing a particular firm to compare the characteristics of the firm with the study data. However, the existence of marketing discounts has been recognized by assessment and court professionals, and limited stock studies are often cited as empirical evidence. In particular, the lowest average discount reported by this study was 26% and the highest average discount was 40%.

Pricing

In addition to limited stock studies, US public companies may sell shares to foreign investors (SEC Regulation S, established in 1990) without registering shares with the Securities and Exchange Commission. Offshore buyers can resell these shares in the United States, still without having to register shares, after holding them for only 40 days. Typically, these shares are sold at 20% to 30% below the publicly traded stock price. Some of these transactions have been reported at a discount of more than 30%, resulting from a lack of marketing. The discount is similar to the marketing discounts deduced from the limited and pre-IPO studies, although the holding period is only 40 days. The study based on the price paid for the option has also confirmed a similar discount. If someone keeps a limited stock and buys the option to sell the stock at a market price (put), the holder has, in effect, bought the market for the stock. The purchase price equals the marketing discount. The marketing discounts obtained by this study were 32% to 49%. However, assuming the entire value of put options for marketing can be misleading, since the primary source of put value comes from downside price protection. Correct economic analysis will use very deep in-money placements or single stock futures, suggesting that stocks of limited stocks have low value because it is easy to hedge using unlimited stock or futures trading.

Pre-IPO study

Another approach to measuring marketing discounts is to compare stock prices offered in an initial public offering (IPO) for transactions in shares of the same company before the IPO. Companies that go public are required to disclose all transactions in their shares for a period of three years prior to the IPO. Pre-IPO studies are the primary alternative to limited stocks in calculating marketing discounts.

Pre-IPO studies are sometimes criticized because of relatively small sample sizes, pre-IPO transactions may not be long arms, and the financial structure and product lines of the firms studied may have changed over the three year pre-IPO window.

Applying the study

Studies confirm what the market knows intuitively: Investors want liquidity and avoid obstacles that interfere with liquidity. Careful investors buy illiquid investments only when there is sufficient discount in prices to increase the rate of return to levels that bring risk rewards back in balance. The referenced study establishes reasonable discounted assessments ranging from mid to low 30% to 50%. More recent studies appear to produce more conservative discount ranges than older research, which may have suffered from smaller sample sizes. Another method of measuring the shortage of marketing discounts is the Quantifying Marketability Discounts Model (QMDM).

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Estimated business value

The evidence on the market value of a particular business varies greatly, largely depending on the market transactions reported in the equity of the firm. A small portion of the business is "publicly traded," meaning that their equity can be bought and sold by investors in the stock market available to the general public. Publicly traded companies in major stock markets have easily calculated "market capitalization," which is a direct estimate of the market value of the firm's equity. Some publicly traded companies have relatively few trades (including many companies that are traded "on the table" or in "pink sheets"). A large number of companies are privately held. Typically, equity interests in these companies (which include corporations, partnerships, limited liability companies, and some other forms of organization) are traded in private, and often irregular. As a result, previous transactions provide limited evidence of the current value of private firms primarily because business value changes over time, and share prices are associated with considerable uncertainty due to limited market exposure and high transaction costs.

A number of stock market indicators in the United States and other countries give an indication of the market value of publicly traded companies. The Consumer Financial Survey in the US also includes estimates of household shareholdings, including indirect ownership through mutual funds. SCF 2004 and 2007 show a growing trend in share ownership, with 51% of households showing direct or indirect ownership, with the majority of respondents indicating indirect ownership through mutual funds. Few indications are available about the value of private companies. Anderson (2009) recently estimated the market value of privately held US and publicly traded companies using the Internal Revenue Service and SCF data. He estimates that the privately held company generates more revenue for investors, and has more value than the company held publicly, in 2004.

src: thegrowthcoach.com

References

International Business Valuation Standards & Ethics course

src: iibv.org

Business valuation

Sabtu, 23 Juni 2018