How to value your company and the use of equity.

1. Valuations and the use of equity
WBS Entrepreneurship Mentoring Programme
Simon Chapman
30 March 2012
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2. Introduction to Burgis & Bullock
 Midlands firm of accountants and business advisers.
 Clients include entrepreneurs, owner-managed
businesses, corporates, and private equity backed
companies.
 Specialist corporate finance practice.
 Valuations for M&A deals, dispute resolution, tax
purposes, and estate planning.
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3. Speaker profile
 Corporate finance partner at Burgis & Bullock.
 17 years in M&A
 Experience at Ernst & Young, Baker Tilly, and in industry
 Valuations for M&A transactions, divorces, shareholder
disputes, and fairness opinions
 Panel of experts of the President ICAEW
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4. How would you value……..
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5. Key questions before you start a valuation
 What am I valuing?
 Why am I valuing it?
 For whom am I doing this valuation?
 As at what date is the valuation?
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6. Reasons to carry out a valuation
 Fiscal valuations
 Dispute resolution
 Commercial valuations
 Financial reporting
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7. Fiscal valuations
 Share option schemes
 Probate and inheritance tax purposes
 Trust and estate planning
 Group re-structurings
 Capital Gains Tax
 Employment Related Securities
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8. Dispute resolution
 Shareholder disputes and exits
 Compulsory share transfers
 Companies Act 2006
 Divorce
 Litigation
 Share purchase agreements
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9. Commercial valuations
 Mergers and acquisitions
 Disposals
 MBOs and MBIs
 IPOs
 Capital reconstructions
 Lender security assessments
 Raising new finance
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10. Why does the reason for the valuation matter?
 Open Market Value
Fiscal  Case law
valuations  Minority discounts
 Valuation date and perspective
 Market Value v Fair Value
 Articles of Association and other agreements
Dispute
 Case law
resolution  Minority discount v quasi partnerships
 Valuation date and perspective
 Freedom to use any method
Commercial  Typically based on whole firm purchase
valuations  Forward looking
 Special purchaser value
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11. Ways of representing value
Market Investing Operating
approach approach approach
Net working
capital
Value of net
interest bearing
debt
Value of net
Market value of tangible assets
the business /
invested capital
(enterprise
value) Value of identifiable
intangible assets
Value of equity
Goodwill
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12. Theoretical underpinning of a valuation
Expected
future earnings
or cash flows
Fair or market value…
What will someone pay
Risk of the given these facts?
Timing of
earnings or
the earnings
cash flows
or cash
not
flows
materialising
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13. Main valuation methods
 Asset value
 Capitalisation of earnings
 Mixed methods
 Discounted cash flow
 Industry “rules of thumb”
 Risk/reward models
 Other methods, e.g. options
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14. Asset value
 Valuation of individual asset components
 Book value v adjusted book value
 Liquidation value
 Entry cost
 Bank security
 Net realisable value
 Low risk / underpins other valuation methods
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15. Capitalisation of earnings
 Comparable quoted companies
 Precedent transactions
 Maintainable earnings
 Comparability adjustments
 Historical v prospective ratios
 Availability of data
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16. Mixed methods
 Operating approach
 Net assets plus value of goodwill
 Goodwill based on excess returns from invested capital
 In practice, goodwill usually derived as a multiple of
turnover or profits
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17. Discounted cash flow
 Early stage / pre-profit ventures
 Mature and predictable businesses
 Theoretically sound, but difficult in practice
 Forecasting risks
 Variability of financial assumptions
 Determining the WACC / discount rate
 Case study 1
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18. Industry “rules of thumb”
 Very common in practice
 Ultimately derived from DCF and comparables – but are
the base assumptions still valid?
 Per unit basis, e.g. nursing homes
 Turnover multiples, e.g. accountancy practices
 Per user basis, e.g. internet businesses
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19. Risk/reward models
 Investor’s target return
 Forecasting risk
 Exit risk/assumptions
 Impact of gearing
 Impact of share structuring and different share rights
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20. Key methods preferred by investors
 Capitalisation of earnings – based on precedent
transactions
 Risk/reward models
 Asset basis and “rules of thumb” may be used as
secondary methods to underpin core methods
 Discounted cash flow rarely used in practice
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21. Quoted company comparables
 Selecting the peer group
 Liquidity and marketability discounts
 Control premia and minority discounts
 Differential size and growth characteristics
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22. Quoted company comparables
Case study 2
 Privately owned specialist nuclear engineering business
 Turnover of £14m and EBIT of £1.8m
 Forecast profit growth of 15% per annum over next 3
years
 Approached by listed company
 How would you value based on listed comparators?
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23. Quoted company comparables
Case study 2
Market Enterprise
capitalisation Net debt value Historic Forecast
Company Activities £m £m £m EBIT x CAGR
Engineering products and services for the
mining, oil & gas, nuclear & defence, power
Weir Group generation and water treatment sectors. 1363 7 1370 10.5 9%
Engineering services for the oil & gas, nuclear,
defence, food,safety & security and
Redhall Group transportation sectors. 54 -1 53 28.8 44%
Marine services and the provision of the
James Fisher & Sons engineering services to the nuclear industry. 306 74 380 18.6 28%
Support services Group operating in regulated
Babcock International indutries including defence and energy 1297 74 1371 16.0 31%
Specialist construction, nuclear engineering and
Renew Holdings land remediation 68 -9 59 11.5 18%
VT Group Defence and support services company 806 93 899 8.1 15%
Average 15.6
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24. Quoted company comparables
Case study 2
35.0
y = 50.523x + 2.5518  Implied valuation of
30.0 R² = 0.8986
£18m
25.0
20.0  Negotiations with
EV/EBIT
trade buyer
15.0
terminated
10.0
5.0  MBO at £16m
completed
0.0
0% 10% 20% 30% 40% 50% 60%
EBIT CAGR
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25. Precedent transactions
 Key method used in commercial transactions including
fund raisings and MBOs
 Determining the earnings / profit figure
 Population of comparable deals
 Assessing the final valuation figure or range
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26. Precedent transactions
 Reported profit – EBITDA, EBITA, EBIT, PBT etc?
 Historical, current or prospective – ensure consistency
 Maintainable/normalised profits:
 Exceptional items
 Shareholder remuneration
 Non-business costs
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27. Precedent transactions
 Large and general population of comparables
 Small and focused comparator group
 Accessing the deal information
 Reported v true deal statistics – using databases
 Earn-outs, deferred consideration and partial exits
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28. Precedent transactions
BDO Private Company Price Index
20
15
FT non-financials
PCPI
10
5
Q1 Q4
Q4 Q3 Q4 Q2 Q4 Q1 Q4
Q4 Q3 Q4 Q2 Q1
Q4 Q4
Q4
2005 2005 2006 2007 2007
2005 2006 2008 2008 2009 2010 2010
2008 2009 2011 2011
2011
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29. Precedent transactions
 How to deal with a range of multiples
 Focus on the true comparators
 Averaging is rarely the best approach
 Understand the outliers
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30. Risk/reward models
 Is it a valuation method?
 Variant of a DCF model
 Based on target investor returns
 Reliant on company forecasts – subjectivity areas
 Capital gain drives the return – impact of assumed exit
multiples
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31. Valuing and using shares
 Valuations: economic, tax and practical considerations
 Using shares for acquisitions
 Using shares for employees
 Using shares with suppliers
 Using shares with customers
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32. Valuing your shares
 Market value
 Minority discounts
 Restricted shares
 Will the recipients attach the same value as you to
shares?
 Practical issues
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33. Using shares for acquisitions
 Powerful way to grow through acquisition
 Valuation issues with unlisted shares
 Exit/realisation options for recipients of shares
 Post deal restrictions / lock-in arrangements
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34. Valuing your shares
Case study 3
 Target business generating £2m EBIT on sales of £10m
 Approached by acquiror – offer at £13m
 Sale multiple of 6.5x
 Consideration split £10.5m cash and £2.5m in shares
 Acquiror generates EBIT of £2.6m on sales of £21m
 What % of the enlarged group should the vendor
shareholders have?
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35. Valuing your shares
Case study 3
 Acquiror’s view:
 Combined group has EBIT of £4.6m
 Enlarged group would merit valuation of 8x
 Therefore, enlarged group worth £36.8m
 So, £2.5m investment equates to 7%
 Is this reasonable?
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36. Valuing your shares
Case study 3
 Seller’s view:
 Acquiror should be rated at 6.5x – the same as target
 Therefore, acquiror worth £16.9m pre deal
 Post deal value of £19.4m
 So, share investment of £2.5m equates to 13%
 What happened?
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37. Using shares with employees
 Why….to save money or attract, retain and motivate?
 Is it appropriate to your industry and employees?
 Shares v options
 Approved and unapproved share options
 EMI options
 Protections and restrictions
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38. Using shares with suppliers
 Which suppliers would value your shares?
 Valuation issues
 Conflict issues
 Restrictions and control
 Keep the equity tight
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39. Using shares with customers
 Recruitment and loyalty tool
 Will your customers value them?
 Shared equity schemes
 Case study 4: Unichem
 Regulatory issues
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40. Different classes of shares and their use
 Ordinary shares
 Preferred ordinary shares
 Preference shares
 Redeemable shares
 Deferred shares
 Flowering shares
 Founder or golden shares
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41. Conclusion
 Triangulate your valuations using several methods
 Thorough analysis of inconsistent benchmarks
 Beware of simplistic methodologies
 Don’t rely on mathematical models – use judgement and
knowledge of key value drivers
 Equity is your most valuable asset
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