Valuation for M&A

CHRIS M. MELLEN, ASA, MCBA, CM&AA, is president and founder of Delphi Valuation Advisors, Inc. (www.delphivaluation.com), located in Boston, Massachusetts and a principal in American Business Appraisers®. He is an Accredited Senior Appraiser (ASA), Master Certified Business Appraiser (MCBA), and Certified Merger & Acquisition Advisor (CM&AA). Chris also holds an MBA with a concentration in finance from Babson College and a bachelor of arts with a major in industrial relations and economics from McGill University. His experience includes completion of over 1,800 valuation assignments since 1989 in a wide range of industries for such purposes as strategic planning, mergers and acquisitions, tax and estate planning and compliance, financial reporting, financing, buy–sell agreements, litigation, and appraisal review. He can be contacted at cm@delphivaluation.com. FRANK C. EVANS, ASA, CBA, is the founder of Evans and Associates Valuation Advisory Services (www.evansandassociates.net), in Pittsburgh, Pennsylvania, and a principal in American Business Appraisers®. He holds the Accredited Senior Appraiser (ASA) and Certified Business Appraiser (CBA) designations and held the Certified Public Accountant Accredited in Business Valuation (CPA/ABV) designation. With an MBA and a bachelor of arts degree in economics from the University of Pittsburgh, he performs valuations and related consultation for strategic planning, merger and acquisition, tax planning, shareholder agreements and disputes, and litigation support. He is the coauthor with David Bishop of the first edition of Valuation for M&A and can be reached at fevans@evansandassociates.net.

Preface xi


Dedication and Acknowledgments xv


CHAPTER 1 Winning through Merger and Acquisition 1


Critical Values Shareholders Overlook 2


Stand–alone Fair Market Value 4


Investment Value to Strategic Buyers 5


Win–Win Benefits of Merger and Acquisition 7


CHAPTER 2 Building Value and Measuring Return on Investment in a Private Company 13


Public Company Value Creation Model 13


Computing Private Company Value Creation and ROI 15


Analyzing Value Creation Strategies 30


CHAPTER 3 Competitive Analysis 37


Linking Strategic Planning to Building Value 39


Assessing Specific–Company Risk 40


Competitive Factors Frequently Encountered in Nonpublic Entities 45


Financial Analysis 46


Conclusion 51


CHAPTER 4 Merger and Acquisition Market and Planning Process 53


Common Seller and Buyer Motivations 55


Why Mergers and Acquisitions Fail 57


Sales Strategy and Process 58


Acquisition Strategy and Process 66


Due Diligence Preparation 77


CHAPTER 5 Measuring Synergies 81


Synergy Measurement Process 82


Key Variables in Assessing Synergies 85


Synergy and Advance Planning 86


CHAPTER 6 Exit Planning 89


Why Is Exit Planning So Difficult? 90


What Makes Planning for Your Private Company Investment Unique? 93


Why Should Exit Planning for Your Private Company Begin Now? 95


Exit Planning Process 96


Step 1: Setting Exit Goals 98


Step 2: Owner Readiness 99


Step 3: Type of Exiting Owner 100


Step 4: Exit Options 101


Step 5: Range of Values 105


Step 6: Execution of Exit Plan 107


CHAPTER 7 Valuation Approaches and Fundamentals 109


Business Valuation Approaches 109


Using the Invested Capital Model to Define the Investment Being Appraised 111


Why Net Cash Flow Measures Value Most Accurately 112


Frequent Need to Negotiate from Earnings Measures 114


Financial Statement Adjustments 117


Managing Investment Risk in Merger and Acquisition 120


Conclusion 125


CHAPTER 8 Income Approach: Using Rates and Returns to Establish Value 127


Why Values for Merger and Acquisition Should Be Driven by the Income Approach 127


Two Methods within the Income Approach 129


Three–Stage DCF Model 134


Establishing Defendable Long–term Growth Rates and Terminal Values 135


CHAPTER 9 Cost of Capital Essentials for Accurate Valuations 141


Cost of Debt Capital 142


Cost of Preferred Stock 143


Cost of Common Stock 144


Fundamentals and Limitations of the Capital Asset Pricing Model 145


Modified Capital Asset Pricing Model 148


Build–up Model 149


Summary of Ibbotson Rate of Return Data 155


Private Cost of Capital 156


International Cost of Capital 158


How to Develop an Equity Cost for a Target Company 158


CHAPTER 10 Weighted Average Cost of Capital 163


Iterative Weighted Average Cost of Capital Process 164


Shortcut Weighted Average Cost of Capital Formula 168


Common Errors in Computing Cost of Capital 170


CHAPTER 11 Market Approach: Using Guideline Companies and Strategic Transactions 173


Merger and Acquisition Transactional Data Method 174


Guideline Public Company Method 178


Selection of Valuation Multiples 181


Market Multiples Commonly Used 183


CHAPTER 12 Asset Approach 189


Book Value versus Market Value 190


Premises of Value 191


Use of the Asset Approach to Value Lack–of–Control Interests 191


Adjusted Book Value Method 192


Treatment of Nonoperating Assets or Asset Surpluses or Shortages 197


Specific Steps in Computing Adjusted Book Value 197


CHAPTER 13 Adjusting Value through Premiums and Discounts 199


Applicability of Premiums and Discounts 200


Application and Derivation of Premiums and Discounts 201


Apply Discretion in the Size of the Adjustment 203


Control versus Lack of Control in Income–driven Methods 204


Fair Market Value versus Investment Value 205


CHAPTER 14 Reconciling Initial Value Estimates and Determining Value Conclusion 207


Essential Need for Broad Perspective 207


Income Approach Review 210


Market Approach Review 215


Asset Approach Review 216


Value Reconciliation and Conclusion 218


Checks to Value 220


Candidly Assess Valuation Capabilities 221


CHAPTER 15 Art of the Deal 223


Unique Negotiation Challenges 223


Deal Structure: Stock versus Assets 225


Terms of Sale: Cash versus Stock 231


Bridging the Gap 233


See the Deal from the Other Side 236


CHAPTER 16 M&A and Financial Reporting 239


U.S. GAAP and IFRS 240


Relevant FASB and IFRS Statements 241


Reviews by the Audit Firm 242


ASC 820: Fair Value Measurements (SFAS 157) 243


ASC 805: Business Combinations (SFAS 141(R)) 246


ASC 350: Goodwill and Other Intangible Assets (SFAS 142) 255


Incorporating ASC 805 (SFAS 141(R)) into the Due Diligence Process 257


References 260


CHAPTER 17 Intangible Asset Valuation 263


Approaches to Valuing Intangible Assets 264


Key Components to Intangible Asset Valuation 266


Intangible Asset Valuation Methods 275


Conclusion 284


CHAPTER 18 Measuring and Managing Value in High–Tech Start–ups 285


Why Appraisals of High–Tech Start–ups Are Essential 285


Key Differences in High–Tech Start–ups 287


Value Management Begins with Competitive Analysis 288


Stages of Development 290


Risk and Discount Rates 292


Start–ups and Traditional Valuation Methods 293


QED Survey of Valuation Methods Used by Venture Capitalists 298


A Probability–Weighted Scenario Method to Value Start–ups 303


Equity Allocation Methods 309


Conclusion 311


CHAPTER 19 Cross–Border M&A 313


Strategic Buy–Side Considerations 313


Due Diligence 322


Sell–Side Considerations 326


CHAPTER 20 Merger and Acquisition Valuation Case Study 329


History and Competitive Conditions 330


Potential Buyers 331


General Economic Conditions 332


Specific Industry Conditions 333


Growth 334


Computation of the Stand–alone Fair Market Value 334


Computation of Investment Value 348


Suggested Considerations to Case Conclusion 356


About the Authors 359


Index 361