Fundamentals of Valuation

M&A for Entrepreneurs Elective

2008 Babson College

Acquisition Process
Acquisition Strategy Targeting, Analysis, and Valuation Letter of Intent Due Diligence Negotiating an Agreement Closing and Management Strategy

2008 Babson College

Targeting and Analysis

Deliver a clear message
Size, Industry, Geography, Expertise

Delineate a contact list and communications plan Arms length analysis and pro forma valuation Debt/equity pro forma Buyers value added Negotiating strategy Exit strategy

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Why is the company for sale?

Establishes credibility of deal Degree of Skepticism

Frames Adjustments & Pro Formas

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Public vs Privately-Owned Companies

Decisiveness

Quality of Information Provided

Assumptions in Pro Formas Degree of Sophistication

Supplier Relationships
Customer Relationships Hockey Stick Quality of Management Tax Impact
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Question to ask

Is the company public? or a subsidiary of a public company?

Or, privately owned?

2008 Babson College

The Analysis Process is LINKED

Assumptions are linked to analysis Analysis is linked with adjustments Adjustments impact valuation and structure Valuation and structure yields price

2008 Babson College

Where do Adjustments and Assumptions Impact? Income Statement and Pro Forma Projections Balance Sheet Cash Flow Projections Buyer Value-Added

2008 Babson College

Cost of Capital
Cost of Capital = Discount Rate/Factor

Simple Cost of Capital Calculator:

Category Cost Bank Debt Weight 50% Cost 10% Weight 5.0%

Mezzanine
Equity

30%
20%

20%
40% Cost of Capital

6.0%
8.0% 19%

2008 Babson College

Valuation Methodologies
Primary Secondary

DCF
EBITDA/FCF Multiple Industry Benchmarks

Asset Value
Replacement cost Payback ROI Market Value Net Worth/ Book Value

2008 Babson College

Discounted Cash Flow (DCF)

1. Discount rate generally is cost of capital 2. Discount rate is higher with uncertain, cyclical, vulnerable companies 3. Target yields:
Banks: Prime + 2-4% Sub Debt/Mezzanine: 15-20% (plus Kicker) Equity: 20-40%

4. EBITDA/FCF assumptions are KEY

2008 Babson College

EBITDA/FCF Multiple
4-8 Times EBITDA Pro Forma Adjustments and Financial Integrity are KEY Used by Debt & Equity Providers Most Common Valuation Technique Used

2008 Babson College

Industry Benchmarks
Industry Comps
Revenue Multiple Customer List Multiple Installations Multiple

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Appraisal Methodologies
Liquidation or Knockdown Appraisal Replacement Value Appraisal Fair Market Value Appraisal Balance Sheet: A/R= Aging/Dilution/Allows./Bd.Dbt Inv.= Aging/Inventory Turn

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In a Leveraged Buyout or Management Buyout

What is the MOST IMPORTANT Guiding Principle?

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Cash is King
(Cash Flow/EBITDA/FCF)

2008 Babson College