V RISK CONSIDERATIONS FOR SBA LENDERS banking, construction, distribution & packaging, food and...
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VALUATION AND R ISK C ONSIDERATIONS FOR SBA L ENDERS N OVEMBER 1, 2017 | 11:30 AM E ASTERN B RAD B RUMBAUGH , CFA, CBA B OB B RUMBAUGH , MCMEA, BCA, MBA
Transcript of V RISK CONSIDERATIONS FOR SBA LENDERS banking, construction, distribution & packaging, food and...
VALUATION AND RISK CONSIDERATIONS FOR SBA LENDERS
NOVEMBER 1, 2017 | 11:30 AM EASTERN
BRAD BRUMBAUGH, CFA, CBABOB BRUMBAUGH, MCMEA, BCA, MBA
VALUATION AND RISK CONSIDERATIONS FOR SBA LENDERS
BIOGRAPHIES
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Brad Brumbaugh is a manager in the Business Valuation Services Division of VMG Health, aleading national healthcare valuation and transaction advisory firm. Brad provides valuation,transaction advisory, and consulting services to privately held entities and clients nationally.
He has valuation experience related to mergers & acquisitions, SBA lending and other financingpurposes, shareholder transactions, gift & estate tax, marital dissolution, as well as forcommercial litigation purposes.
As a consultant, Brad has developed robust financial models to assist clients with expansion,acquisition, capital budgeting, and strategic decision making.
Brad has valued entities and assets across a wide array of businesses and industries, includingagribusiness, banking, construction, distribution & packaging, food and beverage, healthcare,manufacturing, and pharmaceuticals.
Brad graduated summa cum laude from East Carolina University with a Bachelor of Science inBusiness Administration and a concentration in Finance. He holds the designations of CharteredFinancial Analyst (CFA) and Certified Business Appraiser (CBA).
Brad Brumbaugh, CFA, CBA
BIOGRAPHIES
CONTACT INFORMATION
(720) 305-9302
Manager, VMG Health
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Bob Brumbaugh is a Master Certified Machinery and Equipment Appraiser (MCMEA), one of only32 appraisers to have earned this designation. He is also a respected business broker andfinancial valuation consultant. Over the past several years, Bob has prepared Machinery /Equipment appraisals, Furniture Fixture & Equipment (FF&E) appraisals, and Inventory analysisreviews for most major national banks, regional lending institutions, SBA projects, and numerouscommunity banks.
Bob has delivered more than a thousand individual appraisal reports for a variety of projects. Hisexperience covers a wide range of industries including restaurants, food, packaging,manufacturing, medical, heavy equipment, farm, scientific laboratories, and more. One of Bob’sbest references is the FDIC for which he has appraised the assets of about 10% of all failed banksin the country over the past eight years. He has also assisted on numerous occasions withlitigation issues as an expert witness and has assisted with merger and acquisition facilitation byproviding appraisals and valuations for private industry.
Previously, Bob was active in the financial securities industry for more than twenty-seven years.As President and owner of a NASD/FINRA member broker/dealer, he originated several PrivatePlacement Regulation D, Section 504 and 506 security offerings, for funding of start-up anddevelopmental stage companies. Bob has also been an institutional equity trader.
During his business career, Bob has also been associated with the finance departments of TulaneUniversity, Wesleyan College, and an affiliate of the University of Phoenix as an adjunctprofessor. Additionally, he has sponsored and facilitated many CPA continuing education classeson capital formation topics. Bob has also served as a credit manager and controller of a majorcorporation.
Bob holds an MBA degree in Finance and Marketing from Western Michigan University and a BBAdegree in Management from Eastern Michigan University. He has also taken American Society ofAppraisers (ASA) Business Valuation courses, and is also a Business Certified Appraiser (BCA).
Bob Brumbaugh, MCMEA, BCA, MBA
BIOGRAPHIES
CONTACT INFORMATION
(919) 870-8258
Founder & CEO Brumbaugh Appraisals
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AGENDA
SBA Requirements
Business Appraisal Overview
I. Income ApproachII. Market ApproachIII. Cost Approach
I.
II.
Business Appraisal Overview – Report ElementsIII.
Questions & AnswersIV.
II.
III.
IV.
VALUATION AND RISK CONSIDERATIONS FOR SBA LENDERS
SBA REQUIREMENTS
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Property Types
SBA REQUIREMENTS
Special Purpose Properties:
Typically real estate intensive businesses (see next slide for examples)
Requires a Certified General Real Property Appraiser
Appraisal must allocate value to land, building, equipment and intangibleassets
Certified Equipment Appraiser may also be necessary
Non-Special Purpose Properties:
All other businesses not listed on the following slide
Requires Business Appraiser (ASA, CBA, ABV, CVA, or BCA)
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The SBA classifies properties into two main categories:
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Examples of Special Purpose Properties (per SBA)
SBA REQUIREMENTS
If not listed, the valuation is a Non-Special purpose property and requires a
Business Appraiser
Amusement Parks Hotels, motels, and
other lodging facilities Marinas
Travel & Entertainment
Museums Railroads Theaters Wineries
Healthcare & Life Services
Funeral homes with crematoriumsHospitals, surgery centers, urgent care centers and other health or medical facilitiesNursing homes, including assisted living facilities
Bowling alleys Clubhouses Swimming pools
SportFacilities
Golf courses Sports arenas Tennis clubs
Car wash properties Gas stations Service centers
Auto Services
Farms Mines Oil wells
Natural Resources
Quarries Gravel pits
Other Cemeteries Cold storage facilities where more than 50% of total square footage is equipped for refrigerationDormitories Sanitary landfills
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When is a 3rd Party Business Appraisal Required?
SBA REQUIREMENTS
Regarding a change in ownership of a Special Purpose Property:
If the loan amount is greater than $250k1
If it is a related party transaction2
If internal policies & procedures require an independent valuation3
Real estate and equipment must be valued separately
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When is a 3rd Party Business Appraisal Required?
SBA REQUIREMENTS
Regarding a change in ownership of a Non-Special Purpose Property:
If the amount being financed minus the appraised value of real estate and/or equipment is greater than $250k
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If it is a related party transaction2
If internal policies & procedures require an independent valuation3
Real estate and equipment must be valued separately
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Recommendations:
Options When a 3rd Party Business Appraisal is NOT Required
SBA REQUIREMENTS
Limited scope / Calculation Engagement by a business
appraiser
1Internal valuation,
reviewed by business appraiser
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More cost effective and reliable than internal valuation
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Accepted Business Appraisal Credentials
SBA REQUIREMENTS
Accredited Senior Appraiser (ASA)
Certified Business Appraiser (CBA)
Accredited in Business Valuation (ABV)
Certified Valuation Analyst (CVA)*
Business Certified Appraiser (BCA)
*Effective April 1, 2013, the National Association of Certified Valuators and Analysts' (NACVA) Accredited Valuation Analyst™ (AVA®)credential was merged into the Certified Valuation Analyst®(CVA®).
The SBA requires one of the following designations for Business Appraisal as a “Qualified Source”:
VALUATION AND RISK CONSIDERATIONS FOR SBA LENDERS
BUSINESS APPRAISAL OVERVIEW
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Business Appraisal Data Requirements
BUSINESS APPRAISAL OVERVIEW
Financials Minimum of 3 years’ Income Statements and Balance Sheets Interim Financials for the most recent reporting period Accounts Receivable Aging Schedule for the most recent reporting period Corporate Tax Returns for the last 3 years Financial Projections / Prospective Budget
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Business Overview / Plan1
Operating/Partnership Agreement22
Fixed Asset List / Depreciation Schedule24
Employee Roster Including position, compensation level, and structure (i.e. salary, performance based, etc.)
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Significant Contracts (e.g. non-compete, employment contracts, client contracts, etc.)26
Prior or concurrent Real Estate / Equipment Appraisals performed (if applicable)7
Necessary for all valuation methods
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Standard of Value
BUSINESS APPRAISAL OVERVIEW
Fair Market Value is required by the SBA
Hypothetical Willing Buyer / Willing Seller
Arm’s Length Transaction
No Compulsion to Buy/Sell
Knowledgeable Parties
FAIR MARKET VALUE (“FMV”)
Specific Buyer
Synergies
Distressed Sale/Competitive Bidding Process
Generally Produces Higher Value Than FMV
INVESTMENT VALUE
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Fair Market Value vs. Investment Value
BUSINESS APPRAISAL OVERVIEW
Prudent buyers don’t pay for opportunities they bring to the table
Ability to drive revenue from other investments Negotiation power not realizable by most potential buyers
Revenues
Common deviations from FMV in projections representing Investment Value:
Expenses Ability to negotiate with suppliers based on related investments/unique relationships
Ability to eliminate certain job functions and expenses due to centralized functions Rent expense above/below market rates or excluded due to related party
ownership
Assumed ability to use excessive leverage over the long-termCapital Structure
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Approaches to Valuation
BUSINESS APPRAISAL OVERVIEW
Three Accepted Business Valuation Methods
Income Approach
Asset (or Cost) Approach
Compares the subject entity to similar businesses
that have been sold
MarketApproach
Converts anticipated future economic benefits into a single present amount
Value of the assets net of liabilities
Each of these approaches contains numerous variations, or valuation methodologies, thattailor the approach to the specific nuances of the valuation assignment.
Appraisers will typically rely on multiple valuation methodologies in arriving at theirconclusion of value.
FMV is not = income approach value + cost approach value
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Income Approach
BUSINESS APPRAISAL OVERVIEW
Three Accepted Business Valuation Methods
Income Approach
Asset (or Cost) Approach
MarketApproach
Converts anticipated future economic benefits into a single present amount
Multi-year projections vs. single-period capitalization
Projection of future revenues and expenses
Projection of future capital expenditures and working capital requirements
Discount future after tax cash flows
Present Value of Future Cash Flows = Fair Market Value
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Red Flags for Review - Normalization Adjustments
BUSINESS APPRAISAL OVERVIEW – INCOME APPROACH
Were the following adjustments made to the revenues and/or expenses (where applicable)?
Revenue and expense adjustments are necessary for both Income and Market
Approach Methods
Occupancy adjustment
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Non-recurring revenues and expenses One time revenue sources (e.g. government incentive programs) One time expenses (e.g. consulting / legal fees
1
Non-operating revenues and expenses Investment/rental income Personal auto expense Travel
2
Seasonality (i.e. use of annualized YTD vs. trailing twelve) 24
Owners Compensation 25
Corporate Federal and State Income taxes26
Charitable donations Expenses related to other businesses Interest payments
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Red Flags for Review - Application of Income Approach
BUSINESS APPRAISAL OVERVIEW – INCOME APPROACH
Is the proforma reasonable, given expected national, local, and industry trends?
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3
Has the appraiser interviewed the seller and/or buyer, adequately discussing high-level trends, as well as granular items that may impact the valuation?
1
2
Is the proforma materially different than historical trends? If so, is it well supported?
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4
Has the discount rate been well supported, in particular the Company Specific Risk Premium (“CSRP”)?2
5
Is the assumed capital structure reasonable, supported, and in-line with industry trends and expectations?
6
Has the appraiser independently verified/questioned the provided proforma, making adjustments as necessary?
Are future capital expenditure assumptions reasonable and supported, given future growth expectations, the size and age of the asset base, etc.?
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Is the selected long-term growth rate materially different than historical economic trends (i.e. 2-3%)? If so, why?
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Red Flags for Review - Company Specific Risk Factors (“CSRP”)
BUSINESS APPRAISAL OVERVIEW – INCOME APPROACH
Company Specific Risk Premium must be well supported
Local Demographic Trends Local Competitive Environment Location and Condition of Facility
Licensure Requirements Industry Trends Government / Regulatory Risk Pending / Threatened Litigation
Concentration Risk Functional or Technical
Obsolescence Ability to Attract/Retain Key Staff Duration and Relevance of
Contracts
Quality and Accuracy of Financial Data
Historical Financial Performance Liquidity Leverage / Borrowing Capacity
Perceived Risk in Projections
Geographic Risk
Financial Risk
Forecast Risk
Operational Risk
Industry/Regulatory
Risk
CSRP
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Red Flags for Review – Deal Structure Adjustment
Asset Sale – transaction excludes working capital and liabilities, but buyer will purchase inventory necessary for operations
Terms
FMV must be adjusted to reflect the specific transaction structure
BUSINESS APPRAISAL OVERVIEW – INCOME APPROACH
Total Invested Capital Level, Including Normalized Working Capital $1,000,000
Less: Normalized Working Capital (100,000)
Plus: Inventory 25,000
Fair Market Value, TIC Level, Less Normalized Working Capital 925,000
Less: Interest-Bearing Debt N/A
Fair Market Value, Acquired Assets $925,000
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Market Approach
BUSINESS APPRAISAL OVERVIEW
Three Accepted Business Valuation Methods
Income Approach
Asset (or Cost) Approach
Compares the subject entity to similar businesses
that have been sold
MarketApproach
Guideline Public Company and Merger & Acquisition Method
Estimates value by examining the value of similar businesses in a free and open market
Can be used as a reasonableness check for discounted cash flow value indication
Large transaction multiples are not relevant to small, local transactions
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Red Flags for Review - Application of Market Approach
BUSINESS APPRAISAL OVERVIEW – MARKET APPROACH
Do the market multiples align with those generated from the Income Approach? If not, is the deviation well supported?
2
3
Has the appropriate multiple been applied to the right metric and has that metric (i.e. net revenue, EBITDA, etc.) be adjusted to exclude non-recurring revenues and/or expenses?
1
Is the appraiser using known and reliable transaction databases (i.e. Pratt Stats, Bizcomps, IBA Database, etc.)?
2
4
Are the subject transactions from pure play comparables (i.e. is a transaction from a similar business, but has multiple different service lines)?
5
2 Are the observed transactions/multiples from firms of a similar size, industry, and region?
Is a blend of metrics being used to generate the value (i.e. revenue and SDE multiple)? If not, is the use of a single metric well supported?
6
Is the concluded value consistent with the specific deal terms (i.e. are the multiples based on stock or asset sales, and have they been adjusted accordingly)?
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Date Target Description MVIC Price Revenue SDE EBITDA P/Rev P/SDE P/EBITDA
12/29/16 Machine Shop $1,550,000 $2,207,000 $551,000 $372,000 0.70 2.81 4.17
02/01/16 Manufacturer of Metal Parts $19,500,000 $29,350,000 $5,025,000 $4,600,000 0.66 3.88 4.24
04/18/16 Machine Shop $745,000 $2,874,740 $62,929 ($8,025) 0.26 11.84 N/A
10/31/15 Aerospace Machine Shop $3,450,000 $1,883,792 $407,712 $207,712 1.83 8.46 16.61
11/09/94 Manufactures Fiberglass Products $300,000 $487,007 $13,184 $51,717 0.62 22.75 5.80
10/20/04 Manufacturer of Sport and Recognition Plaques $7,140,000 $619,592 $0 $62,426 11.52 N/A 114.38
12/31/12 Precision Machining Manufacturing & Distribution $825,000 $1,225,551 $127,959 $2,631 0.67 6.45 313.57
Red Flags for Review – Selecting Comparable Transactions
BUSINESS APPRAISAL OVERVIEW – MARKET APPROACH
Subject Entity:
Machining and Metal Fabrication Shop $1.5 MM annual revenue; $200k SDE; $100k EBITDA
Transaction Search in Pratts Stats Database:
Industry codes related to machining / metal fabrication 200+ transactions Dates ranging from 1994 to present Revenue ranging from $34k to $845 MM SDE ranging from ($900k) to $5 MM EBITDA ranging from ($6.9 MM) to $56 MM
Transactions must be scrubbed for comparability to the subject entity
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Cost Approach
BUSINESS APPRAISAL OVERVIEW
Three Accepted Business Valuation Methods
Income Approach
Asset (or Cost) Approach
MarketApproach
Value of the assets net of liabilities
Estimates the cost to recreate the business
Measures value by identifying and individually valuing the business’s tangible and intangibleassets and liabilities
Considered to provide a “floor” or lowest minimum value related to a business
Separate Real Estate and Fixed asset appraisals are generally required
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Red Flags for Review - Application of Cost Approach
BUSINESS APPRAISAL OVERVIEW – COST APPROACH
Are only operating assets considered (i.e. real estate owned by a related party, but not held within the subject entity should not be included)?
2
4
Have the assets been individually appraised at fair market value by a certified specialist (i.e. equipment appraiser)?
1
3
Have amounts on the balance sheet been adjusted to exclude assets and liabilities to continue to be held by the seller (i.e. working capital, long-term debt)? 2
2
Have identifiable and transferrable intangible assets been separately appraised and accounted for?
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12/31/XX Adjustments FMV Comments
ASSETSCash and Equivalents 25,000 (25,000) 0 Per deal terms, excluded
Accounts Receivable 50,000 (50,000) 0 Per deal terms, excluded
Inventories 100,000 (20,000) 80,000 Per Inventory Analysis
Current Assets 175,000 80,000
Furniture and Fixtures 300,000 (225,000) 75,000 Per Equipment Appraisal
Personal Auto 30,000 (30,000) 0 Excluded, personal asset
Gross Fixed Assets 330,000 75,000
less: Accumulated Depreciation (150,000) 150,000 0 Accounted for above
Net Fixed Assets 180,000 75,000
Total Assets 355,000 155,000
LIABILITIESAccounts Payable 15,000 (15,000) 0 Per deal terms, excluded
Current Portion of Long-term Debt 50,000 (50,000) 0 Per deal terms, excluded
Current Liabilities 65,000 0
Long-term Debt 200,000 (200,000) 0 Per deal terms, excluded
Long-term Liabilities 200,000 0
Total Liabilities 265,000 0
Equity 90,000 155,000 = Assets minus Liabilities
Indicated FMV of Acquired Assets 155,000
Red Flags for Review – Deal Structure Adjustments
BUSINESS APPRAISAL OVERVIEW – COST APPROACH
Net Book Value does not = Fair Market Value
Exclude cash, AR, current liabilities & LT debt1
Asset Sale – transaction excludesworking capital and liabilities, but buyer will purchase inventory necessary for operations.
Terms
Exclude non-operating assets (e.g. personal auto)2
Adjust all transferrable assets to FMV based on appraisals performed by specialists
3
VALUATION AND RISK CONSIDERATIONS FOR SBA LENDERS
BUSINESS APPRAISAL OVERVIEW – REPORT ELEMENTS
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Red Flags for Review – Report Elements
BUSINESS APPRAISAL OVERVIEW – REPORT ELEMENTS
National and Local Economic Overview “Why” and “how” the national/local economic and industry trends impact the subject entity
3
All report sections must explain the “why”, not just the “what”1
Sometimes, less is more2
Historical Financials Have material variances in historical financials been explained, discussed, and accounted for? If adjustments have been made to the financials, are they well supported and documented?
2
4
2
50+ pages does not necessarily = high quality
Management Interview / Projections Has the appraiser interviewed the seller and/or buyer, adequately discussing high-level trends, as
well as granular items that may impact the valuation? Has the appraiser independently verified/questioned the provided proforma, making adjustments
as necessary?
5
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Red Flags for Review – Report Elements (Continued)
BUSINESS APPRAISAL OVERVIEW – REPORT ELEMENTS
Market Approach Is there adequate discussion regarding the selection process of comparable transactions multiples,
and is it consistent with the overall fact pattern (i.e., economic/industry trends, company specific risk, etc.)
7
Income Approach Is the proforma reasonable, given expected national, local, and industry trends? Is the proforma materially different than historical trends? If so, is it well supported? Has the discount rate been well supported, in particular the Company Specific Risk Premium (“CSRP”)? Is the assumed capital structure reasonable, supported, and in-line with industry trends and expectations? Are future capital expenditure assumptions reasonable and supported, given future growth expectations, the size
and age of the asset base, etc.? Is the selected long-term growth rate materially different than historical economic trends (e.g. 2-3%)? If so, why?
6
2
50+ pages does not necessarily = high quality
Valuation Reconciliation Is there adequate support for the weighting among valuation approaches/methods used? Is there a material deviation among relied upon approaches, and has this been discussed?
8
VALUATION AND RISK CONSIDERATIONS FOR SBA LENDERS
QUESTIONS & ANSWERS
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Brad Brumbaugh, CFA, CBAManager, VMG Health200 Columbine Street, Suite 350Denver, CO 80206Direct (720) [email protected]
CONTACT INFORMATION
Bob Brumbaugh, MCMEA, BCA, MBAFounder & CEO, Brumbaugh Appraisals8601 Six Forks Road, Suite 400Raleigh, NC 27615Direct (919) [email protected]
