VALUATION OF A
SYSTEMS INTEGRATION
COMPANY
5408Woodway Drive
Fort Worth, Texas 76133
817-698-9999
WWW.Reitman.US
• General Accounting, Tax Preparation and
Representation
• Valuation Services
• Brokerage
• Due Diligence
Valuation is a Profession
• Valuators are not required to be licensed.
• Valuation Professionals should adopt and
follow a set of Standards.
Examples of Professional
Standards
• American Society of Appraisers
• The National Association of Certified
Valuators and Analysts
• American Institute of Certified Public
Accountants (AICPA)
AICPA Statement on
Valuation Standards
This statement establishes standards for
AICPA members who are engaged to
estimate the value of a business,
business ownership interest, security, or
intangible asset.
•There is little statutory law governing
valuations:
- IRS Code
- IRS Revenue Ruling 59-60
• There is case law:
- Federal Income Tax Cases
- Divorce Cases
IRS Revenue Ruling 59-60
defines Fair Market Value
Fair market value is defined as the price at
which property would change hands between
a hypothetical willing buyer and a
hypothetical willing seller, both being
adequately informed of the relevant facts and
neither being under any compulsion to buy or
to sell.
Valuation vs. Calculation
• Valuation engagement: Estimate of the value of
a subject interest using the valuation approaches
and methods the Valuator deems appropriate in
the circumstances.
• The Valuator expresses the results of the
valuation as a conclusion of value.
• The conclusion may be either a single amount or
a range.
Valuation vs. Calculation
• Calculation engagement: Valuator and the client
agree on the valuation approaches and methods
the Valuator will use and the extent of procedures
the valuator will perform in the process of
calculating the value of a subject interest.
• The valuator expresses the results of these
procedures as a calculated value.
Valuation vs. Calculation
• The calculated value is expressed as a
range or as a single amount.
• A calculation engagement does not include
all of the procedures required for a valuation
engagement.
Valuation vs. Calculation
Valuation Analyst:
• Applies the valuation approaches and methods
he or she deems appropriate in the
circumstances.
• The valuation analyst expresses the results of the
valuation as a conclusion of value; the conclusion
may be either a single amount or a range.
Valuation Approaches
• Income Approach
• Asset Approach or Cost Approach
• Market Approach
Income Approach
Two frequently used valuation methods:
• Capitalization of earnings method (e.g.,
earnings or cash flows)
• Discounted future benefits method (e.g.,
earnings or cash flows)
Capitalization of Earnings
Method
Best suited for a stable company with
consistent earnings.
Focused on historical earnings
Discounted Future Benefits
Method
Best suited for a dynamic or fast growing
company or a company without a stable
earnings history.
Predicts future cash flows
Asset Approach
Measurement of the net assets
Market Approach
• Guideline public company method
• Guideline company transactions method
• Guideline sales of interests in the subject entity,
such as business ownership interests or
securities
Valuations of Typical
RMR Based Security
Companies
• Usually calculations using the Asset Approach
• Occasionally a blended Income and Asset
Approach can be used
Valuing an Integrator
• Integrators typically have some RMR, which has
stand-alone value
• Most successful integrators also have Earnings
Before Interest, Taxes, Depreciation, and
Amortization (EBITDA)
Valuation Components
• Value of RMR (Asset Approach)
• Value of Adjusted EBITDA (Income Approach)
Valuation Methodology
• Determine the Value of RMR
• Determine the Adjusted EBITDA
Prepare an RMR Rollforward
RMR Rollforward Analysis - Alarm
2016
Jan-15
Feb-15
Mar-15
Apr-15
May-15
Jun-15
Jul-15
Aug-15
Sep-15
Oct-15
Nov-15
Dec-15
RMR Rollforward and the Attrition Trend
Previous Month Ending
$
277,819
$
282,587
$
285,981
$
287,173
$
289,396
$
290,393
$
291,488
$
292,686
$
293,025
$
294,588
$
295,728
$
297,546
Prince Increases
1,679
1,670
1,410
1,641
1,206
1,933
1,433
(5,501)
1,948
1,777
1,865
RMR Added
5,343
3,337
2,248
2,944
1,540
1,776
2,075
9,267
1,585
1,856
1,448
1,521
(1,872)
(1,390)
(2,419)
(2,214)
(1,701)
(2,440)
(2,151)
(3,182)
(1,683)
(1,969)
(1,508)
(1,796)
(382)
(222)
(47)
(148)
(48)
(173)
(160)
(245)
(288)
(524)
-
-
-
-
-
-
-
-
-
RMR Cancelled
Moves and Reconnects
Adjusted Attrtiion (change in RMR)
Net Attrition
Ending RMR
$
$
(1,872)
$
282,587
$
BOM past due RMR
(1,390)
$
Gross Attrition
$
Net Attrition
Beginning RMR (see note below)
$
(2,419)
287,173
-
-
Variance in past due RMR
$
285,981
$
EOM past due RMR
-
13
(186)
-
-
$
(2,214)
$
(1,701)
$
(2,440)
$
(2,151)
$
(3,182)
$
(1,683)
$
(1,969)
$
(1,508)
$
(1,796)
$
289,396
$
290,393
$
291,488
$
292,686
$
293,025
$
294,588
$
295,728
$
297,546
$
298,423
0
-
1,339
0
0
0
0
-
$
-
$
-
$
-
0
0
$
-
0
0
$
-
0
0
$
-
0
0
$
-
0
0
$
-
0
0
$
-
0
0
$
-
0
$
-
1,872
$
1,390
$
2,419
$
2,214
$
1,701
$
2,440
$
2,151
$
3,182
$
1,683
$
1,969
$
1,508
$
1,872
$
1,390
$
2,419
$
2,214
$
1,701
$
2,440
$
2,151
$
3,182
$
1,683
$
1,969
$
1,508
$
1,796
1,796
277,819
$
282,587
$
285,981
$
287,173
$
289,396
$
290,393
$
291,488
$
292,686
$
293,025
$
294,588
$
295,728
$
297,546
Annualized Gross Attrition
8.1%
5.9%
10.2%
9.3%
7.1%
10.1%
8.9%
13.0%
6.9%
8.0%
6.1%
7.2%
Annualized Net Attrition
8.1%
5.9%
10.2%
9.3%
7.1%
10.1%
8.9%
13.0%
6.9%
8.0%
6.1%
7.2%
3 Month Gross Attrition=====================================================
3 Month Net Attrition==============================================
Average beginning RMR - Last three months========================================
$
5,681
$
6,023
$
6,334
$
6,355
$
6,292
$
7,773
$
7,016
$
6,834
$
5,160
$
5,273
5,681
6,023
6,334
6,355
6,292
7,773
7,016
6,834
5,160
5,273
282,129
285,247
287,517
288,987
290,426
291,522
292,400
293,433
294,447
295,954
Annualized Attrition from last three months====================================================
8.1%
8.4%
8.8%
8.8%
8.7%
10.7%
9.6%
9.3%
7.0%
7.1%
Annualized Net Attrition from last three months===============================================
8.1%
8.4%
8.8%
8.8%
8.7%
10.7%
9.6%
9.3%
7.0%
7.1%
6 Month Gross Attrition======================================================================================================
$
12,036
6 Month Net Attrition=====================================================================================================
12,036
Average beginning RMR - Last 6 months========================================================================================== ====
285,558
$
12,315
$
12,315
14,107
$
14,107
287,836
13,371
$
13,371
289,520
13,126
$
13,126
290,693
12,933
$
12,933
291,929
12,289
12,289
292,985
294,177
Annualized Attrition from last 6 months====================================================================================== =========
8.4%
8.6%
9.7%
9.2%
9.0%
8.8%
8.4%
Annualized Net Attrition from last 6 months================================================================================== =======
8.4%
8.6%
9.7%
9.2%
9.0%
8.8%
8.4%
12 Month Gross Attrition===================================================================================================== ===========================
12 Month Net Attrition======================================================================================================= ===========================
Average beginning RMR - Last 12 months========================================================================================= ===============================
$
24,325
24,325
289,867.42
Annualized Attrition from last 12 months===================================================================================== =======================================
8.4%
Annualized Net Attrition from last 12 months================================================================================= ========================================
8.4%
Valuation of RMR
(Asset Approach)
• Determine Net Present Value of Cash Flow from
RMR
• Apply Market Limitations
• Judgmentally determine value of RMR
Determine Net Present Value
of RMR
(NPV = {C for Period 1 / (1 + R) ^ 1} +
{C for Period 2 / (1 + R) ^ 2} ... –
Initial Investment
Apply Market Limitations
Adjust the NPV to reflect adjustments due to
• Quality of account base
• Contract impairments
• Other impairments (geographic, account type,
etc…)
The result is the Value of the RMR (accounts)
Determine Non RMR Cash
Flow
Non RMR Cash Flow includes:
• Adjusted EBITDA less:
• Cash Flow From RMR plus:
• Creation Cost adjustment (if any)
Determine RMR Added and
Net RMR Added
Some integrators have Creation Cost. If an
integrator installs systems below cost, a
creation cost factor should be added back to
EBITDA to compensate for Creation Cost
expensed.
“Gross Up” EBITDA for ‘Add
Backs’
• Add Backs include:
•
•
•
•
Excessive owner compensation
Owner benefits
Over market rent or charges
Any expenditures that are not necessary to
operate the Company
• Determine if there is net cash flow from sources
other than RMR.
Determine Net Assets
• Discount assets with impairments
• Accounts receivable
• Other Receivables
• Inventory
• Fixed Assets (may be marked up over NBV)
• Other Impaired Assets
Consider Undisclosed
Liabilities
• Deferred Revenue
•
•
•
•
•
•
Unaccrued Expenses
Deposits and Retainers
“Off Balance Sheet” debt
Convertible Equity
Contingent Payments
Other Undisclosed Liabilities
Determine Earnings
Multiplier
• Judgmentally determined based upon expectation
of future earnings
• Applied to non-RMR EBITDA
Enterprise Value
• Value of Non RMR Cash Flow
• NPV of RMR
• Market Value of RMR
(Judgmentally select the
most reasonable amount)
• RMR Creation Adjustment (if any)
• Net Assets
• Any other judgmental adjustments
(reasonableness, enterprise,
brand awareness, etc.)
• Total Enterprise Value
XXX
XXX
XXX
XXX
XXX
XXX
XXX
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XXX
Other Considerations
•
•
•
•
In Place Workforce
Secondary Meaning
Repetitive Revenue
Exclusive Relationships
Adjustments for Lack of
Control and Marketability
The Standards (AICPA Statement on Standards for
Valuation Services, Section 40) require that the
valuation analyst consider whether valuation
adjustments should be made to a pre-adjustment
value.
Lack of Control Discount
A Lack of Control Discount is a reduction in the value of an interest
in an entity in order to recognize the absence of certain powers of
control of the entity. These powers generally include the ability to:
• Set policy
• Enter into transactions or agreements
• Pay dividends or distributions
• Offer services of the entity
• Guarantee the financial obligations of others or of other entities
• Invest or reinvest the property or income of the entity
• Manage the day to day affairs of the entity
Discount Amount for Lack of
Control
• In Holman v. Commissioner (130 T.C. 170 (2008)
105AFTR 2d 2010-721), the IRS contended and
the Court affirmed that a minority interest discount
of 14.4% was reasonable.
• Apply a 14.4% Lack of Control Discount to the
previously determined valuation to determine the
value net of Lack of Control Discount but before
Lack of Marketability Discount.
Lack of Marketability
• Lack of Marketability Discount: Recognizes
that an owner of a business interest cannot
convert his/her interest into cash as easily and as
quickly as a shareholder in a publicly traded
company.
Determining the Discount
• Interests in a closely held entity closely resemble shares of
restricted stock.
• In 1990 the Securities and Exchange Commission adopted
Rule 144a which provided limited access to a resale market
for restricted stock.
• Prior to the adoption of Rule 144a restricted stock discounts
were an average of 34%, after the adoption of Rule 144a
discounts on many of those same stocks were an average
of 22%.
• When Rule 144a was amended average discounts dropped
to 13%.
• The IRS has contended (in Holman) that there
are two components that influence investors in
restricted stock: (1) limited liquidity and (2) the
holding period.
• For private holding companies which are not
subject to any legally imposed holding periods or
the risks attendant to restricted stock, the
discount for lack of marketability should be close
to 12%.
• A reasonable buyer would request (and likely
receive) a discount ranging from 10% to 15% for
a restricted interest.
• A Lack of Marketability Discount of 12.5% is
reasonable.
• This, when applied to the net value of after the
Lack of Control Discount, yields a value net of
Lack of Control Discount and Lack of
Marketability Discount.