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The Art & Science of Valuation
- 1. CleanTech North March 25th Bryan J.Watson bwatson@cleantechnorth.com
- 2. Agenda 3:00 - 3:30pmRegistration and Networking 3:30 - 3:40pm Opening Remarks 3:40 - 4:40pm Presentation: The Art & Science of Valuation Feat. Steven Hacker, Partner at MNP LLP Ian Palm, Partner at Gowlings 4:40 - 5:30pm Networking
- 3. Thank You ToOur Partners:
- 4. Upcoming Dates: • April– TBD • OCE Discovery • May 20th • June 23rd • June 8th – Think Asia – BDC
- 5. Membership Structure Total CompanySize (Staff Number) Annual Corporate Membership Fees Membership Type Per Delegate $40.00 + HST (Per Event, Max of 2) Trial 1 Employee $199 + HST Lone Wolf 2-4 Employees $375.00 + HST Tier 1 5-15 Employees $750.00 + HST Tier 2 16-50 Employees $1250.00 + HST Tier 3 51-100 Employees $1875.00 + HST Tier 4 101 + Employees $2500.00 + HST Tier 5
- 6. The Art &Science of Valuation Steven Hacker Partner at MNP LLP Ian Palm Partner at Gowlings
- 7. Thank You ToOur Partners:
- 8. Presented by: Date: Steven Hacker,CPA, CA, CBV March 25, 2015 The Art & Science of Valuation: Understanding Technology Valuations & Value Drivers
- 9. PRESENTER Steven Hacker CA,CBV • Steven is MNP’s Business Valuations and Litigation Support Leader for the Ontario Region. He has 20 years of business valuations and litigation support experience • Provides advice and valuations in connection with: • financing • strategic planning • disputes (employee, shareholder, partner, customer/supplier) • mergers and acquisitions • income tax and estate planning • financial reporting
- 10. MNP: A NATIONALFIRM Key Facts Founded in 1945, we have grown to become the 5th largest public accountancy and business consulting firm in Canada Over 70 offices strategically located in urban and rural markets throughout Canada Over 3,000 team members and 550 partners dedicated to delivering full service solutions Financial Advisory, Consulting, Specialty Tax, etc. with a strong presence in the technology sector
- 11. OUTLINE AND OBJECTIVEOF THIS PRESENTATION 1. What is a “Valuation”? 2. When do you need a valuation / why should you get a valuation? 3. What is involved in a valuation? 4. What drives value – how can you grow value? 5. How do we value a business or its intellectual property? Provide Answers to the Following Questions
- 12. CAVEAT / DISCLAIMER TheFine Print 1. The material presented today and contained in these slides: • Is provided for education purposes • May not be applicable to a specific case, set of circumstances or facts • Is based on laws and practices that are subject to change • Is based on the general views of the presenters and may not necessarily represent the views of MNP LLP 2. The presentation and material should not be relied upon in connection with a particular matter as a substitute for qualified professional advice 3. We do not accept legal responsibility for the contents or for any consequences arising from its use
- 13. WHAT IS AVALUATION Provides a Conclusion on the Notional Fair Market Value Fair market value is typically defined as: • the highest price • expressed in terms of money or money’s worth • obtainable in an open and unrestricted market • between informed and prudent parties • acting at arm’s length • under no compulsion to transact Fair market value is not always equivalent to price paid in an open market transaction
- 14. NOTIONAL FAIR MARKETVALUE Fair Market Value is: • Prospective or future oriented • Determined at a point in time • Influenced by business-specific factors
- 15. ELEMENTS OF VALUE Componentsof Business Value, Risk Levels Identifiable Intangible Asset Value (IP, contracts etc.) Tangible Asset Value Monetary Value BusinessValue Unidentifiable Intangible Asset Value Risk
- 16. WHEN DO YOUNEED A VALUATION What Are the Benefits Provides an independent and objective view on value for: • Strategic Planning • Transactions • Disputes (infringement, employee etc.) • Income tax planning and compliance • Financial reporting Also can provide useful information for benchmarking, goal setting, negotiations and feedback on merits of business plans, forecasts etc.
- 17. WHAT’S INVOLVED INA VALUATION Typically a three stage process Depends on the type of valuation (level of assurance) Stage 1: Gather understanding of business, documents. Stage 2: Select and apply appropriate valuation methodologies Stage 3: Prepare written report, present draft and discuss with client. Technology/start up business valuations typically involve review and analysis of business plans
- 18. WHAT DRIVES VALUE GrowValue by Addressing These Factors Value drivers influence risk and determine the degree of value Categorized as: • Functional/Technological • Commercial/Financial • Legal (protection related) • Specific external/economic indicators
- 19. • Uniqueness, differentiation •Ease and breadth of use • Lifecycle status/remaining useful life, rate of decay • Functionality • Revolutionary versus improvement • Complexity, ease of replication • Competitive advantages, threats • User/market resistance to change • Scalability • Applicability in other contexts VALUE DRIVERS Technology value drivers: a sample
- 20. • Incremental profitmargin, excess earnings • Market potential, growth • Strength, depth and quantity of customer relationships / user base • Switching costs and effort • Quality of distribution/retail network • Competitive edge, barriers to entry, competition • Market demand or acceptance • Extent of further/ongoing investment in upgrades, maintenance, R&D • Quality of management – do they have the vision, and can they execute VALUE DRIVERS Commercial/financial value drivers: a sample
- 21. • Customer recognition (anddoes the customer believe in the brand, trust the brand, associate the brand with the product, service, company) • Differentiation • Is the intangible important to the product or service purchase decision • Age, longevity, lifecycle status, remaining useful life • Potential for expansion or exploitation • Means of promoting • Advertising • Geographic appeal, use • Association VALUE DRIVERS Marketing intangible value drivers: a sample
- 22. • Ownership rights •Protection status, ease or likelihood of infringement • Is it patentable? Patent Value Drivers • Scope of patent • Is there overlapping technology? • Potential for legal challenge • Foreign jurisdictions VALUE DRIVERS Legal value drivers: a sample
- 23. External industry andeconomic trends and circumstances also influence value, for example: • Innovation spending • Employment stats – firms in the industry • Government policy, grants, tax breaks • Consolidation trends • Competition • Availability of capital VALUE DRIVERS External industry & economic indicators
- 24.
- 25. VALUATION METHODOLOGY Asset approaches Assetapproaches typically involve the restatement to fair market value of the balance sheet. They can be applied on a: • Liquidation basis – forced or orderly • Going concern basis
- 26. VALUATION METHODOLOGY Discounted CashFlow Approach to valuing a business • Used when the business is expected to grow in a non linear manner before achieving steady-state • Requires a reasonable forecast • Need to understand inputs, assumptions and support for assumptions • Value is the net present value of the stream of future net cash flow • Present valued using risk adjusted rate of return
- 27. VALUATION METHODOLOGY Discounted CashFlow Example – Business Value CAD Thousands Year 1 Year 2 Year 3 Year 4 Year 5 Terminal Revenue 2% 15% $25,000 $28,750 $33,063 $38,022 $43,725 $44,600 Cost of Goods Sold 60% -15,000 -17,250 -19,838 -22,813 -26,235 -26,760 Gross Margin $10,000 $11,500 $13,225 $15,209 $17,490 $17,840 Operating Expenses: G&A (excluding depreciation) 2% (500) (575) (661) (760) (875) (892) Pre-tax Operating Income $9,500 $10,925 $12,564 $14,448 $16,616 $16,948 Income Tax 26% ($2,470) ($2,841) ($3,267) ($3,757) ($4,320) ($4,406) After-tax Operating Income $7,030 $8,085 $9,297 $10,692 $12,296 $12,541 Adjustments: Changes in working capital (15) (75) (86) (99) (114) (17) Capital expenditures (50) (58) (66) (76) (87) (101) Net Cash Flow $6,965 $7,952 $9,145 $10,517 $12,094 $12,423 Terminal value $69,019 Period Discounting 1 2 3 4 5 5 PV Factor 20% 0.8333 0.6944 0.5787 0.4823 0.4019 0.4019 Present Value of After-Tax Cash Flows $5,805 $5,522 $5,292 $5,072 $4,860 $27,737 Enterprise Value (rounded) $54,288 December 31, 2014
- 28. • Basis ofthe market approach – Market value is derived by analyzing similar intangible assets that have recently been sold or licensed (in arm’s length transactions), and then comparing these transactions (involving “guideline” assets) to the subject intangible asset – Adjustments are made for any significant differences between the guideline asset and subject asset, to the extent the differences can be identified and quantified – May involve comparing metrics other than earnings MARKET APPROACH
- 29. VALUATION METHODOLOGY Market Approaches •Valuation metrics implied by transactions in the subject company’s shares (recent financing rounds) • Most frequently used for valuing intangibles that are somewhat portable from one business to another, such as regulatory assets (FIT contract), or as a corroborative approach • Multiples of earnings, based on comparable publicly traded companies or past transactions involving same or similar businesses • Adjust for differences in size, risk, growth potential, tax attributes, diversity, stage of development, non-cash consideration (earnouts etc.) • Caution re: Multiples of Revenue
- 30.
- 31. VALUATION METHODOLOGY Rules ofThumb • Use only to verify conclusions reached under other methods • Rules of thumb tend to: - Oversimplify – Provide only guesstimates which are not reliable – Be based on revenue or book value, as opposed to future cash flow streams – Be applied without consideration of specific risk, growth – Lead to misleading value estimates
- 32. • Basis ofthe cost approach: – The economic principles of substitution and price equilibrium – A prudent investor would not pay more for the subject intangible asset than the price to obtain an intangible property of comparable functionality and benefits – Cost is influenced by the marketplace • Can be used when the cost to replace is lower than the expected present value of net future cash flows • Sometimes used to value internal use intangible assets • May be only approach that can be used or may not be relevant or practical to apply in many cases • May yield a much lower value than earnings/cash flow based methods VALUATION METHODOLOGY Cost approach to valuing technology, IP
- 33. Situations where itmay be appropriate to use the cost approach: • Internal use technology, software (not commercially exploited, not driving the business) • Where the asset is readily replaceable • Where there is uncertainty about commercial or technological viability • In process R&D (in the earliest stages) • Customer lists, databases • Trademarks and other marketing intangibles • Websites • Workforce VALUATION METHODOLOGY Cost approach: when is it typically used
- 34. VALUATION METHODOLOGY Cost approach:reproduction cost, replacement cost Reproduction Cost Based on the construction (or purchase) of an exact replica of the subject intangible asset. Replacement Cost Based on the cost to recreate the functionality and benefits of the subject intangible asset, but in a form or appearance that may be different from an exact copy of the actual asset being valued. Uses know-how, techniques etc. in existence at the valuation date, as opposed to remaking exact copy
- 35. VALUATION METHODOLOGY Cost approach:obsolescence adjustments • Adjustments should be made to reflect obsolescence compared to original creation • Adjustments include: - Functional Obsolescence - Technological Obsolescence - Economic/Financial Obsolescence
- 36. • The valueof an intangible is based on the future cost savings it earns, in the form of avoided payments of royalties or license fees to a third party • The present value of the future stream of after-tax savings is calculated using a risk-adjusted capitalization rate, if a constant annual savings is projected, or a discount rate, if the future projected annual savings vary from year to year • The approach is mathematically simple however the key assumptions are subjective VALUATION METHODOLOGY Relief from royalty method – IP Valuation
- 37. • Complete analysisof value drivers, economic benefits of the technology • Complete a qualitative scoring of technology value drivers (e.g. rate as positive, negative, neutral) • Determine the life of the technology • Determine appropriate revenue stream to which the notional royalty rate will be applied (maintainable, forecast) VALUATION METHODOLOGY Applying the relief from royalty method: preliminary steps
- 38. • Obtain marketroyalty rates (from third party data source). Look for comparables in same or similar industry (SIC or NAICS) • Assess comparability and adjust transaction data for key differences (market size, profitability, exclusivity, products or technology being licensed) • Consider impact of differing percentage base other than revenue (per unit, percentage of profit, lump sum, combination) VALUATION METHODOLOGY Applying the relief from royalty method: market royalty rates
- 39. Valuation Date CAD Thousands Year1 Year 2 Year 3 Year 4 Year 5 Technology "A" Revenue $28,000 $28,840 $29,705 $30,596 $31,514 Royalty Rate selected 5% 1,400 1,442 1,485 1,530 1,576 Income Taxes 33% -462 -476 -490 -505 -520 After-tax royalties 938 966 995 1,025 1,056 Period Discounting 1 2 3 4 5 PV Factor 18% 0.8475 0.7182 0.6086 0.5158 0.4371 Present Value of After-Tax Royalty Savings 795 694 606 529 461 Total PV of After-Tax Royalty Savings $3,085 Tax Savings Benefit 229 Fair Value of Trade mark (rounded) $3,300 December 31, 2014 VALUATION METHODOLOGY Example: relief from royalty
- 40. • The valueof the intangible asset is based on the present value of the incremental after-tax cash flows attributable only to the subject intangible asset • Measure conventional earnings or cash flow, and then deduct a required return on the contributory assets, called a contributory asset charge. Result is the earnings/cash flow in excess of operating costs and return on supporting assets • Often used when the subject intangible asset is the key driver of cash flows and when the contribution of the intangible asset cannot be measured in other ways VALUATION METHODOLOGY Excess earnings approach - IP
- 41. Calculation: • Determine thelife of the intangible asset • Identify the revenue and expenses associated only with the subject intangible asset and deduct income taxes • Deduct income associated with other assets required to generate the income for the intangible (deduct contributory asset charges) • Present value the remaining excess income using a risk adjusted discount rate Contributory assets: • Support the subject intangible asset in generating cash flows. Also referred to as economic rent VALUATION METHODOLOGY Excess earnings/cash flow
- 42. Year 1 Year2 Year 3 Year 4 Year 5 Year 6 EBITDA $6,406 $5,638 $4,651 $3,411 $1,876 $0 Income Tax 33% ($2,114) ($1,860) ($1,535) ($1,126) ($619) $0 After-Tax Cash Flow $4,292 $3,777 $3,116 $2,285 $1,257 $0 Contributory Asset Charges: Net working capital 0.8% 100 88 72 53 29 0 Fixed assets 0.2% 29 26 21 16 9 0 Assembled workforce 0.7% 83 73 60 44 24 0 $212 $187 $154 $113 $62 $0 Excess earnings $4,080 $3,591 $2,962 $2,172 $1,195 $0 Period Discounting 1 2 3 4 5 0 PV Factor 17% 0.8547 0.7305 0.6244 0.5337 0.4561 0.0000 Present Value of After-Tax Cash Flows $3,487 $2,623 $1,850 $1,159 $545 $0 Present Value $9,664 Present value of tax benefit 752 Fair Value of Technology $10,416 December 31, 2014 Fair Market Value of Technology VALUATION METHODOLOGY Exercise: excess earnings method
- 43.
- 44. CONTACT INFORMATION Steven Hacker,CPA, CA, CBV Partner – Business Valuation and Litigation Support 416-260-3502 Steven.Hacker@mnp.ca
- 45. Techniques to BridgeValue for Investment and Sale Transactions March 25, 2015 W. Ian Palm 416-369-7332 ian.palm@gowlings.com
- 46. Seller’s View of Value Buyer’sView of Value Bridging Different Views of Value 2 of Value of Value
- 47. Seller’s View of Value Buyer’sView of Value Bridging Different Views of Value 3 of Value of Value Zone of Possible Agreement
- 48. Factors for BridgingValue External Factors Availability of Capital 4 Time Unique Value Drivers Risks
- 49. Preliminary Considerations • Agreementon Value – Now, Later or Never • Complexity and Time • Preserving Flexibility and Agility 5 • Preserving Flexibility and Agility • Transactional Dynamics • Resolving Disputes
- 50. Investment Transactions • ConvertibleNotes • Preferred Shares • Other Techniques 6 • Other Techniques
- 51. Investment Transactions -Convertible Notes • Next Round Conversion Pricing and Triggers • Repayment Obligations • Security 7 • Security
- 52. Investment Transactions -Preferred Shares • Liquidation Preferences • Preferential Dividends • Anti-Dilution Protection 8 • Anti-Dilution Protection
- 53. Investment Transactions –Other Techniques • SAFE Financings – Simple Agreement for Future Equity • Hybrid Debt and Equity Investments • Tranche Investments 9 • Tranche Investments • Pay to Play Features
- 54. Sale Transactions • Holdbacksand Escrows • Vendor Take Back Notes • Rollover Equity 10 • Rollover Equity • Earn Outs • Other Techniques
- 55. Sale Transactions –Holdbacks and Escrows • Working Capital and Other Near Term Post Closing Adjustments • Escrow Release Conditions • Escrowed Letters of Credit 11 • Escrowed Letters of Credit
- 56. Sale Transactions –Vendor Take Back Notes • Payment Terms • Intercreditor Arrangements • Information and Governance Rights 12 • Information and Governance Rights
- 57. Sale Transactions –Rollover Equity • Management Incentive Arrangements • Minority Shareholder Challenges • Dealing with Conflicts on Future Claims 13 • Dealing with Conflicts on Future Claims
- 58. Sale Transactions –Earn Outs • Challenges to Post Transaction Integration • Getting to Agreement on Triggers and Measurement • Anticipating Change 14 • Anticipating Change
- 59. Sale Transactions –Other Techniques • Milestone Payments • Contingent Value Rights • Collars on Share Exchange Deals 15 • Collars on Share Exchange Deals • Structured Equity – Hurdle Rate of Return • Spin Offs • Royalties
- 60. Other Considerations • ClearProcess for Determining Value • Dispute Resolution Procedures • Escape Hatches – Shotgun Provisions and Sale Process Rights 16 • Escape Hatches – Shotgun Provisions and Sale Process Rights
- 61. montréal ottawa toronto hamilton waterloo region calgary vancouver beijing moscow london W. Ian Palm 416-369-7332 ian.palm@gowlings.com