A Recent Business Valuation Engagement Involving Divorce - How The Business Valuation Specialist Can Help You.
With the preeminence of options in the corporate world, and the emergence of "reporting" but non-listed corporations [often those issuing "junk bonds" to the investing public,] private company analysis, research and valuation can now rely more than before on the tools developed by analysts of public securities. A recent Business Valuation assignment of mine made this particularly clear.
My facts were as follows. An executive had taken three divisions of two public corporations, including the one he had managed and grown over quite some time, private in a leveraged buy-out transaction. In order to finance the transaction, the executive took one of the selling corporations and an investment bank as equity partners. Both bank debt and publicly traded subordinated debt was used to finance the balance of the purchase price.
The bank debt, incidently, was rated by the rating agencies one notch higher than the subordinated debt, in view of the first lien security on all corporate assets provided to the bank group. A fairly common occurrence thus far, except that through its public issuance of [subordinated] debt securities, the new entity was publicly reporting. As a result, the usual 10-K's and other financial documents were available to analysts from the rating agencies, banks and now the business appraiser. The rating agencies' analytical work product and conclusions are also public for the most part, and this provided yet another source of rather detailed information about the new group, its background, its clients, its management, its properties, its prospects, its business plan, and eventually its quarterly results. Not only is the agencies' work public, but as part of their service the agencies like to proselytize about their clients, and one can even call their analyst and learn quite a bit about the company and its debt rating. Overall, a good deal more information for the appraiser to work with than is normally available from private companies.
The executive received stock and stock options in the new company equal to as much as 10% of the company and it is clear that the LBO investors's exit strategy was to take the business public as progress was to be achieved over time and equity market conditions were to become favorable.
Some six months into the LBO, the executive and his spouse are divorcing. On the date of valuation, which was stipulated by the parties to the divorce, the entity was private, but financials covering six months since its inception were on file at the SEC. Only 9 months after the stipulated valuation date, the company took advantage of the strong bull market to make an initial public offering, and the stock started trading. I got involved in the case at the request of the wife's attorney perhaps six months after the chosen valuation date, i.e. before the stock traded.
Given the stipulated date, all subsequent information, including some improved earnings and valuation multiples could not be used by the appraiser. However, subsequent information including the earnings and price of the stock after it traded, certainly could be used as corroboration of the value on the valuation date.
Using the actual results of the first 6 months of operations, the valuation made a case for normalized annual earnings which were then capitalized at an appropriate rate to give us the first indication of value. Even after backing up the substantial debt, an equity value 2-3 times book value was in evidence.
When management was inducing a bank group into financing the LBO, it prepared projections which in retrospect were conservative; we know that because the projection for the first 6 months could be compared with actual results. That projection was used as the raw material for a discounted cash flow analysis ["DCF"] which also yielded a value, albeit a relatively low one because management was conservative when addressing its bankers. The raw data was updated for the actual results known as of valuation date, and subsequent data was increased using the growth supported by management. This time the DCF yielded a value which was more in line with the value shown by the capitalization of earnings.
Clearly, the guideline companies approach was also called for: here was a sizeable firm with [through its predecessor firms] a long history in the business, an experienced management, and an industry with several large public companies whose stock is priced to market daily. The group of guideline companies was chosen as those listed by management as their competition, even if only in one of their product lines. The standard analysis of the relationship between net invested capital and sales, capitalization, and several measures of earnings lead to a value for the subject's equity if traded.
The three approaches were, in effect, boxing the value, and a weighting based on the respective merits of each method led to a number I felt was "bullet-proof" for the business as a whole.
Finally, using a standard Black-Sholes model, the options were valued, using as input the price per share previously determined. In this article, I have disguised the industry and subject companies by multiplying all data by a constant factor; the modified spreadsheets are available upon request. The wife's attorney was duly told that the other side was sitting on stock and stock options worth $15 million, all acquired during the marriage.