On Friday, February 10, the Nicholas Center for Corporate Finance and Investment Banking welcomed Board Member Cathy Durham, Vice President of Capital Valuation Group, to lead a discussion with first-year MBA students on “Privately Held Business Valuation.” Capital Valuation Group (“CVG”) is an independent consulting firm providing business advisory and litigation support services. Cathy explained how the firm is successful at complex valuation because it does an excellent job of meshing together staff expertise across the areas of law, accounting, finance, and business ownership. As a local Madison firm, CVG is also able to draw upon the resources of the UW academic community for research on specific projects.
After some brief background introductions from the first-year students, Cathy kicked off our discussion with a high-level overview of why there is a need to value many of the small to medium sized privately held businesses that comprise a large portion of the client group at CVG. Valuing a publicly traded company is easy; valuing a closely held business is much more difficult, but also more interesting. While there are approximately 16,000 publicly traded companies in the U.S.; there are approximately 27 million closely held businesses. Therefore, understanding closely held business valuation is likely an important tool for us to have.
Cathy explained how the reasons to value a business fall primarily into two areas. There is either an actual transaction in process or a hypothetical transaction where the business will not actually be sold but is valued as though it were—such as for divorce purposes. Before discussing how a closely held business is valued she pointed out that it is important to first determine if there is a transferable business rather than just someone’s career with the tools of the trade. The test for whether a business is transferable or not has two components: 1) The business is not dependent on one person’s skills or relationships (which can’t be transferred) —can the business continue without that person? and 2) Does the company generate sufficient cash for both compensating the owner at market level while also providing the owner with a return on their investment?
Afterwards, she delved into a topic that I personally thought was very interesting and absolutely crucial for all of us soon-to-be finance professionals. Cathy challenged the audience about the true meaning of fair market value. She discussed what the meaning was and how every business has more than one value based on how the buyer and seller are characterized. I found this to be quite a helpful reminder since all of the current first-year students are taking a Corporate Valuation class this semester being taught by our faculty director.
Cathy explained that financial statements were never intended to reflect value; instead, they tell us how well a company is utilizing its existing assets and liabilities. Accounting is, by its nature, backward looking while valuation is forward looking. There are many other components of a business’s value that are not reflected anywhere on the company’s financial statement; so how can applying a multiple to some line on the income statement provide us with a meaningful conclusion of value? Multiples are great for publicly traded companies because those companies within the same industry have a great deal in common. Not so with closely held businesses. She did an excellent job of explaining how the value and transaction price are two different things; the latter being dependent on the specific motivations of buyer and seller.
If we hurriedly capitalize historical earnings or apply an industry multiple to a closely held business we are missing the “story behind the numbers” —those factors that provide opportunity or risk for the business. She mentioned how there is always a unique story behind every business valuation case that envelopes far more than just the numbers, such as taking into account that a business might be dependent on a specific customer for a significant portion of its’ revenues, or experiences very low turnover in their well-trained workforce.
After Cathy highlighted the differences between why and how professionals measure utilization (GAAP) versus capacity (value), we slowly walked through a full discounted cash flow valuation model with a terminal year calculation for our imaginary example business. Without getting bogged down in details, all I can say is that it felt good in that classroom to understand that process. For many of us first-year students, it was almost like a litmus test to see if we’d been keeping up in Professor Seward’s Corporate Valuation class and had turned that proverbial academic corner.
I very much enjoyed Cathy’s visit as she masterfully balanced her expertise of the technical aspects of business valuation with her cautionary insight toward the softer, more qualitative aspects of what finance MBAs should be aware of when it comes to business valuation. As someone interested in pursuing investment banking I will certainly be doing my best to internalize what we discussed with Cathy.