2. Agenda
3:00 - 3:30pm Registration 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
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 NATIONAL FIRM
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 OBJECTIVE OF 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
The Fine 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 A VALUATION
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 MARKET VALUE
Fair Market Value is:
• Prospective or future oriented
• Determined at a point in time
• Influenced by business-specific factors
15. ELEMENTS OF VALUE
Components of 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 YOU NEED 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 IN A 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
Grow Value 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 profit margin, 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
(and does 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 and economic 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
25. VALUATION METHODOLOGY
Asset approaches
Asset approaches 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 Cash Flow 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 Cash Flow 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 of the 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
31. VALUATION METHODOLOGY
Rules of Thumb
• 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 of the 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 it may 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 value of 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 analysis of 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 market royalty 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
Year 1 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 value of 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 the life 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 Year 2 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
47. Seller’s View
of Value
Buyer’s View
of Value
Bridging Different Views of Value
3
of Value of Value
Zone of
Possible
Agreement
48. Factors for Bridging Value
External
Factors
Availability of
Capital
4
Time
Unique Value
Drivers
Risks
49. Preliminary Considerations
• Agreement on Value – Now, Later or Never
• Complexity and Time
• Preserving Flexibility and Agility
5
• Preserving Flexibility and Agility
• Transactional Dynamics
• Resolving Disputes
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
• Holdbacks and 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
• Clear Process 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
