Business Valuation

Z. CHRISTOPHER MERCER, FASA, CFA, ABAR, is the founder and CEO of Mercer Capital. A nationally renowned author, speaker, and business valuator, Mr. Mercer’s interests include the valuation of privately held and public companies, as well as litigation engagements in which valuation questions require analysis. TRAVIS W. HARMS, CFA, CPA/ABV, is the leader of Mercer Capital’s Family Business Advisory Services Group. He focuses primarily on providing financial, strategic, and valuation consulting to multi-generational family businesses. Mr. Harms regularly speaks and writes on valuation and related topics for family business owners and their advisors.

• Introduction xiiiWhat’s New in the Third Edition? xivWho Should Read This Book? xviiPart One Conceptual Overview of the Integrated TheoryChapter 1 The World of Value 3Introduction 3Common Questions 3The World of Value 4The Organizing Principles 5Summary 16Chapter 2 The Integrated Theory (Equity Basis) 19Introduction 19Common Questions 20The Fundamental Valuation Model 21The Conceptual Levels of Value 23Symbolic Notation for the Integrated Theory 27The Marketable Minority Interest Level of Value 29Introduction to the Control Levels of Value 35Strategic Control Level of Value 51Firmwide Levels versus the Shareholder Level of Value 58The Nonmarketable Minority Level of Value 60The Integrated Theory of Business Valuation on an Equity Basis 67Summary 67Chapter 3 The Integrated Theory (Enterprise Basis) 71Introduction 71Comparing the Levels of Value: Equity and Enterprise Bases 73Final Comparisons of the Equity and Enterprise Bases 77Summary 79Part Two Valuing Enterprise Cash FlowsChapter 4 Income Approach (Cash Flows) 83Introduction 83Reconciling Single-Period Capitalization and Discounted Cash Flow Methods 84Defining Enterprise Cash Flows 90Defining Equity Cash Flows 95Reinvestment Rates and Interim Growth Rates 99Terminal Growth Rates 104Expected Cash Flows and the Integrated Theory 108Marketable Minority Interest Level: Public Company Equivalent 115Financial Control Level: Private Equity Cash Flows 124Strategic Control Level: Strategic Acquirer Cash Flows 128Assessing the Reasonableness of ProjectedEnterprise Cash Flows 136Conclusion 139Chapter 5 Income Approach (Discount Rate) 141Introduction 141Return Basics: Realized versus Required Returns 142Components of the Weighted Average Cost of Capital 148Market Participants and the WACC 165The Levels of Value and the WACC 169Assessing Overall Reasonableness 175Chapter 6 Market Approach (Guideline Public Companies) 177Introduction 177Relationship of the Income and Market Approaches 178What Do Observed Public Company Valuation Multiples Mean? 180Adjusting Valuation Multiples for Differences in Risk and Growth 199Guideline Public Company Multiples and the Enterprise Levels of Value 214Assessing Overall Reasonableness 219Chapter 7 Market Approach (Guideline Transactions) 221Introduction 221Attributes of Guideline Transaction Data 222Drawing Valuation Inferences from Guideline Transaction Data 225Minority Interest Discounts Inferred from Observed Control Premiums 240Guideline Transaction Multiples and the Levels of Value 242Assessing Overall Reasonableness 244Appendix 7-A: A Historical Perspective on the Control Premium and Minority Interest Discount 247Part Three Valuing Shareholder Cash FlowsChapter 8 Restricted Stock Discounts and Pre-IPO Studies 271Introduction 271An Overview of Restricted Stock Discounts 275Review of the FMV/Stout Restricted Stock Database 306Pre-IPO Discounts 317Conclusion 325Chapter 9 Introduction to the QMDM (Quantitative Marketability Discount Model) 327Introduction 327Potential Valuation Approaches at the Shareholder Level 328A Shareholder Level Discounted Cash Flow Model in Outline 331Economic Factors Giving Rise to the Marketability Discount 338Conclusion 346Appendix 9-A: Liquidity and Marketability 349Chapter 10 The QMDM Assumptions in Detail 359Introduction 359Assumption 1: Expected Holding Period for the Investment (HP) 360Assumption 2A: Expected Dividend Yield (D %) 368Assumption 2B: Expected Growth of Dividends (GD) 377Assumption 2C: Timing of Dividend Receipt 378Assumption 3A: The Expected Growth Rate in Value (GV) 379Assumption 3B: Adjustments to the Terminal Value 385Assumption 4: Required Holding Period Return (Rhp) 385Conclusion 399Chapter 11 Applying the QMDM 401Introduction 401Comprehensive Example of the QMDM in Use 401Condensed QMDM Examples 414The Uniform Standards of Professional Appraisal Practice and the QMDM 427Chapter 12 Applying the Integrated Theory to Tax Pass-Through Entities 435Introduction 435The Nature of the S Corporation Benefit 437The Firmwide Level Value of S Corporations 440Other Observations Regarding Relative Value at the Firmwide Levels 443The Shareholder Level Value of S Corporations 446S Corporations and the Tax Cuts and Jobs Act of 2017 458Conclusion 467About the Authors 469Index 477