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We have been engaged to prepare a valuation of My Little Pizza Parlor (MLPP) located in Brooklyn, New York. The valuation is being prepared in conjunction with an ongoing shareholder dispute between the two existing shareholders. Our due diligence of the historical financial information indicates that the gross revenues and related expenses of the business are not properly reported. The following has been extracted from our report.
APPROACHES TO VALUATION
The selection of the most appropriate valuation method(s) is largely dependent upon the purpose of the appraisal, the characteristics of the subject company, and the availability of reliable information requisite to the various methods. In this process, we analyzed the business’s tax returns, inspected the business, and interviewed both shareholders. Like many small businesses, MLPP shares the advantages and disadvantages of the industry, as well as having specific considerations of its own. Based upon our efforts we determined that the Corporate Income Tax Returns are not a reliable indication of the actual gross revenues of the business. As derived from our interview each shareholder, gross revenues are substantially more than those reported.
We inquired with management as to the availability of cash register tapes or any other sales summaries. None were available. In the following section of this report, we have prepared an analysis to reconstruct the annual gross revenues.
Neither shareholder receives any salaries or wages, only a small distribution of tax basis profits.
The distribution of these profits is not representative of either shareholders lifestyle.
During our field visit, we noted two or three employees in addition to the two shareholders. The tax returns do not reflect any salaries being paid.
Other expenses that one would assume to be incurred in the normal course of business are not clearly observed. For example: payroll taxes, rubbish removal, or a gross profit margin consistent with similar business.
All of the above elements must all be considered in the development of the ultimate value of the business. Although we prepared an extensive analysis of the financial results of the business, the historical financial information provided was deemed to be incomplete and unreliable. As such, we have not included it within this report.
We considered a number of approaches to the valuation, such as the market approach, the income approach, and the asset based approach. Businesses like MLPP are often bought and sold based upon a percentage of gross revenues, not necessarily based upon the net income or its net asset value. In reality, buyers of such businesses are frequently buying themselves a job.
To determine the value of MLPP, we employed the direct market data method, within the market approach. This method applies a selling price to gross revenue multiple (from sales of similar businesses) to the gross revenues of the subject company. In the following sections of this report, we have identified how we determined these two variables.
Reconstruction of Gross Revenues
Gross revenues were determined from product and sales quantity information provided by the shareholder, as well as the prices listed on the MLPP menu. This information was used to reconstruct gross revenues of the business.
Determination of Price to Gross Sales Multiple
We selected a price to gross revenues multiple from an independent third party transaction database. The criteria used identfied those transactions reported from sales of pizzerias, classified under the SIC (Standard Industry Code) 5812.13, whose annual sales are between $500,000 and $1,000,000.
The ratio produced by the database includes intangibles and furniture, fixtures and equipment (fixed assets). In other words, all the sales prices are based on a buyer purchasing a business’ intangibles and fixed assets only, all other assets and liabilities are not otherwise reflected.
To calculate a company’s value, we used the company’s net asset value (minus fixed assets and real estate) and added it to the value calculated from the multiples observed. Based upon the transactions found, the median price to gross revenues ratio of 0.29 was observed.
VALUATION SUMMARY AND OPINION
Based upon the methodology detailed above, we have formed the opinion that the fair market value of MLPP on a non-controlling, non-marketable and going-concern basis is as follows:
Reconstructed Gross Sales $750,000
Price/Gross Revenue Ratio 0.29
Net Asset Value Less Fixed Assets & Real Estate 40,000
Indicated Value $ 257,500
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