How to estimate the impact of highly depreciated assets on valuation?

Several posters have covered the step-up basis for an asset sale, so I won't cover that. The other two pieces to a high capex that I want to understand that very much do affect valuation are:

1. Maintenance capex (or "recurring" capex like a fleet refresh). For more capex heavy businesses, I tend to look at a multiple on EBITDA less mtc capex, since you can assume you'll be spending that much cash every year so it will not be available to service debt.

2. What the growth/replacement capex needs of the business are moving forward. Agree with other posters that book/tax value of assets doesn't represent actual value nor reflect any meaningful view of remaining useful life. But understanding what investments above and beyond your maintenance capex will be needed over the next 3-5 years and including that in your valuation model will help you structure the deal more appropriately (e.g., seller note amortization timing, ability to lever the business up more w/ a capex line of credit, or if there are several things needed early on it may even influence how you think about the cash flow/earnings amount you put a multiple on).

I'd suggest asking for a fixed asset schedule - make, model, year, high level specs, original price, maybe other items I'm missing. You can also have an equipment appraisal done for relatively cheap (couple thousand bucks) - maybe worth considering as well.

Good luck and let me know if helpful to talk further!

This is a common scenario - There are a few factors involved, but it comes down to a pretty simple spreadsheet exercise that then becomes a complex negotiation issue -

The first thing to consider, as it is a red herring to some degree, is whether the seller has used an advanced depreciation schedule or not on his assets - the fact is that it doesn't matter whether the "book/tax' value of the equipment became depreciated fast or slow, it simply is a question of what the valuation is NOW. I would say in 90% of all cases, almost all "book/tax" value of all equipment on a company's books is going to practically be 0. There are exceptions, but people accelerate write offs consistently.

So, given that the tax basis is now 0, there is actually a huge difference in the total valuation of a company between a stock and asset sale. Depreciable assets generate a one time cashflow at a level of around 35% of their initial value -> if you get $3MM of Equipment in an asset sale, you decrease future tax bill by $~1MM. On a company that is worth around $5MM to start with (so,8-1.4MM EBITDA), avoiding $1MM in tax is effectively like getting a whole multiple off the deal (so a 5.0 becomes a 4.0).

If that same business were a stock sale, the 100% depreciated assets would yield 0 tax savings, in this sense, effectively ADDING a multiple to the deal (a 4.0 at stock sale would really be a 5.0 at asset sale).

This is where the negotiation comes into play - The seller pays a noticeably larger tax bill (normal income vs capital gains) on anything he sells as an asset vs a stock. So he wants stock sales.

The buyer gets the tax benefit (to the tune of around ~35%) on anything he buys as an asset compared to stock (with the caveat that the assets in the stock purchase are assumed to be fully depreciated, which they will be).

At this point, I've only added to the confusion, so let me try to actually offer something constructive - The Market is in many ways your friend as the Buyer - Sellers consistently list businesses for 2-3 multiples HIGHER than provable market trends for deals that actually go through. As a practical manner, you can feel good as a buyer knowing what multiples exist in your specific niche and EBITDA size, and then also knowing that in almost all cases those multiples represent AN ASSET SALE with recapitalization. So, if the buyer insists on selling as stock to get his tax break, that's fine - a minimum of 1 multiple off fair market multiple must be dropped. He can't have his cake and eat it too - he doesn't get a "market rate" of 4.5x AS WELL as saving the tax bill. He can have a 3.5 and save the tax bill.

I think anyone will find if they run the numbers that at any level of reasonable leverage###-###-#### turns), a stock sale CANNOT support the debt coverage at the same multiples an asset sale can. For that reason, the seller has to understand that the only business he can sell is one someone else on the other side can buy, and they are constrained by the DSCR, and other banking questions.