ValuAdder Business Valuation Blog

If you own a coin laundry or plan to purchase a laundromat business, you are in good company: there are over 16,700 such businesses in the US alone. The annual revenues for the industry as a whole are just under $2.2B. Yet the average coin laundry is a typical small business: it employs 3 people and grosses around $100,000 a year.

What creates business value in a laundromat

Coin laundries are cash businesses which are prized for their ability to generate steady income and show considerable resistance to recession. It is relatively easy to find a profitable niche in this industry and most laundromat owners experience only moderate levels of competition.

If you study coin laundry sales data, you will no doubt spot a number of factors that contribute to a laundromat business value - and higher selling price:

• Stability of historic business earnings.
• Location. Customer access, exclusivity arrangements and presence of a reliable anchor nearby are very important.
• Rental expense within 10 - 20% of gross revenues.
• Labor expenses within the industry norm of 10% of gross revenues.
• Condition of equipment.
• Additional value added services, such as an on-premises mart, game and video rentals.

Business valuation methods for coin laundries

Laundromats are a frequent acquisition target. So there is plenty of comparable business sales data to price your business. Typical valuation multiples for coin laundries are based on the discretionary cash flow, plus inventory. These businesses are also priced using  the multiples of gross sales. Again, the value of inventory is extra.

You can use ValuAdder business valuation Rules of Thumb to price a laundromat. Just provide the basic financial inputs about your business. Within seconds, ValuAdder shows you the business value range, median and average values.

Since coin laundry ownership is about cash flow, income-based business valuation is often used to price such businesses. For small shops, the Multiple of Discretionary Earnings business valuation method is a common choice. This method lets you determine the coin laundry business value based on the income and 14 essential financial and operational performance factors.

The Discounted Cash Flow business valuation method lets you determine the laundromat value based on the business income and risk. Since these businesses have a decent resale value, you can account for it directly in your Discounted Cash Flow business valuation.

If you plan to acquire a small business, a central question is what the business is worth. Business valuation is the key step to determine your offer price and terms.

Business value: what happens after you buy?

In addition, understanding the target business economic value is essential to address some strategic questions after the purchase:

1. Which business value drivers are important?
2. What can you do to continue increasing business value?

Knowing what creates business value helps you focus your precious resources on things that matter most to your business worth. Smart allocation of resources is what sets apart successful business acquisitions from failures.

Approaches and methods to valuing a business for sale

Regardless of your acquisition target, you have 3 ways to determine the value of a business:

1. Market approach.
2. Asset approach.
3. Income approach.

Business Valuation using Three Approaches

To get a reliable, accurate appraisal of business value you should use several methods under each of these key valuation approaches. This strategy is adopted in all professionally prepared business appraisals. The reason is that no one business valuation method is better then the others. Each approach lets you see the business against the background of important economic considerations.

Market based business valuation methods let you compare the target business against similar businesses that sold recently. Needless to say, this is a very compelling way to estimate your offer price!

Asset-based business appraisal methods, such as Capitalized Excess Earnings, help you determine whether the costs of buying the business are consistent with its true economic value. Should you pay the business seller’s price or build a similar business - and save?

Finally, the income-based business valuation methods, such as Multiple of Discretionary Earnings, let you look at the core of business value - its earning capacity and risk. The power of income based business valuation is that you can determine what the business is worth based on your specific business ownership objectives.

Structuring a business acquisition deal – cash is king!

Detemining the business value is one important step toward a successful business acquisition. To ensure that your business purchase works you need to structure the terms of your offer. The important questions your offer terms must address are:

• Does the business throw off sufficient cash flow to cover all my financial needs?
• Can the business service debt without difficulty?
• Is there enough cash to fund important capital expenses going forward?
• When do you get your down payment money back?

Structuing Your Business Acquisition

Debt service - margin of safety

The focus in your deal structuring analysis is on the business available cash flow. If you plan to fund the business acquisition with debt, whether from a lender or using seller financing, adequate debt service coverage is critical to your success. A key funding criterion by commercial lenders is debt service coverage ratio of at least 1.25.

Project costs - more than the business purchase price

Most small business acquisitions are so-called asset purchases. This means that you must account not just for the purchase price but provide for adequate working capital as well. You total outlay will also include the transaction costs of buying the business. The sum total of these three elements is your business acquisition project cost - which may exceed the contract purchase price by a hefty amount!

Can the busines pay the working owners?

Make sure that the business acquisition gives you a living wage. If a bank loan is involved in deal financing, your banker will certainly check if the business cash flow supports adequate salary for all new business owners.

Cash flow drain: deferred maintenance and equipment replacement

One key mistake to avoid is failing to allocate enough funds for new equipment purchases and other capital investments. You need to check the condition of business equipment and other hard assets and determine if they need to be replaced or upgraded in the near future. Unexpected capital expenditures can wreak havoc with your business finances!

Return of your investment

Smart business buyers and investors always want to see a return of their down payment. Make sure that business cash flow allows you to recover your investment within as short a period as possible.

As with successful business ownership, in business acquisition the golden rule is: cash is king!

When it comes to valuing a partner’s stake in the business, valuation of the business as a whole is the first step. The next big question is how to allocate this business value among the partners.

You may think that that the total business enterprise value should be divided in proportion to the partners ownership interests. Let’s say there are two partners, one owns 75% of the business and the other the remaining 25%. The overall business is worth $1,000,000. In the pro-rata allocation scenario, the first partner’s business ownership stake is worth $750,000 while the second partner has a claim on $250,000.

Control premia and minority ownership discounts

There are significant differences in the actual value of the two partnership interests though. The first partner, who owns the so-called controlling interest in the company, has a lot more say on how the critical decisions are made, including:

• Timing and size of dividend payouts or partnership draws.
• Hiring decisions.
• Acquisitions and sale of business assets.
• Raising equity and debt capital for business growth. 

As a result, such controlling business ownership interest comes at a premium, quite often a significant one. You can watch the market for publicly traded company securities to see that. An acquiror making a bid for a controlling block of shares in a company tends to offer a price per share that exceeds the market price. 

If you study the control premia offered, you can also deduce the minority discounts that apply to non-controlling business ownership interests. In fact, the minority discount can be calculated directly from the control premium as follows:

Here P stands for the control premum, expressed as a ratio, and M is the minority discount.

Example

Suppose that a group of investors wants to buy a 75% stake in a company. Current price per share of company stock is $10. The investors offer $15 per share. This means that the investors are ready to pay a 50% premium to get the controlling 75% ownership of the company.

Using the formula above, we can calculate how much minority discount applies to a non-controlling partner’s share who owns the remaining 25% of the business.

In this case M = 33.33%. In other words, each share of company stock held by the minority partner is worth 2/3 of a share held by the investors who own 75% of the company.

Valuing a partner’s business ownership stake for buy-out

In partner buy-outs, you can determine the value of a business ownership interest in three steps:

1. First, calculate the total business enterprise value.
2. Next, determine the pro-rata share based on the ownership split.
3. Finally, apply the minority discount to establish the worth of the partner’s business ownership interest.

Using our earlier example, let’s say that the partner who owns 25% of the company wishes to depart. The total business value of $1,000,000 is divided into two pro-rata pots of $750,000 and $250,000. Applying the 33.33% minority discount to $250,000 gives the value of $166,675.

With increasing numbers of the baby boomers reaching retirement age, there is one skilled services sector that is sure to flourish - home health care.

Indeed, home health care services, classified under SIC code 8082, have been experiencing rapid growth recently. There are excellent opportunities for differentiation since a business can specialize in providing services to a targeted demographic.

With excellent earnings upside, low capital asset investment requirements, and net profit margins that can exceed 20% of revenue, mid-market home health care businesses are in high demand. Smaller companies need to focus on growth to reach the critical mass and establish themselves as the dominant presence in their market.

Risk factors that affect business value

While the industry prospects are good, there are some challenges that impact what a home health care business is worth:

• Intensity of competition from new market entrants.
• Exposure to litigation.
• Difficulty in attracting and retaining qualified staff.

In addition, as the industry matures, consolidation pressures may force smaller operators to merge or be acquired by larger firms.

Business valuation methods for home health care companies

As many service businesses, the typical home health care firm has a relatively low asset base. Thus, business valuation focuses on assessment of the business earning capacity and risk.  You can choose a number of income-based business valuation methods to value your company.

For smaller, owner-operator managed businesses, Multiple of Discretionary Earnings method provides a great way to appraise a business based on its earnings and 14 key financial and operational performance and risk factors.

For businesses looking to expand rapidly, Discounted Cash Flow is a proven way to determine the business value based directly on the projected income stream.

Valuation of a Business as Multiple of its Earnings

Don’t forget to check the market place for actual selling prices and valuation multiples - especially if you plan to sell or buy a home health care business.

Typical valuation multiples for the companies in this service sector are:

1. Based on gross revenues.
2. Based on discretionary cash flow.

The value of inventory is added to the estimate you get using either valuation multiple. Since home health care businesses sell often, there is plenty of  market data to compare against - and make a fact-based decision on your asking price or purchase offer terms.

Calculate business value by direct market comparison

One way to do such market-based business valuation is to use ValuAdder Rules of Thumb. ValuAdder provides coverage for over 400 industries, including home health care businesses.

You can calculate your business value based on the actual sales of similar businesses in this service sector. All you need to provide is the business revenues and inventory - ValuAdder calculates the business value range, average and median values instantly!

Business Valuation using Market Comparison

We talked about the factors that create personal goodwill in small businesses and professional practices. The key takeaway is that personal goodwill is associated with the individual practitioner, not the business organization.

In contrast, institutional business goodwill arises from the business or practice itself. This is the type of goodwill that you can transfer easily when the business or a partner’s share sell.

Increase total business value by building the institutional business goodwill

One value-enhancing strategy you can follow is to make sure that the large part of goodwill is created by the business or practice itself. This is known as the institutional goodwill. So which factors indicate this important type of business goodwill? Here is the list:

Top 8 factors that create institutional business goodwill

1. Quality and skill of employees.
2. Business reputation.
3. Business name recognition.
4. Competitive postion of the business or professional practice in its market place.
5. Location of the business premises.
6. Business referral base.
7. Stability of earnings.
8. Business marketability.

How the 8 factors affect the value of business goodwill

It goes without saying that skilled, long-term staff is the major asset in any business or professional practice. If such employees remain with the practice after key partners depart, the new owners acquire the considerable benefit of trained and assembled workforce. The result? A higher value of business goodwill and the entire business enterprise.

Focusing on building the reputation and name recognition of the business tends to attract loyal customer following. The clients come to respect and prefer the company as the product and service provider. Needless to say, this translates into higher earning potential - and higher business goodwill.

If your business or professional practice has built up a set of sustained competitive advantages, it probably enjoys superior earnings - through lower costs and greater pricing flexibility. Above average earnings are a key element in creating business goodwill over the long term.

Excellent location makes the business more visible and accessible to its target market. The result is often strong repeat and referral business. Good location also tends to help reduce the marketing expenses.

You need to understand if new client referrals come because of the business reputation, rather than an individual practitioner. Should the expert depart, the clients will likely keep coming. Such client retention is the major contributor to the business goodwill.

Stable business earnings indicate the staying power of the business or professional practice. Business people pay attention to historic earnings stability to predict what is likely to happen in the future. Again, this future earnings outlook indicates how valuable the business is.

If you find a strong market for existing businesses in some industry, buyer competition tends to increase business selling prices. Remember that the value of business goodwill is the difference between the total business value and the appraised value of its assets. Hence, strong competition among the buyers - and higher business selling prices - point to higher value of business goodwill.

Business goodwill valuation comes up often in the context of valuing professional practices and consulting service businesses. The typical examples are medical and dental practices, CPA and law firms, engineering and architecture consulting businesses and other professional service companies.

A key question you may need to address is how much of the practice or business goodwill can be transferred to new ownership. In addition, legal dispute situations generally require that practice goodwill value be included in your business valuation.

Business goodwill sources: business or personal?

An important challenge you may face is how to distinguish between the business goodwill and professional goodwill. Business goodwill is created by the business or practice itself. On the other hand, professional goodwill is personal in nature - it is associated with the individual professional practitioners.

This important distinction is important because it is generally much easiler to transfer goodwill that is associated with the business, rather than individual professional practitioner.

Elements of professional goodwill

You may need to separate the professional from business goodwill in many practice valuation situations. Here are the key elements that help you identify the professional goodwill:

• Practitioner skill and ability.
• Professional judgement.
• Practitioner age and health.
• Professional’s reputation and name recognition.
• Fee schedule commanded by the individual professional.
• Personal referral base.
• Level of client involvement.
• Work habits.

High levels of specialized skill, demonstrated ability and excellent professional judgement are strong indicators of professional goodwill. Clients tend to trust professionals that are skilled and make correct decisions.

Professionals that are in good health and have a long career horizon have excellent earnings outlook - a major element of continued professional goodwill.

A professional who is respected by peers and clients tends to be successful and enjoys excellent earning potential.

In addition, the fee schedule indicates how well the professional can translate the skill and reputation advantages into superior earnings, and greater professional goodwill.

Clients are a lifeblood of any professional practice or service business. The practitioner who has a steady, high quality referral base creates a considerable level of professional goodwill. Answer this question: do the referrals occur because of the business or individual professional’s reputation? The greater the level of professional’s involvement with the clients, the greater professional goodwill.

While it is common knowledge that professionals work long hours, how well you allocate your time among the various tasks can make a big difference to your earnings.

Predictably, professional goodwill increases as the practitioner dedicates more time to the highest value-creating tasks.

Business and Practice Goodwill Valuation

Auto tire retail stores, classified under SIC code 5531, represent around 19,000 establishments in the US alone. Over two thirds of these businesses are small, owner-run single store operations.

Check these interesting facts: while the industry as a whole generates over $77bn in revenues, the average store makes around $1,500,000 in annual gross sales, employing just 7 employees.

A well-run store offers around 6 - 12 brands of tires, with commercial dealers carrying as few as four or five. Big brand tire products are a major plus since they tend to attract repeat business from brand-loyal customers. As a result, a store which offers the right mix of top brand name products in its market tends to command valuation multiples that are 15 - 20% higher than its competitors.

Key factors that affect an auto tire store business valuation

When it comes to valuing a business or setting its selling price, not all auto tire stores are created equal. You need to consider the factors that drive business value in this industry. Here are the top ones:

1. Location
2. Established, loyal customer base
3. Availability of trained employees and strong store management, beside the owners
4. Terms of lease
5. Condition and quality of store equipment
6. Percentage of sales derived from product sales and service.

For many stores, service offerings tend to be more profitable than tire sales. In times of rapidly increasing oil prices, tire product costs tend to crimp product profit margins. Service revenues on the order of 50% of the total typically indicate a store with excellent profit potential. The result is higher business valuation and, very likely, a higher business selling price.

Business valuation methods for auto tire stores

Auto tire stores sell often, so there is plenty of business sales to compare your selling price and terms against. Such business market value comparisons can give you very accurate and compelling results. Typical valuation multiples are based on the business discretionary cash flow plus inventory levels at replacement cost.

Valuing a Business using Market Comps

Another excellent way to value a business in this industry is to use the time-tested Multiple of Discretionary Earnings valuation method. In addition to the business earnings, this business valuation methods lets you account for all the key value factors above.

Using this business valuation technique, you can determine what the business is worth today, then see what can be done to increase business value - before making critical decisions such as offering the business for sale or bringing a partner on board.

Business Valuation based on Multiple of its Earnings

If you are looking to have a business appraised hiring an appraiser is one of the ways to do it. As with any professional engagement the question of costs comes up rather quickly.

Not surprisingly, professionally prepared appraisals don’t come cheap; the average hourly rates these days are around $300. A well-done business appraisal takes about 20 hours or more. Do the math, and the price tag runs to $6,000 and up.

That’s not including any extra consulting time to present the business appraisal to partners, other professionals, prospective buyers, sellers or investors.

Instant business appraisals - too good to be true

What about those “instant” business appraisals for a few hundred dollars? Let the buyer beware: professional appraisal takes time. And time costs money. With a “minimum wage” business appraisal you quite literally get what you pay for.

So, can you get an accurate, defensible business appraisal and save?

Yes indeed! Given the right tools, you can do your business appraisal yourself - and save quite a bundle.

Most of the business appraisal cost is in the time the appraiser takes to do the work. And most of the time is spent understanding the business being valued.

Obviously, you can use your own knowledge of the business to cut down on time and costs. But what about the business valuation tools and knowledge?

A complete business valuation system

That’s where ValuAdder comes in. To make sure you can do your business appraisal yourself, ValuAdder gives you both the knowledge and tools to do it:

1. Complete business valuation software system. You can use the same valuation methods the professional appraisers use to calculate your business value.
2. A Learning and Information Center and 190-page Business Valuation Handbook. There is plenty of expert advice and guidance to get you through your business appraisal.

There is a Business Valuation Guide to introduce you to the fundamentals of business appraisal. Detailed Tutorials on valuation methods and helpful How-To Sections with examples. Every term is defined and explained in the Glossary.

To save you both time and money, ValuAdder is designed to simplify and speed up your business appraisal:

• Do split-second business market value comparisons in any of 400 industries.
• Determine business value based on its earnings and risk.
• Calculate business goodwill and total business value.
• Structure a successful business sale or purchase.
• Get tips on each input - right as you enter your numbers.
• Pick and choose the tools you want with a mouse click.
• Generate reports and share your business valuation results in the format you want: PDF, spreadsheet, Web page.

Latest word in valuation software reliability and accuracy

You may ask: how is all this possible? The short answer: state-of-the art technology and sound software engineering.

ValuAdder relies on the leading edge Java technology to give you a superior business valuation system - at a fraction of competitors’ costs:

Do your business valuation on any computer of your choice, in any currency

You can run ValuAdder on any Windows, Mac OS, Linux or Unix computer. ValuAdder naturally adapts to your computer preferences and settings - including multi-currency calculations.

Open Source technology saves you money

Java and Open Source lets us cut down dramatically on our development costs - and we pass the savings directly to you!

State of the art in security, reliability and accuracy

This technology also makes your ValuAdder an extremely stable, reliable and accurate business valuation software system. 

Less support costs for us, better price for you!

Valuing a Business based on Income, Assets, and Market Comps

One of the greatest strengths of ValuAdder business valuation software is that it evolves continuously to respond to our customer needs. Our latest product release, ValuAdder V4.0.5 is no exception - by popular demand we have added the following new features:

1. Business valuation Rules of Thumb Tab now provides the standard SIC and NAICS industry classification codes for all 402 industries.
2. Multiple of Discretionary Earnings business valuation result reports the overall earnings multiplier, in addition to the 14 valuation factors.
3. Financial recasting worksheets now let you determine the company-specific risk premium from 10 key risk factors.

As before, ValuAdder Rules of Thumb let you locate the industry of interest three ways:

• By name: with all industries arranged in alphabetic order.
• By industry group: so you can see all related business types for quick comparison.
• By direct search: typing just part of the business description instantly produces all matches. You can quickly narrow down your choices by providing a more specific business description, e.g. specialty retail instead of retail.

Business market value comparison - quick and accurate

Once you have found the industry to do your market comparison, click on the Info button to see the actual SIC and NAICS industry classification codes. Make sure you are using the right industry for your market comparisons!

Business valuation as multiple of its earnings

Multiple of Discretionary Earnings business valuation automatically creates the earnings multiplier based on your assessment of the business across 14 key financial and operational performance factors.

With ValuAdder V4.0.5 your business valuation result now also displays the earnings multiplier value. This important result is also reported in the ValuAdder Earnings Multiple report. If you are creating a business valuation report, include this important value along with your valuation factors.

Assess company-specific risk for accurate business appraisal

If you are using the famous Discounted Cash Flow method for valuing a business, you will find that the accuracy of your business valuation results depends upon the discount rate you use. One of the most important and challenging parts is how to figure out the company-specific risk.

ValuAdder V4.0.5 worksheets introduce a build-up procedure to determine the company-specific risk.

Now you can estimate this important value easily - by ranking the business accross 10 key risk factors:

• Earnings stability
• Financial leverage risk
• Operating risk factors
• Profitability
• Customer concentration
• Product concentration
• Market concentration
• Competitive position
• Quality of the management
• Skill of employees

The result? Quite simply, the most systematic and accurate way to value your business based on the two essential parameters:

1. Business earnings
2. Business risk profile.

One common reason business people get their businesses appraised is gift and estate taxes. Grants of business ownership interest by living owners to family members trigger gift tax liability. If the owners pass away, the business is inherited by the younger generation. One of the first tasks for the new owners is how to handle the very large estate taxes. With estate tax rates approaching 50%, the tax bite may be very painful.

Business valuation results: high or low?

Usually, business owners are interested in the highest business valuation possible. This is certainly the case if the business is to be sold to a third party. The same desire for high valuations applies if you consider partner buy-ins, and outside investment, whether venture capital or debt financing.

Gift and estate tax situations are very different. Since the tax is assessed on the current business enterprise value, business owners are interested in the lowest possible figure for their business value.

The tax authorities, for obvious reasons, are skeptical about low business valuations. Experienced tax agents expect that business people want to reduce their taxes - and often retain skilled tax lawyers and accountants to help them do so. Since gift and estate taxes are among the highest, it is natural that business owners would seek the most conservative estimate of their business value.

Tax authorities may develop their own business appraisal. Not surprisingly, the tax man’s business valuation may be quite a bit higher than the owners’ value estimate.

Business valuation: points of contention

Business owners and tax agents typically disagree on what a business is worth on the following points:

1. Total business value.
2. Discount for lack of control.
3. Lack of marketability discount.

Since any business valuation result depends upon the set of assumptions, tax authorities may challenge your business appraisal by questioning your financial forecasts, risk estimates, as well as definition and premise of business value.

Business valuation is always forward-looking. Will the business earnings continue growing at their historic pace of 10% per year? Or will the growth rate stay within 5%, as claimed by the businsess owners? Will the industry become more risky in the next 5 years? Will the business continue operating or have to exit certain markets and sell some of its assets? Depending on which position is taken, the business valuation results you get will differ considerably.

Whether the assumptions of business owners or tax agent are more accurate, only time will tell. The business valuation result needed today may become a matter of dispute between the owners and tax authorities. And if the two sides cannot develop a reasonable compromise, these situations often end up in court. To avoid the costs of litigation, it is best to work out a solution acceptable to both sides.

Marketability discount and private business sale comps

Tax authorities generally understand that private business ownership interest is less marketable than public company securities. The question often is the amount of marketability discount that applies. Again, the owners tend to argue for higher marketability discount percentages.

This is where private business sale comparable data comes in very handy -  if you can show the selling prices of similar closely held businesses, the fair market value of your business is much easier to defend.

Control premiums and minority discounts

If the value of partial business ownership interest is disputed, you can work up a reasonable minority discount by citing the control premiums paid for business acquisitions in your industry. Most sales of public company stock are minority ownership transactions. On occasion, a controlling ownership interest is acquired. The offer terms are publicly disclosed and typically state the price per share - which often includes a premium over the current share market price.

Alternatively, you can value the business ownership stake directly by using the Discounted Cash Flow method - and calculating the present value of the expected returns to the minority shareholder.

If you are looking at valuing an owner-operator managed small business, then the Multiple of Discretionary Earnings business valuation method should be high on your list of priorities.

One of the best examples of the so-called direct capitalization valuation methods, this method determines the value of a business as a multiple of its discretionary cash flow.

One of the greatest strengths of this well-known business valuation method is an excellent match it provides between the business earnings and a broad range of financial and operational performance factors.

You can get very accurate business valuation results with this method. Equally important, you can see how the business value is affected by the quality of the operation.

Balance sheet inputs that affect business value

For highly accurate results, you also need to provide several financial values from the company’s recast balance sheet.  These include:

1. Net working capital.
2. Non-operating assets.
3. Long-term liabilities.

For the purposes of your business valuation, Net Working Capital is the difference between the business current assets, less inventory; and its current liabilites, less the short-term portion of the long-term debt. Essentially, this represents the liquid capital used by the business owners for short-term financing.

Non-operating assets may include such items as business-owned real estate, excess inventory and underutilized production or distribution capacity. The idea is that the business asset base should be adequate to support its level of earnings. All assets that are not used to generate these earnings are extra - and can become additional and valuable parts of a business acquisition.

If you value a debt-free business, the long-term liabilities are zero. However, if the business uses financial leverage, then your business valuation must factor in these liabilities. The result is the value of business owners’ equity interest in the business.

If you bought or sold a small business before, you may notice that Multiple of Discretionary Earnings method measures the business value on an asset sale basis. In fact, most small business sales are asset transactions.

In these cases, the business assets, less cash and trade receivables, transfer to the buyer. The seller pays off all business liabilities to deliver these assets free and clear. Non-operating assets may be valued separately and included in the deal.

If you ever tried raising debt capital from a bank, you know that lenders base their decisions on business cash flow. In other words, the key consideration is whether the business can repay the loan in full and on time.

Lenders build in the risk into the debt service coverage ratio. This gives the bank the extra margin of safety if the business earnings dip temporarily. Typical DSCR expected by commercial lenders is in the range of 1.25 - 1.5.

Banker’s main worry: default

In addition, banks expect that some loans may go sour. To address the risk of default, your bank will look for some collateral. Business owners can expect that only a fraction of their business asset values can be pledged as a loan collateral.

Typical business asset values as loan collateral

Accounts receivable, adjusted for uncollectible bad debt may fetch close to 75% of their book value, the finished goods inventory around 50-60%. Hard business assets such as furniture, fixtures and equipment (FF&E) are likely to be worth about 50% of their fair market value when offered as collateral.

Some banks may even be willing to accept certain intangible assets, especially the readily marketable trademarks, copyrights and patents. If a licensing agreement is in place, you can use the Discounted Cash Flow method to determine the value of such assets. Otherwise, you will need to research typical royalty rates and prepare a defensible income forecast for your intangible asset valuation.

Lenders: what are the business assets worth in a liquidation

Business owners and lenders often disagree on the value of business assets used as business loan collateral. The reasons are obvious: from the lender’s perspective a low-risk loan is one offered to a business with plenty of stable cash flow backed by a valuable, highly marketable asset base.

If the loan goes bad, the bank will look to dispose of these assets quickly. Hence, your lender is likely to use the so-called liquidation premise when valuing your business assets.

Business owners: what is the cost to replace business assets?

The fair market value of these assets can be considerably higher. Business owners often object to the lender’s business valuation results - after all, they know what their inventory is worth when sold in the normal course of business. Besides, it seems far more reasonable to value the FF&E on a replacement cost, value in use or going concern basis.

Different assumptions lead to differences in business valuation results!

Whose valuation is right? Actually, both sides are correct! As is the case with any business valuation, the assumptions drive the results. Put differently, the business owners and the lender use different premises of value - each based on their respective position.

Both the lender and business owners need to understand that this business value spread is normal, then work together to find an acceptable compromise.

If you own a car wash business or looking to buy one, here is a piece of good news: car washes are one of the most profitable sectors of the service industry with above average profits. These businesses are known to generate steady income due to the necessary and recurring nature of the service they offer.

While changes in car designs and energy alternatives may have lasting effect on many auto service businesses, the car wash will continue to provide the same basic service. This, of course, means that you can expect the revenues in the car wash sector to continue growing steadily.

The car wash service is a typical small business industry: classified under SIC code 7542, there are over 29,500 car washes in the US alone. The industry generates a very respectable $4.4 billion each year in gross sales and employs just under 138,000 people. Yet the average car wash is quite small, employing a staff of 5 and having the annual gross revenues around $200,000.

Established, profitable car wash operations are very marketable - the up-front investment of starting a new business can easily tip $2 million! Buying an existing business offers a very attractive alternative of immediate cash flow and steady business growth prospects.

Car wash businesses come in several types: the self-service, conveyor and the highly automated in-bay. The more profitable establishments tend to offer additional value-added services which include on-site detail services, gift and coffee shops, and periodicals for sale.

Business valuation methods for car washes

Given that car washes sell often, there are plenty of market comparables data to do your business valuation. Typical pricing multiples used are selling price to gross annual revenues, discretionary cash flow or EBITDA. The price to cash flow multiples are especially well suited for valuing a business with the above average profitability.

Valuing a Business using Market Comps

Well-established car washes may have considerable goodwill. In these cases, the Capitalized Excess Earnings method is an excellent choice. In addition to showing the value of the business and its tangible assets, you can use this well-known business valuation method to demonstrate the value of business goodwill.

For younger car washes or businesses in a rapid expansion mode, the Discounted Cash Flow business valuation method may be more appropriate. You can demonstrate the value of a business to partners and outside investors based directly on your earnings forecast and risk assessment.

Perhaps the greatest advantage of the renowned Discounted Cash Flow business valuation method is its flexibility. You can choose any stream of business income and discount it to determine the business value today. However, to get accurate business valuation results, you need to match your earnings and the discount rate carefully.

Net cash flow and build-up discount rate formula

Most business appraisal experts recommend the net cash flow as the earnings basis for use with the Discounted Cash Flow method. The widely accepted rationale is this:

The discount rate, which captures your business risk, is typically derived from the public capital markets. The investors in these markets generally obtain the economic benefits equivalent to the net cash flow. Hence, the use of net cash flow to ensure that the earnings basis and discount rate are matched.

That said, you can make an adjustment to the discount rate and then use it to discount a different income stream, such as the seller’s discretionary earnings.

In this case the discount rate will need to account for the additional opportunity cost of owning and operating the business. This cost is not included in the Build-Up cost of capital formula directly - since typical investors do not work in their portfolio businesses.

Once matched, the two sets of income streams and discount rates should provide you with comparable results.

Discretionary earnings and capitalization rate that match well

In comparison, the Multiple of Discretionary Earnings, a widely used direct-capitalization method, uses the seller’s discretionary cash flow as the earnings basis. The capitalization rate is developed from the 14 business financial and operational factors you specify.

This cap rate is matched specifically to the seller’s discretionary cash flow as the earnings basis. An important difference from the net cash flow is that SDCF includes the single owner-operator compensation and non-recurring business expenses as addbacks.

Companies large and small often realize that they cannot be all things to all people. A business may excel at product development but have little experience in providing specialized services to its customers. A company may have an established position in a regional market place, but lack resources to enter a larger national or international markets.

In such cases, business owners can decide to form a joint venture with another firm that has the capabilities they lack in their own organization.

Joining forces together has advantages in that each partner in the venture brings the right and complementary set of skills and abilities to the table. Given the synergies that may result, such combination can do very well indeed.

Whenever a joint venture is considered, a couple of important questions arise:

1. What is the overall business value of such an enterprise?
2. How is the business ownership allocated among the venture partners?

Most of the time these business valuation issues arise in the planning phase, before the business combination is finalized. Hence, there is no track record of the joint venture’s financial performance. Under these circumstances the income approach to valuing the business is the best choice.

Business valuation of a joint venture - methods

Using the income-based business valuation methods makes sense because they let you determine the value of the joint venture directly from your financial forecasts and risk assessment.

Assuming that your venture partners buy into the financial projections, you can determine the business value of the entire enterprise by using such well known valuation methods as Discounted Cash Flow.

Valuing a Business based on Cash Flow and Risk

This agreement on the expected financial performance of the joint venture is essential to determine what the entire business is worth - and address the first question above.

Determining the value of business ownership interest in a joint venture

Allocation of the business ownership interest depends upon the relative contribution each partner makes to the joint venture.

Example

Let’s say that the combined company will design and market a new product. One of the partners has the research and development expertise while the other has experience in marketing, sales and distribution of similar products. Each brings considerable value to the venture. What are their interests in this business worth?

Assume that your financial projections were used to calculate the total business value of the venture to be $10,000,000. The partner will provide the product and technology for the venture. The value of such business contribution can be estimated using the asset approach to valuing businesses. Your goal here is to estimate the costs of creating a suitable alternative.

If you were to develop the product by yourself from scratch, the costs associated with this effort can be estimated. In addition, there is an opportunity cost incurred due to sales lost while the product is being developed. Let’s say that you estimate these costs to be $4,500,000.

This provides the estimate of your partner’s share of the venture, which in this case equals 45% of the total business value. If no adjustments are made, you would wind up with 55% of the company which gives you the controlling ownership interest in the venture.

If your partner insists on having an equal stake in the joint enterprise, a balancing payment of $1,000,000 would need to be made.

ValuAdder raises the bar once again on business valuation software with the latest V4.0 edition.

Now in its 4th generation, ValuAdder has helped thousands of small business people and professional advisors world-wide to determine the value of their businesses and structure successful business acquisitions.

The secret of success? Listening to our customer needs, using the best technology available, passing the savings directly to our customers, and offering world-class support!

With ValuAdder 4.0 we follow this tradition to give business people anywhere the valuation software system that has stood the test of time:

1. Market-derived valuation rules of thumb for over 400 industries. Virtually all business types are now covered!
2. Latest discount and capitalization rates to ensure that your business appraisals are accurate and up-to-date.
3. Worksheets streamlined for quick financial statement recasting and forecasts - an important requirement for any business valuation.
4. Flexible selection of any business valuation method under the standard income, market and asset approaches. You can do what-if scenarios, side-by-side comparisons and custom business valuation method selections with a mouse click.
5. Updated Learning and Info Center covering all aspects of valuing a business and structuring a business sale or purchase.
6. A number of performance enhancements which take advantage of the cutting-edge Java 6 technology features.

The result? Quite simply, the business valuation system that is more accurate, flexible, secure, easy to use and reliable than anything available on the market.

Business market value comps for over 400 industries

For market comps, we have focused on additions in the hottest industries of today. The industry coverage in the ValuAdder Rules of Thumb module is now the impressive 402! You can estimate your business fair market value in just about any industry - by direct comparison to similar business sales.

Here are the latest additions:

Health care services

• Intermediate care facility
• Nursing and personal care services
• Specialty hospitals
• A number of medical laboratory and test facilities

Energy sector and green industry businesses

• Energy management and conservation services 
• Oil and gas production, development and exploration
• Oil and gas well drilling services
• Recycled wood products manufacturing
• Recycled paper products manufacturer
• Metal products recycling
• Metal distributors and service centers

Personal and business finance, insurance

• Personal and consumer credit companies
• Short term business credit, factoring services
• Business credit and underwriting services
• Life insurance carriers
• Accident and health insurance
• Hospital and medical service insurance plans
• Fire, marine and casualty insurance

Information technology services

• Computer facilities management service
• Computer maintenance and repair
• Computer peripherals and software products value-added resellers

Manufacturing industry

• Electronic components manufacturing.

Retail industry

• Radio, television and electronics store.

Educational services

• Private schools, including pre-school, elementary and secondary education levels
• College level and professional training schools
• Junior / associate degree colleges

There are also extensive updates for the restaurant, construction, finance and real estate industries.

Construction companies are frequent business acquisition targets. The volume of business sales is largely due to the industry size - there are over 346,000 firms in the single-family housing construction alone, classified under SIC 1521.

While this construction industry segment generates over $196 billion in annual sales, the average construction company is small - employing just 3 people and generating around $600,000 in annual revenues.

There is a sizable pool of business buyers looking for construction companies, especially in the mid-market segment - with the profitable firms topping $5,000,000 in gross revenues.

If you own a business in this industry or plan to buy one, knowing the value of your construction company is essential. While standard business valuation methods under the income, market and asset approaches work well for construction business valuation, there are 5 key factors you need to keep in mind:

Construction company worth: 5 key factors

1. Longevity, name and reputation of the business make a big difference to what the company is worth.
2. Value of a construction company is affected by the expected level of repeat business. Established sales and marketing function that does not depend on the current ownership translates to higher business value.
3. Current contract pipeline and billing practices.
4. Accounts receivable collection. Slow collection calls for higher working capital which increases business risk and leads to lower valuation multiples.
5. Availability and retention of key skilled employees.

Often, higher business selling prices are achieved when a company sells to a competitor or a larger firm looking to enter the market.

Construction business valuation methods

Since construction firms sell often, there is plenty of market comps to detemine the construction company worth. Market-derived Rules of Thumb for construction companies under the SIC 15, 16 and 17 are generally based on the business discretionary cash flow or EBITDA.

For owner-operator managed businesses, the Multiple of Discretionary Earnings business valuation method is an outstanding choice. In addition to the business earnings, this method lets you account for the 5 factors above when valuing a construction company.

Well-established construction businesses may have considerable goodwill. Consider using the time-tested Capitalized Excess Earnings method to measure the worth of your construction company, as a sum of its tangible assets and business goodwill.

If you are buying a business or selling your business, estimating the business selling price by market comparison is a good idea. Recent business sales in your industry offer an excellent way to develop your asking price or check your offer price and terms.

A number of business pricing multiples to choose from

As we discussed in the Business Valuation using Market Comps post, you have a number of valuation or pricing multiples to do your comparisons. Which ones work best?

How to pick your pricing multiples

The answer depends on your business valuation situation. Your choice of the valuation multiples needs to address these important questions:

1. Which pricing multiples give the most accurate prediction of business market value?
2. Which valuation multiple gives the best estimate of what my business is worth?

In the market, business selling prices are set by the business sellers and buyers. So what do these players use as their basis to determine the business value?

Valuation formula multiples are developed by statistical analysis of the actual business sales. Let’s say that in your industry the Price to Gross Revenue valuation multiples cluster around the average value. In other words, business values determined using such pricing multiples fall within a narrow range.

This means that your business peers tend to rely on the business gross revenues to determine the business selling price. Knowing this, you can use the Price to Gross Revenue valuation multiple to get a good idea of what your business is worth.

Obviously, such pricing trends can differ by industry. ValuAdder market-based Rules of Thumb Pricing Formulas use advanced technology to help you make the most accurate choice of the valuation multiple for your business.

Business valuation multiples - making strategic choices

You can use a number of other business valuation multiples as a strategic choice to demonstrate your business value.

For example, the business may be exceptionally profitable compared to its industry peers. In such a case, you may decide to use the Price to Net Income or EBITDA valuation multiples which will show how profitability translates into superior business market value.

If the business is asset rich, business Price to Tangible Assets or Total Asset base may be a good choice of a pricing multiple.

Alternatively, you can pick the Price to Gross Profit valuation multiples. This may be a good fit if the business shows outstanding operational efficiencies which keep its direct costs low compared to the competition.

Take a peek at ValuAdder Business Market Value Reports to see how a number of business valuation multiples can be used to estimate your business market value.

If you need a bullet-proof way to show what your business is worth, compare it to similar businesses that sold recently. In fact, such business market value comparisons are widely used by business people and professional business appraisers. So much so, that they deserve an official name: Comparative Transaction business valuation method.

Market comps and business fair market value

One of the greatest strengths of valuing a business by the Comparative Transaction method is that it establishes the business fair market value. This is perhaps the best known standard of business value.

Done correctly, such business valuation results are compelling and defensible. Many business people believe that the market ultimately decides what businesses and their assets are worth.

Business valuation mechanics: pricing multiples

To make an apples-to-apples comparison, you can use a number of pricing multiples - ratios which relate the likely business selling price to its financial performance. Examples of commonly used business pricing multiples are:

• Business selling price to discretionary cash flow or net cash flow.
• Business selling price to gross or net revenue.
• Business selling price to net income, EBITDA, EBIT, EBT.
• Price to total assets, tangible assets or business book value.

To make the comparison accurate, you can pick a number of actual business sales in a specific industry. Some questions that come up often:

1. My business generates income from several profit centers. How do I do my business market value comparisons?

2. My business is very specialized. Are there enough similar business sales to compare against?

Business market value comparisons, such as those offered in ValuAdder Business Valuation Rules of Thumb, are organized by industry. If your business is pure play, deriving all or most of its income from one industry, you can make your business value comparison directly against your industry group.

For multiple profit center businesses, you can estimate your business fair market value as follows:

1. Check the business values in each industry group of interest.
2. Assign a weight to the business market value result from each industry in proportion to its revenue contribution to your business.
3. Sum up the results to get a business value estimate for your company.

Valuing a Business with Market Comps

Example

We are looking at a business with $1,000,000 annual sales.

Let’s assume that the business generates 70% of its revenues from retail product sales. The remaining 30% are derived from its client consulting services.

We check comparable business sales using the pricing multiples for retail sales and consulting services. The first comparison uses the $700,000 revenue as the basis and indicates that this part of the business is worth around $550,000.

The second comparison, using the $300,000 revenue basis, shows an additional business value of $250,000.

Combining the two results, we get the business market value estimate of $800,000.

Note that this estimate does not account for the synergies among the business profit centers. That is why it is a good idea to value your business several ways - including the income-based business valuation methods such as Discounted Cash Flow and Multiple of Discretionary Earnings.

Fair market value estimation for specialized businesses

If your business is very specialized, chances are there are not enough comparable business sales. In this case, you can choose a broader industry group to do your business value comparison. 

Standard industrial classification systems, such as SIC and NAICS, are very helpful to locate the relevant industry groups.

Perhaps the most misunderstood part of valuing a business is that business valuation results may differ depending on the assumptions you make, namely:

• Who needs to know what the business is worth?
• What are the circumstances surrounding your company valuation?

Business appraisers use the formal term business value standard to address this situation. You have a choice of several business value standards that are well known:

• Fair market value
• Investment value
• Intrinsic value
• Fair value

Fair market value is used most often in valuing small businesses and professional practices.
It is an excellent fit when a business is valued for sale or purchase - after all the fair market value is established by business buyers and sellers themselves.

If you are valuing your business by comparing it to recent sales of similar businesses, the fair market value is the typical choice. The assumption here is that, by and large, business buyers and sellers act in their best interests, have taken pains to educate themselves about the market, and are not forced into a deal by circumstances.

Business fair market value and fair value may differ

Enter a deceptively similar definition of business value: fair value. Watch out - this is most often seen in legal disputes and is subject to interpretation by courts.

The assumption often made in this situation is that business owners may be involuntarily deprived of their ownership interest and need to be fairly compensated for their loss.

This is hardly the same as the business owners who freely bargain to get the fair market value for their business!

If business valuation is done for investment reasons, the investment business value definition is common. Each investor seeks to determine the expected returns and risks associated with the business of interest. Since each investor’s perception of risk and required returns is different, their business valuation results for the same business can differ considerably.

Business investment value is unique to each investor

Truly, business value defined under the investment standard is in the eyes of the beholder! This is one reason that business brokers often suggest targeting specific business buyers - those that look for synergistic benefits in a business acquisition - and are willing to pay the price.

Business value definition - a strategic choice

Giving a bit of thought to your choice of business value has strategic implications:

1. Fair market value standard is easily defensible. You can use this to justify your business asking price or offer price to buy a business.

Market-based business valuation methods are typically used to establish your business fair market value.

2. Fair value standard can be very helpful in a legal dispute such as divorce, shareholder disagreements or ownership rights infringement.

3. If you invest in a business or look to attract the right investors, investment business value should be your choice.

Income-based business valuation methods such as the Discounted Cash Flow give you an excellent way to value businesses under the investment business value standard. Each target business is valued based on its specific risk and return profile.