Archive for October, 2008

Given the current situation in the real estate market, there is an uptick in real estate agency valuations. Many brokerage owners want to know what the agency is worth should they decide to put the business up for sale.

When it comes to valuing a business in this industry, real estate brokerages are quite similar to professional practices:

  • Hard asset base is relatively low.
  • Revenue generation depends upon the skill of professional real estate agents.
  • Business goodwill, especially for established agencies, is very important. At least a part of business goodwill is personal in nature, which may complicate its transfer to the new business ownership.
  • Licensing requirements create a barrier to entry, reducing the available pool of business buyers.

Business valation approaches and methods

A real estate brokerage can be valued under all three standard approaches to business valuation:

  1. Market – based on comparison to similar real estate business sales.
  2. Income – factoring in the real estate agency earnings prospects and risk.
  3. Asset – by accounting for the values of the real estate agency assets and liabilities.

Asset-based business valuation methods are less common in valuing a real estate agency. The hard assets are typically concentrated in the office furniture and fixtures, computer equipment and productivity software tools. Their market values can be easily determined. However, valuing the business intangible assets, such as client lists, is far more difficult.

One asset-based business valuation  method that is useful for valuing a real estate brokerage is Capitalized Excess Earnings. This well-established business appraisal technique lets you calculate the value of business goodwill based on the so-called excess earnings – those over and above a fair return on the business tangible assets.

Business valuation using market comps

Market data on real estate agency sales is a frequent source of comparables. Just as in the real estate sales, market comps offer a way to estimate the fair market value of a real estate brokerage.

Typical business valuation multiples for real estate agencies

The most reliable valuation multiples are:

Valuation Multiples and Business Market Values

At ValuAdder, we analyze recent private business sales in all types of industries. To offer you an accurate business market value estimate, we calculate over 40 valuation multiples – relating the business selling price to its revenues, profits, EBITDA, EBIT, cash flow, and assets, among other measures.

This statistical analysis shows that accuracy of business valuation multiples varies by:

  1. Industry.
  2. Company size.
  3. Over time.
  4. Selected measure of business financial performance.

The best valuation multiples tend to give you business sale price estimates with low variation that tend to cluster tightly around the average.

This basically means that business buyers and sellers rely on these valuation multiples when pricing a business for sale in your industry.

Valuation of real estate agencies on income

Business values of established and young real estate agencies are very often determined using the income-based business appraisal methods.

For mid-market real estate brokerages, the discounted cash flow is the preferred valuation method. For smaller, owner-operator managed agencies, the multiple of discretionary earnings method offers a great way to directly capitalize the business value.

Business selling price and market value

Your business valuation number does not necessarily equate to the business selling price. When offering a real estate business for sale, both price and terms affect the “cash value” of the deal.

Just as with other types of professional practices, an earnout is a frequent element of the deal. This makes part of the contract business selling price contingent upon its future financial performance, such as achievement of a certain level of sales.

Ask a professional business appraiser about how to value a business and you will hear that there are three ways or approaches to measuring the business worth:

  1. Market – based on comparison to similar business sales.
  2. Asset – which looks at the values of business assets and liabilities.
  3. Income – where you determine what a business is worth based on its income and risk.

The good thing is that you can value any business using these approaches, regardless of the company’s current financial performance.

Put differently, a business that is not profitable at the moment, may still have considerable economic value, and be worth quite a bit of money.

Business value depends on the long-term earnings outlook

Remember that all business valuations are forward looking – your business value is defined by the future business prospects. And there is a number of things business people can do that affect their business worth. For example:

Business owners may decide to merge businesses that lose money. The combined company may enjoy advantages that drive profitability: better product bundling, access to new markets, lower costs due to economies of scale from combined operations, and much more.

A business can attract smart investors that bring not just money but considerable managerial skills to the table. This may help the company develop new products and services, enter new markets, and turn its technology and know-how to profitable use.

Over time, the company owners may introduce operational changes that cut costs and improve efficiency. Long-term employees are often an excellent source of ideas to maximize profits and how to implement them to contribute to the bottom line.

Putting the business up for sale

Of course, the company owners may decide to sell the business. Can an unprofitable business sell? Yes – provided the right type of business buyer is found. Some typical types:

Financial business buyers

Typically savvy investors that focus on low-cost income streams. They tend to look for low-debt, highly profitable companies. These market participants often focus on the so-called cash cows, businesses that tend to generate steady income year after year.

Synergistic business buyers

These may be a group of investors or a larger company looking to grow through acquisitions. Such buyers may well be interested in the acquired company’s longer-term potential beyond its immediate profit numbers.

Business valuation models and methods for unprofitable businesses

Market comparisons to similar established companies are an excellent way to estimate what your business is worth. You have quite a choice of standard valuation multiples that relate the business potential selling price to its financial fundamentals.

Valuation multiple choices that work well

For an unprofitable company, the following valuation multiples are especially useful:

  • Business selling price to gross revenues or net sales.
  • Business selling price to business assets, such as total assets or tangible assets.
  • Business selling price to book or market value of business equity.

If you plan to re-capitalize the business or sell it to a well-funded buyer, the valuation multiples based on business revenues or asset base are very useful. Selling price to total assets is especially well suited for valuing a business that has both tangible and intangible assets, such as intellectual property, customer lists, valuable distribution rights, and the like. Think valuation of a high-tech start-up that hasn’t turned a profit yet.

The valuation multiples based on profitability, such as discretionary cash flow, EBITDA, or net income, will likely paint an unfavorable picture of what the business is worth.

Business valuation based on future income

Income based business valuation methods, such as the Discounted Cash Flow, are very well suited for valuing a business that currently runs at a loss.

This well-known method lets you calculate business value based on the company’s earnings forecast and risk assessment. Typical forecasts are done for 5 years, followed by the estimate of the business long-term terminal value.

Valuing a Business based on Cash Flow and Risk

Asset based business valuation methods

You can also use asset business valuation methods, such as asset accumulation or capitalized excess earnings. A well-established company may command considerable goodwill, despite the current slide in profitability. To calculate business goodwill, you will need to use the earnings estimate that represents the long-term business earning potential.

Your business valuation model may include a number of methods to determine what the business is worth. This multi-faceted approach is typical of professionally done business appraisals and tends to produce accurate, defensible results.

Take a look at the sample business appraisal report to see how the results of different valuation methods are consolidated into a comprehensive conclusion of business value.

Business Valuation three Ways

The tradition continues – our customers ask and ValuAdder delivers: the latest release of our business valuation software gives you all the tools you need to value a business or professional practice.

What is new in ValuAdder 4.0.6

We have increased the coverage in ValuAdder business valuation Rules of Thumb to 410 industries. Every Rule of Thumb is statistically derived from latest private business sales.

Valuing a business based on market comps

You can determine the value of a business based on direct comparison to similar privately owned businesses that have sold recently. ValuAdder gives you immediate results providing the business market value range, average and median values based on your selection of the business type and just a few financial inputs.

Here are the latest industry additions:

  • Control and measurement instruments manufacturing businesses.
  • Data processing, item capture services.
  • Document production and distribution companies.
  • Document storage, archival and destruction companies.
  • Electric services, power generation and transmission service companies.
  • Radio, video, data communication equipment manufacturing firms.
  • Systems integration services, hardware and software resellers.
  • Toy and game manufacturers.

That’s in addition to the other 402 business types across all major industry sectors!

The financial recasting worksheets have been further streamlined to save you time and effort. You can start your business appraisal from the company’s usual financial statement data such as Income Statements and Balance Sheet. The worksheets give you a step-by-step way to prepare for your business valuation:

  1. Determine the company’s true earning power.
  2. Assess business risk.
  3. Prepare all the inputs you need for your business valuation calculations.

Avoiding costly mistakes in your business appraisal

The adjustments you make on the worksheets are key to accurate business appraisal. Using business valuation formulas on incorrect financial inputs is the biggest cause of mistakes in business valuation.

One example is the use of valuation multiples:

Small business owners typically seek to minimize taxable income. Hence, business cash flow is a far more accurate measure of business earning power than net income. Discretionary cash flow or net cash flow are most commonly used in business appraisals.

You need to make several critical adjustments, known as addbacks, to get from the net income to the discretionary cash flow.

For many small businesses, seller’s discretionary cash flow can be several times the net income. If you apply a valuation multiple based on cash flow to net income, the business valuation error can be on the order of 300 – 500% or more!

Another mistake is using discount and capitalization rates that have nothing to do with your business risk profile. ValuAdder lets you assess your company-specific risk – an essential requirement for accurate business valuation.

Business Valuation using ValuAdder

Privately owned specialty coffee shops are ubiquitous and their number is constantly growing.

In the US alone, there are some 19,000 privately operated coffee shops, classified under the SIC code 5812 and NAICS 722211. They generate over $11.1B in total annual sales. Yet an average coffee shop is definitely small business – with annual revenues of $1,500,000 and a staff of just 9 people.

Coffee shops can be very profitable, recession proof businesses. A well-run business focuses on its local target market, satisfies the tastes and offers the unique atmosphere to develop a loyal customer following.

Successful franchises have come forward by capitalizing on the “affordable luxury” appeal of specialty coffee drinks and the ambiance that draws the customers in.

Business value drivers for coffee shops

While starting a coffee shop is relatively easy, running a successful business is more challenging. Here are the top factors that affect what your business is worth:

  1. Location. Coffee shops are gathering places, so the best location is where your target customers like to get together.
  2. Quality and variety of coffee drinks offered.
  3. Cost of goods including the wholesale coffee costs.
  4. Competitive differentiation, such as additional on-premises food and beverage offerings, retail coffee and tea sales.

Business valuation techniques for coffee shops

Coffee shops sell quite often, so you can estimate your business market value using valuation multiples based on private coffee shop sales. The most accurate valuation  multiples are:

  • Business selling price based on its revenue plus inventory.
  • Business selling price based on the annual discretionary cash flow plus inventory.

Valuation Multiples and Business Selling Prices

Many small coffee shops are owner-operator managed. For such an operation, the Multiple of Discretionary Earnings business valuation method is a great choice.

You can determine what your coffee shop is worth based on its earnings and a number of key financial and operational performance factors. What’s more, you can also see how these factors affect your business value – and what you can do to increase your business worth.

If you are looking to sell your small business or plan to buy one, the central question is what the business is worth on the market.

Overprice your business, and you will see little buyer interest. If your asking price is too low, you risk leaving a lot of money on the table. Knowing the market value of your business helps you set the asking price that attracts qualified buyers – and results in a successful business sale.

Equally, if you want your offer to be taken seriously by the business seller, your price must reflect the realities of the business market place.

Beyond business acquisitions, business market value is key to establishing the business worth in a number of important situations – in legal disputes, business partner buyout situations, and in dealing with the tax authorities.

A solid evidence of what the business is likely to sell for if put on the market is often the most convincing proof of its value.

And there is no better way to estimate the likely business selling price than comparing it to the actual sales of similar private businesses.

Private business sales are very different from sales of public companies

Be careful looking at the sales of publicly traded companies when estimating the value of a private business. Valuation multiples for public companies are likely to be very different than those you get form private business sales.

Here are the top three reasons for this:

  1. Small private businesses are less marketable than large public firms.
  2. Small business sales are done on the controlling ownership basis. Most public company stock sales are non-controlling.
  3. Small businesses are more risky and their valuation multiples reflect that.

Small businesses are less marketable than big company stock

If you own shares in a large publicly traded company, you can sell them within minutes by placing a market order through your broker. And you can get your money the next business day. More importantly, your actual selling price and the market price per share just before the sale are likely to be very close.

In contrast, selling a small privately owned business is a lengthy and uncertain proposition. Small businesses take 6 to 9 months to sell on average. Finding the right buyer, negotiating and closing the sale cost time, money and effort. And there is no certainty that your actual business selling price will be close to the asking price.

In formal terms, small businesses are illiquid investments, unlike shares of stock in publicly traded companies, which are highly marketable.

This lack of marketability of small business ownership interest leads to significant discounts being applied by investors, such as financial business buyers. In other words, the buyers want to be compensated for taking the risk – and they do so by lowering the price they are willing to pay for a private business.

Valuation multiples you get by comparison to small business sales reflect this risk. Public company share price ratios do not.

Small business vs big business: what sells?

Most investors in public companies trade a small number of shares. When a large company is acquired, the buyer typically pays a premium for getting a controlling stake in the business. It is not unusual to see the control premium in the 50% – 80% over the market price of the company’s shares.

Almost all private business sales are done on the controlling ownership basis – the entire business sells. If you were to use the price per share numbers based on the public company data, you could be 80% wrong!

Again, valuation multiples derived from sales of similar small businesses are based on sales of the entire business. This is not the case for public company data.

Small businesses are more risky

For a proof of this take a look at the stock market to see that small firms tend to generate higher returns than, say, Fortune 500 companies. Put differently, investors use lower valuation multiples when pricing shares of smaller companies.

Best way to estimate business market value?

For accurate estimate of your business market value, you should use valuation multiples derived from the actual sales of similar small businesses. These businesses operate in the same industry, are privately owned, and are about the same size as your company.

Make relevant comparisons!

Such “apples to apples” comparisons can give you a very reliable estimate of your what your business is worth on the market.

Business Market Value based on Small Business Sales