Business valuation tips, updates and advice. Pick up a few suggestions on how to value a business. Feel free to browse the contents or share your thoughts by leaving a comment.
Do you own a lanscaping services company? Need to determine the value of your own business or prepare an appraisal for a client? Here are some interesting industry statistics to consider:
Key landscaping industry statistics
Classified under SIC code 0781 and NAICS 56173, there are over 93,680 landscaping planning, design and counseling establishments in the US alone. The industry as a whole generates $53.9B in annual revenues and employs over 596,800 people. Yet an average landscaping company is a typical small business: it produces around $575,000 in annual sales with a staff of 6.
Business valuation of landscaping companies
By far the most objective evidence of what a landscaping company is worth is recent sales of similar businesses. Business appraisers refer to this business valuation technique as the Comparative Transaction Method.
Valuation multiples derived from such business sales offer you an excellent tool to estimate your business value. Here are the typical multiples used for landscaping business appraisals:
Multiple of gross revenues or net sales.
Multiple of gross profit.
Multiple of net income.
EBIT and EBITDA based valuation multiples.
Multiples relating your business value to its fixed or total assets.
Business value as a multiple of owners’ equity.
Example: valuing a landscaping company using multiples
Let’s take a typical landscaping services firm with the following financial parameters:
Annual net sales: $600,000.
Gross profit: $410,500.
Net income: $56,250.
EBIT: $57,000.
EBITDA: $59,600.
Total business assets: $195,000.
Book value of owners’ equity: $102,500.
We next pick a set of reasonable valuation multiples to calculate the company value as follows:
Multiple
Multiple value
Business value
Price to net sales
0.55
$330,000
Price to gross profit
1.2
$492,600
Price to net income
8.2
$461,250
Price to EBIT
9
$513,000
Price to EBITDA
8.6
$512,560
Price to total assets
3
$585,000
Price to owners equity
5.5
$563,750
Average Business Value
$494,023
Asset and income methods for valuing a landscaping business
To complement your market-based valuation, consider the the well-known Multiple of Discretionary Earnings method. This income-based business valuation technique is especially suitable for valuing owner-operator managed landscaping service companies.
For a business that has excellent reputation in its marketplace, the value of business goodwill can be considerable. To appraise the value of business goodwill, consider using the Capitalized Excess Earnings method, known as the Treasury Method. Many professional business appraisals use this asset-based method to value goodwill as well as determine the total business value.
If you own a software firm, plan to start one or acquire an existing company, here are some interesting facts to consider:
The two main segments of the software industry are custom software services and pre-packaged products.
Software development services firms
Classified under the SIC code 7371 and NAICS 541511, the firms in the software service industry concentrate on creating solutions for clients, usually other businesses.
The industry segment as a whole counts over 55,000 establishments in the US alone. These software companies employ around 494,000 people and generate over $84.9B in annual sales. The average contract software development company makes about $1.54M in annual revenues and employs a staff of 9.
Software product development companies
Software companies that develop and sell their own products are classified under the SIC code 7372 and NAICS 5112. The pre-packaged software industry has just under 8,300 firms operating in the US market with a total employment force of some 386,900.
The segment generates an impressive $135.4B in annual sales. An average company does about $16.4M in revenues per year with a staff of 46.
One interesting observation you can make is that the software services industry creates fewer dollars with more people. One reason is that the software services are more labor intensive. However, the service companies have an easier time establishing a loyal customer base and recurring business.
Key value drivers for software companies
Regardless of which market segment your software company is in, these key factors make the major difference to its value:
Earnings growth prospects
Software products can be highly profitable if focused on the right market segment with significant demand. Product firms especially can experience significant revenue growth quickly with the right product mix.
Profitability
Keeping costs under control is not an easy task for a software company. The costs of developing and marketing software products are very high. The firms that manage growth while keeping their cost from escalating are far more valuable than their unprofitable counterparts.
Stability of earnings
Maintaining consistent level of sales and profitability can be very difficult especially for pure product software companies. Competition can introduce an alternative product and sudden market changes can make a star product obsolete very quickly.
This is where the service companies tend to do better – the customer loyalty tends to translate into repeat business, stable prices and steady earnings. The costs of entering the new market segments are also lower for software services companies as they tend to rely on existing customers and referrals to do so.
Business valuation methods for software companies
As with any business, you can value a software company three ways, known as appraisal approaches:
Asset – based on the company’s asset base.
Income – based on the firm’s earning power and risk.
Established software firms tend to be frequent acquisition targets. Hence, there is solid evidence of their market value as shown by the actual business selling prices. Thus, you can use the market valuation methods quite effectively to appraise your software business.
At the same time, the growth potential is a key element of value in any software company. Income-based business valuation methods, such as the Discounted Cash Flow technique, are an excellent choice to value a software firm.
Combined Market and Income approach: First Chicago Method
For a highly accurate business appraisal, you can combine the two approaches. This technique is often referred to as the First Chicago method. Under this method, you can assess the value of your software business using the Discounted Cash Flow method. This requires that you create a set of earnings forecasts and assess the business risk.
Since the future is never certain, you can improve the accuracy and validity of your business appraisal by repeating the Discounted Cash Flow analysis under a couple of possible scenarios, such as the worst case and best case outcomes. You can average the results to come up with an estimate of what your company is worth.
The market comparisons serve as the objective proof to back your income-based valuation results. Since the market valuation is based on the actual data on similar business sales, it tends to act as a sanity check on your forward-looking income-based valuation.
Again, combine the income and market-based valuation results for a highly defensible, comprehensive estimate of what your software company is worth.
If you talk with professional business investors or business brokers, soon enough you will hear them mention business valuation ratios. Business appraisers refer to these tools as valuation multiples.
Basically, the ratios are a technique to estimate the value of a business based on comparable business sales. Such market-based valuation tools are very useful in a number of situations that call for a defensible, objective business appraisal:
Business sale or purchase. Buyer and seller can justify their valuations based on the objective, empirical evidence.
Legal disputes which often require that the fair market value of a business be determined. Again, objective market proof of business value is a great way to resolve disagreements.
Tax issues such as gift, estate and income taxes. Tax authorities are very keen on checking the market data to verify the business appraisal results submitted by tax payers.
Typical ratios used in business valuation
Since no two businesses are the same, the actual business selling prices will differ from one transaction to another. Relating the selling prices to the business financial performance measures is the best way to develop reliable ratios for your business valuation.
As you can expect, the business income statement and balance sheet items are the usual choice of basis to calculate the business valuation ratios. Here are the most common ones:
Business selling price to gross revenues or net sales
Price to gross profit
Price to net income
Price to EBT, EBIT and EBITDA
Price to seller’s discretionary cash flow or net cash flow
Price to fixed business assets or total asset base
Price to owners’ equity.
The accuracy of each business valuation ratio varies by industry, company size, and the time frame when the business sale comps have been selected. The best ratios are those showing the smallest spread of values, from low to high. This indicates that business people rely on some business valuation ratios more when pricing the actual business acquisitions.
Choosing the ratios for your business appraisal: best practice
One way to develop a highly defensible market-based assessment of your business value is to use several ratios or valuation multiples at once. Each will produce a result indicating what your company may be worth based on the specific financial performance measure.
You can then use these valuation results to come up with a solid estimate of business value. Let’s say that the lowest business value for your company as determined by the price to gross revenue valuation ratio is $1,000,000; the intermediate value based on the discretionary cash flow is $1,100,000; while the highest is $1,250,000 as indicated by the price to net income ratio.
You can conclude that the market value of the business will fall somewhere in the range established by these numbers, in this case $1,000,000 – $1,250,000.
On the other hand, the numbers can be averaged to give a single number for the business value: $1,116,667.
In fact, both the range and a single value number reporting is industry-standard for professional business appraisals.
Privately owned and operated florists are a major part of the retail industry. Classified under the SIC code 5992 and NAICS 453110, there are around 35,650 such establishments in the US alone. The industry as a whole generates an impressive $6.6B in annual revenues and employs over 135,000 people.
Yet an average flower shop is a classical small business: producing around $200,000 in annual sales with a staff of 4.The industry is highly fragmented with the top 5 companies accounting for less than 2.5% of the total industry revenues.
Key value drivers for retail florists
The product for flower shops is arranged cut flowers that usually account for over 50% of a store’s revenues. Florists with significant commercial accounts that tend to result in stable recurring revenues are valued above the average.
Another key value driver is an attractive store location with the rent expenses below 6% of the shop’s gross revenue. The highest valued flower shops are located away from the major “big box” competitors such as do-it-yourself home improvement or grocery chain stores.
The florists that focus on the special event and gift market segments tend to command higher business valuations. Essentially, such flower shops differentiate on superior service that leads to customer loyalty, higher profitability and, not surprisingly higher business value.
Sales from an online presence or phone orders tend to be more cost-effective ways to generate sales. Some of the most valuable flower shops achieve close to 80% of their revenues through these channels.
Business valuation methods for flower shops
Florists with a track record of highly stable, above average earnings are very desirable and sell often. If you study such business sale comparables, you can develop a very good idea of what your business is worth.
The typical tools to estimate your business value is to use the valuation multiples derived from such business sales. The multiples relate the actual flower shop selling prices to their financial performance.
Thus, you can calculate your business value in relation to its revenues, profits, EBIT, EBITDA, cash flow, assets or owners equity.
Here are the typical valuation multiples used to estimate the value of a flower shop:
Business value based on gross revenue or net sales.
Business value based on net income.
Business value based on EBIT and EBITDA earnings.
Business value based on the seller’s discretionary cash flow.
Business value based on the furniture, fixtures and equipment assets.
Example: valuing a flower shop using valuation multiples
To demonstrate the idea, let’s pick a typical retail florist business with the following financials:
Business gross revenue: $250,000.
Business net sales: $225,000.
Net income: $35,553.
EBIT: $36,000.
EBITDA: $39,500.
Seller’s discretionary cash flow: $154,247.
Furniture, fixtures and equipment assets: $25,307.
Inventory: $4,601.
We pick a set of reasonable valuation multiples to calculate the value of the business as follows:
Multiple
Multiple value
Business value
Price to gross revenue
0.4
$104,601
Price to net sales
0.41
$92,250
Price to net income
3.5
$124,437
Price to EBIT
3.1
$111,600
Price to EBITDA
2.8
$110,600
Price to SDCF
3
$467,342
Price to FF&E assets
8.1
$209,586
Average Business Value
$174,345
Other methods to use for valuing a florist business
You can value an established owner-operator run flower shop by the well-known Multiple of Discretionary Earnings method. This income-based business valuation technique lets you determine the value of the business based on its earnings outlook and a set of key financial and operational performance factors.
Since many privately owned florists are lifestyle businesses, the Multiple of Discretionary Earnings is particularly well suited for their business valuation.
For a florist that has created an solid reputation in its market, the value of business goodwill can be considerable. To appraise such a business, consider using the Capitalized Excess Earnings method, known as the Treasury Method. This technique is specifically intended to help you determine the value of business goodwill and total business value.
If you are like most business people, CPAs, brokers or investors, you probably take the actual business selling prices as a strong indication of what a similar business is worth.
Business selling prices offer an objective evidence of how other business people determine the value of businesses.
A large enough number of arms-length business sales is also a good way to establish the fair market value of your business. This is useful even if you do not plan to buy or sell the company.
Here are some key situations where the fair market value is the de-facto standard for business appraisal:
Gift and estate taxes
Divorce and other legal disputes
Buy-sell agreements
Employee stock ownership plans (ESOPs)
That said, the question is this: just how well do the recent selling prices of similar firms represent the value of your business?
Business selling price: key elements
First, some points about the elements that can make up the business sale price:
Buyer down payment
Seller financing
Lender financing
Earnout
Key employment agreements
Non-compete agreements with outgoing management or owners
Whether all these elements exist in a given business sale deal can make a material difference to the contract business selling price.
Business market value is affected by deal financing
In just about any industry, seller-financed deals tend to result in higher selling prices. If the deal can be financed through a commercial bank loan on attractive terms, the business selling price is likely to reflect it as well.
Typically, the business selling price includes the seller and lender financing at face value, i.e. not discounted over the time it is paid off. Arguably, the cash value of a financed deal is lower than an all-cash business sale.
Earnouts are usually excluded from the business selling price
By convention, the earnouts are excluded from the broker-reported business sale price. That’s because the earnout is contingent upon some future events and may not be paid in full measure or not at all – if the business fails to achieve the objectives agreed upon between the seller and buyer.
Other valuable parts of the business selling price
On the other hand, the employment and non-compete agreements with management and key staff are usually included in the selling price.
Private business value is determined based on total invested capital
Another important rule in valuing small businesses is that the value is established on the total invested capital basis. This includes both the owners’ equity and long-term debt.
That is very different from the public company valuation multiples that are typically computed on the owners’ equity basis only. If the company being valued uses debt financing, the resulting valuation results can be very different!
Get a defensible business value number by following established conventions
Since these conventions are followed by most professional business appraisers, it is wise to stick with them – if you want to avoid the challenge by other business people, tax authorities or courts.
Check your valuation multiples
Valuation multiples derived from market comps are the tools you can use to estimate your company’s fair market value. You can calculate it in relation to your firm’s financial performance such as revenues, gross and net profits, EBIT, EBITDA, business assets or owners equity.
When you use such valuation multiples, you need to be aware how they are calculated. Otherwise, your business value estimate may be way off.
