Archive for February, 2010

If you turn to a commercial lender for a business loan, expect the focus to be on the company’s cash flow. In other words, the lender wants to know whether the business will be able to repay the loan from its profits and cash flow.

Lender’s view of value: ability to repay plus valuable collateral

Just in case this assumption does not work out, the lender will want the business owners to put up sufficient collateral – typically in the form of valuable business assets. Should the loan repayment become a problem, the lender will lay a claim on these assets.

Loan to value depends on how quickly the assets can be converted into cash

For a lender it is important to establish the marketability and values of the business assets pledged against the loan. The more easily the asset can be converted into cash, the higher the loan to value figure.

You can expect the bank to offer around 80% of the value of current accounts receivable. On the other hand, most lenders will likely offer just around 50% of the value of business furniture, fixtures and equipment (FF&E) assets.

Inventory is another business asset that the lenders scrutinize carefully. For a manufacturing company, the bank is likely to lend against the values of raw materials and finished goods inventory. In the event of default, the finished goods can be sold off to a jobber, while the raw materials usually can be returned to the supplier or sold at a discount to a competitor.

Since the bank is not in a position to complete the production, the work-in-progress inventory is usually not a good collateral.

Experienced lenders are well aware that some inventory may be slow moving. In the event of default, this type of inventory is much harder to convert into cash quickly.

Good inventory control records are very important if you are to get high loan to value figures for inventory. Writing off obsolete inventory has the additional advantages of reducing your property taxes and insurance costs.

Conservative commercial lenders are also likely to apply a haircut to inventory levels in excess of the industry average. The assumption here is that the business inventory value is likely overstated or partially unmarketable.

Business valuation results depend on the premise of value!

A major cause of disagreements between business owners and lenders is how the value of pledged business assets is determined. Business appraisal can be done under several premises of value. Depending on the choice of premise, the business valuation results and, therefore, the amount of business loan, can vary dramatically.

Lender’s position: liquidation premise of business value

Expect the lender to take a conservative position and use the so-called liquidation premise of business value. This establishes the worst case scenario in the event the business fails to repay the loan and the collateral needs to be liquidated quickly.

Business owners’ view: going concern

For the owners of a going concern business, the typical premise is value in use. The resulting business valuation is considerably higher than under the liquidation assumption.

Both the business owners and the lender are right. However, each party is viewing the business value from a very different perspective!

Business Valuation under Different Assumptions

You can improve your chances of getting the loan you need by valuing your business under different assumptions. Knowing the value of your business and its assets is an excellent way to prepare for a business loan discussion with your lender.

See How to Do it »

Despite the current economic headwinds, many building maintenance service companies with established client contracts continue to thrive. There are some 92,300 such firms in the US alone, classified under the SIC code 7349.

The industry segment contributes an impressive $28B in annual revenues to the economy employing just under 840,000 people. The typical janitorial services company is quite small – generating around $300,000 in gross annual sales with a staff of 9.

Business valuation methods for janitorial service companies

Given the size of the market and the recurring need to clean and maintain office buildings, the janitorial companies tend to be “recession-resistant”.

Companies with stable earnings from long-term commercial contracts are bought and sold regularly. This is very good news: business selling prices and terms from such deals offer you an excellent way to estimate the value of your janitorial service company.

The typical tools are valuation multiples that relate the actual selling prices of similar companies to their financial performance. You can apply these valuation multiples to estimate the value of your company based on its revenues, profits, EBITDA, cash flow, asset base and owners equity.

Example: valuing a building maintenance business using valuation multiples

To demonstrate this market approach to valuing a business, let’s pick a typical private janitorial service company with the following current financials:

  • Gross revenue: $300,000.
  • Net sales: $290,000.
  • Net income: $60,000.
  • EBITDA: $75,000.
  • Seller’s discretionary cash flow (SDCF): $110,500.
  • Furniture, fixtures and equipment (FF&E) assets: 55,000.
  • Inventory: $10,000.
  • Book value of owners’ equity: $35,000.

To calculate the fair market value of this business, we choose a set of sensible valuation multiples as follows:

Multiple Multiple value Business value
Business value based on gross revenue 0.7 $220,000
Value based on net sales 0.8 $232,000
Value based on net income 4.5 $270,000
Value based on EBITDA 3.8 $385,000
Value based on SDCF 2.5 $286,250
Value based on FF&E assets 5 $285,000
Value based on owners equity 6.5 $227,500
Average Business Value $257,964

Note that this averages to about 0.86 times the business gross revenues.

Other business valuation methods for janitorial service companies

To supplement the market-based valuation and check your results, consider using the Multiple of Discretionary Earnings method. This well-known technique lets you assess business value from a totally different point of view: based on the company’s earning power and 14 key financial and operational performance factors.

Companies with a long history of success in their market may have built up significant business goodwill. As a result, they may be worth well above the value of the business tangible assets. The Treasury Method is a great choice to calculate the value of business goodwill and total value for such firms.

Valuation of a Janitorial Services Company

The best way to handle business valuation is to use a set of established methods. This gives you a solid view of business value – by showing how the business measures up from a number of important perspectives.

With a global focus on sustainable manufacturing, scrap metal recycling is a key growth industry segment. Classified under the SIC code 3339 and NAICS 331419, there are just under 8,200 metal recycling companies in the US alone. The industry as a whole generates some $21.1B in annual revenues and employs close to 75,600 people.

Yet an average metal recycling firm is quite small – with around $3,000,000 in annual sales and a staff of  9.

Business valuation methods for metal recycling companies

Being in a growth segment usually means there is considerable investor appetite for business acquisitions. Indeed, scrap metal recycling businesses sell quite often.

The recent sales of similar businesses offer you an excellent way to determine you company value. Valuation multiples that relate the actual business selling prices to key financial performance measures are the typical valuation tools.

Using valuation multiples derived from recent recycling business sales, you can develop an accurate estimate of value for firm in this industry segment. The most common valuation multiples used for valuing metal recycling businesses are these:

  • Business selling price to business gross revenues or net sales.
  • Price to gross profit.
  • Price to net income.
  • Price to EBIT and EBITDA.
  • Price to seller’s discretionary cash flow.
  • Price to business assets.
  • Price to owners’ equity.

Example – valuing a metal recycling company using valuation multiples.

To demonstrate how the value of a business in this industry can be determined, let’s select a firm with the typical financial performance as follows:

  • Gross annual revenue: $3,000,000.
  • Net sales: $2,900,000.
  • Gross profit: $1,000,000.
  • Net income: $250,000.
  • EBIT: $145,000.
  • EBITDA: $282,500.
  • Seller’s discretionary cash flow (SDCF): $750,000.
  • Furniture, fixtures and equipment (FF&E) assets: $400,000.
  • Inventory: $355,200.
  • Total business assets: $950,000.
  • Book value of owners’ equity: $600,000.

Next, we apply a set of reasonable valuation multiples and come with the following business valuation results:

Multiple Multiple value Business value
Business value based on gross revenue 0.8 $2,755,200
Value based on net sales 0.82 $2,378,000
Value based on gross profit 3 $3,000,000
Value based on net income 11 $2,750,000
Value based on EBIT 15 $2,175,000
Value based on EBITDA 12 $3,390,000
Value based on SDCF 2.75 $2,417,700
Value based on FF&E assets 6.5 $2,955,200
Value based on total assets 2.75 $2,613,875
Value based on owners equity 5 $3,000,000
Average Business Value $2,711,067

Fair market value or investment value?

Market based valuation as this example illustrates tends to be a great way to determine the fair market value of your business. This is because the valuation multiples are derived from a large number of comparable business sales, establishing the “going rate” for similar business investments.

Exceptional companies may attract very strong investor interest. Professional investors that are looking for synergies to enhance their portfolio in your market segment may be willing to pay a premium for the right business opportunity. As a result, your actual investment business value may well exceed the fair market value estimate.

Valuation of a Metal Recycling Company

You can determine the market value of your business by comparison to similar business sales. Market Comps from reliable, court-tested data sources make your business appraisal both very accurate and defensible.

Business people often ask us: “Are different business valuation methods used to value companies in different industries?” It is a very sensible question – after all the differences between, say, a manufacturing firm and a dental practice are profound.

Professional business appraisers have developed an elegant, powerful framework to deal with this challenge. At the core of this framework are a set of universal business valuation methods that can be applied to valuing any business.

All these methods are grouped under the three major approaches to business valuation:

  • Asset – based on the values of individual business assets and liabilities.
  • Income – based on the company’s earnings outlook and risk profile.
  • Market – by comparing the subject business to similar companies, in the same industry segment, that have recently been sold.

There are several reasons why this business appraisal framework can handle any business:

  • All standard business valuation methods consider the industry-specific value drivers.
  • These valuation methods provide a consistent way to measure business value while accounting for the unique attributes of your business and its industry.
  • Each standard valuation method offers a different way of measuring the business worth, complementing the results you get from other methods.

Support by major business appraisal standards

The power and flexibility of this business valuation framework have made it the de-facto standard in all professionally conducted business appraisals. In addition, the multi-method business valuation is supported by the key appraisal standards such as the USPAP, AICPA SSVS No 1, and the IRS Revenue Ruling 59-60.

Let’s take a quick look at the typical valuation methods that are used to value companies in just about any industry:

Asset based valuation methods

The Asset Accumulation method lets you determine the overall business value based on the valuation of individual business assets and liabilities.

Current market values of these assets and liabilities are used to create the appraisal of a business. Needless to say, these market values are defined by the industry-specific factors. Examples are prices paid for similar equipment, royalty rates charged for customer lists or licenses and property rental costs.

Capitalized Excess Earnings method is another asset based valuation technique that is especially useful in measuring the value of business goodwill. Again, the industry conditions affect the market value assessment of individual business assets along with the capitalization rates used by this method.

Income based valuation methods

This group of appraisal techniques is perhaps the best example of how the industry factors affect the business value. Both capitalization methods, such as Multiple of Discretionary Earnings, and discounting techniques, such as the Discounted Cash Flow method, require business risk assessment. The industry-specific risk is one element of the discount and cap rates used by these valuation methods.

Income based valuation also requires that you forecast business earnings. This will most certainly be affected by the trends in your industry segment.

Market based valuation methods

These appraisal techniques rely on comparison to sold businesses in your industry segment. As a result, the business value estimates reflect the industry conditions such as investor demand for similar companies.

As a rule, business investment requires careful assessment of industry-specific growth prospects and risk. Hence, by using the market-based valuation multiples derived from similar business sales, you are effectively relying on the judgment of other business people about what a company in a specific industry is worth.

Since each method takes a different view of business value, throwing several standard methods into the mix is a very good idea. In fact, the use of multiple valuation methods is expected of all professionally prepared business appraisals.

Business Valuation using Several Methods