BUSINESS VALUATION (9/2/02)
Today, I am going to discuss business valuations. I think it is a very important topic, which is closely related to the small business financing information provided in the loanuniverse.com site. During the last three years, I have received dozens of emails, and a good portion of them relate to opportunities to buy a businesses and how to obtain the money to purchase it from a bank. However, most of the emails that provide some financial information fail to disclose how the seller and buyer arrived to the selling price.
Frankly, the whole situation reminds me of those commercials advertising sales. I do not believe in anything that claims to be in special. I also, as a potential buyer, would look closely to the math that a seller uses to come up with a price for its business. Hopefully, this article will give you a foundation on business valuation for you to question the numbers presented by the seller or allow you to realize when a fair price is presented to you or discovering a bargain. Of course, keep in mind that this is a bit outside my expertise.
Lets use an actual request from one of my readers as an example of how to go about evaluating the fair price for a business.
On 8/24/02 Eugene R. wrote on the message board: "I just came from your site and I am interested in getting an SBA loan to buy a coin laundry advertised in the Times. There are about 40 washers and 20 dries and the business also does dry cleaning. The owner wants $200,000 and the business makes him $100,000 a year. How do i get the loan?"
The following are the steps I would take if I were on Eugene's position:
I would go visit the business.
There is nothing like actually walking through the business and seeing it in action. It does not matter how good the numbers look in paper, you have to visit the business. In fact, set up an appointment with the seller to see the business and go again by yourself. In the case of a coin laundry, I would go at a time where I would expect it to be busy "Saturday afternoon comes to mind". Take notes of anything you might want explained by the seller.
Decide if you can do the evaluation yourself or you might need help.
I would seriously consider contacting someone to help you with the valuation aspect, and even if you don't hire someone for the evaluation, please hire an attorney for help on the sales contract.
Request financial information.
If you are working with someone for the valuation, that person will tell you what he/she needs to work. If you are working by yourself at a minimum you should require:
- Corporate financial statements for three years.
While the seller is gathering the financial information or even before step #1. You should be looking at the price of comparable businesses and the industry.
There are many sources for this information. You could take a look at the local newspaper or the good old internet. I found a couple of sites in less than a minute that had some information on coin laundries for sale and the industry.
a) From USBX.com I found four coin laundries for sale in my state. They are as follow:
This is a very small sample. If I was going to do this for real, I would get a much bigger sample probably by running a query for coin laundries for sale on other states. However, even in this small sample, I can see something that peaks my interest and seems to be out of the norm when I compare what Eugene tells me with the four listings. The seller told Eugene that his business made him $100k a year, that seems like a very high number per machine when you compare it with the listings. Nevertheless, we would have to factor how much of the business is coming from dry cleaning so the claim might be correct. Something else you could do is request information from the brokers selling the comparable business. Send the brokers an email requesting addresses and how they came up with the cash flow figures and they will most likely reply with some useful information.
b) From coinlaundromat.com I found a great article regarding coin laundry valuation, here is an excerpt. The whole article, which I found very interesting can be found on their website
Who and Why Evaluate?
Owners of businesses for profit have traditionally been concerned with the value of their assets, perhaps with an eye to selling, perhaps with the thought of acquiring another facility. Only a careless businessperson would be insensitive to this matter. Likewise, first-timers who are looking for business opportunities need to have some criteria for deciding whether the market is offering anything of value.
A Poor Rule of Thumb
Coin laundry owners and brokers commonly use two rules of thumb for evaluating a facility. One states that the laundry is worth twenty times its monthly gross. This parameter has limited, if any worth. Thus, consider two laundries each showing $10,000 monthly revenue. If the rent in the first is $3000 per month, and a full-time attendant is required so that wages amount to $2000, it will be worth far less than a similar store with $1500 rent and $400 in wages for nightly cleaning. In fact, assuming that all other expenses are identical, the first store will net $3100 less than the second, translating to about $150,000 less sales value.
A Good Rule of Thumb
Another frequently used multiplier is fifty times monthly net. This measure is decidedly more valuable than that based on gross. However, one must be cautious in accepting the "net" figure cited by an owner or broker. Usually the seller will include only those expenses which are mandatory for operation. Certain other more or less optional expenses, which are legally deductible for tax purposes - e.g., phone, auto, managerial, wages, and interest, will not be part of the computation. And neither will non-cash expense, such as amortization and depreciation.
This is turning out to be longer than expected so I am going to divide this article in two parts. Go to the second part.
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