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.
– Interim corporate financial statements.
– Corporate Tax returns for three years.
– List of equipment.
– Inventory listing
– Accounts receivable aging.
– Accounts payable aging.

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 a no longer existing website USBX.COM I found four coin laundries for sale in my state. They are as follow:

Price	Location	Description
Under $250K	Orlando	EBITDA Cash Flow: $68,000Dry cleaning plant with 25lb machine and 2 pressers and a big coin laundry attached. Currently as a drop store due to owner’s frequent absencies. Gross sales comprise of 70% dry cleaning and 30% coin laundry. Good location in a growing area.
Under $250K	Ft. Lauderdale	Gross Revenue: $50,000FULLY ATTENDED AND AIR CONDITIONED COIN-OP LAUNDRY. EQUIPMENT INCLUDES 28 WASHERS AND 15 DRYERS; SOME MACHINES AROUND 2 YEARS OLD. SERVICES INCLUDE WASH-DRY-FOLD AND DROP OFF DRY CLEANING. ALSO HAS SODA AND CANDY MACHINES AND VIDEO GAMES. OWNERS ARE VERY MOTIVATED AND SOMEWHAT FLEXIBLE. STORE OPEN & OPERATING. BRING ALL OFFERS. PLEASE REFER TO LISTING #164-2065 & ASK FOR BROKER #20 WHEN INQUIRING.
Under $250K	Melbourne	Gross Revenue: $111,987Cash Flow: $17,152Clean laundromat with 90 plus washers/dryers. Owner offers wash and fold service, executive shirt service, and dry cleaning drop-off. A food/snack bar, video games, and a large screen TV, add additional income. Owner and wife are the only staff. Adding employees, and extending hours, would be a plus. No other laundry in immediate area.
Under $250k	Tampa	Cash Flow: $7,446Well located coin operated laundry. Run with absentee Owner. 18 washers and 8 dryers. Located in Tyrone Square area of St.Pete. Well established and great for first time buyers.

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 used to be in their website, but the website is no longer there so I took out the link.

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.

So far we have done the following:

We have visited the business.

It has been decided if you can do the evaluation yourself or outside help has been obtained.

We have the requested financial information.

We are familiar with the prices of comparable businesses and we know the industry.

It is now time to do some number crunching and look at other factors that might affect the purchase price.

It is time to decide, which valuation method we will use.

In the old message board, I mentioned “cash flow from operations” as my favorite method of determining the value of the business. I am a bit biased since that phrase in hammered into your brain from the moment that they hire you as a credit analyst, and frankly that will be the source of repayment for any loan. However, I am going to try to be impartial and give you a listing of the methods at your disposal.

a) Capitalization of income. For clarification purposes lets use imaginary numbers for the laundry Eugene is interested on. (These numbers are completely made up)

Coin Laundry Income	$200,000
Dry Cleaning Income	$200,000
Total Revenue:	$400,000
Cost of Goods Sold	$100,000
Gross Profit	$300,000
Labor expense	$100,000
Utilities	$50,000
Interest Expense	$25,000
Depreciation	$25,000
Operating Expenses	$250,000
Profit Before Taxes	$50,000
Earnings Before Interest, Amort., Depreciation and Taxes EBITDA	$100,000

After this very simple income statement we have figured out that the laundry makes about $100,000 in earnings before you have to pay interest expense, deduct depreciation and pay taxes. Now you have to ask yourself a question, what kind of return do you require to put your money into this industry and this particular business. Lets say for argument sake that you require a 25% return in your investment. Then $100,000 / 0.25 = $400,000. According to this method the value of the business would be $400,000.

b) Cash flow from Operations. Cash flow not only looks at EBITDA, but actually tracks the inflow and outflow of cash from the business. Suppose that the following has also happened to the laundry during the last year.

The Dry Cleaner got a new contract, which has increased sales but at the same time has increased accounts receivable by $40,000. This affects your cash collected from sales downward by $40,000 to $360,000.

Inventory has had to grow by $15,000 to support increasing revenues and operations. In addition, the suppliers have been pressuring for prompt payment decreasing accounts payable by $20,000. These two factors have decreased cash flow further by another $35,000.

There are many factors that can affect cash flow the three listed above have reduced it by $75,000 leaving only $25,000 to cover the debt service for any kind of loan used to pay for the purchase of the business. The actual value of the business using this valuation method varies accordingly to the terms that you can get from the financing institution for the purchase.

c) Multiplier of sales / Rule of thumb. As you could read from the excerpt of the coinlaundromat.com website. Coin laundries are usually valuated at twenty times monthly gross. The rule of thumb averages may work for coin laundries whose performances are average. However, if the business expenses and profits are not right on target with industry averages, this method would result on a misleading valuation. The warnings expressed in the article apply to all types of business.

d) Asset Valuation. This method only concerns itself with the value of the assets of the business being sold.

After deciding, which valuation method to use and before putting it in practice, make yourself a list of questions about the business you are going to buy. This will help you determine the risk associated with the transaction.

Use that list that you created while visiting the business and any other thing that you want to ask the borrower.

I hope this article has helped you.