A great article was recently published in the New York Times
regarding business valuation.
Do You Know What Your Business Is Worth? You Should!
At 53, Joe Ritz is old enough to remember a time when many of the classic cars that now pull into his specialized repair shop were new. ”It’s one field where it pays to be a senior citizen,” he said.
Based in Tempe, Ariz., near the site of the Barrett-Jackson car auctions and a hotbed of the collectible car scene, Mr. Ritz may know all there is to know about American muscle cars and multicarburetor European exotics.
What he did not know when he first tried to buy his own repair shop several years ago was how difficult it would be to pin down shop owners on the actual value of their businesses.
Few owners seemed even to know how to make a good guess. ”One guy I talked to about selling said the business had to be worth $1 million, because that’s what he needed to retire on,” Mr. Ritz said. ”Another was like, ‘Well, let me see, my alimony is $4,500 a month. … ‘ It was ridiculous. I finally just gave up and decided to start my own shop.”
Today, that shop, the Sports and Collector Car Center, has four mechanics working on roughly 20 cars a month, and Mr. Ritz can tell you exactly what he thinks the business is worth. All he has to do is check the latest figure on a cloud-based computer program that synchronizes with his regular accounting software to give him a real-time estimate.
Every time another ’57 Morgan wheels into his lot, every time he orders new parts, every time a similar garage is sold across town, a new value flashes on Mr. Ritz’s computer screen and a bar chart notches the progress toward his five-year goal. ”We’re not for sale,” he said, ”but now, at least, I’m not guessing anymore what my biggest asset is worth.”
Online Valuation Calculators
Based on anecdotal evidence from professionals in the mergers and acquisitions industry, Mr. Ritz seems to be in the minority. With the day-to-day demands of running their businesses, most owners put off getting a valuation until a sale is imminent. But some are starting to treat the act of valuing their business as an integral part of running it. ”Everyone likes to think they’re building something that they can sell someday, but unless you focus on it, you don’t know if you really are,” said Chris Myers, the 27-year-old chief executive of BodeTree, a start-up that created the software used by the Sports and Collector Car Center.
The BodeTree valuation service, one application in a financial analysis platform that costs about $50 a month (or $500 a year), has attracted 4,000 subscribers since its introduction last April, and bills itself as ”the finance tool for people who hate finance.” There are other online valuation calculators, including BizEquity and uValue, an iPhone app developed by Aswath Damodaran, a valuations expert at the Stern School of Business at New York University.
”I can’t speak for all the online tools, but I tried a couple of them and they didn’t come up with the same figure I did on a company I was valuing,” said Barbara Taylor, co-founder of Synergy Business Services, a business brokerage firm in Rogers, Ark., and a former contributor to The New York Times’s You’re the Boss blog. ”I think there’s something to be said for having a real person trained at valuations come in and get to know your business before running the numbers. There’s an art to doing a valuation.”
Business brokers, who routinely run valuations as part of marketing a company for sale, are another option. While their reports are not as detailed as the certified appraisals required by some buyers and in some legal proceedings, they tend to be more detailed than the reports from online services — and, at $900 to $1,500, they cost a fraction of what a certified appraiser at a large public accounting firm will usually charge. In some industries, hands-on valuations at discounted rates may also be available from trade associations and industry-specific consulting firms.
But before engaging outside experts, virtual or nonvirtual, it helps to have at least a basic understanding of the valuation process. Here is what you need to know:
THREE APPROACHES There are essentially three methods for calculating the value of a business. The asset approach, typically used in distressed situations for the sale of defunct businesses, determines a company’s value by adding up its tangible and intangible assets.
The market approach, probably the most common way to value a healthy business, produces a valuation based on a multiple of the company’s past earnings — usually the last 12 months of Ebitda (earnings before interest, taxes, depreciation and amortization). If you found that the last 12 months of Ebitda totaled $1 million and you chose a multiple of, say, five, you would get a valuation of $5 million.
The third approach, the income method, is forward-looking, relying on the present value of expected cash flow. More common in high-growth sectors like technology, this method tends to paint the fullest picture of a company’s potential, but prospective buyers may view it skeptically. That is why some services, like BodeTree, prefer a blended approach.
PICKING A MULTIPLE While multiples can vary widely, most have fallen since the financial crisis. Part of a valuation expert’s job is to analyze the ”comps,” or the multiple of earnings at which comparable businesses have been selling, to choose the appropriate multiple for your business. You can also visit business-for-sale Web sites like BizBuySell to get an idea for yourself.
CONSIDER YOUR BUYER Another factor that figures heavily in the size of the multiple is the type of buyer you think might want to acquire your business. Strategic buyers — those with a vision for how to improve your business’s operations, possibly by combining it with the buyer’s operations — tend to pay more than financial buyers, like private equity funds, which focus on maximizing their returns when they eventually exit the business.
LITTLE THINGS ADD UP One of the first things prospective buyers (and valuation experts) look at is the strength of your management team. If the depth chart does not instill confidence, the multiple will suffer. In addition, starting at least a year before any sale, you may want to revisit the mix of personal expenses — car payments, children’s college tuition bills, season tickets to sporting events and the like — that you have been running through the business. While you may be getting back 30 to 40 cents after taxes for every dollar expensed now, every dollar you deduct could take $3, $4 or $5 off the sale price, depending on the multiple.
OPTIMIZE, OPTIMIZE, OPTIMIZE One reason to use valuation as a planning tool is that it can help you isolate variables that can drive your valuation higher. The BodeTree program, for example, has sliding meters that allow you to adjust your company’s ranking on important metrics within your competitive set and see the impact on your valuation.
Soon after signing up for BodeTree, Mr. Ritz noticed that his invoicing policy — he typically gave customers up to 60 days to pay — placed him near the bottom of the pack in accounts receivable. So he began asking customers to pay on delivery. His customers did not seem to mind, and cash flow improved. That allowed him to hire a fourth mechanic, which helped his revenue.
One morning last August, Mr. Ritz saw a new valuation figure flash on his screen: $1.15 million, up 15 percent from the valuation six months before. ”I have to admit,” he said, ”that was pretty cool.”