Here are some recent valuations, which have sometimes been complicated by COVID-19. We recently analyzed a gym, a landscaping company, and physical therapy and chiropractor practices. We do small business valuations for SBA loans, exit and succession planning, and business mergers.
SBA Business Valuation of Fitness Center / Gym / Martial Arts Studio
The team at Harvest Business, LLC, and valuation analyst Gregory Caruso prepared an Opinion of Value for a bank and the SBA, for a fitness center, gym, and martial arts studio that was positioned in the high end of the discount gym industry. The gym was located on somewhat side roads near a major mall with signage and visibility from a major highway. The facility had been well maintained and the equipment was reasonably modern.
COVID-19 has been a problem for the gym and fitness industry. In this case, they experienced a dip in 2020 as the facility was closed for about two months. The number of members had dropped during 2020, but the very large membership was rebounding. A new martial arts director was onboard and increasing ancillary income from classes. Monthly data showed that the gym was recovering quickly therefore only a small reduction in value (compared to a possible 2019 value) occurred due to COVID.
A high value compared to the business valuation market data comparison set was warranted and found for this SBA Opinion of Value Business Valuation.
Landscaping Business Valuation for Exit Planning & Succession Planning
This was a specialty landscaping business that provides new installs of landscaping, mainly for home builders and developers. The company also provides sediment control and related services. The company has many inter-company charges with two related companies. Those inter-company charges were often made based on which company had the ability to pay the bills as opposed to true cost. Therefore, the inter-company charges had to be unwound in order to determine true future cash flow for business valuation purposes of the company.
In addition, the entrepreneurial owner had many other related investments that had to be sorted out and adjusted or removed as they are not part of a future continuing cash flow.
The company has had several very nice growth years increasing business value. However, it mainly serves a cyclical industry. Therefore, values tend to be moderated (as compared to pure reoccurring income type service industries) as is the case with most new construction oriented companies.
Chiropractor, Physical Therapy, Other Medical Therapy Business Valuations for Family and Management Buy Outs
We have had a bunch of these recently. Between the retirement of baby-boomers and upheavals in medical related fields, there has been a lot of interest in business valuations for transition in medical related industries.
While each of these was unique, we saw many of the same complicating factors. They had issues relating to billings vs. collections, and payers and payment reimbursement rates received is very important to these businesses. Another area of concern is the utilization of therapists and physical space used due to lower margins or mark-ups over therapists employment or contract rates that some other medical specialties.
Do you have a business valuation question or perhaps need a business valuation?
Business valuation market method multipliers are useful as rules of thumb or sanity checks on business valuations, calculations, and estimates. Below, I include many small business multipliers and industry multipliers such as construction, HVAC, plumbing, auto repair, manufacturing, accounting and service businesses, liquor stores, distributors, and more.
Many business owners just want the question answered – what is the business valuation multiplier for my business? Well, hang on. Using multipliers for business valuation is at best a rule of thumb and not a professional business valuation. Although sometimes, a multiplier is all you need.
Disclaimer: These business valuation multipliers are our best belief based on 20+ years valuing hundreds of small businesses and brokering over 60. The typical small business has an SDE multiplier range of 1 to 3, and 2.2 is about average. Again, using these multipliers is a rule of thumb NOT a business valuation. Always obtain a professionally prepared business valuation for major life decisions, tax matters, estate and gift tax planning, succession and exit planning, required fairness opinion or other compliance.
Watch the 1:35 Minute Video About Market Multipliers and
Rules of Thumb Below.
What is a Business Valuation Multiplier?
The market method valuation approach formula for valuing business is:
Future Cash Flow x Multiplier = Indication of Value
Multipliers are estimated by taking reported business transactions and dividing the sales price by the business’s reported cash flow. This is the only method that ties to actual sales in the marketplace. In an actual business valuation, there are several other additions to the formula. These include adjusting the cash flows, adjusting the balance sheet, and taking into account discounts and premiums. All of these can impact value. Business valuation is more than this simple version of the market method formula.
There are several cash flows commonly used including revenues, Sellers Discretionary Earnings (SDE), and Earnings Before Interest, Taxes, Depreciation, and Amortization (EBITDA) in the market method. There are other cash flows occasionally used or used in different industries including gross revenues, EBIT, after tax cash flow and more. I recently shared more about cash flows in “Five Cash Flows Used in Business Valuation.”
It is important to align the cash flow used with the proper multiplier. It is also important to adjust the multiplier based on profitability of the company, systems, employees and contractors, customers, products, inventory on hand, economic outlook, industry outlook, and many other factors. That is why just applying a multiplier to a cash flow without judgment can be so misleading.
How to Select the Right Multiplier
Most business owners select a multiplier that is too high. Certainly there are “high multiplier” companies out there, but often the cash flow multiplier actually drops as the company becomes more profitable. While this seems hard to believe, we have charted hundreds of companies and can assure you it is common.
When the market method is properly applied, multiple data points (usually 10 – 30) are obtained and compared to the subject company. Usually industry, revenue range, date range of transactions, and profitability range are all searched. It is important to chart the data by profitability. Comparables are then examined as a group. When appropriate, they are also examined individually to fully understand how the comparables really compare to the company being valued. We recommend DealStats from BVR as this is the best small business data at this time.
Multipliers Are Not Always Best in Business Valuation
As with all business valuation, professional judgment comes into play. While we are pleased to post these business valuation multiples for your use we highly recommend you have a proper business valuation performed by a professional business valuator–if it is to be used for anything beyond a fun conversation.
We are always available to serve you in that capacity. Contact Greg Caruso for more information about professional valuation services.
Successful businesses are usually valued by estimating a future cash flow using either an income approach or a market approach. The goal is to select the best cash flow to reflect the true earnings power of the business for the size and type of business and the valuation risk data available. The risk in business valuation is that projected cash flows will not be met.
Examples of alignment between cash flow and risk adjustment/ measure:
Market Method Revenues —– Total Revenues
Market Method EBITDA —– EBITDA
Market Method SDE —– SDE
Capitalization of Earnings —– Usually After Tax Cash Flow from historic data
Discounted Cash Flow —– Usually after Tax Cash Flow from projections
In all cases, the proper selected cash flow for business valuation is forward looking. We look at the past because usually that is the best indicator of the future. (This is not always the case as Covid-19 has shown us but it usually is the best that can be done.) Valuators also look at company staffing depth, systems, projections, industry growth rates and other data to estimate future cash flow.
Cash Flows Used in Business Valuation
Here are a few cash flows frequently used to measure value.
Revenues
Revenues are easy to agree on but not always an indicator of the money making ability of the business. In this case, value is much more influenced by the bottom lines, namely the income generating power of the business as opposed to the pure revenues. But, sometimes revenue is all there is compare. Certain industries such as accounting, insurance, and financial planning will often be valued by revenues.
EBITDA ( Earnings Before Interest, Taxes, Depreciation, and Amortization)
This is viewed as an indication of the income that could be available for distribution to an investor. This cash flow assumes that the company is fully managed–namely an investor that owns the company will not be working there as all management required to make the cash flow is in place. We use EBIT (Earnings Before Interest and Taxes, which does not add back depreciation and amortization) for some industries with large equipment investment requirements. If a company must continually buy new equipment, then depreciation may not be available for distribution to investors. This cash flow is generally used for businesses that are large enough that they are likely to have a corporate or private equity group type buyer that wants a fully managed business.
SDE – Sellers Discretionary Earnings
In the simplest form, this is EBITDA plus all the ways one owner makes money from the business. If there are multiple owners, the labor value of all owners beyond the first one has to be compared to salaries. Some owners are paid more than their labor value, some less. This is then added to or deducted from the profits. For smaller owner-operated businesses (whose fair market buyer is likely to be another individual) this can be the most accurate cash flow available.
After Tax Cash Flow
This measure of income is used many times with Income approach valuation methods. Income approaches tend to use buildups of layers of risk to determine a capitalization or discount rate. In effect, that rate is what an investor would need to invest in the business out of all investment options in the world. Those risk levels primarily come from public market data. Therefore, they are viewed as being after tax since public company earnings are after tax and after tax cash flow is used as it is similar to public company earnings.
Gross Profits
Some industries use gross profits after deducting the cost of goods sold. While not a bottom-line profit, it can show if the product or service of the business is profitable enough to pay for overhead and profits if volume can be increased.
Normalizing the Cash Flow
Whichever cash flow you use you will hear the term, “Normalizing the Cash Flow.” When a cash flow is normalized, it is adjusted to be apples-to-apples to reflect the earnings power of the business and be comparable to the risk factor source data. Once more, cash flow in business valuation is forward looking so the valuator is always trying to estimate future cash flow in these adjustments. Normalizing adjustments have three main categories.
Comparability Adjustments — these are made to make the data comparable to the risk data. For instance interest is often added back as an owner does not have to take on debt (under valuation theory anyway).
Non-operating or Non-recurring adjustments – these are also called one-time adjustments. For instance PPP loan income is a one-time adjustment so it is removed for valuation purposes as they are not likely to happen again in the future.
Discretionary Adjustments – these are adjustments that usually benefit the owner or the owner chooses to pay for the expense but it is not required to generate the earnings of the business. This can be things like the owner’s pension expense, underemployed family members on payroll, owner’s health insurance, etc.
In summary, the valuator selects the cash flow that will best represent the earnings power of the business being valued and has sufficient data to generate a valid estimate of value. The valuator then normalizes the company cash flow to improve comparability and show true earnings power. Finally, the normalized cash flow is adjusted by the risk adjustment to determine value.
The last step is always stepping back and asking, “Does this make sense?” Namely, is there a sufficient return to the owner/operator or investor for the risk of the investment? As I always say, valuation is an art and a science, and often experience and practice helps with understanding the art. Contact me to learn more about my valuation services or learn more about the Art of Business Valuation in my book.
In the July/ August Issue of The Value Examiner, the publication of the National Association of Certified Valuators and Analysts (NACVA), I wrote about two common mistakes I see when valuators use the income approach with small businesses. Here is an overview of those two mistakes, or you can read a PDF of the article by clicking this link:
Understanding company-specific risk in business valuation.
In my last blog post, I explored some of the concentrations and risks that small businesses face. The risks that large companies have are not the same risks that small businesses have. The income-based method captures risk with the company-specific risk premium (CSRP), but I’ve seen this understated too many times. I explain in the article that different methods will give different discount rates, and those will change the value of the company. Valuators who do not regularly value small businesses often understate the risks associated with them.
Understanding long-term growth for early-stage and growth-stage companies.
The second mistake I often see is understating the long-term growth of small businesses in an early or growth stage. For example, using a 10% growth rate in the capitalization of earnings method gives you completely unrealistic results for cash flow over time. However, because present value discounting is also part of the process, it may not give you an unrealistic business value. In the startup and growth stages of a business, that business might experience annual growth rates of 100% range or more, but often average 10–35%. At some point, the companies level off. Knowing the business growth cycle and which phase the business is in helps you evaluate cash flows and the company more accurately.
Valuation is an art and a science, and often experience and practice helps with understanding the art. Contact me to learn more about my valuation services or learn more about the Art of Business Valuation in my book.
Let’s say you are doing a home renovation. You’d expect the professionals you hire (from the carpenter to the plumber) to actually be able to do the work you need. When we hire any professional for any task, we expect them to be professionals who can do their job well.
The same is true for Certified Valuators and Analysts® (CVA’s). In fact, the NACVA’s Professional Standards says that, “A member shall only accept engagements the member can reasonably expect to complete with a high degree of professional competence.” Basically, it is unethical for CVA’s as professional valuators to say we can do something that we can’t.
However, this standard can prevent us from taking engagements that we aren’t qualified to do. So how do we take our practice to the next level? In a recent article for Association News, the newsletter for the National Association of Certified Valuators and Analysts, I suggest three main ways in which valuators can expand their knowledge, and therefore their practice.
I suggest you explore the tools that the NACVA makes available to members (and valuators should become members to access these tools). In my decades of work as a valuator, I have also found that a network of trusted peers (whether through your firm or the NACVA’s Mentor Support Program) can be really helpful. Finally, there are so many resources that others have to offer (including this blog and my book). Simply searching the internet for what you need may help you learn more.
As I’ve written about previously, the three main valuation methods each have their pros and cons. Understanding valuation means understanding when to use the Income approach, the Market Methods approach, and the Asset approach. Here are some basics about these approaches, and when to use them.
A Profitable vs. Unprofitable Business Valuation
As much as business owners hate to admit it, there are unprofitable businesses. Remember, you can evaluate a unprofitable business. It just means taking a different approach. The Income and Market approaches are primarily used when valuing a profitable business. The Asset approach has methods that tend to be used for unprofitable or poorly performing businesses with significant assets.
The Income approach uses the Capitalization of Earnings Method and the Discounted Cash Flow Method.
The Market approach uses methods such as the Revenues Method, the SDE (Sellers Discretionary Earnings) Method, and the EBITDA (Earnings Before Interest, Taxes, Depreciation, Amortization) or EBIT (Earnings Before Interest and Taxes) Method. Each method is a different cash flow, and can be used for a comparison between the company that is being valued and a comparable company.
Small Businesses Can Benefit from the Income Approach
The Income approach is the most commonly used method for small business valuation, generally using the Capitalization of Earnings method. This is usually the best approach because of its simplicity and the fact that it can be applied to most businesses.
The Capitalization of Earnings method typically looks to the past 3 to 5 years of after-tax cash flow. This is used to estimate a cash flow for the future. This single cash flow figure is divided by a capitalization rate, commonly referred to as the Cap Rate. The capitalization rate is usually estimated using a Build Up method for the different risk levels from public market data made available by many sources including Business Valuation Resources (BVR) (https://www.bvresources.com/) and Duff & Phelps (https://dpcostofcapital.com/).
The Problem with the Income Methods for Small Businesses
The methods are not always perfect for small businesses. There is no quantifiable information linking small companies to public data–they don’t have to make their information public. This is less of a problem for larger small companies (those with EBITDA above $400,000), since there are several methods that appear to provide a reasonable starting point for analysis. These include the Duff & Phelps Navigator, using the Build Up in the Risk Premium Report Study section with the Regression Equation Method button turned on.
However, a smaller company may have insufficient cash flows for any other method than SDE to work. In this case, there is absolutely no data to estimate the Company Specific Premium. The Company Specific Premium is the adjustment used to bridge the gap between the public data and small company reality. There are no third party sources of Specific Company Premium for SDE cash flows. This means for smaller companies, the Cash Flow Market Method makes more sense. Fortunately, for these smaller companies there is usually more comparable market data making this method when properly applied quite supportable.
The Cash Flow Market Method for Small Businesses
Cash Flow Market Methods review the past to estimate a future cash flow. You select a comparison set of actual reported transactions from a transaction database. Then, this set is reviewed against the company being valued and a multiplier is selected. The multiplier is then multiplied against the cash flow to find the business value. I explain a very effective methodology for selecting and reviewing comparables in my book, The Art of Business Valuation, Accurately Valuing a Small Business, which you can purchase at this link.
There are legitimate issues and concerns around quality of the comparable data when using the Market Methods. Yet, with enough data points (which doesn’t have to be that many, depending on the data set) and analysis, you can reach a high-level supported comfort. For businesses with SDE under $500,000 and EBITDA under $400,000 the Market Method Cash Flow is usually the best way to value a business.
