What’s Business Worth?

“It’s 9:00 am and I have already reached the end of my rope. Three employees called in sick including my Operations Manager, two 3-day old employees did not return to training, 4 vacuums are on the fritz, my staff dropped bleach on a client’s Swedish finished floors and I received a notice from the state saying that I am to be audited! There must be an easier way to make a living! So, polish up my resume, and pass me the want ads… I quit!”

There are days that all of us business owners have where we are just ready to call it quits and take the next paying job that comes along… but I urge you not to do it until you see what your business is worth. After finding out what kind of nest egg your business may deliver, you might just fall in love all over again with your business, or gain the energy and motivation that you will need to sell it for a pretty penny.

So, how do you know what your business is worth? Where’s the easy reference table where we can look up what your business is worth? Unfortunately, identifying what your business is worth is more of a dance than a sprint. Of course, I am not an accountant, but when I sold my business seven years ago I learned a lot about the valuation “samba”, and would like to pass my notes onto you.

Note #1: There are many different factors that can be taken into account when valuing a business, and buyers and sellers will each choose those that are most advantageous to them, and negotiate from there.

Prior to selling my business I did countless hours of research on valuation, marketing strategies, and historical sales of businesses like mine. I found that everything is a consideration when valuing a business: assets, profitability, market position, financial growth potential of your region, liquidation value and much more.

Note #2: Choose a starting valuation method that is appropriate for your industry.

Asset sales, liquidation value, or other traditional valuation methods that rely heavily on assets are not the most advantageous for the seller of a cleaning business, since we do not have very many hard assets. We do, however, have good cash flow that comes from recurring transactions. I didn’t realize until I was out of the cleaning business what an uncomplicated sales process that we had compared to other industries. Cleaning biz owners get to make fairly easy sales, and then if they keep up the good work can continue to sell to those customers potentially forever. That is an unusual selling point. So, we want a valuation method that takes the non-asset cash flow into account. Two methods to consider are “Multiplier or Market Valuation” (Also Called “Rule of Thumb Valuation”) or “Owner Benefit Valuation” (also called “Return on Investment Valuation”)

Multiplier or Market Valuation – This method takes an “industry average” multiplier and multiplies it either by the gross sales of a business, or the profitability (there are different multipliers for multiplying sales and profitability). These industry average multipliers are hard to find because they are based on prior sales of businesses, but you can find some historical information in books found at your library on selling a business. “The Complete Guide to Buying a Business” by Richard Snowden has some good statistics. Buyers are going to want to see an explainable trend over several years. I used a multiplier method with the profitability for my business sale. Action: Go to the library and find out the most recent multipliers for your industry. Also check with brokers, and real estate agents to see if you can find more recent, and regionally appropriate business salesl data.

Owner Benefit Valuation – In a recent article from an unnamed writer from American Express’s Small Business News this formula “focuses on the seller’s discretionary cash flow and is used most often for valuing businesses whose value comes from their ability to generate cash flow and profit. It uses a fairly simple formula — you multiply the owner benefit times 2.2727 to get the market value. The multiplier takes into account standard figures such as a 10% return on investment, a living wage equal to 30% of owner benefit, and debt service of 25%.” Discretionary cash flow could be argued to be the cash flow remaining after you pay wages and taxes of direct labor (those necessary for the delivery of service). Action: Run your Profit and Loss and calculate your value based on this method.

Of course with either method, you can make an argument to add value back in for any hard assets that you do have, and alternatively those assets could be sold separately.

Note #3: Don’t rely on business brokers to appraise the value of your business.

Everyone in the business sale process has an agenda, and the business broker does too. His/her agenda is to sell the business quickly and get a commission. For many brokers a commission on a quick, easy sale for less than the business is worth, is much better than spending months of work for no sale at all. So, their incentive is to convince you to sell low. Picking the right broker, creating marketing materials, and getting the deal done are topics to be continued in a later article. I just mentioned them here because I had several brokers try to “low ball” my price, but I did my homework before coming in and knew not to take it. Action: Talk to brokers who have sold businesses like yours before, and do your own research too.

Note #4: This is the biggest ticket sales job you have likely ever had, and buyers are going to be cautious. You need to be a good sales person and know ahead of time the other considerations that buyers will be looking at to negotiate a lower price.

Accounts Receivable –A high accounts receivable can be a read flag to potential buyers that the money is hard to collect, and that the cash flow may not really represent cash flow that they can expect. Action: Run an Accounts Receivable Summary and Accounts Receivable Aging Report and begin aggressive collection, and procedures to avoid further increase.

Business Cycles – According to Ronald McGregor, author of “Buying a Business, the Most Import Questions to Ask”, many businesses grow in cycles that look like a bell curve, where the market is first new and sales increase expodentially every year, then reach a maturity where new competitors have come into the market and the novelty has worn off, and finally a decline where the market has been saturated with competitors. This is primarily a concern for “trendy” industries, however can influence a buyer’s opinion of your business value if your sales represent that kind of a pattern of rapid growth, then plateau, and then decline. To offset this potentially devaluing point, check the profits for those same time periods. Possibly your sales may be in decline, or less rapid growth, but possibly because you have found ways for the business to be more efficient and deliver higher profits with less revenues. Action: Plot your last 5 years of gross revenues and profits on a graph and see the trend and prepare you explanation of the numbers.

Sub-Contractors – I recently was interested in purchasing a business in a different industry and passed on the deal because the business hired primarily subcontractors. When a business hires subcontractors the buyer’s perspective is that there could be potential legal problems, there is likely to be little continuity in the team’s work (since care and control are prohibited to maintain the non-employee status), and they have a higher possibililty of the contractors leaving the company and taking customers with them after the rockiness of a sale occurs. Action: Run a report on any 1099 contractor’s and begin converting those relationships to employees.

Business Location – The reality of a cleaning business is that in most cases where your business is located is not a relevant factor in your ability to run a profitable business. However, if you are in a prime location for advertising traffic and the lease is not expected to transfer, or you have a home office in a very high rent area (where the buyer may not have a home office option), a buyer may want to negotiate a lower price. Action: Check out your lease and/or office situation and see if you could set the new buyer up with options by finding a good location, with a flexible lease so that they can choose to transfer the lease, or have a home office.

Legal Issues – Most brokers that I talked with said that legal problems can be a serious devaluation ding, and possibly the death of the deal. You simply must attend to all legal matters before putting your business up for sale. Action: Make a spreadsheet of any potential and current legal disputes and their expected financial impact on the business (disgruntled employees, on the job injuries, vendor disputes, tax agency disputes, lack of insurance, lack of worker’s compensation, etc.). Resolve any that can be resolved and get all of your insurances up to date.

Condition of the Financial Records – Sloppy financial records may indicate sloppy management, and prompt buyers to want to pay less. Action: Get all of your financial records up to date and accurate (both manual and computerized).

Outstanding Accounts Payable – If you have vendors that have been unpaid for a long time, this may indicate to potential buyers that you are having financial troubles, or are not honest with your business transactions. Action: Run a Vendor’s Balance Detail and a Vendor’s Aging Report and see where the negotiation points may lie. Get all of your bills up to date, and have an explanation ready for any older bills that went unpaid for a long time.

Goodwill – Probably the top factor that could devalue your business in the cleaning industry is the business’s dependency on the owner, or lack of goodwill (predictable and transferable sales). According to the brokers that I talked to, a serious concern of many potential buyers when purchasing a business that has virtually no assets is that after a sale, the customers and employees are so reliant on the owner to make the business a success that they all leave, and the business fails. Because this is a reality, lack of goodwill can not only devalue the business, but also change the terms of which people are willing to buy. For example, they may want to make payments over time based on continued performance instead of an all cash deal. Action: Keep a record of how much time you are spending in the business, and doing what tasks. If you are the primary person for resolving client complaints, selling new business, managing employees, and resolving daily operational matters, then that is a sign that your goodwill may be low. You need good systems put into to place to allow effective delegation of those tasks, and a building of transferable goodwill. Shameless plug – Call me to help get the systems that you need in place.

Note #5: Different buyers, different value.

Have you read about the piece of toast that sold for $28,000 on Ebay because it appeared to have the image of the Virgin Mary on it? Different people will place a different value on things than you will. For example if there is a large commercial cleaning company looking to move into the residential market in your area and you own the prime market position, then you can likely fetch a higher price, since you hold something that is hard to find for that buyer. On the flip side, if you were going to sell to a family member who really can’t afford to pay much, but will take the business off of your hands this week, then you will likely get a lower value for the business.

According to David Newton’s article “What Is Your Business Worth?
Find out how to value your privately held business” from Entrepreneur.com, there are up to eight different factors that can be taken into consideration when valuing a business. Everything from assets, to profitability, to liquidation value, and others. Basically both the buyers and the sellers will pick the valuation method that and then negotiation will occur until you meet in the middle.

Current Balance Sheet
Profit and Loss statements (3-5 years back)
Tax Returns (3-5 years back)
Accounts Receivable Summary
Accounts Payable Summary
Employment Tax reportings
A host of other financial and business related data (which you may choose to include or not)