Business Valuation for Business Sale Price Estimates – More Detail on

Calculating a Valuation Multiplier

https://www.bizex.net/business-valuation-tool

Small business valuation for selling your business, or business merger and acquisition purposes is tricky
and depends on many factors. In this article I summarize how a valuation multiplier for a small business
could be calculated. The calculated value should also be checked against the business sales comps
available from one or more databases such as Pratt’s Stats, www.bvmarketdata.com and BizComps,
www.bizcomps.com. You can also look in The Business Reference Guide by Tom West, available
at www.bbpinc.com . Also, get a check from a reputable experienced business broker or valuation
professional in all cases before entering into contracts or even negotiations.

This methodology is most effective for businesses with a value between $150,000 and $1,500,000.
Below $150,000 in value in my experience it is hard to reasonably calculate value although in many cases
it does exist. If the value is low enough you must also look at what the liquidation value of the assets may
bring. Sometimes this is the highest value. Once a company grows larger than $1,500,000 there are
other methods that may be more accurate which should be used to estimate value. We will post another
article or articles on valuing larger businesses in the near future.

This methodology works for estimating the business value or business sales value of most types
of companies including subcontractors, electrical companies, HVAC, plumbing, engineering firms,
service firms such as CPA’s and consultants, manufacturers, government contractors, retailers,
restaurants, etc.

Generally, the multiplier is calculated by looking at risk and how the business will continue to
generate cash flow for the new owner and the perceived desirability and growth prospects of the
firm. This is similar to the concept behind bonds or bank accounts. Junk bonds pay more
interest than government insured savings accounts in order to attract your investment dollar. Of
course, you will never lose principal on the government insured savings account. Small
businesses are very risky and carry a large discount usually in the 20% to 50% range. The safer
the business the higher the multiplier. The higher the multiplier the higher the value and price
when it comes time to sell.
Typical factors in the calculation:

 Ease of entry into business

 Location of business
 Competition in Market Area
 Historical profit trend
 Industry trend
 Size of business
 Management systems in place
 No one customer providing more than 10% or 20% of sales revenues
 No major suppliers that would be hard to replace
 Availability of financing
 Condition of Books and Records
 One way to do the analysis is to rate each factor above from 1 to 4, with four being the most
favorable, then divide by the number of applicable factors. In all likelihood your business
multiple will be between 2 and 3. The average is between 2.3 and 2.7 depending on who is
collecting the data. Businesses that tend to be owner intensive such as auto shops and small
independent restaurants tend to sell around 2 or less. Highly efficient larger service firms with
contracts may sell for 3 to 3.5. Again, only proven rapid growth companies or unusually hot
businesses (think BMW auto dealerships) reach above 4.

Example of Calculating a Multiplier:

Sam’s Auto Repair factors

Ease of entry into business 1 easy to enter

Location of business 3 Sam’s is in an urban area

where auto related land usage
is discouraged

Competition in Market Area 3 Same as above – few

competitors, hard to get a nearby location

Historical profit trend 3 Sam is profitable

Industry trend 2 Too many new cars

Size of business 2 Sam’s is still small

Management systems in place 2 Has great receptionist /

scheduler

No one customer exceeding 10% or 20% 4 Few large commercial acc.

No major suppliers that would be hard to replace 4 Many parts stores and suppliers

Availability of financing 2 Hard to finance Auto related

Condition of books and records 3 Easy to follow, accurate books

and records and tax returns
That totals 11 factors with a sum of 29 creating a multiplier of 2.6 which is high for an auto
repair but the assumptions make this look like a pretty good small business. Give him poor
financial books, low profitability, and a neighborhood with car repair on every corner and you
quickly have a 2 multiplier.

Now you just multiply your discretionary cash flow by your multiplier and you get an estimate of
value. ($150,000 discretionary cash flow times 2.6 equals $390,000 estimated value). If done
accurately (experience helps!) this can produce a very good indication of value. It is also useful
for internal purposes just as a check to see how you are doing as good businesses are valuable
businesses.

DISCLAIMER: Please note that this is a useful formula for preliminary planning or tracking
your progress but is not a substitute for a proper valuation when selling your business. NEVER
go to market or enter into important negotiations or legal proceedings based on a rule of thumb
formula such as this. Get proper valuation assistance. Call us.

Example: Valuation of an auto service center by multiples

A typical way to estimate the value of a company in this industry is to use the annual revenue as
the key metric. To illustrate the idea, let’s take a typical company with $462,000 in annual sales
and inventory on hand of $50,000.

Here are the valuation multiples we choose along with the results:

Multiple Multiple value Business value

Low 0.18 $134,361

High 0.65 $349,838

Average 0.32 $196,177

Median 0.29 $183,564

Average Business Value $215,985

The value results above include the inventory addition as is typical when valuing the auto repair
shops.

Note that there is quite a range in our business valuation results. What makes some companies
worth more than others? This is a labor intensive business involving highly specialized auto
mechanics. For higher valuation multiples the staff has to be managed well to prevent defection
and loss of customer following. This is a growing concern since many large car dealerships seek
out skilled auto mechanics aggressively.
Availability of seasoned management over and above the owners is important as well. Such
shops are easier to take over even for a someone who is not an auto repair expert. As a result, the
pool of potential business buyers is larger resulting in a higher selling price.

Summary of Valuation Approaches

There are three different types of valuation methods that can be used to value auto
repair shops, these methods are:

1. Asset-based valuation
The basic formula to use for this method is: The fair market value of a
company’s assets less the fair market value of its liabilities = the fair market
value of a company’s equity.
2. Income approach to value (capitalization of earnings)
This method is most the accurate for restaurants, which usually have a constant
growth of earnings.
3. Income approach to value (discounted cash flow)
The value of equity utilizing this method is equal to the present value of free
cash flows available to equity holders over the life of the business.
4. Market approach to value
This method utilizes market indications of value such as publicly traded
comparable auto repair company stock and acquisitions of privately held auto
repair companies.

Description of the Industry

The U.S. auto repair industry (SIC codes 7538, 7539) includes approximately 170,000
firms and brings in about $90 billion in revenues each year. The industry is very
fragmented and the largest 50 companies hold less than 10% of the market. The
industry is very labor-intensive and is separated into two segments: Mechanical repair
and Collision Repair. Mechanical repairs are usually maintenance repairs to the
“undercar” or “underhood” systems of the vehicle. Collision repairs include damage to
the exterior such as paint and body work.

Industry Trends
1. Fewer Car Crashes
With new technology and the auto industry focusing on safety features for
vehicles, there have been fewer accidents occurring. This means fewer collision
repairs for auto shops and if collision repairs decline they will have to rely on
maintenance repairs to bring in more revenue.
 2. Poor Economy Increases Business
With the economy down, fewer people are buying new cars. Instead, they are
keeping the ones they have and doing more maintenance repairs to make sure
their cars last longer. Repairs are cheaper in the short run than buying a new car
and currently consumers are trying to save money anywhere possible

Auto Repair Shop Performance Metrics

1. Number of customer complaints
2. New customers per month
3. Number of hours per task
4. Net Income
5. Free cash flow
6. Operating Margin

Benchmark Statistics
The following average benchmarking data is based on studies from various auto repair
shops:

Industry Organizations and Publications

 What kind of sales does your business make?
 What are the profits?
 What are the growth trends within the company?
 What drives new sustainable sales?
 What are the consumer demographics?
 What is your market position?
 Is the location favorable?
 How involved does the owner need to be within the business?
 What systems are in place and what procedures go into running your business?