This month, we conclude our series on Multiple Shop Operations with an in-depth examination of the methods available to design and cost new facility construction, place a value on a potential acquisition, and options for financing your business’s expansion.
In previous installments, we have examined and balanced methods of going multi-shop by focusing on the differences between expansion through acquisition and the building of brand-new greenfield sites. The valuation of an existing business is a decidedly involved process. In comparison, determining the cost of greenfield expansion is far more straightforward. However, greenfield construction carries with it complex decision-making regarding location, size, and design of the new facility- each step along the path will affect the ultimate price of the new facility.
If you have made the decision to pursue expansion by building a new facility, you are about to embark on a rigorous process marked with many opportunities, challenges and potential disasters. You have a clean sheet of paper; what you make of it, you will live with for a long time to come.
In all seriousness, greenfield locations provide a marvelous opportunity to create your ultimate repair center. Chances are, you have some pretty good ideas on the features, equipment and workflow of the operation you want to create. Even so, you should pursue expert help.
INSIGHT recommends the following process to get started:
INSIGHT will examine the process of building a new facility and existing facility expansion, including an examination of the design process, in an upcoming issue.
Acquisitions of existing businesses are increasing in the collision repair industry because of consolidation. If this is the route you will take to start multiple shop operations, you need to contact potential businesses identified during the research suggested in previous issues. Once you have made the contact with a potential acquisition, the process of determining what that acquisition is worth must take place.
The answer to this question lies in a careful balancing of the values for several items including:
The historical financial performance of every business plays a crucial part in determining the shop’s value. The most important financial data to examine when determining the value of the business includes gross sales and true net earnings and cash flow.
Determining gross sales is a straightforward process providing accurate records have been kept on the business. A common multiple for valuing a collision repair business is based upon a multiple of average gross sales. According to research conducted by INSIGHT, collision repair facilities have typically sold for 55-65 percent of gross sales in 1998.
Another multiple to use when valuing a successful collision repair business is a multiple of annual true net earnings before interest expenses and taxes. Why true net earnings instead of actual net earnings? The reason is quite simple.
As with most closely held businesses, the owner’s perquisites, i.e. automobiles, above average pay, etc., can place a drag on actual shop profits. These must be removed to develop an accurate financial picture of business health and value. To eliminate these added costs, determine the fair value of salary and perks that would be paid to a manager if the owner did not run the business.
From this net earnings figure, a cash flow statement and projection can be constructed with the assistance of an accountant. (Editor’s Note: See Chart 1 on page 14.)
The cash flow projection will help determine if the business can pay for itself and, more importantly, if the desired rate of return is achieved on the investment. (Editor’s Note: See the second feature ‘Funding Expansion’ starting on page 11.)
In addition to balance sheet accounting figures, buyers should check gross profit figures against industry benchmarks. Access to this information will show a new owner possible areas to improve the business.
Also, the potential buyer should determine what the facility’s current level of utilization is, and if it can be increased through improved marketing and management techniques.
Underutilized facilities are prime targets for acquisition by a growing concern. Buying based upon existing performance, then improving that performance without major capital improvements, increases the profitability of the investment. (Editor’s Note: See the Multiple Shop Operations feature in the June issue of INSIGHT for a complete explanation of determining facility utilization rates.)
One common method for determining the desirability of an investment is to determine the present value of the shop’s future cash flow. This method of analysis examines the cash flow of the business against a time-adjusted rate of return. To time-adjust the value of each year’s cash flow, we need to create a factor for each year which represents the internal rate of return (IRR) we desire on an investment. This number, called the Present Value (PV) factor, is divided into the cash flow generated by the business to compare the future cash flow value against the rate of return.
For simplicity’s sake, think of IRR as the cost of capital or the opportunity cost of the investment. For example, if you invested $100,000 dollars in a mutual fund, the return on the investment would increase in actual dollar terms if the cash flows were reinvested in the fund.
In the cash flow projection chart, we have determined the Present Value of cash flow for each of the ten years in the projection. Adding each year’s PV cash flow figure gives us a total of $513,000 over the ten year period. In essence we are saying: The cash generated by this facility gives the owner a 10 percent rate of return, on a $513,000 investment, over a ten year period.
This number, when compared to the Multiple of Annual Gross Sales outlined above (See Chart 2), returns a multiple of 53 percent. This is on the lower side of typical body shop sales. As outlined in the chart, using higher rates of return in the PV calculation will return lower multiples of gross sales.
Which is the proper method to determine a particular shop’s value? There is no correct answer. Each business represents a different risk. Each prospective owner needs to weigh this risk against one’s own comfort level and desire for a profit.
However, by creating a cash flow projection and present value calculation, a prospective owner can compare the potential performance of similar investments.
Additionally, the PV calculation should be compared against the fair market value of the equipment and property of the business. The property value of a collision repair business can often skew valuations. In many cases, particularly with long-established facilities, the local community may have grown around the shop. The value of the real-estate may be far more suitable to a retail store operation than a collision repair center.
Many acquisition deals are structured so that the original owner keeps their real-estate. The organization that acquires the business then leases the use of the real-estate for a specified period of time at an agreed price. This enables the current owner to realize continuing income from their property.
Using the facility in the cash flow chart, consider this example:
Given these factors, this facility could justify valuation based upon financial performance instead of strictly asset value. With proper transition from the present management, the customer base can be maintained, greatly reducing a potential risk of the business purchase. However, if sales were shrinking, the local population older, or other problems existed, the valuation would be weighted to fair market value of the assets.
Remember, the strategies outlined in this article are only tools for approximating the value of a business. In the end, the business is only worth what a prospective buyer will pay for it.
Over the past several months we have examined the myriad challenges facing today’s collision repair facility operator and how they can be met to ensure continued growth.
Whether your final decision is to take the leap toward multiple shop operations, or to simply expand and improve your existing operations, the suggested research and analysis presented in this series will provide the basis for success.
Have a comment? Send an E-mail to: rthrall@postoffice.ptd.net
© 1998 Collision Repair Industry INSIGHT. All Rights Reserved
Return to Archives