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Letter to the Editor

Shop Valuation

How do you measure what your shop is worth?

The last time INSIGHT visited the issue of body shop valuation was in 1993, five years before the hype of consolidation had a major affect on valuation. Well, the hype of consolidation has abated and the record prices paid by some consolidators, especially those on the West Coast, have come down to what could be considered normal or realistic pricing, but just what might be a normal or realistic value.

This month we would like to address that question: What is your business worth today? The short answer is whatever someone is willing to pay for it. The longer, more complete answer is that your operation is worth some multiple of the present value of the stream of cash that it provides for you, its owner. What does this mean in English? Simply put, a multiple of the cash earnings plus whatever the business can be sold for in the future must be calculated and discounted back to a value for that stream of cash today to come up with a meaningful selling price. That meaningful price may vary from market to market, and is dependent to some degree on the hunger or the affluence of the buyer, but we would like to discuss in this article some general rules.

Before we go on to explain just what discounting means in this context and review a formula or two for determining just what your particular business may be worth we might detour through the yellow brick road of e-commerce and Internet company valuations. Perhaps the grossest example is Homestore.com, an Internet company that serves the real estate industry. In October 1999 it had a valuation of 75 times the estimated sales for 2001. Or perhaps it might be Blue Mountain Arts, an electronic greeting card company that sold in 1999 for $780,000,000 - and has almost no revenue nor much hope of any. Forget about these; you have a business that actually does something. You employ people and repair vehicles in a very slow growth industry - not quite the glamour of a dot com company. You cannot hope to attain valuation levels such as those, nor can the dot coms hope for out-of-this-world values to continue for too long.

Down to the real world of collision repair. How to value your operation? The first thing you need to do is identify the real profitability of your shop - not what you report to the Internal Revenue Service. Redo your accounts to base them on what the shop would be worth to someone else, who would not benefit from having a car leased through the company, boats, or company-paid health insurance; all owned by or directly charged to the company. Another area of concern is rent expense. If you own the building this should be in the four to five percent of sales area to be realistic. These are add-backs to earnings, and need to be deducted from your reported operating expenses. Best of all is an audited financial statement of at least the last year, with two or three years being better.

When you have determined this figure, you need to do two additional calculations. First, we have to look at what other shops around the country, and more specifically in your market, are selling for as a figure of times pre-tax interest and amortization (EBIT) earnings - and that is the first figure for what your company may be worth. Right now mid-sized owner-sold shops seem to be going for around four to five times EBITDA, and this is not a bad place to start our discussion.

Another method, and one we show in our example shown inour sample charts, is to determine the growth rate on sales/earnings. Take that growth rate out for five to seven years and then discount that back to today. To discount this back to today’s value, a number of factors must be taken into account. They include:

The rate of return that investors typically expect to obtain through investment in risky ventures. We will use 30 percent for our example.

Interest rate that the buyer will expect to pay to finance the transaction. We will use 10 percent for this example, although some consolidators are at the 7 to 8 percent level.

A forecast rate of growth in sales and EBITDA for your operation over the five years. This should approximate your last 3-year rate of growth in most cases. We will use 7 percent for sales and approximately 6.5 percent for cost of sales and overhead expense growth. For our example a rate of growth of 8 to 15 percent is a more likely consolidator target.

Population and income growth in your market area is another factor that not only affects the value directly but also impacts the overall saleability of your operation. For our example we will assume a modest 3 percent increase in vehicle population and in the income level of owners in that population.

Market share is the last factor. If it is too low it is a problem, and if too high also a problem. For our example we will assume a 15 percent market share, which will have no direct impact up or down on the calculated value. More important than market share is the shop’s present position with key DRP-focused insurers, such as Allstate, Farmers, and State Farm’s Service First program. Buyers want shops with strong insurer relationships.

Basically, the discounting of future earnings is a recognition that having a dollar in hand today is worth more than getting a dollar tomorrow, and putting a price (or value) on that fact. (Note: This chart in Excel format, with the supporting formulae and blanks for inserting your own data is available at no cost to INSIGHT subscribers. Call (800- 860-2744.)

The actual value of your business will then be determined through negotiation with a willing buyer. Unfortunately, the calculated price is never the correct price. The correct price is a negotiated number based on the review of a number of external factors. Not only is the price a subject of negotiation, but terms of payment are equally important. Typical today is 50 percent each, with a seller financed rate at 7 to 8 percent over five years for the remainder. Stock may also be an alternative to the note.

Let’s look at the steps that you might go through to evaluate these factors:

STEP 1 - Estimate acquisition benefits:

A consolidator or a competitor will pay more for your operation if he thinks that the value of the new company exceeds the sum of individual values. Synergy can be created by increasing individual location revenues, decreasing overhead costs, decreasing taxes, or decreasing capital requirements. You can help increase the value of your operation by identifying and estimating the ways and impact that your operation can have. Specific areas include DRP relations, positioning, the community, etc.

STEP 2 - Know your competition:

You should be able to answer the following: What sets your company apart from your competitors, and how will those characteristics transfer to a buyer? What is your market share, and has it increased or decreased recently? Why? Has new competition entered your market, and what has been the response by established players? How concentrated is your local market? Do a few shops control most of the market or are there lots of small players with no real dominant market share? How will competitors react to the sale of your company? Will their reactions make a difference?

STEP 3 - Identify company strengths and weaknesses:

Every operation has some weak spots. A thorough analysis of your company’s financial condition, sales and profitability trends, capital requirements, working capital, and financing needs compared to industry benchmarks can help determine what is a reasonable asking price. Identifying weak spots allows you to determine what steps to take now to improve and maximize value. Buyers are always suspicious about the good things they are told about a company by its owner, expecting him to puff the good and hide the bad. A key area is obviously people. A buyer wants a strong and capable management/operating team in place at the time the deal is done. This team in many cases will not include the present owner on more than a short term basis.

STEP 4 - How will you get along with your new Boss? Working for a New Master - Not Always Easy for the Seller:

If you are selling to a consolidator you must also evaluate whether you can work for the new owner. You in all likelihood will not be able to walk away from the company, but will have to assist in the transition. This assistance usually takes the form of a multi-year employment agreement and a non-compete agreement preventing you from starting up a new business in the area or joining a local competitor. You might find it difficult no longer being the top dog and watching your company being managed in a direction you may not agree with.

Business owners seldom sell too soon but often wait too long. Most businesses are not sold! They just fade or are given away. Examples of long established shops simply closing their doors are legion. Many others are sold at less than fair value because of ill health, divorce, partner disputes, owner burnout, or business slow down.

This article is a highly abbreviated discussion of a complex topic and does not constitute advice to be applied to specific situations. No valuation, tax, or legal advice is expressed or implied herein. When you are seriously considering a sale or purchase we suggest that you seek the services of a skilled and trained professional.

(Dan Hall of Collision Team of America and Dennis Cahill, industry consultant, were significant contributors to this article.)

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