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Letter to the Editor

Seeing the Value

Knowing how to determine what your business is worth - and how to improve its value - is important no matter what your future plans

Joe Sanders has been on both sides of the sale of a collision repair business.

Sanders, now the Collision Division Administrator for the Automotive Service Associa-tion (ASA), is a former Texas shop owner who had bought a second shop, then sold his business in the mid-1990s to a consolidator, Caliber Collision Centers. He subsequently was involved in the acquisition of 30 shops, either as part of his work for Caliber, or later as an independent consultant.

That experience has taught him a lot about determining what a collision repair business is worth - and why knowing what a business is worth is valuable even if you're not planning to sell anytime soon.

"It can help you spot opportunities, say when a shop in your area comes on the market," Sanders said. "It's critical if you want to bring on a business partner, or if you're planning for retirement down the road. It can help you protect your heirs by making sure they have the insurance or financial wherewithal and don't end up losing the business if something unexpected happens to you. And maybe most importantly, knowing how a business is valued can help you understand what you can do to increase its value."

Calculating it for yourself

No doubt you can think of several different ways to go about determining a value for any of the vehicles in your shop right now. Determining the value of a business is similar in that there are dozens of ways to approach it. And even experts will tell you that business valuation is almost as much art as science.

"People say a business valuation is a prophesy to the future," said Scott Miller, a CPA and Certified Valuation Analyst in Portland, Ore. "So if you want to determine a fair value for a business, you have to figure out what's going to happen in the future. And you can base that on a number of different things. Most commonly you say, 'Historically, my business has done this, and so based upon that history, we can assume that this is what it will do in the future.'"

Here's an example of one method of determining the value of a business (see Chart A). ABC Autobody has assets totaling $500,000. The owner's salary, bonuses and profit total $59,000. When half of the depreciation expense on equipment, and all of the interest expense on loans is added to this $59,000, the owner's "cash flow" totals $70,000.

A portion of this cash flow is assigned to cover the cost of carrying the shop's assets. Let's say the current interest rate is 10 percent. Then $50,000 (10 percent of the $500,000 in assets) is deducted from the cash flow and viewed as satisfying the return on the investment in assets. Any cash flow over that amount is considered excess.

Deduct $50,000 from the ABC Autobody owner's cash flow, and there will be $20,000 in excess earnings. This amount is then multiplied by a number between one and six (based on such criteria as stability and growth potential of the company) to get the value of ABC Autobody's cash flow.

Let's say ABC Autobody's track record indicates that it is about average in terms of risk and desirability. Its excess earnings ($20,000) could be multiplied by a factor of 3.5. This figure is then added to the value of the assets to get the total price. For ABC Autobody, this means $70,000 is added to its $500,000 in assets. The total value of ABC Autobody: $570,000.

Or you can use the method the owner of XYZ Collision used to determine the value of the business (see Chart B). Write down the net profit of your business for the past five years, 1998-2002. Figure a "weighted average" by multiplying your 2002 profit by five, your 2001 profit by four, your 2000 profit by three, your 1999 profit by two and your 1998 profit by one. Add these five numbers and divide by 15 for your average yearly earnings.

Then divide your average yearly earnings by an appropriate rate of return (usually between 20 and 30 percent for businesses with average "risk factors"). XYZ Collision, for example, found its weighted average yearly earnings was $90,000. Divided by a 30 percent rate of return placed the value of XYZ Collision at $300,000.

EBITDA and ROI

Sanders said the method he has generally seen used is similar to the first example, and goes by the acronym "EBITDA" (earnings before interest, taxes, depreciation and amortization).

"Two businesses can each have $2 million in annual sales, but the EBITDA for one could be 6 percent, while the other could be 13 percent," Sanders said. "That EBITDA is increased by a multiple, usually between 3.5 and 6. So if you just look at annual sales, the two are the same, but obviously, the one with the better ability to generate cash, with a higher EBITDA, is going to have a higher value."

A buyer might recal-culate your EBITDA after reviewing your financials, Sanders said. A buyer with multiple shops, for example, won't have the salary expense of an owner onsite, which could boost your business's EBITDA. Or if the buyer expects to offer better employee benefits than you offer, that would lower the EBITDA.

A buyer might also set the value of your business based on return on investment (ROI). Say the buyer wants a 25 percent return on its investment, and is looking at the shop with $2 million in sales and $120,000 in annual earnings (6 percent EBITDA). If the buyer paid $1 million for the shop, that $120,000 in annual earnings would equate to a 12 percent ROI. In order to hit the 25 percent ROI, the buyer could only pay $480,000 for the business.

Improving your business's value

So once you have an idea of what your business is worth, what can you do to improve its value? Sanders offers this list of factors that can impact the "sales appeal" and value of your company.

Trending

About the time your business is growing and doing well - and you decide maybe you should stick with it - is actually the time it has the most value to sell, Sanders said. Anyone buying your business is likely to review your financials for the last three years, but the most recent information - especially the last 6-12 months - are the most important. So timing can be critical.

Location:

Sanders said he used to be among those who thought high-visibility locations weren't very important in the collision repair business until he moved one of his shops to a main street and found his business doubled almost overnight.

"So location is incredibly important even if you're getting work through referrals from a dealership, insurers or word-of-mouth," Sanders said.

Being located in a growing market area will also make your business more valuable than one in a stagnant or declining area.

Facility and equipment:

Most buyers - particularly shop consolidators - have an idea of the types of equipment they'll want to have to operate the shops they acquire. So while the primary reason to buy and maintain good equipment is to help you generate revenue, it can also help improve the value of your business.

On the other hand, virtually every shop has equipment or other assets that are no longer used. Selling or disposing of these non-essential assets will eliminate unnecessary complexity in establishing value.

Sanders also recommends giving your building and office a facelift about every five years.

"If a buyer walks through and estimates he's going to need to spend $300,000 to get that facility how he wants it, that's $300,000 off what he's going to be willing to pay for it," Sander said.

Buyers are also going to look at the design and layout of your facility. If it's broken up in several building or otherwise less than ideal, it can impact the value of the business.

"You may make it work, but a buyer may not want to try," Sanders said.

Capacity:

A buyer will want the ability for the business to grow, Sanders said. So if you are running your business at its peak capacity, that's great for you but may decrease its value to a potential buyer.

Motivation:

"If you're highly motivated to sell your business, that may tend to bring the value down," Sanders said. "If you're highly motivated to buy a business and the seller isn't motivated to sell, that could drive the value up. To me, this is one of the biggest factors that will affect the price of a business."

Source of revenue:

Your annual sales volume may attract a buyer, but where those sales come from is even more important. Sanders says most buyers will want to see a source report, which shops can generate through their shop management system, that for each source shows number of ROs, total dollars, gross profit, and percentage of total business.

"It can be a bit of a red flag if any one source of work - one insurer, one dealer, one fleet - is over 20 percent of the shop's work," Sanders said. "A buyer is going to ask: Does the shop draw work from lots of sources? Does it have a fair percentage of customer referrals and repeat customers? Is the work desirable? Restoration or custom work, or low-profit business like most rental car work, may not be what the buyer wants."

Reputation:

"A lot of people really hang their hats on this," Sanders said. "They're thinking, 'Boy, I've got a great reputation; that's got to be worth a lot of money.' It is important, but it's not going to drive the value a lot one way or the other. If the reputation is not real good, the buyer can hang all new signs on the building and it's a new business. So reputation may not help you as much as you might think it would."

Barriers to market:

Zoning laws that would limit others from operating collision repair shops in your area can obviously drive the value of your business up, Sanders said. On the other hand, grandfather clauses or zoning overlays may be good for you now but may restrict a future owner's options, driving the value down.

Lease issues:

A lease that's set to expire without renewal options is going to hurt the value of your business, Sanders said. He recommends that when negotiating a lease, push for those renewal options; for first right of refusal to give yourself a chance to buy the building should the owner decide to sell; for a non-disturbance clause that prohibits a mortgage holder from selling the property - even if the owner stops making payments - as long as you are paying your rent; and for clear guidelines as to who pays for bringing the building up to compliance with building codes at any point.

Accurate financial records:

Most businesses are operated to minimize reported earnings. To a buyer, this may make it seem like the business is overpriced. "I think it's incredibly important that your books directly reflect what you're doing in business," Sanders said. "It's not that much of a benefit to try to hide a bunch of expenses in your books, because it hurts your ability to manage a business by the books, by the numbers. I can't overstate that."

Accretive value:

Owning multiple shops can often make your business worth more than the sum of its parts.

"If you have one shop worth $1 million, and you buy another shop for $1 million, the sum of those two shops, because of the way you're positioned in the marketplace, might be $3 million," Sanders said. "But it can work the other way, too. A weak shop can pull down the value of your other shop."

Getting a professional appraisal

If your interest in the value of your business is more than just idle curiosity, it may be time to hire a professional. When choosing a business appraiser, ask about his training, certification and experience with the automotive industry. One option: Calling the American Society of Appraisers (800-272-8258), or the National Association of Certified Valuation Analysts (801-486-0600), for a referral.

Remember that a business appraiser will help you determine a value for the business but isn't likely to be involved in the sale process. A business broker can help you buy or sell a business, and may be able to help you determine an appropriate selling price, but might not have formal training or certification in business valuations. A broker's valuation also may be influenced based on his interest in selling the business.

The cost of a professional business appraisal will be based on which of three types of reports you ask the appraiser to provide. The most comprehensive and formal reports will include more than 30 pages of research and detailed explanation and can easily cost $12,000 to $18,000. At the other end of the spectrum is a verbal report, in which the appraiser provides a valuation but no written report based on a limited amount of research.

Probably of most use to shop owners is the limited-scope report, in which the appraiser provides a valuation letter and often some supporting documentation. Costs for this type of report generally start around $2,500 to $3,500.   o

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