April 1, 2016

What's it worth?


Strategies to help set a meaningful price for your business, when it’s time to move on

It’s been a great career but John and Nancy are ready to sell their landscaping business and retire. They started out shortly after they were married, with a couple of lawn mowers, a few gardening tools and a pick up truck. Their business office was in the basement of their home and they stored tools in their garage. Today, 40 years later, the truck is newer, they’ve acquired a chipper, state-of-the-art pruning saws and a few other tools — all of which still fit nicely in a mid-sized shed in their backyard. As far as equity goes, they don’t have a lot. And the shed stays. But their landscaping business has put four kids through university, it’s taken them on some pretty nice vacations and it’s provided three jobs in their community. It has a strong customer list, a solid reputation and a robust cash flow. 

How, they want to know, do you put a value on that? 

John and Nancy aren’t real. They were invented for the purpose of this feature but they represent landscape business owners across the country, who are asking that same question. What is my business worth? What would be a fair and attainable selling price?  What John and Nancy need, what you may need, is a thoughtful valuation. 

The valuation of a business is the process of determining the current worth of that business, and most business advisors maintain you should not try to do it yourself. In the same way that a mother can’t be objective about her child’s talents, they maintain, a business owner can’t put together an objective valuation of their own business. 

Michael Murray is in the process of turning a horticulture business in Portugal Cove, N.L., over to his grown sons. While not exactly the same as publicly selling a business, this process also requires a valuation of the business.

Murray hired a consultant who deals with marketing development and research. The consultant did a survey, polling customers and non-customers to get a sense of how the business was viewed in the community.

It’s important to get that third party involvement, he says. “You can believe your own baloney, but you’ve got to have an unbiased evaluation of where you stand — independent sources who can cut through the baloney and get a sense of who you are. Believing your own BS only takes you so far.”

Getting started

Valuation assesses the market value of a company’s physical assets and also provides an analysis of its management, its future earnings prospects and the capital structure (mix of types of debt and equity) of the business. 

Start early, says Adam Carter, a valuations expert with KPMG. He has a decade of experience in the field and has done valuations for agriculture, automotive and manufacturing businesses. “A lot of people don’t realize that selling a landscape business may take a while,” he says. “It’s not the same as selling a house. Start early, say three plus years in advance if possible.”

A landscape business carries much of its value in intangibles such as reputation and good will; therefore, potential purchasers will want to see complete financial records, including sales receipts, customer contracts, profit and loss statements, tax returns, asset lists and balance sheets. The owner who is selling the company should also be prepared to discuss employment agreements and marketing strategy.

Getting to the numbers

There are several methods used by valuators to reach a price for a landscape business. 

Fair Market Value is a valuation which assumes that there is a willing buyer and a willing seller, both having the facts about the business operating in an open market. The business will be listed at a value that reflects comparable sales.

Adam Carter is cautious. In order to compare you must have that information and many/most landscape businesses would be private sales. “You could look at public companies which disclose all of their information, but these are large, large companies.”

Liquidation Valuation Method is based on the assumption that the sale must take place as quickly as possible. This could be due to several reasons including bankruptcy or illness of the owner or owner’s spouse. It’s the price that can be realized for a business that will soon be going out of business; it’s bad news for a landscaping business because the intangibles have become valueless. No customer base means no goodwill.  The value of the tangible assets is also reduced because the business must be sold quickly. 

Although this is clearly not an ideal situation in which to find oneself, a liquidation valuation may be included in a business valuation report simply to show the lowest possible valuation of the business. 

Multiples of Earnings valuation method reaches a valuation by multiplying yearly earnings times a number. For example, a buyer might pay three or four times earnings if a business has market leadership and strong management. On the other hand, if these and other factors aren’t as favourable, the multiple, also known as the capitalization factor, will be decreased.

How then do John and Nancy arrive at that multiplier number?
“That’s the million-dollar question,” says Catherine Tremblay, partner and National Leader of Valuations at MNP, with a chuckle. “It depends on the business. Every single situation is different. There is no black or white answer.”
“We evaluate the business from all its different angles, whether it’s operation, finance, human resources. We look at all the different aspects of the business, evaluate their risk and how they’re doing. Are they dependent on certain customers or people in the business?”

Tremblay also looks at external forces: competition, regulatory issues, economy: how dependent is the business on economic cycles? Is it affected by ups and downs in the economy?
To determine what the multiplier number would be, Tremblay describes a process called the Buildup Method. 
The Buildup Method is based on the truth that the investor, instead of buying a business, could simply invest his money in a very low risk option such as Government of Canada bonds.  Assuming that return to be say, four per cent, risk factors are assigned percentage numbers and are added to that base of four per cent.

There are industry risk premiums and company-specific risk premiums. “Some of these are based on certain databases we have access to,” says Tremblay.  “Others are based on the valuator’s judgement, an assessment of all those different value drivers and risk factors.”

If, after John and Nancy built-up their rate to represent the percentage of returns that an investor would want, the number is 20 per cent, the valuator would then change that number into a multiple by converting it to its inverse, that is dividing that number, 20, into the number one. This would give a multiple of 5. In other words, yearly returns multiplied by five would be the value of the business. 

Where does that leave the couple? With plenty of questions still, no doubt, as they contemplate selling their life’s work to an employee or an outside buyer. But at least they have a number to work with that represents value. 
Shirley Byers is a Saskatchewan-based freelance writer.