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How Much is Your Business Worth?
© 1999 Stuart Daw
One of the most popular topics of
conversation at any coffee service convention is business evaluation. What’s
a coffee service worth today? Lately we have been seeing a maze of
acquisitions where this has become a most practical issue.
Many industries seem to have their own
shorthand way of making approximations when it comes to putting a value on a
member’s business. In coffee service the most popular method is to state
that value as a multiple of one month’s gross profit, with gross profit
being defined as sales minus cost of materials sold.
One hears of wild variations in the amount
of that multiple. It can range from a low of around ten times one month’s
gross profit to as much as twenty times or even more. The objectively correct
price always turns out to be what a willing buyer actually pays a willing
seller. And of course that price can always be stated as a multiple of a month’s
gross profit, even if one or both parties never employed it as the criterion
for the transaction.
The sale price is often a function of how it
is to be paid, cash or terms, with terms giving the buyer the ability to pay
off the purchase price from the earnings of the acquired. This consideration
alone can account for a big difference in the ultimate return to the seller,
and if the buyer is solid and a reasonable rate of interest is involved, a
time sale can be a good way to maximize results.
The type and age of equipment on the seller’s
locations can be a factor, whether it is regular pourovers with glass bowls,
automatics with glass, or either type with thermal servers. The single cup
machines seen more and more today will get special consideration in terms of
value to the business.
The media is full of material covering the
subject of how to maximize the selling price, usually for the seller’s
benefit. Perhaps this is because of the perception that the buyer has likely
made enough acquisitions to no longer need a lot of outside advice. But what’s
going on in his mind when he looks at an acquisition?
He may want to establish a presence in a
particular market he is not in now and be willing to pay a premium for it,
wanting to avoid the startup losses of a new operation which can take a lot of
money and time. Or he may want the synergy of a merged operation with all the
attendant economies of scale; or he may wish to acquire good personnel. There
are many other possible reasons.
But the buyer is aware, usually from
experience, that there are potential pitfalls, many of which I myself
encountered in the over 30 acquisitions and divestitures in coffee service
alone since its inception as a business roughly 35 years ago (this does not
include a number of startup situations).
The trouble with a gross profit criterion is
that by itself it is too simplistic. There are many variables that need
consideration. How many customers are involved in generating that GP? That
gives the average customer GP contribution. Does one or a very few customers
make up a disproportionate share of total sales?
What is the average cost of conducting each
sales transaction (divide total company operating costs for the past year,
less non-transactional expenses such as interest and brewing and serving
equipment, by the number of sales transactions), and does that average cost,
including specific direct costs such as equipment on location, exceed the GP
contribution of certain accounts? A coffee service that built the business by
cutting prices to secure accounts will often suffer the consequences when the
"come and get it day" of selling the business comes along, with too
many small non profit-producing accounts on board.
While the seller should expect the buyer to
recast the seller’s earnings by adding back to the bottom line certain
non-recurring items and other things such as interest, depreciation and excess
management income, he should be aware that the buyer is very concerned about
account attrition. What is it now, and what might it be with the owner/seller
gone?
There is a variation in attrition rates from
company to company. It is true that heavy automatic installations are less
likely to fall out than are old time pourovers. And very carefully tended
customers, usually a characteristic of a small operation, will have a lower
attrition rate. But what I call "natural attrition" alone, those
accounts lost due to bankruptcies, fires, elapsed leases, pickups because of
low sales contribution, etc., can account for around 1% per month in lost
accounts. In other words, a one thousand account business could lose as many
as 10 accounts monthly this way.
The loss from competitive attrition may be
less, especially in a smaller business, nonetheless it can run another 1% per
month, depending on how aggressive a sales program is involved. The higher the
number of new accounts per month, the shorter the average account age and the
higher the attrition rate. Some acquirers count on as much as 25% of all
accounts being lost shortly after an acquisition because of change of
management styles, the higher selling prices that may be required, possible
personnel defections or downsizing by the acquirer at the local level.
For the above and many more reasons, one
should drop the idea of a hard and fast formula for selling a coffee service.
And certainly one can not expect a wild multiple of earnings either. For one
thing, a publicly listed buyer wants to preserve his own numbers by ensuring
the price/earnings ratio of the seller is better than his own. A public
company whose shares sell for 18 times earnings may only want to pay three to
six times net earnings to a private seller, which is always an unpleasant
surprise to the latter. The seller should understand the reasons, space for
all of which is not available here, but include the fact that investors in a
public company are often not necessarily buying based on actual profit
performance, but on the discounted value of hoped-for future earnings.
One mustn’t forget that almost all buyers,
for tax reasons, want to only buy assets, not shares. In most asset sales of
coffee services, the price includes equipment on location and in the
warehouse. In addition the seller gets the value of existing salable floor
inventory as well as collectible receivables one way or another, but must face
the little matter of having to pay off all liabilities. The net proceeds of
the sale can then be divided by one average month’s GP to conclude what
multiple was actually paid.
But to fit that "low" multiple
into the "how many times GP" equation, let’s look at a concrete
example: A company does one million dollars per year in business. The gross
profit is $480,000 ($40,000 monthly). The recast earnings are established at
$80,000. If the asset selling price is $480,000, then on this model the seller
got a twelve times monthly GP price (assuming receivables and inventory
canceled out all payables), or to put it the other way, he got a six times
multiple of pretax earnings.
© 1999 Stuart Daw
If the above is sufficiently confusing, please
feel free to e-mail me at stuartdaw@heritage-coffee.com
if you wish to question or clarify any of the above.
Consultations are free for Heritage customers; $200 per hour for
non-customers.
