Operations

Do You Really Know What Your Business Is Worth?

Posted on June 2, 2010 by LCT Staff - Also by this author - About the author

Valuing a transportation business can be distorted by myths and miscalculations. Know how to apply three key approaches to assessing the value of your business.

By Spencer Tenney

ARLINGTON, Texas — Business value in the transportation industry is widely misunderstood by business owners, accountants, general business brokers, consultants, and lenders. At a recent industry event, I asked six business owners how they thought transportation businesses were valued and I got six different answers.

The suggested formulas included:

• The average of the last 5 years’ annual sales.

• 2 times annual sales (last complete fiscal year)

• 3 times profit + the value of the furniture, equipment, and fixtures

• 4 times “net”

• 24 times monthly profit (using most profitable month in last 12 months)

• 1 times annual sales + the value of the equipment

The wide variety of answers from such a small sample of owners underlines a serious disconnect in our industry. Business owners obtain valuation information from many sources. The most common source comes from other business owners. Industry colleagues, with the right intentions, share what they know, have heard, or what they “think” they understand with others who misinterpret, misunderstand, or misapply the information to their own businesses.

The consequence of applying questionable or flat wrong valuation information can leave transportation business owners susceptible to taking financial risks they may never take if they truly understood the value of their businesses.

Further, using poor valuation information when taking a business to the market can prolong a business sale by one to three years (even after the price is adjusted to market value) or end the possibility of a sale altogether.

When business owners clearly understand the value of their businesses, they make sound reinvestments in their business where the risks are proportionate to the potential rewards. When it is time to sell their businesses, they are positioned to experience the process in the most seamless and rewarding manner possible. So if understanding the value of your transportation business is so important, even when selling is not in the foreseeable future, what is involved in valuing a transportation business and what methods are used?

The following valuation methods are a sample of many that have been used in over 160 transportation business sales and thousands of limousine & charter/tour business valuations completed by Charles Tenney & Associates, LLC.

BALANCE SHEET VALUE APPROACH

There are several balance sheet valuation methods, including adjusted book value, book value and liquidation value. The adjusted book value is determined by revising the asset’s book value to reflect the cost it would take to replace the assets in their current condition. This method requires the total values to be offset against the sum of the liabilities.

The book value considers the figures from the company’s financial records, as depreciated at the time of the sale. The book value can pose some difficulties for sellers, particularly if the seller has depreciated the assets too much to gain prior tax advantages.

The liquidation value is the amount that could be realized if all assets — equipment, furnishings and inventory — were sold separately. This value is typically much lower since it doesn’t consider a company’s intrinsic value.

INCOME APPROACH

The income approach considers the company’s level of earnings using a capitalization rate, discount rate or multiplier. Several income approach methods are frequently used. Each method requires a level of earnings and a conversion factor to translate the earnings into a company value. Selecting the proper level of earnings — after-tax, pretax, discretionary or cash flow — and matching it with the proper conversion factor — discount rate, cap rate or a multiplier — is critical to calculating a reasonable value.

Income approach often creates confusion for many transportation business owners. Example: I received a call from a business owner this week. He shared that he heard his business value was based on a multiple of three times discretionary earnings. However, it quickly became clear that his definition of discretionary earnings was inaccurate and making decisions with inaccurate information is a dangerous. It is critical to develop your financial intelligence so you can communicate apples to apples in the transaction arena.

Discretionary earnings (DE) equals:

DE = Adjusted Earnings Before Interest, Taxes, Depreciation, and Amortization (EBITDA) + (Owner/Manager compensation).

For small transportation businesses ($200,000 to $2 Million in annual sales) businesses often attract multiples of one to three times discretionary earnings. According to the International Business Brokers Associations, the average multiple of discretionary earnings applied to all small business sales across all industries over the past 30 year has been 2.3.

MARKET APPROACH

The market approach sets a value based on the values of other businesses that have been sold recently. Setting the market value involves researching the sale prices for similar businesses in a geographic area. It can be very difficult to obtain public information about a transportation sale that also contains market data that is applicable to your particular business — unless you were involved in similar sales and have knowledge of the details that influenced the sale price of similar transactions. Many factors can influence the sale price of a transportation business. Some of these include but are not limited to:

• Terms. Cash offers look much different than transactions paid out over time.

• Customer concentration. If one client comprises 20%, 50%, or 75% of the total business, it is going to influence the sale price and terms.

• Capex requirements

• The business location, market footprint, and how meaningful these are to the buyer.

• Pricing strategy

• Technology

• Human capital

• Permits that apply to a geographical area

• Liabilities assumed in purchase

• Employment agreement with seller

• Goodwill and reputation

• Buyer type: strategic or financial

Again, these methods are just a sample of many methods used in valuing the unique characteristics of a transportation business. “Rules of thumbs” rarely apply to the transportation industry and can greatly mislead business owners. Applying a combination of seven to eight different methods and weighting them accordingly is the most reliable approach to valuing a transportation business.

Although the process of accurately valuing a transportation business can be very complex, the purpose is simple. The current value of your transportation business should influence almost every significant financial decision throughout your company’s life cycle — not just the final decision to sell it. When businesses owners clearly understand the value of their businesses, they make sound reinvestments in their business where the risks are proportionate to the potential rewards. When it is time to sell their businesses, they are positioned to experience the process in the most seamless and rewarding manner possible.

Spencer Tenney, CBI is a senior broker at CHARLES TENNEY AND ASSOCIATES

Spencer Tenney, CBI: (817) 274-0054. [email protected] Value Definition Contributions Provided By: IBBA

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