Shop Valuations in 2008

I read the board a lot but this is my first post. I have read all the information on valuations, and I am a former owner. (Tried the corporate life but it did not take).

I am going to buy a place to get back into the market quickly (or so I think). It used to be that we bought and sold on profits. We used to calculate profit as the amount of money made over and above paying someone fair wage to take your place (call it GM or staff) in the shop. My rule of thumb was 15%-17% of gross was profit over and above your wage was a good day.

In dealing with brokers now, I see them asking for multiples of Owners Cash Flow, but it is the owners cash flow that I question. They seem to think when the owner works some kind of crazy 82 hours a week instead of paying staff, the money they save becomes part of the profit number you should pay for. Has the market changed that much that people are now buying jobs and paying multiples for their own salary (or expected salary)?

Here is a hypothetical example with some rounded numbers of what I keep seeing:
Gross = 300k I would have said 68% cost - Fixed = Profit. Therefore, Buy it for 2 * Profit plus value of equipment.

( Before you ask here is how I get to 68%: Quick breakdown:28% of that is labor, 34% is food and paper, 7.5% indirect, Delivery 1.4% (decent mix say 40%)). My rule of thumb is on a lower volume shop you run on average fixed cost at 18% of gross (thats utils, insurance, rent, etc). I might have some regional PA flavor in my %s so CA and Australia owners might disagree.

Has the market changed that much that places would now sell for 40%-50% of gross without regard to profit? I ask the question because most of the valuation threads I see on this board indicate my numbers for cost %s still hold true but most places for sale look like totally different.

Thanks xtra_cheese.

if you are an investor and you are making 10k a year from your investment how much would you invest to get that kind of return a year?
i would multiply 10k by 5 times, then add the price of equipments that would be a fair price

The most important thing is just determining what they are “really” making and how much of the owner’s time is accounted for in the P&L’s. Then do your own pro forma based on the current sales and compare it to the seller’s P&L’s. No complex calculations can tell “you” if the purchase is worth “your” time and money. A good return is not necessarily a good investment and a bad return is not necessarily a bad investment.

there is a LOT of crap out there… business brokers for the most part are trying to sell the business for the highest possible price an most of them don’t know anything about valuations. Most would be hard pressed for comparables. I don’t trust most of them.

A good rule of thumb is 3-5x earnings before interest and taxes. EBIT, if the operation has some debt, and you’re buying the company vs. assets, you may need to consider deperication and amortization, but unlikely in a single store setting.

I’ve bought and sold a few businesses in my time, I don’t really allow anyone to “add back” their salary if their are a full time owner/operator. There needs to be a manager, whether its you or someone else… that salary is legit expense. Valuation should be total, not 3x profit + the value of the equipment, the equipment is at liquidation value without the business, so if the business isn’t profitable, its value is its equipment, if its profitable and a multiple of EBIT is less than the value of the equipment, its probably not a business worth buying… or maybe at some small premium over the value of the assets.

Go find a good business lawyer that can help you with valuation and help you construct a deal. I’ve made lots of offers that were rejected or laughed at… for a while and then had the guy call me back 60 days later willing to accept my offer, well that offer wasn’t their anymore. Be patient and make a real offer that you can live with… if its rejected find another and make another offer. Their are a lot of bad business people that have to exit quickly… you’ll find something you can afford in the next 12 months for sure.

There are several different approaches to valuation that work. Each represents a different approach to valuing the various components of the business. Personally, I think that owner’s cash flow is the simplest to use but you do have to take into account what kind of hours the owner is working. Chicago, your approach of not including the owner’s wage in earnings is really no different. You call for 3-5X earnings excluding the owner/manager wage. Most owner’s cash flow approaches that include the owner’s wage call for 2-3X In the end, both are using cash flow available to the buyer as a basis for value.

Another approach that I like to use to check value from another direction is replacement cost. What would it cost to open from scratch in an equivalent location with buildout, equipment, opening marketing etc and what kind of premium are you paying for a ringing phone and customers at the door? If cash flow and replacement cost are telling you the same story, you probably have a pretty solid number.

It gets more challenging when the business you are looking at does not make any money above an ordinary manager’s wage. The commetns above that buinesses like this are worth the equipment value at most are correct. You also have to take into account the lease, the age of the equipment, recent sales track (increaseing or decreasing) and several other factors.

In the case of a profitable, established business with some steady growth and with plently of time left on the lease and no major equipment issues, I am comfortable with up to 3X owner’s cash flow. The reason I like to refer to owner’s cash flow is that there are so many ways for an owner to take value out of the business. It could be wages, S-corp dividends, car expenses, travel, retirement contributions, spouse wages etc. If the owner does not work in the business day-to-day, I would add back the manager wages in the place of owner wages. I would then work on what the cost of opening a comparable business from scratch would be. If the new store opening is close to the same number, I would prefer to buy one that has cash flow already!

I own two pizza locations and am also a licensed broker doing small business business brokerage.

Listen to this man. He reviewed a lease for me and it was incredible the amount and detail of information he provided compared to the attorney.

Thanks All for the great replies. Sorry I did not respond sooner, but I spent the weekend scouting new possible start-up locations. Guess I have a longer point to re-entry than I was hoping for but at least I will not start out in a hole I cannot climb out of.

I will have to make some real use of this board, I spent some time on the phone today to find out many of my old contacts for distributors and equipment have moved on when I was out of the market.