If you haven’t read my previous guest blog content, my name is Joseph Hollcraft and I am the Director of IBA’s Oregon Hospitality Industry Transaction Division. In this fifth and final installment in the series, I’m going to discuss best practices around preparing your business for sale as it relates specifically to restaurants, bars, and lodging establishments.
Business valuation is a sophisticated and nuanced process. If you’ve spent time researching how to exit your business you’ve likely come across the concept of a “multiplier.” A multiplier is a multiple of SDE, or Seller Discretionary Earnings. SDE is the measure of benefit to ownership generated by a business and includes salary, profit and any expenses run through a business by ownership. However, there are some elements that are benefits to ownership that my valuation process can’t account for. The short version of this concept is this: dollars taken out of the business or put into things like Cost of Goods Sold can’t be examined, and each dollar taken out of the business costs between two and six dollars in final valuation due to the use of multipliers. Below are three cases where business value is lost due to discretionary choices by ownership.
The first and most common expression of the above is running personal costs through Cost of Goods Sold. Let’s say you go to Costco to bulk purchase supplies for your company. Unless each purchase is itemized and personal expenses notated, anything you buy and bring home is a cost to the business that ultimately comes out of the bottom line. This could be food for home, necessities like paper towels, or other home goods you or your family might want. If you spend $1,000 a month doing this, that translates into $12,000 a year. This would reduce your company’s valuation by between $24,000 and $72,000, depending on the multiplier. If you spend more than $1,000 a month in this scenario the loss of business value goes up accordingly.
The second is hiring family members or other people close to you at a rate above market. If you have a son or daughter who is running your business in the GM position, and you’re paying them $100,000 when the position in your business’s market only commands $65,000, then your business is spending $35,000 it doesn’t have to pay. Caring about the people close to you and giving them an extra boost is a privilege few of us are able to provide. Those business owners that can, often enjoy helping the people around them. The bottom line here is the cost at time of valuation is substantial. As in the above example, $35,000 spent on an employee that doesn’t need to be spent to hire and keep a quality GM translates into $70,000 to $210,000 in business value. This may be worth it to you, but it’s a point to consider. It can also create problems in terms of retention of the individual for the buyer. Would a person stay at a job where they have to take a pay cut?
The third example is holding cash rather than running it through the business. No one enjoys paying taxes. One way business owners reduce their tax liability is keeping cash income off the books and taking it home as a benefit to ownership. In businesses that generate substantial cash, even just 10% of gross, the loss in value can be gigantic. I valued a restaurant that was generating approximately $5,000,000 in sales. About 10% of that gross was in cash. Figuring a 12% net profit margin, which is common for restaurants, this 10% of gross in cash equates to $60,000 of net a year, which translates to a loss of between $120,000 and $360,000 in go-to-market price. The business I valued in this example had a profit margin even higher, at around 25%. The owner took almost every dollar of cash out of the business, not reporting it on his P&L. My valuation of this incredibly successful business was approximately $1,200,000. Had the owner left all of the cash in the business, it would have commanded a value closer to $2,000,000. This can be the difference between comfortably retiring for the rest of your life and needing to work again five or ten years down the road.
This concludes my five part series on strategies and best practices around an exit from your business. If you haven’t read the previous four blogs posted here on the ORLA website, it may be beneficial for you to review them. Should you desire a professional opinion of the value of your business, feel free to contact me via email or at (503)739-4880. All conversations will be held in strict confidence. You can also review IBA’s website at www.ibainc.com which houses a veritable treasure trove of information on preparing your business for sale and what professional mergers and acquisitions specialists such as myself can do for our clients.
Thank you for your time and attention. I look forward to hearing from you should the need arise, and I hope you and yours had a wonderful holiday season. | Joseph Hollcraft, IBA