A Basic Guide for valuing a company phần 5 pot

110 Valuation of a Restaurant Bank Ser. Charges 1,475 2,514 904 3,958 5,250 Contributions 590 300 710 1,521 2,000 Dues & Subs. 255 1,239 625 1,510 2,000 Emp. Benefits 475 — 2,559 2,818 4,800 Equipment Rental — — — 11,529 17,172 Utilities 17,164 25,261 32,442 33,215 45,000 Insurance 27,735 35,106 35,881 47,747 52,592 Linen & Cleaning 547 671 968 816 1,050 Taxes/Licenses 25,166 50,412 52,393 16,426 73,500 Prof. Fees 3,075 3,841 4,800 200 6,000 Miscellaneous — — — 632 500 Office Expense 2,529 4,267 7,503 5,225 7,500 Contract Services 6,671 8,055 13,827 14,302 19,500 Rent 4,550 4,575 4,650 375 5,000 Repair/Maint. 15,216 13,520 32,164 32,639 45,000 Supplies 18,062 33,585 41,931 26,352 37,500 Telephone 3,271 4,838 6,350 5,132 7,500 Trash Removal 2,364 3,415 3,992 3,284 4,500 Travel/Ent. 2,006 1,595 452 4,091 5,000 Total Expenses $240,340 $345,443 $ 476,555 $ 482,296 $ 690,756 Recast Income $116,051 $167,336 $ 200,718 $ 226,970 $ 272,244 Recast Income as a Percent of Sales 21.5% 21.6% 18.9% 20.6% 18.1% When income statements are set side by side, and debt service, depre- ciation, and owner salaries removed, the picture becomes quite clear as to how the infrastructure of operations r eally works. Debt leverage, depre- ciation ‘‘funny money,’’ and owner’s salaries have little or nothing to do with operations per se, and, as we know by now, owners camouflage their profits from being taxed on the bottom line. Thus reconstruction of state- ments lets us see performance as it really is. This restaurant business, owned by two brothers, is a fine example of a well-run operation. One brother is the chef, and the other is the business manager. Note how clustered, year to year, are the percent gross profits and recast incomes. Sales increased 43.6% between 1998 and 1999, 37% between 1999 and 2000, and, in nine months year-to-date in 2001, they have already exceeded all of 2000’s performance. In this light, the $1.5 million 2001 forecast is hard to doubt. Year Sales Increase 1998 $ 540,555 1999 776,412 43.6% 2000 1,063,993 37.0% 2001 (forecast) 1,500,000 41.0% The Valuation Exercise 111 Nine-month year-to-date recast income stands at 21% yield thr ough actual per for mance, yet the 12-month forecast reduces this income to 18%. I don’t know about you, but eyeballing these statements convinces me that the forecast for the 2001 completed year is quite believable. The forecast gross profit percentage and individual expenses track in line with the past year’s per for mance. The balance sheet reveals exceptional li- quidity and strong equity positions for the owners, and thus we must summarily conclude that there is growth and good management present in our valuation-targeted business. Knowing this business since its in- ception, I can assure you that it started out leveraged to the hilt and from a foreclosed property base. These statements represent over 11 years of hard, intelligent work. We might also guess that it could stand among the top 25% of the best-r un companies in the industry. But we don’t know that without comparisons. 2001 Subject Smaller Industry Sample A Industry Sample B 1 Sales 100.0% 100.0% 100.0% Cost of Sales 35.8 37.0 41.2 Gross Profit 64.2 63.0 58.8 Labor Expense 21.3 29.8 — Ratios Upper Quartile Current 4.6 3.0 1.4 Current Assets/Total Assets .223 .547 — Debt/Worth (Safety) .335 .911 .10 Fixed/Worth 1.0 — 1.2 Debt/Assets .243 .790 .325 Sales/Total Assets 1.6 4.4 3.4 Sales/Net Worth 2.2 13.8 3.8 Land/Buildings as % Total Assets .606 .650 — Equipment as % of Total Assets 13.9 30.9 — 1 389 restaurants of all types other than franchised operations in similar sales-size comparison. Current Ratio: Generally, the higher the current ratio, the greater the company’s ability to pay current obligations. Current Assets over Total Assets: Indicates the percentage of the com- pany’s total assets that are current—the lower the percentage the greater the liquidity. 112 Valuation of a Restaurant Debt to Worth: Referred to as the safety ratio, this ratio determines the extent to which the owner’s personal investment has been made in relationship to outside debt. The higher the ratio, the greater the risk that is being assumed by present and future lend- ers. Fixed to Worth: Measures amount of owner’s equity invested in fa- cilities and equipment. A lower ratio suggests a better margin of safety to creditors in the event of liquidation. Total Debt to Total Assets: Expressed as a percentage, this measures the leverage by long-term debt of all assets. Sales to Total Assets: Provides an indication of how well assets are employed to produce sales—the higher the ratio, the better em- ployed. Sales to Net Worth: A higher ratio indicates that owner’s funds are being turned more effectively to generate sales. With these brief data, we can draw a general overall conclusion that this restaurant compares favorably to the 287 firms in the smaller sample A, and 389 mixed category firms in the upper quartile sample B. They may be somewhat heavy on assets in relation to sales, but growth could be precipitating this feature of operations. In fact, facilities and equipment were expanded by over $150,000 during the past two years alone to ac- commodate the five-year forecast for growth in sales. This operation fits nicely into the upper quartile of the top 25% of the sample average. Though I can do no more than guess at where they might fit into the national picture, their performance falls within the top 10% of restaurants in their local geographical region. With this in mind, we can now proceed with the valuation. Book Value Method Total Assets at September 30 $455,512 1 Total Liabilities 252,120 1 Book Value at June 30, 2001 $203,392 1 1 This will not reconcile with the previously shown balance sheet since that statement has been reconstructed to show a fair market value of assets. However, the owner’s book value (in ac- counting terms) is as depicted by these numbers. The Valuation Exercise 113 Adjusted Book Value Method Assets Balance Sheet Cost Fair Market Value Cash $200,927 $200,927 Inventory 4,000 4,000 Property & Equipment 235,085 699,174 1 Investments 15,500 15,500 Total Assets $455,512 $919,601 Total Liabilities $252,120 $252,120 $203,392 Adjusted Book Value at 6/30/01 (relative to stockholder equity) $667,481 1 Stated at appraised and thus, Fair Market Value. Hybrid Method (This is a form of the capitalization method.) 1 ס High amount of dollars in assets and low-risk business venture 2 ס Medium amount of dollars in assets and medium-risk business venture 3 ס Low amount of dollars in assets and high-risk business venture 1 2 3 Yield on Risk-Free Investments Such as Government Bonds 1 (often 6%–9%) 8.0% 8.0% 8.0% Risk Premium on Nonmanagerial Investments 1 (corporate bonds, utility stocks) 4.5% 4.5% 4.5% Risk Premium on Personal Management 1 7.5% 14.5% 22.5% Capitalization Rate 20.0% 27.0% 35.0% Earnings Multipliers 5 3.7 2.9 1 These rates are stated purely as examples. Actual rates to be used vary with prevailing economic times and can be composed through the assistance of expert investment advisers if need be. Addendum to overall table: You’ll note that this table changes from that used in the professional- practice valuation in the previous chapter. This is because capitalization rates and earnings mul- tipliers change from business to business. This table, showing several rates in a range, is provided simply to give readers a scope of the judgmental conditions the value processor undergoes. 114 Valuation of a Restaurant This par ticular version of a hybrid method tends to place 40% of busi- ness value in book values. However, before we finalize the assignment, we need to reconcile the ‘‘gray’’ area in the 1-2-3 asset/risk elements above. Assets ar e high and risk seems low to medium due to the stability of cash flow in three previous years, and the availability of a large amount of cash. Experience in working with this instrument teaches one not to be too bold in assigning multipliers. For the convenience of readers, I have a saying in my firm that goes: ‘‘Only God gets a multiplier of much in excess of 5—and, I’ve never been asked by him or her.’’ The key to r educing labor hours in the assignment is to be conservative in determining multipliers. Weighted Cash Streams Prior to completing this and the excess earnings method, we must rec- oncile how we are going to treat earnings to ensure that we have a ‘‘sin- gle’’ stream of cash to use for reconstructed net income. I prefer the weighted average technique as follows: (a) Assigned Weight Weighted Product 1998 $116,051 (1) $ 116,051 1999 167,336 (2) 334,672 2000 200,718 (3) 602,154 2001 272,244 (4) 1,088,976 Totals (10) $2,141,853 Divided by: 10 Weighted Average Reconstructed $ 214,185 Eyeballing column (a), we can conclude that the weighted average re- constr ucted income seems reasonably fair on the surface; the weighted is slightly higher than the completed 2000 but, based on the track record, may be somewhat inappropriate because the restaurant completed $226,970 during the first nine months of 2001. Furthermore, there is no compelling evidence that this operation could not complete the 2001 forecast of $272,224. At this stage we need to be conservative because the formula will get us up to par in the end. However, I have a leg up on you through experience; thus, I’m going to arbitrarily start with $250,000, in spite of what I’ve calculated as the weighted average cash flow. The Valuation Exercise 115 Book Value at 6/30/01 $203,392 Add: Appreciation in Assets 464,089 Book Value as Adjusted $667,481 Weight Assigned to Adjusted Book Value 40% $ 266,992 Reconstructed Net Income $250,000 Times Multiplier ן3.0 $ 750,000 Total Business Value $1,016,992 Excess Earnings Method (This method considers cash flow and value in hard assets, estimates in- tangible values, and superimposes tax considerations and financing struc- tures to prove the most-likely equation.) Reconstructed Cash Flow $ 250,000 Less: Comparable Salary (Industry Composite) מ 80,000 Less: Contingency Reserve מ 15,000 Net Cash Stream to Be Valued $ 155,000 Cost of Money Market Value of Tangible Assets $ 699,174 Times: Applied Lending Rate ן10% Annual Cost of Money $ 69,917 Excess of Cost of Earnings Return Net Cash Stream to Be Valued $ 155,000 Less: Annual Cost of Money מ 69,917 Excess of Cost of Earnings $ 85,083 Intangible Business Value Excess of Cost of Earnings $ 85,083 Times: Intangible Net Multiplier Assigned ן5.0 Intangible Business Value $ 425,415 Add: Tangible Asset Value 699,174 TOTAL BUSINESS VALUE (Prior to Proof) $1,124,589 (Say $1,125,000) Financing Rationale Total Investment $1,125,000 Less: Down Payment (25%) מ 280,000 Balance to Be Financed $ 845,000 116 Valuation of a Restaurant At this point, we know that we have a serious pr oblem with financing because total assets less liabilities equal $667,481, and we know that banks want ‘‘collateral’’ to make loans. We also know that banks don’t like to finance restaurants. In addition, we know that $280,000 cash is a lot of money to expect from buyers in general; thus, as it is, this cash require- ment already puts us into a category of finding perhaps no more than 3% to 5% of all buyers who will qualify to purchase this restaurant business. It’s important to use a good deal of logic at this stage of valuation or you will waste a lot of time coming up with reliable estimates. One can set up the financing scenario any way appr opriate to their local conditions, but my guess is that the following would be pretty close. The business’s ownership of real property is a key feature that makes this particular restaurant more inclined to locate financing. Combined with a Small Business Administration (SBA) loan, other assets may receive more attention, since banks can receive ‘‘guarantees’’ on substantial por- tions of their loans. Combine the strength of this operation with a buyer ‘‘experienced’’ at running a restaurant, and much of the stigma banks recount disappears. This business is no mom-and-pop venture, or at least it should not be; therefore, we might safely assume that a buyer will be experienced or not be the buyer. Also, the size of down payment cuts the chaff from the wheat and, more than likely, leaves us with a purposeful buyer intent on the r estaurant business. Equipment ($127,610) at 50% of Appraised Value $ 63,805 Land/Buildings ($557,410) at 70% of Book Value 390,187 Leasehold Improvements –0– * $453,992 (For good measure, say $460,000) *Leasehold improvements, traditionally painting, new flooring, etc., have a short life in restaurant operations. Subsequently, these are often ‘‘expensed’’ in years completed. Structural changes, new equipment, and furniture/fixtures are booked into their balance sheet categories, and thus, reflected there. Restaurant equipment holds a relatively low ‘‘hammer’’ value, due primarily to mass availability of used, functionally good replacements. Bank (10% ן 15 years) Amount $460,000 Annual Principal/Interest Payment מ 59,318 Assume: Owner’s Financing (8% x 20 years with a review toward ‘‘balloon’’ at the end of the fifth year [not a balloon provision necessarily]) Amount $385,000 Annual Principal/Interest Payment מ 38,643 The Valuation Exercise 117 Testing Estimated Business Value Return: Net Cash Stream to Be Valued $155,000 Less: Annual Debt Service (P&I) מ 97,961 Pretax Cash Flow $ 57,039 Add: Principal Reduction 26,396 * Pretax Equity Income $ 83,435 Less: Est. Dep. & Amortization (Let’s Assume) מ 27,401 Less: Estimated Income Taxes (Let’s Assume) מ 6,700 Net Operating Income (NOI) $ 49,334 *Debt service includes an average $26,396 annual principal payment during the first few years that is traditionally recorded on the balance sheet as a reduction in debt owed. This feature recognizes that the ‘‘owned equity’’ in the business increases by this average amount each year during the early period of the loan. Return on Equity: Pretax Equity Income $ 83,435 סס29.8% Down Payment $280,000 Return on Total Investment: Net Operating Income $ 49,334 סס4.4% Total Investment $1,125,000 Although return on total investment is abysmally low in relationship to conventionally expected investment returns, the return on equity is at- tractively better than most other optional uses of a buyer’s cash. Cash flow is strong. Basic Salary $ 80,000 Net Operating Income 49,334 Gain of Principal 26,396 Tax-Sheltered Income (Dep.) 27,401 Effective Income $183,131* *There is also the matter of $15,000 annually into the contingency and replacement reserve that would be at the discretion of the owner if not required for emergencies or asset replacements. At this time we have estimated business value . . . but have we esti- mated the estimated value? $280,000 cash down payment plus $460,000, or $740,000 leaves us with a $385,000 shortfall of the all- cash or cash-equivalent target that typifies the general definition of fair market value. If we leave the price at $1,125,000, either the buyer has to make up the difference outside this business, or the seller must be- come flexible toward pr oviding $385,000 of seller financing, or find an- other buyer with more cash; or the estimated price must be ‘‘squeezed’’ to fit the conditions of available financing. We have a dilemma . . . or so 118 Valuation of a Restaurant it would seem. This business is not being valued for potential sale, and of course, it would be easy to ‘‘assume’’ that the owners would pr ovide this financing. However, that would be an ill-founded assumption if taken alone. Thus we must explore the options and provide alternatives for choice. How then might we resolve the discrepancy? 1. We know that we ar e $385,000 short on conventional financing. 2. We know that we have an effective income stream of $156,735 ($183,131 minus non-cash equity buildup $26,396). A powerful stream in light of cash outlay at purchase. 3. We know that sellers in general are anxious to receive cash as quickly as possible. 4. We know that fair market value might be depressed to the amounts of down payment ($280,000) plus bank financing ($460,000) or the sum of $740,000. Of course, discounted thus, between the bank and a prospective buyer this estimated value might rise to $850,000 all said and done. This could be termed the fair market value of an all-cash deal. 5. Another possible alternative might be answered by the question: What effect would a five-year payout of $385,000 bring to bear on the buyer? In attempting to solve for this alternative, we return to the point in the equation for Financing Rationale. Financing Rationale Total Investment $1,125,000 Less: Down Payment (25%) מ 280,000 Balance to Be Financed $ 845,000 Bank (10% ן 15 years) Amount $350,000 Annual Principal/Interest Payment 45,133 Seller (8% ן 5 years) Amount $385,000 Annual Principal/Interest Payment 93,677 Total Annual Principal/Interest Payment $ 138,810 Testing Estimated Business Value Return: Net Cash Stream to Be Valued $ 155,000 Less: Annual Debt Service (P&I) מ 138,810 Pretax Cash Flow $ 16,190 Add: Principal Reduction 94,188 * The Valuation Exercise 119 Pretax Equity Income $ 110,378 Less: Est. Dep. & Amortization (Let’s Assume) מ 27,401 Less: Estimated Income Taxes –0– Net Operating Income (NOI) $ 82,977 *Debt service includes an average $94,188 annual principal payment that is traditionally recorded on the balance sheet as a reduction in debt owed. This feature recognizes that the ‘‘ownedequity’’ in the business increases by this average amount each year. Tax obligations are reduced since interest expense is deductible from business cash flow. Return on Equity: Pretax Equity Income $110,378 סס39.4% Down Payment $280,000 Return on Total Investment: Net Operating Income $ 82,977 סס7.4% Total Investment $1,125,000 Note that return on equity increased from 29.8% to 39.4%, and that return on total investment went from 4.4% to 7.4% under our new sce- nario. As we know, mortgage payments are normally comprised of both principal repayment and interest on debt. That portion of the payment designated as interest is lost to the gain of the financing party . . . and provides an ‘‘expense’’ to the income statement of the debtor. However, the principal portion is reconciled on a debtor’s balance sheet as a reduc- tion in debt owed and translates into an increase in owner’s equity. It’s similar to the mortgage with home ownership and paying off the loan. Granted, the debtor has no real control, nor can he or she make immediate use of this ‘‘principal’’ until the debt is paid or the business sold, but make no mistake, it nevertheless is income. In our case, annual debt service grew from the first instance of $97,961 to $138,810 in the last example. Along with these higher payments, the principal being returned to the balance sheet rose from $26,396 to $94,188. I’ll admit that this feature is some- times hard for the unwary to grasp. And I’ll also admit that some ac- countants find it hard to admit this concept of ‘‘additional’’ income into valuation practice as I do. However, I maintain that it is a vital element for consideration in how a business ‘‘pays for itself’’ out of cash flow, although it may not always be how a prospective buyer might view the equation. So let’s look at how a prospective buyer might view what we’ve presented. Buyer’s Potential Cash Benefit Forecast Annual Salary $ 80,000 [...]... support of my argument I submit the following information to estimate how much greater yield: Mailing List Names 5- year Average Sales per Catalog Mailed Projected Sales per Mailing Number of Mailings Gross Yearly Sales Forecast List Rental Revenue (annual) Consolidated One-Location Retail Sales Estimated Total Gross Sales 75, 000 $1.00 $ 75, 000 ‫4ן‬ $300,000 15, 000 27,000 $342,000 Advertising in a major New... Goodwill/Trade Name Copyright Noncompete $ 45, 000 — 5, 000 $ 5, 000 16,000 5, 000 Aggregate Selling Price $127 ,50 0 $127 ,50 0 We have structured the allocation to provide the most favorable tax status to a buyer The previous owner has agreed to enter into a noncompete agreement as well as to provide whatever information about past operations that a buyer might wish Wife and husband now separated, their financial... Installers are paid a combination of base wage and piece rate Seamstresses are paid by piece rate only Two decorators were employed and paid in a combination of base salary plus commissions paid on product sales made external of store resources The operation was contained in 4,000 square feet of a 10,000-squarefoot building, and 6,000 square feet was revamped for rent to other retail shops In 1988 a. .. but in his day, his process of estimating ‘‘hammer’’ value was considered as accurate a forecast as money could buy Book Value at Current Value Less: Use Assumption Based on Visual/Ticket Sales Assumed Remaining Inventory at Cost $ 65, 008 11,961 $53 ,047 Marked Up to Customary Retail $ 95, 591 Therefore: 30% @ 100% of retail 30% @ 70% of retail 30% @ 10% of retail 10% @ no value Assumed Retail Value $28,677... set aside annually to fund reasonable growth Cash flow beyond debt service might accommodate more financing so long as expansion were to provide additional collateral As a side note, many businesses are not so fortunate The Valuation Exercise 121 Equipment and facilities needing short-term replacement must be factored into the valuation task For reasons outlined, I place small restaurants in the least-likely... tile and stone flooring were added, along with an art gallery line of prints that the owner produced and also sold wholesale to various gift shops locally and nationally Carpet installation and drapery fabrication stood in shambles due to poor workmanship and installation Two full-time flooring and tile installers were hired, and two drapery seamstresses were employed for improved quality and overall... through sale Thus one must examine product-line issues not just for profitability but also for what remains to be valued and/or sold Forecasting is complicated where such multiplicity of product lines exists Seasonality, waxing and waning within lines, makes straightforward forecasting of sales and cost of goods sold inappropriate for major items of sale Inventories are more apt to contain larger measures... business The task was to convince the court and 124 A Bankruptcy Court Proposal 1 25 creditors that the business had a reasonable chance of being sold as a going concern, thus the motivation to secure approval for Chapter 11 The owner accepted that there was little hope for personal salvation in the deal but was determined to preserve the ‘‘idea’’ and wanted to help recover what she could for well-meaning suppliers... blackand-white catalog The attempt at a color version failed abysmally to pull anywhere near the returns generated by the last black-and-white sent just three months earlier The color version modeled the company after its giant competitors and stole away its unique characteristics The founder believes that an appropriately written letter in the body of the catalog previously used could actually be a great marketing... furniture and fixtures as of the last year-end balance sheet was $5, 914 The figure for machinery and equipment was $2,681 No professional appraisal has been made or recommended, due to the cost in relationship to the probable or perceived value and visual inspection One might reasonably assume that these asset values collectively would not be greater than $5, 000 if sold individually Under auction conditions, . $ 8 45, 000 Bank (10% ן 15 years) Amount $ 350 ,000 Annual Principal/Interest Payment 45, 133 Seller (8% ן 5 years) Amount $3 85, 000 Annual Principal/Interest Payment 93,677 Total Annual Principal/Interest. 110 Valuation of a Restaurant Bank Ser. Charges 1,4 75 2 ,51 4 904 3, 958 5, 250 Contributions 59 0 300 710 1 ,52 1 2,000 Dues & Subs. 255 1,239 6 25 1 ,51 0 2,000 Emp. Benefits 4 75 — 2 ,55 9 2,818. Nonmanagerial Investments 1 (corporate bonds, utility stocks) 4 .5% 4 .5% 4 .5% Risk Premium on Personal Management 1 7 .5% 14 .5% 22 .5% Capitalization Rate 20.0% 27.0% 35. 0% Earnings Multipliers 5