How to Value an Automotive Business
About Business Valuations:
We have all heard the short cut methods that we are expected to use when valuing a business. There are statements like, “Values in our business are always six times the pre‐tax net profit” or “values in this industry are always one times Gross sales. The problem with these “one size fits all” formulas is they are designed for a median price. That means, when you use them, half of the businesses will be lower and the other half will be higher. If you are selling and use this method, then you may sell for less than you should. If you are buying, then you may pay more than you should. This is not a good situation in either case. So what do you do?
Our Team has been dealing in the world of Private and Independent Businesses for many years. One of the first questions we are asked is, “What do you think my business is worth?”. If you look on the internet and search the various terms dealing with valuing a business, you will more than likely come away with more questions than answers. What we can tell you is that all of the information you see and read is both right and wrong. So what do we do? Let’s clear the air first.
What is a Business Valuation?
Before we can decide the answer to this question we need to ask:
Why are we valuing this business?
Who are we valuing the business for?
And what is included in the valuation?
We will then find that “Skilled Business Appraisers” have come up with several ‘Valuation Methods” to try and de‐mystify the process and short-cut the process. We will look at the 12 most often seen and used. Before we do that, we will state the obvious: “Any business that you wish to sell or buy has a TRUE market value that is based on two things: What a willing Seller will sell for and What a willing Buyer is willing to pay for the business”. This is assuming the valuation is for the purpose of selling or buying. There are many other reasons to value a business and each reason will bring a different potential value. If we are dealing with a Public Company then the answer is easy. You take the value of one share of stock and multiply it by the number of shares outstanding. However, we are not dealing with publicly traded companies, as most automotive businesses are privately held.
Twelve “Methods” of Business Valuations
1. Book Value ‐ this is simply a valuation method based on the accounting books of the business. That is the Assets less the Liabilities which equals the owners equity, this is the “book value” of the business. The problem with book value as a valuation method is the accounting records may not show the true value of the assets or trade names.
2. Adjusted Book Value ‐ your CPA or MBA will normally perform two types of adjusted book value valuations: Tangible Book Value and Economic (or Market) Value.
A. Tangible Book Value is different than book value as it deducts from the asset value intangible assets, such as goodwill, patents, start up expense and deferred cost.
B. Economic Book Value allows for the valuation to adjust the assets to their current market value. This allows a restating of assets such as real estate, goodwill, inventories adn other assets at their "market value". Who is to say what that is?
3. Income Capitalization Method ‐ For this to work, you must determine a capitalization rate. This rate tries to measure the risk of operating the business. The perceived higher risk naturally would call for a higher rate and "vice versa". The earnings of the business are then divided by the capitalization rate. The earnings figure that is to be capitalized should reflect the nature of the business, which could be the last three years average, the current year, or even current year and projections. Plus, the capitalization rate should compare with rates available from investments with similar risk. (Seems like a lot to agree to).
4. Discount Earnings Method ‐ For this method, we are determining a business value based on the present value of future earnings, discounted by a required rate of return (here’s that capitalization rate again).
5. Discounted Cash Flow Method ‐ This method isl normally used when cash flow is more important than earnings. This might be an entity or business set up for a specific purpose or project or where an investor wants to see a return in a certain time period. With Discounted Cash Flow, the present value of the liabilities is deducted from the combined present value of the cash flow and tangible assets. This determines the business value.
6. Price Earnings Multiple ‐ This method becomes almost worthless if the stock of the business is not publicly traded. Here we divide the value of a share of stock by the earnings per share (commonly known as the price earnings ratio). Then, we multiply this multiple by the net income and we have the value of the business. As you can see, this is totally subjective if the business' stock is not publicly traded.
7. Dividend Capitalization Method ‐ In order for this method to work, we must first determine the ability of the business to pay dividends. Assuming this is not a public company and knowing that most small businesses do not pay dividends, we must determine the near capital needs, expansion plans, debt repayment, operations cushion, contractual requirements, past dividend history, and dividents of a comparable company. After we analyze all of this information, the per cent of net income and average net cash flow can be used to estimate the dividend. We then need to determine the dividend yield and then compare this to a similar business. As you can see, this can be somewhat subjective, like the price earnings method.
8. Sales Multiple Business Valuation ‐ Sales and profit multiples are probably the most recognized and quoted methods of business valuation. These are median benchmarks that require two basic types of information: annual sales and an industry multiplier. These multipliers will start at a low of .25 and increase to 1 or higher. The multiplier can usually be found in industry publications or financial publications and will vary from time to time. This is easy to use and understand, but remember this measures the median so half are higher and half are lower.
9. Profit Multiple Valuation ‐ Profit multiples like sales multiples, are a widely used benchmark used to value a business. The information we need to reach a value is pre-tax profits or earnings before interest, taxes, depreciation and amortization (EBITDA) and a multiplier usually a low of 1 and a high of 5. Look for the multiplier in financial publications or comparable business analysis information. Again, easy to use and understand, but lacks depth and is based on a median average.
10. Liquidation Value ‐ Sometimes you will hear this method referred to as adjusted book value. But Liquidation value is different in that it uses the value of all assets at liquidation. This is often a smaller number than market value. Liabilities are deducted from the liquidation value of the assets to determine the value. This is an extremely low value. Liabilities are deducted from the liquidation value of the assets to determine the value. Naturally, this is an extremely low value and considered the "bare bones" benchmark.
11. Replacement Value ‐ Here we are looking at the market cost of replacing the assets of a business and then deducting the liabilities from that number. This will give us a higher number than liquidation and higher than the book value of the company. In theory, what we learn here is the replacement value of the business.
12. True Value Business Valuation ‐ The True Value of a Business is the amount that a Buyer is willing to pay. After all is said and done, this is the “Real Value”.
The bottom line is that there is no “magic formula” that dictates what a business and its assets are worth. The process consists of gathering the information about your business and communicating the many parts into a valuable whole that Buyers and Sellers can agree on. You should specialize in an industry to make that successfully work. Automotive Business Brokers does just that - specializes in the automotive industry. We take our broad depth of knowledge of the automotive marketplace and brings value to the table for both parties. What is your business worth? Whether you are selling or purchasing, we can lead you through the process and show you the real value of your asset.
Ever wanted to know what your business is really worth? Automotive Business Brokers offers a "Snap Shot" business valuation to all of our clients to help them determine a TRUE market value for their business and provide the tools to help them make important business decisions.
Call Automotive Business Brokers at 770-885-0000 for a confidential discussion regarding your business valuation!