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Business Evaluation and Valuation (Part 2 of 2)

Howard Scott |

Richard Ehrenreich, president of Olney, Md.-based Ehrenreich & Associates, continues explaining how he evaluates drycleaning operations and places value on them, in his own words (Editor’s note: read Part 1 of this story here.). Ehrenreich has so far assessed the bussiness' strengths and weaknesses and suggested ways to improve cashflow in advance of a possible sale.
The next step is weighing the various factors and their importance to the final price to ask or offer. “Once we get our financials down to what we think is an accurate reflection, we fully evaluate each operating plant, analyzing each aspect, and giving each component a 0 to 4 rating — 0 being the worst and 4 being the best,” Ehrenreich says.
“We grade each plant on 60 individual components including location, businesses trends, employees, pressing capabilities, plant efficiency, route sales, trends, marketing and more. We take a hard look at each area, assessing how the pieces work together. Company-owned drop stores are graded using a similar, 40-component matrix, and the various values are merged together.
“Once we review the components, we assign a weight to each segment from 1 to 3 according to value and importance. In other words, some components are more important than others, and they can vary from company to company. For instance, visibility isn’t as important in a small town where there is only one drycleaner; everyone simply knows the sole drycleaner in town.
“Providing weighted averages assigns importance in two-dimensional terms. For example, if two different plants earn a 4 and a 2 in a certain category with weighted values of 3, the resulting values for the two plants would be 12 and 6. These numbers will have far greater significance than components with weighted averages of 1, which result in a 4 and 2. In the first example, the first plant has six more points, and in the second example, the first plant only has two more points.
“Then, we look at macroeconomics — factors an owner/operator doesn’t have any control over. We seek out factors that either improve positive or reduce negative values. For example, today’s economy makes it difficult to sell any business, due to poor sales, lack of commercial financing and a “buyer’s market.” We also investigate governmental regulations in the area and how they might change in the future.
“We summarize these macroeconomic factors into a multiplier. It might be 100%; this will produce no change. But, if there are more negatives than positives, it might be 75%, which will lower the plant’s value. On the other hand, it could be 125% if factors are mostly favorable, raising the value of the operation.
“We take all of this input and come up with another multiplier to determine the final business value by multiplying it against the adjusted profits. For example, a business generating $40,000 in owner’s discretionary cashflow or profit with a 3.2 multiplier would give us a fair market value of $128,000 in our range of values.”ALTERNATE VALUATION METHODS
Ehrenreich occasionally strays from his time-tested formula based on the demands of the sale. “We can also use other recognized methods of determining the value of a drycleaning operation that aren’t as complex or as specific to industry as our proprietary methods.
“Using an alternate method of establishing Fair Market Value (FMV), we look at all sources of revenue, including the plants’ over-the-counter (cash-and-carry vs. accounts), pick-up (owned or wholesale) volume, commercial accounts, hotels, fire-restoration business and delivery routes.
“We value each different revenue stream by evaluating how solid it is, its consistency, what contracts are in place, how much complementary work is done, and what the history of claims and costs associated with the revenue stream is. Depending on the analysis, it might come out like this: 100% plant, 150% fire restoration, 80% drop stores and 50% wholesale.
“Then, we adjust the revenue to an adjusted gross sales figure and multiply this number by a fraction developed from the above evaluation. We also consider macroeconomic factors to arrive at another form of FMV. If a business has the potential to be sold to a member of the Korean community, we can use the formulas they prefer for a valuation.”ARRIVING AT A PRICE
“After we have determined Fair Market Value, we sit down with the client to discuss our findings, offering a “greedy seller” high end of the price range, as well as a “frugal buyer” low end of the range. We also discuss variables that can help determine where the final sale price falls.
“As you can see, valuation of a drycleaning business isn’t valuation of a residential house. In residential transactions, neighboring home sales are recorded and available to the valuation professional; he or she can obtain these numbers and factor in differences in time and features to do a reasonable analysis to determine value.
“With a drycleaning business, there is no source for comparable sale amounts. Individual transactions are very different due to owner or bank financing, real estate ownership and lease arrangements, the transfer of cash and assets, owner consulting arrangements, noncompete agreements, etc. These items and the aforementioned valuation methods are the ‘science,’ but the seller’s and agents’ experience and judgment also come into play.
“As with any market-driven sale, there’s only one true value, which is what a knowledgeable buyer and seller agree upon after a reasonable exposure to an open market. Thus, the ‘art’ is perhaps more important than the ‘science’ when it come to the actual sale of a business.
“In my consulting practice, we focus on the larger drycleaners — those doing $500,000 to $5 million in annual gross sales. We train the owner/operator to analyze his business — to see the good, the bad and the ugly. That’s a big help in making a sale.
“We try not to deal with owners who want to sell out of greed,” Ehrenreich says. “Their expectations are usually not realistic, and they are hard to get to the table. Owners who have a real reason for selling, on the other hand, need help in selling their businesses.”Two years ago, Ehrenreich entered semiretirement and dedicated himself to running the MidAtlantic Association of Cleaners (MAC), offering limited coaching to MAC member cleaners and select clients. For specialized consulting services, contact Ehrenreich at ehrenassoc@comcast.net or call 301-570-3000.
 

About the author

Howard Scott

H&R Block

Industry Writer, Drycleaning Consultant, and H&R Block Tax Preparer

Howard Scott is a longtime industry writer and drycleaning consultant, and an H&R Block tax preparer specializing in small businesses. He welcomes questions and comments, and can be reached by writing Howard Scott, Dancing Hill, Pembroke, MA 02359.

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