Asking for Guidance (Part 1 of 3)

Asking for Guidance (Part 1 of 3)

THE INITIAL QUESTION:

Dear Bill:

I hate to take up your time, but I have a matter you may be able to help me with. I got your name from the BBP publication. What I’m looking for is an indication of a pricing mechanism(s) for an “Executive Office Suites” business, which a friend of mine established in Massachusetts and has owned and operated for 25 years. My research on pricing and/or sales has proven very unproductive.

He improved the raw space, has 65 offices for rent in an excellent location on a major thoroughfare in a large office complex, provides the usual secretarial, phone, etc. support, but rents the 17,000 square feet from the landlord. He is 95% occupied.

Do you have any ideas about to put a proper value on this business? I know we can price on earnings, but I’m not sure how to deal with the revenue, LHI, furniture, telephone system (new and very expensive), etc.

I would sincerely appreciate any guidance or suggestions you could give me.

Thanks in advance and best regards,

Ron
Business Broker


MY REPLY:

Ron, I’m happy to try to help you with this project. Of course, the below is just “one man’s opinion”….but, it’s based on our having sold hundreds of commercial service businesses, over the last 30 years I’ve been a business broker. I hope you’ll forgive me for the length of the email, but, I think these issues are so important, that they deserve a proper explanation, not just on this opportunity, but on any listing.

(1) You will not be able, in this case, to tap into some data base of info that will help you price this type of business. Unlike other businesses (fast food, laundromats, manufacturing, etc.), where there is ample info from Pratts Stats, The Business Reference Guide, and other sources, executive office suites are (a) a very tiny % of the number of businesses that exist, and (b) therefore, not much info is available from brokers brokering them.

(2) Another pricing/valuation problem can be the asset value and/or the overhead costs, which some brokers/evaluators get “hung up on”. Some Executive Office Suites, for example, will have ultra modern FF&E, others will have older equipment. Some will be in ultra fancy locations, in high rise office buildings, others will be in older, less dazzling buildings. It’s the same problem I’ve always had with any “asset based”, or Rules of Thumb methods of valuations, in that, when using a Rule of Thumb, or a recapture for the seller of their investment in ff&e valuation method, or if the price of a business is based on a percentage of the annual sales volume, those methodologies don’t take into account the variance in overhead costs and net profit. For example, some in our industry say that Subway Shops will sell for 60% of annual sales. But, I’ve found that a Subway doing $400,000 per year, that pays $4,000 per month rent, and is earning less profit than one doing $400,000 that pays $3,000 per month rent, cannot be valued using the same Rules of Thumb. I can always sell the more profitable Subway for more. So, in that case, the “% of sales” criteria, if used alone for the evaluation, is bogus.

(3) We’ve been forced to determine our own “formula’s” for evaluation, and that’s been, in my opinion, the “secret” to my agencies having been able to sell over 60% of all the listings we’ve taken in the last 30 years, instead of the 20% Tom West’s annual survey proves is what typical business brokerages sell, of their total listing inventory. In good times and not so good times, we’ve been able to sell 60% (and, in some years, even more) of our listings. In fact, we’ve sold 80% of all the listings I’ve personally listed, because I’m a fanatic about pricing them in conformance with our formula’s.

And, by pricing them “realistically”, not only do the buyers respond positively to that pricing theory, these pricing practices make the financing (at traditional

lending institutions) much, much easier, as well.

I’ve found that, even if a broker can successfully convince a buyer to pay a Rule of Thumb price, or a price based on the supposed value of the assets, if that price, after deducting the buyer’s down payment, won’t (a) service the contemplated loan payments, and (b) deliver to the buyer, after overhead and loan payments, an amount of salary that allows the buyer to survive financially, “in a manner his family is used to”, and (c) also deliver an impressive Return On Investment (return on the down payment) annually, either the buyer’s banker, or his accountant, or his attorney, or someone else the buyer relies on for good advice, will eventually convince the buyer to withdraw, pre-closing.

It’s heartbreaking to watch brokers, year after year, decade after decade, improperly price businesses, then spend important advertising time and money

promoting the listing, then watch them invest more time and money working with buyers, even getting an offer, then watch it all fall apart, because it really wasn’t a “good deal” (which, in my opinion, means a deal that will/or won’t satisfy 3(a), (b), and (c).

So, my “formula’s (example below) are based not on Rules of Thumb, nor on the appraised value of the FF&E or other assets, nor on comparables of similar businesses sold, but are based on a conservative analysis of the seller’s cash flow, and how that will likely impact on the buyer. My agencies aren’t the first brokerages, nor the only brokerages, that follow the “multiple of cash flow” methodology. But, we are one of the few brokerages that also impose the other conservative “rules” described in this memo, which, along with the multiple of cash flow, are, collectively, “the formula”.

(4) Yes, I understand all the arguments against the “multiple of cash flow” theory. I’ve heard those arguments, from sellers, from brokers I’ve met at the IBBA, and in friendly debates with accountants, lawyers, and other “experts”. In fact, most business brokers, including some of the most famous (and most successful empire builders) in our industry, prefer to fill their agencies with all the listings possible, almost regardless of merit, rather than “say no” to an unreasonable seller. But, with 30 years experience being able to sell listings at a rate that is arguably 300% better than most of my cohorts in business brokerage, I’m a “hard sell”, for anyone trying to convince me to price differently.

(5) Yes, there are exceptions to our “formula’s”, and there are variables. Since we’ve sold over 4,000 businesses in my agencies over the years, we’ve developed our own wonderful data base of comps, and, we’ve “fine tuned” the formula’s, and introduced some interesting and highly effective variations. I won’t try to explain those to you in this report.

 
 
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