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Opinion of Value - Guidance in a Sale or Purchase

By Robert Roman

02/01/15

An opinion of value report (OVR) is an estimate of a commercial property’s current fair market value based upon an assessment of market and property conditions that affect its commercial value.

Fair market value is defined as the price at which a business would change hands between a buyer and seller that are both willing and knowledgeable.

An OVR is prepared when an owner is seriously considering the possibility of selling and, while not intended to be definitive, frequently provides that owner with guidance on when and how to proceed.

The report is compiled by independent third parties such as consultants or real estate brokers who have intimate knowledge of the car wash industry. However, an OVR should not be considered an appraisal because information may be incomplete or imprecise and market conditions do change as can be seen in Figure 1, below.

In arriving at an indication of value, the analyst must exercise considerable judgment about the history and nature of the company, the economic outlook, financial condition of the company, future earnings capability and associated risks, cash flow, and the worth and value of the goodwill of the company.

Preparing an OVR for a closely held business such as a car wash is not an exact science and there is often a disparity in OVR values and those arrived at by certified property appraisers.

The reason for the disparity is appraisers are more concerned with the purpose or type of value to assign to the property and not whether a property will sell at the appraised price. Conversely, the focus of an OVR is with function and less with justification. Here, the goal is to ensure that a property will sell at the price designated by the market analysis.

The true investment value of a car wash business to a potential buyer is the free cash flow or current net earnings. For example, if new equipment is purchased for an express conversion, the owner should be able to pay for it over a period of time from the resulting savings in labor costs. Similarly, a car wash business should be able to pay for itself in three years, assuming earnings remain stable for that time period.

To illustrate, let’s develop an opinion of value for a one-person mobile detail business. This is an established business with a customer list that has generated recurring revenue for several years.

 

GOODWILL

According to the experts, a significant portion of the value for a small business is generated from intangibles (goodwill) that create income and not hard assets like the furniture, fixtures, and equipment (F/F/E).

Goodwill can be described as the difference between the preliminary value of a business and the liquidation value of F/F/E. Preliminary value is determined by available cash flow (ACF) and the risks associated with obtaining it.

The first step in valuing goodwill is to calculate the weighted-average adjusted ACF which is also referred to as earnings before interest, taxes, depreciation and amortization (EBITDA), and before owner’s discretionary expenses and adjusted for extraordinary and nonrecurring income and expense items.

The factor by which ACF is multiplied to determine the preliminary business value depends on how much risk is involved in the continued profitability of the business under the new ownership. The lower the risk, the higher the value.

For example, most analysts opine a small personal service business, like our mobile detail operation where the owner will be the only professional service provider, is worth about one times current profits. The reason for one times profit is risk.

Since a mobile detail operation has no real estate development and ownership investment risk, the risks are competitive risk of producing sufficient gross sales and operations risk of ensuring effective and customer-centric operation.

For example, because there is no one else to run the business, continuation of earnings would be at serious risk if our detailer broke a leg. Risk is also high because there are few barriers to entry from new competition. Likewise, without seller financing, the purchase may be difficult because there are few hard assets for a bank to collateralize.

ACF is based on the premise the most recent financial results are the most predictive of future earnings and should carry greater weight over the time span under consideration.

So, ACF is calculated as ($48,825 x 1) + ($68,700 x 2) + ($68,700 x 3) / 6 = $65,388.

Applying the valuation formula results in the preliminary value of the company as $65,388 ($65,388 x 1.0).

To arrive at an overall value for 100 percent of the company, it is necessary to adjust the preliminary value for assets included in the sale such as inventory (saleable), equipment, tools, and other assets (if applicable) less any liabilities to be assumed (i.e., outstanding redeemable vouchers).

For example, to be conveyed with this business is $2,500 in inventory and $10,000 in equipment and vehicle. Consequently, the business would have a concluded value of $77,888 ($65,388 + $2,500 + $10,000).

The goodwill value of this business is calculated as the preliminary value less the liquidation value of F/F/E. Here, the liquidation value is $2,500 ($10,000 x 0.25). Thus, goodwill is $62,888 ($65,388 - $2,500).

Of course, this opinion is only as good as the quality of the information that was used. Here, particular scrutiny would be given to ensure business-operating records correspond to tax flings and verify the integrity of the customer list.

 

CONVEYOR WASH

Next, we tackle a conveyor car wash. The designated property comes from my internal files so the information has been massaged or obfuscated to protect confidentially.

ACF is calculated as ($102,200 x 1) + ($303,400 x 2) + ($341,100 x 3) / 6 = $288,717

Here, the valuation formula is based on guidance: an established business with no significant advantage, some competitive pressure, and requiring continual management attention is worth a multiple of between two and four times current profits.

Determining a multiple from this interval requires combining pertinent elements of most published capitalization rate estimation processes and subjectivelyrating risk associated with the continued operation of the business.

This means evaluating elements we mentioned in the detail example as well as growth projections, expansion opportunity, management retention, operational analysis, industry strength, environmental risk, and other factors.

After evaluating these factors, our model indicated a multiple of 3.43 and the preliminary value of this company was calculated as $990,300 ($288,717 X 3.43).

Other assets were $500,000 in real estate (based on market comparisons) and $1.2 million in improvements, building and F/F/E (replacement cost new). Inventory was $5,000.

Thus, the concluded value for 100 percent of the company was $2.7 million or a sales multiple of 4.15, which is fairly consistent with current broker’s equation of 4.3 to 5.0.

In the final analysis the price or value is up to the buyer and seller. An OVR provides a logical and economical way to address this based on a company’s sales, earnings, balance sheet, and other considerations.

 

Bob Roman is president of RJR Enterprises – Consulting Services (www.carwashplan.com). You can reach Bob via e-mail at bob@carwashplan.com.



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