This article are provided for information purposes only, and are not intended as legal advice.


Why is it so difficult to value a business?

May 20th, 2009

You are your reviewing your personal situation and you need to value your business, for estate planning purposes or in case you are planning to sell the business.  You see ten different valuators and everyone comes up with a different value of your business and everyone has a disclaimer saying that the actual selling price could be different.  The true value of the business is what someone is willing to pay.  Until you find that person, you never know what the final price will be.  When you sell your house, if you live in a subdivision, many houses are either identical or very similar, the lot is the same, the front elevation may look different but the house is very similar.  One house may have a few more upgrades and you can factor that into differentiating the two houses.  It is much easier to value a house because you can compare it to the house that sold in the same neighbourhood.

 

When if comes to a business, no two businesses are identical.  You have have a franchise with identical name, price of products etc but no two locations have the same value – why?  Each location is unique, the traffic count could be different, the product mix could be different, the average purchase price and average sales per customer can be different.  What is the same between these two businesses – the name and nothing else.  One location could be making money and another could be losing money, they cannot be valued the same. 

 

Many years ago I saw a fast food franchise, it was in an office building.  Two main tenants of the building moved out but were still paying the rent because they were unable to sublet the space.  As far as the landlord was concerned, the building was fully occupied however the head count in the building was down by 50% because of so many vacant floors in the building.  As a result of the lack of people in the building, the fast food restaurant was struggling and ultimately went bankrupt.  The fast food franchise has a location in a hospital which has a very large traffic flow, open 7 days per week vs 5 in the office building.  Are the two locations worth the same? absolutely not. One has revenue 7 days per week probably for 15 hours per day or more, the other was open 5 days a week from 6 am until 3 since no one went to the fast food place for dinner.  Revenue was probably a fraction of the hospital franchise.  Given the choice, which one would you pick? 

 

Some people would pick the slower location because the business was only 5 days per week and they could be home for dinner.  Others, would pick the place based on profitability and would be willing to pay a significant premium for the steady traffic.  There is a potential buyer for both locations but they would not be worth the same amount of money if both were put on the market to sell.

 

You also have to look into how long is the lease on the property.  I saw one case where the landlord was not going to renew the lease at the end of the lease agreement and there were two more years left on the lease.  That meant the business would only survive for another two years and it would have to relocate or close down.  Is that worth the same as a business that can stay in the premise indefinitely?  What about local bylaws. Many cities do not smoking in restaurants.  If you lived in a city which allowed smoking, you would have more traffic than the one across the street from you in a different city.  Which one is worth more, the one with the extra traffic however if you know that the zoning bylaws will change and the two locations will once again be put on equal footing, then the premium for the additional traffic will be only for a very short period of time.

 

I have given just a few examples and you can see that no two businesses are identical, they may have similar names and products but each business is different from the other. 

 

Blog to be continued tomorrow.


Filed under: valuation of a business — Gary Landa @ 10:09 am


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