The following case study is designed to give prospective
business acquirers, business owners, financiers, and
advisors some insight into the role an independent business
valuation may have in identifying mispricing of assets and
grounding expectations regarding price and value.
The Canteen is a local franchised restaurant and pub
serving quality lunches at reasonable prices at ten area
locations in the tri-city area. The franchise is
well-known throughout the region and has a strong customer
base, ranging from professionals on the go to retirees and
local college students. The Canteen's five area locations
are organized as individual corporations which are, in
turn, owned and operated by Thor Holdings, LLC, a local
company that also owns several other franchise restaurants,
ice cream shoppes, and gourmet coffee houses. Louie
Peters, Helga Stevenson, and Harvey Rogers own Thor
Holdings, LLC and are seeking to sell two of the Canteen
locations that are outside their immediate territory. They
had started the two locations about eighteen months ago as
part of an expansion plan incentive offered by The
Canteen's parent company. Since then, Thor Holdings
declined the rights to additional franchises in those
outlying locations.
The two Canteen locations that Thor Holdings is seeking to
sell had revenues of roughly $750,000 each in the last
fiscal year as compared to the other locations that each
generated revenues in excess of $1 million per year. Both
locations have had trouble maintaining quality staff, and
the managers have been largely unsuccessful in running the
business and controlling costs. However, the locations are
in high traffic strip malls where rent is roughly $10,000
per month. These two locations experienced net losses for
the last fiscal year of roughly $50,000 each.
Mark and Diane Jones both work at one of the Canteen's more
profitable locations. Upon hearing rumors that Thor
Holdings is contemplating a sale of the two underperforming
locations, they approach Louie Peters to discuss the
possibility of purchasing the franchises. All parties
agree that this would be an ideal situation, given Mark and
Diane's background with the Canteen and their commitment to
increasing the franchises' revenues through additional
marketing and cost cutting initiatives. Thor Holdings
offers to sell the two franchises for an aggregate price of
$1,000,000. Mark and Diane agree, in principle, on the
price. The deal is contingent upon their ability to secure
financing for the acquisition.
Mark and Diane consult Lee Davis, a local business
consultant and former head of the state's Small Business
Development Center who has extensive experience in
negotiating deals and working with entrepreneurs to develop
a viable business plan. After reviewing the tax return
(which lacks a balance sheet) provided by Thor Holding's
accountants, Lee has several concerns over the viability of
the plan. Mark and Diane believe that they will be able to
increase sales by over $200,000 at each of the locations
within twelve months. In subsequent years, they anticipate
sales to increase by 8% annually. They expect to
accomplish this through increased advertising initiatives
that will have a marginal cost of $10,000. In addition,
they estimate that employee retention and training programs
will help to reduce their turnover expenses by roughly
$20,000 per location. They also believe that they will be
able to reduce their cost of sales from 35% to 30%, saving
$50,000 at each location, through better employee training
and inventory management. The other Canteen locations have
cost of sales of roughly 32%.
As a way of assessing the acquisition of the Canteen
locations and in order to facilitate the lending process,
Lee suggests that Mark and Diane engage a business
valuation firm to provide an estimate of the fair market
value of the firm. They agree to this and feel this is an
excellent way of obtaining an impartial opinion on the
value of the business relative to the price being paid.
The valuation analyst receives the tax returns for the
Canteen locations. The valuation utilizes an income
approach and a market approach to value these two
locations. Within these approaches, the valuation analyst
employs the multi-period discounted earnings method (income
approach) and the direct market data method (market
approach). The final value estimate for each of the
Canteen locations is $300,000 for a total value of $600,000
for the two locations. In arriving at this indication of
value, the valuation analyst suggests the following:
There is little to suggest that Mark and Diane will be able
to reduce the cost of sales at each location to 30%, a
level that is below that of the other Canteen locations,
particularly given that the cost of sales is now in excess
of the average.
The growth expectations for the two locations are higher
than the current and historic growth rates of the more
established Canteen locations. The 8% growth rate is
unlikely to be sustained indefinitely into the future.
The valuation analyst states no opinion as to the
likelihood of the marginal increase in advertising to
increase sales by such a disproportionate amount.
After a visit to both locations, the valuation analyst does
not believe that the local traffic is sufficient to support
any dramatic increase in sales. Further, the analyst does
not believe that the locations are conducive to the
business.
The break-even point for each of the Canteen locations is
roughly $1.1 million. The ability of the firm to reach
this level of sales is possible only under highly
optimistic projections. In addition, Mark and Diane would
likely be forced to make additional capital contributions
to the business in order to maintain operations until they
reach break-even.
In light of the comprehensive valuation report, Mark and
Diane begin to reassess their acquisition of the two
Canteen locations. Lee is glad that he arranged for the
valuation to be conducted. The bank is also glad to have
the insight on the business in order to more fully assess
the loan request. Thor Holdings is not pleased with the
results of the valuation and its role in killing the deal
that would unload these two unprofitable assets that are a
drain on the resources of the other Canteen locations. The
Thor owners realize, however, that it is the job of the
valuation analyst to provide an objective opinion of value,
not to work toward a particular value that would get the
deal done.
This case study should clearly indicate the value-added
nature of business valuations when entrepreneurs are
assessing the acquisition of an existing business. The
prospective owners benefit from the valuation of the firm
which reveals, in this case and in many others, that the
companies being acquired are underperforming assets that
warrant a lower valuation than the contemplated transaction
price. The valuation report may also serve as a reality
check to the prospective buyers by providing an independent
assessment regarding the future earnings potential of the
firm and the errors or overreaching in their assumptions
regarding future operations. In addition, the bank
benefits from not making a loan to the prospective buyers
whose business venture would likely be doomed from the
start. Finally, Thor Holdings could also benefit by
considering its options for the two underperforming
locations—close the locations and liquidate the
limited assets, maintain existing operations that drain the
other resources of the company, or sell the locations to
Mark and Diane at a lower price that is more reflective of
fair market value.
----------------------------------------------------
Robert M. Clinger III has strong experience in the fields
of business valuation and financial analysis, having earned
the Accredited Valuation Analyst (AVA) designation from the
NACVA and the Certified Business Appraiser (CBA) More
information on business valuations/appraisals may be
obtained by visiting Highland Global's website
http://www.HighlandGlobal.com .
No comments:
Post a Comment