Service Companies
The most important asset of a service company is its employees, from senior management to the most recent hiree. An equally important asset is its customers. The third major asset is the business system utilized by the company. This section focuses on middle-market service companies with sales of from $2 to $150 million.
Such service companies are very difficult to value, since they are highly dependent on the personal relationships of the management and its customers. In talking to the owner of a very profitable public relations firm who wanted to sell her company, I was stunned to hear that she not only got up for work every morning at 4:30 a.m. but was responsible for securing every new account in the agency. Even though she would stay on for a period after the business was sold, this superwoman was almost irreplaceable!
The company had $3 million of annual billings and reconstructed net before tax of about $300,000. Is this business worth $1.5 million? Possibly, but more important is the payout period and the extent to which the owner will remain in the business to retain the key accounts and teach the new CEO how to run the business. The most critical issue is the retention of the existing accounts, and for this reason the purchase agreement might be constructed as follows:
Payment at closing $ 500,000
Payment in 1 year 333,000
Payment in 2 years 333,000
Payment in 3 years 333,000
Total $1,500,000
Conditions:
1. Owner works for two years at base salary or for one year plus two years as a consultant.
2. Any loss of an account existing at the time of closing will reduce payout by 50 percent of one year’s billing of that account.
3. A loss in the third year will reduce the payout by 25 percent of one year’s billing.
Service businesses are varied, and for this reason it is very difficult to generalize valuation techniques that will cover all situations. Glenn Desmond, in his book Handbook of Small Business Valuations, (contact Business Brokerage Press, P.O. Box 247, Concord, Mass. 01742) lists some of the advantages of using rules of thumb or formulas for small service businesses:
1. They are market derived and provide market comparisons.
2. They provide a uniform guide and a range of values.
3. They are easy to use and can be used for preliminary value estimates.
The disadvantage of using rules of thumb is that they are general in nature and there is no single, all-purpose formula.
In the book Guide to Business Valuations by Fishman, Pratt, Griffith, and Wilson, it is stated that “rules of thumb should not be used by themselves. They may, however, be useful in assessing the reasonableness of valuations based on other methods.” Some examples of rules of thumb are:
Janitorial service:
4 times monthly gross billings plus equipment and inventory.
Travel agency:
35 percent of annual gross sales plus furniture and fixtures.
* Source Adams - Buying Your Own Business
Identifying opportunities, Analyzing true value, Negotiating the best terms... by Russell Robb