The long-term plan is for him to buy out my shares someday. When we reach
that point, how should we determine the value of the company? Are there
rules of thumb based on a multiplier of sales or profits or some other
financial indicator?
San Francisco cyclist
A: The business brokerage industry does have standard formulas for valuing
most kinds of companies. The Business Reference Guide - an annual publication
by Tom West, available at www.businessbookpress.com - provides such formulas
or "rules of thumb" for more than 550 different kinds of businesses.
Bike shops on average are valued at 20 percent of annual sales plus inventory,
or 1.5 times available cash flow plus inventory, according to the 2007
edition of the guide.
But - and this is a very big "but" - such formulas are only
a very gross generalization. They may not apply to your particular shop.
"The problem with rules of thumb is that they are generic or average,
and nobody is average," said Russell Brown, publisher of the Business
Reference Guide. "I'm not a big fan of them even though I compile
this book on rules of thumb."
The actual value of any business depends on specifics that may not easily
boil down into a simple multiplier: How long has it been in operation?
Does it have name recognition and a loyal customer base? How profitable
is it, once you account for all the free labor that the owner may have
been putting in? Does it have skilled workers who will stick around if
the business is sold? If it's a retail store, is it in a prime location
with lots of pedestrian traffic?
In the case of a bike shop, the value also depends on whether the shop
does repairs along with sales. And it depends on the kind of bikes sold
by the shop. Does it have a unique niche or is it competing with Target
and Wal-Mart?
"The thing that hangs over any retail business is that the barriers
to entry are often quite low," said Brown. "Almost anybody with
some knowledge of bikes and repairs can open a shop. So if I were doing
an appraisal, I'd ask whether they were selling high-end bikes or bikes
that could be bought anywhere."
When you're closer to exiting this business, you and your friend should
obtain an independent analysis of its value. One approach is to hire an
appraiser, business broker or accountant with business valuation experience.
You can find such folks through the National Association of Certified
Valuation Analysts at www.nacva.com or the Institute of Business Appraisers
at www.go-iba.org.
There are also do-it-yourself software programs for business valuation,
including one called BizPricer produced by Brown's firm.
The two of you should agree in advance to abide by the valuation - because
it's likely that one of you may be disappointed by what it says.
"Every seller probably values the business at twice what it's worth,
since we all want more money," Brown said. "I've had guys come
to me who are at each other's throats or in lawsuits over what constitutes
the value of the business. There can also be fights over what's in and
what's out. Say the company car is a Mercedes: Is it part of the business
or does it belong to the partner who's been using it?"
I suspect that, as a bike shop, you don't have a company Mercedes. But
the point is the same. No matter how valuable this shop is, it's not worth
ruining your friendship.
Want to learn more about business valuation? BizBuySell.com, which lists
businesses for sale, offers tips on valuation at links.sfgate.com/ZBVL.
Or see links.sfgate.com/ZBVM.
