How to Value a Care Home Business
Accurately valuing the small business aspect is often the most challenging part of the process for buying a care home.
Naturally, a buyer's valuation is usually quite different from what the seller believes their business is worth. Sellers are emotionally attached to their businesses. They usually factor their years of hard work into their calculation.
The challenge for the buyer is to formulate a valuation that is accurate, and will prove to provide the buyer with an acceptable return on your investment.
There are several ways to calculate the value of a business:
Asset Valuations: Calculates the value of all of the assets of a business and arrives at the appropriate price.
Liquidation Value: Determines the value of the company's assets if it were forced to sell all of them in a short period of time (usually less than 12 months).
Income Capitalization: Future income is calculated based upon historical data and a variety of assumptions.
Income Multiple: The net income (profit/owner's benefit/seller's cash flow) of a business is subject to a certain multiple to arrive at a selling price.
Rules Of Thumb: The selling price of other "like" businesses is used as a multiple of cash flow or a percentage of revenue.
Let's look at each to determine what's best:
Asset-based valuations can work for some small business purchases. Assets are used to generate revenue and nothing more. If a business is asset rich but doesn't make much money, how valuable is the business altogether? Conversely, if a business has limited assets, such as computers and office equipment, but makes a ton of money, isn't it worth more?
The asset value of a care home are the beds, kitchen, dining, living room furniture, the business equipment, and all other personal property (not real property) to run the care home. Valued in its current condition, these items used, generally do not have a strong value.
The Liquidation Value is the amount of money a person will receive for selling the business assets in the open market in its current condition. A care home’s assets of used beds and other furniture does not create much value.
Income Capitalization is generally applicable to large businesses and most often uses a factor that is far too arbitrary for most small businesses. But the process of future income being based upon historical data has some value in a care home operation. The number of clients generally is determined by the license. Therefore a change in income would mean a significant change in license and operation.
The "Rule of Thumb" method may be too general since it's hard to find any two businesses that are exactly the same. Valuation must be done based upon what the buyer can reasonably expect to generate so long as the business's future is representative of the past historical financial data. Notwithstanding this, the "Rules of Thumb" methodology is a good place to start, but is a bit too broad to consider by itself.
The Multiple Method is one of the best ways to evaluate a care home business. You have probably heard of businesses selling at "x times earnings." However, this can be quite subjective. When buying a small business, every buyer wants to know how much money he or she can expect to make from the business. Therefore, the most effective number to use as the basis of your calculation is what is known as the total "Owner Benefits."
The Owner Benefits amount is the total dollars that you can expect to extract or have available from the business based upon what the business has generated in the past. The beauty is that unlike other methods (i.e. Income Cap), it does not attempt to predict the future. Nobody can do that. Owner Benefit is not cash flow! It is, however, sometimes referred to as Seller's Discretionary Cash Flow (SDCF).
The theory behind the Owner Benefit number is to take the business's profits plus the owner's salary and benefits and then to add back the non-cash expenses. History has shown that this methodology, while not bulletproof, is the most effective way to establish the valuation basis of a small business. Then, a multiple, based upon a variety of factors, is applied to this number and a valuation is established.
The Owner Benefit formula to use is:
Pre-Tax Profit + Owner's Salary + Additional Owner Perks + Interest + Depreciation less Allocation for Capital Expenditures
Add Back Depreciation
Depreciation is an expense that allows a business to deduct a certain amount of money each year from an asset so that its purchase value is reduced by its overall useful life. As an example: if the business buys a $20,000 van to transport clients and its useful life is estimated at 5 years, then each year the company can deduct $4000 off its income to lessen its tax burden. However, as you can see, it is not an actual cash transaction. No money is physically leaving the business or changing hands. Therefore, this amount is added back.
What Multiple to use for buying a care home?
Normally, small businesses will sell in a one-to three-times multiple of this figure. A care home business can create many tax deductions which reduces the net income which makes knowing what multiple to use a harder proposition. With that in mind, 1 to 3 times is a wide range. So how do you determine what to apply? One best mechanism is that a one-time multiple is for those businesses where the seller is "the business." In other words: "as the seller leaves, so too can the customers leave." Consulting businesses, professional practices, and one-man businesses come to mind.
Businesses that have a strong track record, repeat clients, historical pattern of growth, more than 3 years in business, perhaps some proprietary item, or an exclusive territory, a growing industry, etc., will sell in the 3-times ratio. The others businesses fall somewhere in-between.
The Owner's Benefit number if added to the income is considered. But if there is no income or the Owner's Benefit number is taken separately, then a new multiple figure can be used.
Return on Investment (ROI)
What is the Return on Investment (ROI) that a buyer calculates to achieve when buying a business? Return on Investment in part is determined by risk. In some low risk investments a ROI of 5% is great. The ROI on some slightly higher risk commercial real estate, which is a solid, stable investment, then 10% return on your money would be the goal
Buying a business is clearly a greater risk. Many feel that a 25% return on your investment should be the minimum. If negotiated well or you feel the business is more risky, then ask for a higher ROI in the range of 35% -50%.
Some basic skills needed to evaluate a care home:
Know how to read an income statement and other accounting statements.
Know how to determine the true Owner Benefits of the business.
Be careful about the add-backs. Make certain that any benefits being added back are not necessary expenses needed to run the business. You can only add back something that has been expensed.
Calculate a multiple in the 1-3-times window based upon the business's strengths and weaknesses. Note that the multiple will increase along with the Owner benefit figure.
Understand that value is personal. If the business is right for you, it is all right to pay a slight premium
Consider applying other valuation formulas simply as a test to your figure.
Property value is very important to a care home business. Understand the real estate market for the location of each care home.
Business valuations are not scientifically based; they're subjective.
Use a variety of methods.
Owner Benefits is the number on which to base your multiple
Uncover how the seller established the asking price. Valuation is a personal formula.
Put yourself in the other’s shoes: What is the business worth to the buyer? Or what is the business worth to the seller?
The buyer will consider the potential return on your cash investment.
The seller will consider how the transaction is funded.