How Algorithms Stack Up Against Expert Insights: Navigating the Art and Science of Business Valuation

There are many triggers for a business valuation. In this case, the trigger was the passing of a restaurant owner. Some keys to the story:

·???????? His estate was placed into a trust with his mother as the executor of his estate. There were specific instructions on how the restaurant owner wished his estate to be handled. The primary pieces being the sale of his home and his business.

·???????? The restaurant owner passed away in August of 2023

·???????? Valuation analyst was engaged in October of 2023

For the purposes of this story, let’s call the restaurant owner Johnny and his mom June. As mentioned, June was named the executor of his estate. She did not know where to start with valuing the restaurant that her son had built up over an 8-year period. So, she went to the company’s CPA. The CPA utilized an algorithm-based valuation tool to establish the value for the business. This tool utilized the company’s tax records. Based on the information entered this system, a valuation was assessed at $346,000. June thought the business was worth more.

The CPA contacted the Commercial Real Estate Agent who handled the lease for the building the restaurant had moved into in March of 2023. This agent has attended speeches and training courses that we have hosted in the past. So, he called us to see if we could meet with June. She was willing to fly into Houston whenever we could meet.

This initial meeting included June, the CPA, the Commercial Real Estate agent and myself as the Certified Valuation Analyst. June explained that she did not want to “fire sale” the business. She wanted to maximize the sale of the business so that her grandkids would have the best opportunity in the trusts left to them by their dad. She explained that the CPA had run a valuation, but she felt the business was worth more. With her permission, I began the background interview to gather as much data about the business as possible to be able to take all the variables into consideration. There had been a few key changes that occurred to the business in 2023 alone.

1.?????? Business moved locations which doubled the seating capacity of the restaurant from 50 to 99 and increased the parking capacity

2.?????? Due to inflation, the cost of food had increased

3.?????? Also due to inflation costs, the restaurant raised it’s prices across the board

June signed our engagement letter and cut us a check before she left the meeting and instructed the CPA to send us anything that we needed. Since the valuation date was as of her son’s passing, we requested 2021, 2022 and YTD to August 31, 2023 financial statements. They did not want to include the 2020 financials due to the pandemic shut downs.

Our team entered the financials into our system for analysis and industry comparison purposes. When reviewing the industry comparisons for a Full Service Restaurant we confirmed what June had told us when it came to the food costs. The business was running about 20% higher than the rest of the industry. The component that was impressive was the sales growth. With the increase in seating and menu prices the company saw an increase in sales from 4% year over year to 20%. Which is slightly higher than the industry standard, but sustainable through the location, customer base, and portion sizes.

A full detail valuation report was prepared for June, and the following valuation methods were calculated:

·???????? Discounted Cash Flow (Income Approach)

·???????? Capitalization of Benefits (Income Approach)

·???????? Merged and Acquired (Market Approach)

·???????? Adjusted Net Asset Value (Asset Approach)

Based on the income potential and changes that were made to the business through the move and increase in menu prices, the Discounted Cash Flow Method was chosen. This established the value of the business at $5.5 Million. That is a significant increase from the initial algorithm value of $346,000.

June was able to get the business listed on the market and she received a Letter of Intent for $4.2 Million.

What did we learn through this story? The numbers can say anything that you want based on the base financials and the circumstances taken into consideration. We have talked with many professionals who have tried to use algorithm based software to create a valuations, and they historically come in low.

Why is having an accurate valuation important? In June’s case, it was the difference of about $4 Million for her grandchildren’s trust funds. For the average business owner who is planning to make their exit, they have spent early mornings, late nights, missed holidays, birthdays and who knows what other sacrifices. If you base your Exit Planning on a computer program, who knows what your foundation of your exit could be.

Set your exit up for success with a business valuation with an actual valuation expert. Here are a few things to look for in a valuation expert:

·???????? Credentials and Experience

·???????? Industry Knowledge

·???????? Methodologies and Approaches

·???????? Communication Skills

·???????? Independence and Objectivity

·???????? Reputation and References

·???????? Understanding the Purpose

·???????? Cost and Timeline

·???????? Technology and Resources

Are you planning your exit and need a solid foundation business valuation? Send me a message or give us a call at 281-724-1134.