ALEXANDRIA, Va. — “How much is my business worth?”
That’s the question Jim Gutheim, president of James Gutheim & Associates Inc., hears all the time. The company, which started in 1993, helps laundry and linen service operations through the process of valuation and selling the business.
“I try to explain to everyone who asks, including the clients we’ve tried to help sell their companies, there’s no magical number,” he says. “There are a wide variety of numbers and factors that go into calculating how much your rental laundry is worth. In the end, it’s just an estimate. They tend to respond with, ‘Yeah, I know, but seriously, how much is my business worth?’”
Gutheim explained how laundry and linen services are valued and some of the various factors that influence how much a business is worth during the webinar Plant Sales, Mergers & Acquisitions, presented by TRSA, the association for linen, uniform and facility services.
FOUR KEY FACTORS
According to Gutheim, the “jumping off point” for business valuations is earnings, or EBITDA—earnings before interest, taxes, depreciation, amortization.
“No matter what the buyer uses to determine valuation, the industry norm is to convert it back to a multiple of weekly sales,” he shares.
What else determines a company’s value? Gutheim says the list is long, but the four important areas are contracts, pricing, profitability and product mix.
Contracts and pricing tend to go hand-in-hand, since the pricing of services is set in the contract. And he says it’s important for most customers to be under contract when it comes to business valuation and a potential sale.
Having customers that aren’t under contract tends to reduce the value of a business in the eyes of a buyer.
“That’s not to say that you can’t sell a business without contracts, but the price will be discounted,” Gutheim points out. “No company we’ve ever been involved with has contracts with 100% of their customers. There’s always the exceptional customer; however, as long as there are only a few customers like this, buyers understand.”
Of course, there can be elements in a laundry and linen service contract that will affect the valuation of the business. Gutheim shares two key ones: agreements and length of contract.
“You may have a contract, but not all contracts are created equal,” he says. “Agreements come in a wide variety of shapes, sizes and clauses. Most clauses are not necessarily going to affect the potential sale. However, there are two clauses that do directly.”
The first is the assignment clause. This clause states that if the customer or the owner sell their business, the contract is still in effect. Gutheim says this is critical, because if there is no assignment clause, it cannot be legally enforced by a buyer.
“In the real world, 95% of customers are not aware of this clause and would not realize that their contract is not legal,” he says. “However, from a buyer’s point of view, this causes uncertainty, which translates into a lower price.”
The second type of clause that can impact valuation is contract restrictions. These are provisions restricting price increases, loss and abuse charges, delivery restrictions, etc.
“Any of these restrictions can be viewed by the buyer as a potential problem and therefore a reduction in value,” Gutheim cautions. “You need to look at your contracts from a buyer’s perspective and how these restrictions could become a problem, and make the appropriate changes.”
When it comes to the length of a contract, he says the best situation for business valuation is having agreements with a significant amount of time remaining.
“The buyer’s arithmetic is simple,” Gutheim points out. “A $100-a-week contract with five years remaining is $26,000, that’s what they’re buying. If the same contract only has two years remaining, that’s $10,400.”
He also cautions that the larger the customer, the more value is at risk when it comes to contract length.
But what if a laundry and linen service’s contract renewal rate is high?
“The argument is even if we have a short contract length, there is a high probability that the customer will renew the contract,” says Guthiem. “This may be true, but from the buyer’s point of view, it’s an increased risk and therefore leading to a lower price.”
When it comes to the profitability of a service and its impact on valuation, Gutheim points out that a buyer will operate a business using its own P&L (profit and loss) figures, to a certain extent discounting the service’s P&L statement.
“For example, they can purchase merchandise cheaper than you and therefore will use their percentage for merchandise expense,” he shares as an example. “However, the more profitable you are, the higher the price will be for your business. The plant with a 10% profit, all things being equal, is worth more than a plant with a 5% loss.”
Finally, the product mix of a laundry and linen service impacts the valuation of a business. This includes the type of linens (industrial, linen supply, healthcare, etc.) and whether the goods are rental or customer-owned (COG).
“Everything is dependent on your particular situation,” says Gutheim. “However, as a general guideline, industrial accounts are valued the highest, followed by linen supply and then hospital/healthcare. Retail healthcare would be valued between industrial and linen supply.”
OTHER VALUATION FACTORS
Beyond basic business factors, Gutheim points out that there are other elements that affect a business’ price, including if it’s a stock or asset sale, whether real estate is involved, if the purchase is a financial or strategic one for the buyer, industry consolidation, and tax reform.
A stock sale does not mean the seller will receive stock in the company in purchasing it, rather, it means the purchaser is buying the stock of the seller, he says.
“What this really means is they are buying your entire business, including all of your assets and liabilities,” he says. “All things being equal, stock sale price is lower than asset sale.”
An asset sale, which Gutheim says makes up the vast majority of his company’s sales, means the purchaser is buying a portion of the company. This often means the purchaser is buying customer contracts and possibly a few other items from the business.
“That is, the rental revenue and nothing else,” he says. “This is a much simpler transaction, and the tax implications are less.”
Guthiem points out that the availability of a plant in addition to the business revenues could be both a benefit and a liability in terms of valuation.
“If a buyer doesn’t have a plant in your area to process the business, or the current plant is filled to capacity, this is a must,” he shares. “It could very well be a deal breaker if there is no plant available. If the buyer has the capacity in their own plant to process the additional business, it will probably have no need for your plant.”
According to Gutheim, this can work both ways. Not purchasing the plant would reduce the price. However, if the buyer has a plant that has additional capacity and could integrate the seller’s customers into their plant, this would be extremely profitable to the buyer. The buyer would only be increasing variable or direct costs routes, merchandise, increased utilities, etc. The fixed costs would remain the same.
“On this basis, profitability on the incremental business, business purchased from the seller, could be as high as 30 to 35% of sales,” he says. “This increased profitability percentage would be a factor for an increased price.”
Gutheim says there are basically two fundamental concepts for buyers regarding purchase, which can impact valuation. The first is a financial purchase, where the buyer evaluates the worth of the business on the basis of the P&L balance sheet and other financial aspects.
The second, a strategic purchase, takes into account the financial factor but also includes strategic elements.
“These would include elements such as eliminating a competitor, entering a new area and additional plant capacity,” he offers as examples. “Strategic purchase has synergy. That is, there is something beneficial to purchasing the business in addition to the normal parameters.”
Besides business considerations and buyer strategies, other “outside” factors can influence a laundry and linen service valuation. The first Gutheim points out is industry consolidation.
“The purchase of G&K by Cintas and AmeriPride by Aramark has reduced the number of major potential buyers by two,” he says. “This is not a positive sign for selling your business. Obviously, the less the potential buyers in the marketplace, the less pressure on upward pricing.”
However, Gutheim does point out that things are not quite that simple.
“While less buyers overall is not a good thing, individual plants do not always conform to the norm,” he says. “The point being, by having desirable characteristics such as location, ability to be integrated into a potential buyer’s system and other factors can always result in a good price.”
The overall conclusion Gutheim makes is that although there are fewer buyers, a specific situation can still result in a competitive bidding process. In addition, he points out that there are many regional and independent potential buyers. Also, there is an increased interest in laundry and linen services from equity groups around the country.
Finally, 2017’s Tax Cuts and Jobs Act has elements that will impact valuation, according to Gutheim. The major change is the corporate tax reduction from 35% to 21%.
“This means that for every $1 million of profit, a buyer will now get to keep $790,000 instead of $650,000,” he says. “The buyer will get to keep $140,000, or 21% more profit. Does that mean the price will go up 21%? Not necessarily but given the right considerations, it could. As usual, this only one part of the puzzle, but it certainly gives the seller justification for increasing the purchase price.”
BUYER SELECTION, NEGOTIATIONS AND THE FINAL PURCHASE PRICE
Beyond the factors mentioned that affect a laundry and linen service’s valuation, Gutheim adds that the purchase price can also be influenced by buyer selection and the negotiation process.
“This is where subjectivity comes into play,” he points out. “Your business is only worth what someone is actually going to pay you for it. You could be doing a fantastic job, have positives in all areas and be worthy of a good price, but that doesn’t mean that’s what a buyer’s actually going to give you.”
Gutheim says it’s important to consider a broad range of potential buyers, not just the obvious ones. As stated earlier, he says that sometimes the most interested buyers may come from less obvious regional companies, or even independents, so equity companies should be considered.
“Also, it’s not just about knowing who the potential buyers might be, it’s also knowing who is most likely to give you the best price,” he shares. “There might be some who aren’t actually buying at the moment, some whose CEO instructed them to make a big push in acquisitions, some who are trying to go to an adjacent area, some who value a certain product mix or geographical area, etc.”
When it comes to negotiations, Gutheim strongly suggest laundry and linen services use a broker. Why? Most owners are selling a business for the first time.
“They’ve not gone through the process and therefore have no idea about the pitfalls to look out for,” he cautions. “Normally the buyers have gone through the negotiation process numerous times, and therefore have a distinct advantage. There are dozens of factors that come up during negotiations that could turn a good price into a not so good price.”
Gutheim again cautions that this is only a partial list of factors that influence how much a business is worth. Many elements are involved in a laundry valuation.