The Value Of a Child Care Business
How do you value a child care business—what’s the magical number? Determining a logical value for evaluating your child care business or someone else’s is often a confusing and frustrating experience with an abundance of opinions, formulas, logic, and complicated terms. Many models can be applied in estimating the value of a business, based on such measures as a dollar amount per licensed capacity, cash flow analysis, previous year’s gross income, and future predicted income. Often a business is evaluated using several different methods, and then an average of the various methods used it totaled to get a final number. In the final analysis, no matter what number games are played, a business is worth what a ready and financially able buyer is willing to pay for it.
Adding It Up
Although businesses are valued for a number of reasons—including real estate and tax purposes, divorce settlements, and raising capital—the reason is much more often selling or buying. Problems often exist selling or buying. Problems often exist from the beginning of sales negotiations because buyers and sellers disagree on what the business is worth. Emotions run high with sellers who have invested their lives into building more then just a business—they are attempting to place a value on it as if it were like family. Buyers, understanding the sensitive nature of this transaction, will proceed with compassion and logic that will take them farther than the average investor. Many child care transactions have been concluded, based on the feeling surrounding the negotiation process, as an indicator of how both parties operate, rather than on the purchase price.
Estimated Business Value
Logically speaking in deriving or arriving at a number, most will evaluate a business on its ability to return an investment over a fixed period of time, with an acceptable margin of risk. Simply stated it is the buyer’s ability to get his invested money back over a number of years. This is most often calculated by multiplying the business’ annual earnings by some number, usually referred to as the earnings multiplier, to derive an estimated business value.
Annual Earnings x Multiplier = Estimated Business Value
The first step in determining a business’ value is deciding what earnings figure to multiply. This question often causes the greatest point of conflict between sellers and buyers in deriving a logical value of a business’ worth, because historical profits earned by the seller in the past are not accurate indicators of the buyer’s future earnings. In my opinion, it is the ability to make future earnings that determine the business’ worth. Even more confusing is the owner’s salary, perks, and other one-time expenses. Since a buyer will operate differently than the seller, differences in expenses must be accounted for in the future projection; therefore it is imperative for a potential buyer to adjust the center’s past financial statements to reflect future operations.
To build a proforma, or projected financial statements that gives a good indication of predicted future income, first obtain an average of historical adjusted earnings. A common definition used by accountants and lenders for these numbers is “Earnings Before Interest and Taxes” (EBIT) with adjustments to these historical numbers based on future projected operations.
To illustrate, let’s looks at an oversimplified, mythical child care center. This child care center has been collecting tuition and other related income at about $1 million per year for the past three years. After analyzing operations quality, potential future competition and business environment, it is predicted that the center is likely to collect this amount of money in the future. Therefore, the center’s gross income is used as the basis for building a proforma of future predicted EBIT. Next, the most costly fixed expense is rent or mortgage payments, and these are calculated based on the terms offered by the seller (usually defined by the appraised value of the facility), and other fixed expenses such as property taxes and vehicle leases or payments, are known or calculated. Finally, variable expenses such as payroll, other related staffing costs, food, supplies, utilities, office expenses, etc. are applied, based on the experience of the purchasing company.
Annual Gross………………………………...….… $1,000,000
Less: Rent................................................................…... 150,000
Other Fixed Costs……………………………………... 50,000
Estimated Variable Costs…………………………..... 700,000
Projected Annual Future Earnings (or EBIT)…….. $100,000
After obtaining a projection of future earnings, it is necessary to decide what number to multiply earnings by to get a value of the business. The multiplier chosen represents the number of years it will take a buyer to recoup his investment in the business. This multiplier will vary based on the risk of the business, considering such factors as longevity, stability, current and potential competition, the ability to expand the market, etc. For most businesses, the multiple is somewhere between three to five times EBIT, but can be less when there is extreme risk or more when the business is especially attractive. What this means to the buyer is that he can get his investment back in three to five years from profits. That’s equal to an annual return on your investment between 20% to 33% Using our previous example, the child care business is worth between $300,000 and $500,000.
EBIT of $100,000
Earnings Multiplier of 3
EBIT of $100,000
Earnings Multiplier of 5
This EBIT approach is a rule of thumb that can be applied as a starting point to evaluate a child care business, or any business, for many different purposes. Because it is a rule of thumb and not an exact science, many factors have the potential to influence business value beyond this formula. Potential positive influences include location and competition, building and playground condition, stable management, strong curriculum and staff, and cost management procedures. And again in the long run, value is relative to each individual and can only be determined by what a ready and willing buyer is willing to pay.