It’s a sign of the times. There are lots of distressed spas on the market right now. Many of these spas look like real bargains, selling for pennies on the dollar of their replacement cost. How is a potential buyer to know what the business is really worth?
Valuing a business is both a science and an art. The science includes the valuation formulas that are typically used. One valuation formula is “multiple of earnings.” Earnings include net profit, but it’s typically adjusted upward with “add backs,” things the business owner has written off that are primarily for their personal benefit, such as their salary, a car or business-with-pleasure travel expenses.
The art? That’s the value of the business relative to the buyer’s opportunities. Strategic value is just one of these considerations. For example, if you already own a spa and you’re considering the purchase of a second spa in a nearby town to expand your brand, and you can leverage an existing back office, that business may have more value to you than to the buyer who’s starting from scratch.
Is the seller using a business broker? If so, the “book,” or sales documents for the spa, should be filled with important data that will help you assess its real worth. There’s also a lot of fluff in there, but the numbers are the most important.
The financial statements should tell you much of what you need to know–that is, if they’re in good shape. A spa that’s for sale is probably losing money, so expect to see that reflected in the profit and loss statements. If things look too rosy, ask to see a P & L that has not been recast for the sales package, so you can understand what the add-backs are quickly. (The business broker should have this information at his or her fingertips anyhow.) We want to know what the spa has really been doing in the last year. Previous years were probably better–but that’s not terribly relevant these days.
Once the add backs have been calculated, you might see a small profit. Here’s the sad news for that seller, and for you as the future owner: spas generally sell for 2-3 times earnings (profits.) My brother in law, who’s in biotech, on the other hand, can sell his company for 18 times earnings. Spas and salons (and most personal services businesses) are at the low end of the scale when it comes to valuation.
That’s right; a salon with a net operating profit of $50,000 may sell for $100,000, but a biotech company with the same earnings could fetch $900,000.
It’s not just our low profit margins that dampens value, but the flighty nature of our workforce. Plenty of spas and salons that are sold lose a substantial number of their service providers. Spa and salon employees spook easily, often not waiting around to see if a new owner will actually improve things. As we know all too well, even the loss of one good employee with a strong following can mean a substantial drop in revenue, as clients follow them elsewhere.
Of course, it’s not just profit, but the balance sheet, that will determine the valuation of the business. The business is worth less if its assets are outweighed by its liabilities. One potential source of liability is unredeemed gift certificate/gift cards. You must be confident that the documentation of this liability is complete–and it often isn’t.
If you are simply purchasing the assets of the spa (an Asset Purchase), such as its lease and its equipment, and don’t plan to use the business name, you don’t have to assume its liabilities, including gift liability. Even so, it may be a good marketing idea to redeem gift liability in part or in full, on a voluntary basis and for a limited term. The value of the goodwill generated will probably exceed the hard cost of redemption.
You may be looking at a spa whose earnings with addbacks are $50,000, and using a multiple of 2x to give it a value of $100,000. But their gift certificate liability is $200,000. Here’s where “art” comes in, again–how do you determine the real liability there, since we know not all gifts will be redeemed? This is where a spa management consultant can help–looking at historic trends, aging of the gifts, etc., to produce a realistic number. Maybe that number is closer to $80,000, and you’ll only end up spending $40,000 in payroll and backbar supplies to service that $200,000 liability. If you want to use the spa’s trade name, you’ll pay for this. But an asset purchase, where you wipe the brand slate clean, can eliminate the liability. Will changing names and rebranding the business cost you more than $40,000, in hard costs and lost business?
As well, you need to know the laws about gift certificate expiration in your state. Some spas pay tax on their gift revenues as they come in (the most prudent and IRS-favored approach); others wait and pay taxes as those gift certificates are redeemed (setting a spa up for an ever-growing tax liability.) If you want to sell your business and you’re in the latter camp, a buyer will have to consider this.
In California, the value of unredeemed gift cards can be converted from a liability to income after three years of dormancy. By law, the gift cards don’t expire and you still have to honor them, but at least you can get it off your balance sheet.
We’re even aware of spas being “sold” for the price of assuming gift liability and a lease–no money is being exchanged in some of these deals. Landlords who are desperate to avoid vacancies in their shopping center real estate (which depresses rents and makes any other space less desirable) are sometimes willing to provide free rent–we’ve seen periods up to one year.
The decision to retain the spa’s existing name and branding is one to approach carefully. Look at online review sites to get a sense of how well the spa is managing its customer relations. It’s usually not possible to interview employees, but sometimes key management employees are privy to an owner’s decision to sell.
Reputations are on vivid display online, though you do have to take ratings with a grain of salt, since most review sites skew to the negative. Yelp, most notably, will “age out” positive reviews posted by people who write no other Yelp reviews, after just 90 days. Google aggregates reviews from different sites, providing a cross section. Some spas ignore online review sites, like Yelp–to their peril. If you think the spa’s name is “radioactive,” then don’t hesitate to rebrand. If the spa is established, with a reputation that’s slightly tarnished, an aggressive “under new ownership” marketing campaign, followed up with real improvements, may work the needed magic. Keep all of this in mind when thinking about how much you’re willing to spend on a spa.
This is merely an introduction to some important fundamentals of valuing a spa for sale, but it’s far from comprehensive. It’s essential to get help from a reputable business broker experienced in the sale of small businesses, and doubly so if the sellers are not using a broker themselves.
Owners are often emotional about selling, and probably under a lot of stress. It’s helpful to have a cool, collected third party between you and them. The first notion a seller needs to discard if they’re serious is the idea that they should be able to “get their money out of” a failing spa. It’s not going to happen–but you don’t want to be the one who gives them the reality check.
Next time: financing the purchase of a spa