Business Valuation is an interesting area; and one that generates a lot of debate. It’s partially due to the highly subjective nature of some of the valuation methods and partially due to the fact that there are multiple valuation methods which can result in multiple (and highly divergent) numbers. Having now spoken to a number of businesses, it can be extremely frustrating as sometimes, the valuation differences is extreme. At the end of the day though, what a business is worth is exactly what someone else is willing to pay for it.
There are basically a few major forms of valuation:
- Income Approaches
- Asset-based approach
- Market approach
Income Approaches take a run at a company’s profits to decide it’s sale value. The simplest form of this uses a multiple of the net profit – generally between 2 to 5 depending on the business. Sometimes, the net profit is adjusted to add back the salary paid to the owner; though that is obviously dependent on the business involved. This is potentially quite useful if the business is profitable; but quite often (at least in this industry); it’s not profitable. And a multiple of a negative number isn’t going to be useful at all.
Asset based approaches basically take the combined value of all the parts of a business to come to a valuation number. It doesn’t take into account things like Goodwill or Growth factors; just the actual assets of the business (generally adjusted towards fair market value); so it actually provides a lower valuation number for an on-going business. In a gaming business, most of your assets would be in terms of stock and potentially shelving /office equipment. If you have a website and domain name, it might be included in this too – especially if the website has been well developed.
Market Approaches value a business based on its competitors. It’s really only useful if you know the sale value of another business; which is uncommon when you consider that we’re dealing with private businesses here.
Before we finish; I’d add that quite often a discount is also added to a business. The most common reasons for adding a discount is for purchasing a minority control (added risk) or a lack of marketability (especially relevant for private sales). If you’re buying a private business; getting out of the business is a major problem since there’s only a limited number of individuals who might wish to buy it.
All of the above factors make buying another game store difficult. If someone is offering to sell to you; 90% of the time what they are selling is a business that is losing money. As such, you’ll need to value them based off their assets. However, quite often the seller bases their sale price on unadjusted value of their inventory, goodwill and growth ‘potential’ and other intangibles. Sometimes those intangibles include things like ‘what I invested to get the company this far’.
Now, some of those factors make sense – goodwill from customers and a strong brand has value. The question is; how much? That’s where things might get highly contentious, since a business owner is often much more optimistic than the purchaser. As a purchaser, quite often you also have to input an amount for opportunity cost – if I paid $15,000 for your business; what else could I have done with that $15,000? To make it worthwhile, you’d need a sufficient amount of ‘discount’ or potential for profit to make it worth spending that $15,000. On the other hand, if you expect too high a discount you won’t be able to purchase the business.
It’s this gap that I think that is often why the end game for a game shop is so bleak. Unless you’re selling the business at firesale prices; it’s hard to get much money back as most purchasers will just value you at your cost of inventory (with a slight bump for brand name, etc). Yet, quite often none of the years of hard work you’ve put in is valued at all; which can be quite frustrating. Sometimes, it’s just better to close shop rather than deal with the hassle.