We recently worked with a high-end clothing and home goods retailer which operates shops in Los Angeles. One of the partners wanted out of the business, and the other partners agreed to buy her out.
What each side had in mind as a fair price was somewhat contentious. They simply could not come to an agreement. So, they reached out to us to get to a number, backed by well-established methods of valuation.
The Combined Approach
The two primary approaches to appraising an operating business are the market-based approach, comparing the company with other similar ones that have sold recently; and the income approach, which is based on the company’s historical financials and projected future results. We determined there was sufficiently good data to use both approaches.
But first, we would need data. We requested the past 3-5 years of the company’s historical financial data, including balance sheets and income statements, as well as three-year projections. Fortunately, the company had a great CPA they worked with, which made it relatively easy to obtain this information.
Everyone Has Issues
Once we thoroughly reviewed the company data, we noticed some issues. As would be expected, company performance in 2020 suffered greatly, due to the COVID pandemic. However, we could largely set aside this year’s results in our analysis.
The bigger issue was that the company had recently experienced a significant drop in sales, as well as a large increase in expenses. It was a double whammy, reducing the company’s profits to negative territory. It was quite odd, and things were not looking good.
When we interviewed the partners to follow up on the numbers, they attributed the drop in sales primarily to the unusually wet weather in the region. This made sense, and it was reasonable to believe that their loyal customer base would return to the stores, as they had in the past.
As for the increased expenses, these were mostly related to increased labor costs, which would not likely decline in the future. However, some of the expenses were one-time occurrences, so we were able to adjust the numbers accordingly.
A Success Story
When taking these factors into consideration, we ultimately determined that it was reasonable to believe that the company would continue to grow sales and stabilize expenses. Thus, the company would likely continue to be profitable, as it had been historically.
Our holistic analysis allowed us to conclude a valuation for the company that was reasonably fair for everyone. The partners were thus able to consummate their deal amicably, an overall successful result.