I was asked this question today from buyer who asked about a valuation/equipment dilemma he was pondering when looking make an offer on a machine shop business with substantial equipment included in the deal.
Here is the buyer's question:
“ I am about to make an offer on a machine shop, the asking price is $1.9M, the adjusted net income on average for the last three years has been $287K with equipment valued at approximately $600K, it seems to me the business is overvalued – with a multiple of 4 the price seems like it should be more like $1.2M. The question is do you add the equipment value to get a valuation of $1.8M or should the “equipment value” be included in the price of $1.2M?"
Several responses from our BizBen panel of experts:
From Joe Atchinson, Business Broker, CBI, CBB, CPA, MBA
"My opinions on your machine shop valuation question are:
First, this machine shop is not worth anywhere near 4.2X to 6.6X SDE ($1.2M to $1.9M asking price) unless there are some extremely unusual circumstances like just landing a very large, non-cancellable, multi-year production contract from a reputable customer. I think that the starting point should be 2X to 3X, max.
The most relevant year is the 2007 which is just over two weeks from being over. If 2007 revenues and net are considerable higher than 2006 then value it up. If 2007 is a down year, especially if it is the second or third down year in a row, value it down – perhaps way down.
What is the capacity utilization? If only at 40% of capacity, value it up. If at 90%, value it down.
What are the quality, concentration and geography of the customer base? Value up or down depending on the answers.
As for the equipment, that is what was necessary to produce the $287K SDE so there is no adjustment for the equipment unless there is an unusual circumstance like the seller recently purchasing a high productivity piece of equipment that would reduce unit costs and improve margins and, better yet, allow them to get contracts that they did not have the capacity or capability to produce in the past.
What are the competitive threats - especially from the customer going offshore to China, India, etc.
Does the seller have long-term, talented employees?
Does the seller have a long-term lease with favorable terms?
How large of a note is the seller willing to carry? An all cash deal will sell for a big discount compared to the price of a financed deal.
What is the sellers purchasing leverage – probably not much; and what is the seller’s pricing leverage?
Nothing was asked about the value of the inventory (raw stock, work-in-progress/semi-finished and finished goods). That is another important question with the biggest issue being how much do I discount the cost value for excess and obsolete inventory?
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From Willard Michlin, Business Broker and Due Diligence Specialist:"The equipment is always included in the price when usuing the income approach. . Why? The rule is that whatever is necessary to produce the income stream or to produce the product must be included.
What the seller is trying to do, in this example is to use two different appraisal methods in order to raise the price.
Under the income approach, the value of this business is based on the owners benefits approach. Your example is 4 times but can be some other number times the net income or total owners benefits. This value includes the equipment and everything else with the exception of the accounts receivables and inventory. In some cases, even these are included in the price.
If the seller is valuing the business based on the assets which includes the equipment then he might also add the accounts receivables, inventory and the value of the customers. In this case you can not also use the income valuation approach."
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For more feedback on this topic check out the article and the opinions from more California experts on the topic "
Valuing A Machine Shop: Does Equipment Value Effect Valuation?"
Do you have feedback on this topic? How would you value this business? How would you handle the situation posed by this buyer. Please feel free to contribute your thoughts on this topic in the comments section below.
Posted on December 12, 2007 | 
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