This is often one of the first questions we hear in my business of FBO and flight school sales and acquisitions, and the answer invariably is, “It depends.” The technical definition for fair market value goes something like this, “The probable price at which a willing buyer will buy from a willing seller when (1) both are unrelated, (2) know the relevant facts, (3) neither is under any compulsion to buy or sell, and (4) all rights and benefit inherent in (or attributable to) the item must have been included in the transfer.” While this is great for textbooks, it does not really answer the question. The bottom line is that valuation is a subjective process, but it is important to understand the basic ways in which it is assessed to begin the process of either selling or buying a business.
There are two primary determinants of value, income, and assets. If the company were not profitable, it would simply be worth the sum of the fair market value of all of its assets. This of course assumes item two above; if the seller were under duress (i.e. creditors were demanding to be paid), then the company is worth the liquidation value of its assets, which is the price they would attract at auction. This is the proverbial “fire sale.” Of course, the entire purpose of running a business is to be profitable, so how does income affect valuation?
The principal of income valuation comes from one of the main tenants of finance, the time-value of money. Specifically, a risky asset (i.e. the business) is worth the sum of present values of all future cash flows at the appropriate risk adjusted rate of return. Once again, this is great for textbooks but not particularly useful from the business owner’s perspective. The main problems involve determining “future cash-flows” and “appropriate risk adjusted rate of return.”
A private equity firm or Wall Street analyst would typically try to model out future cash flows using historical financials combined with forecasts and projections, and then compare the private company to a public company to determine what the market thinks the appropriate return should be. This is referred to as the Discounted Cash Flow (DCF) method of valuation.
An alternative to DCF valuation is relative valuation. When you hear of someone discussing income multiples, this is the approach they are using. Generally, the past three-years of financials are used to determine a baseline for comparison. These financials are “recast” to express the true profitability of the company. This not only includes adding back depreciation, amortization, and interest to arrive at an EBITDA number (Earnings Before Interest, Taxes, Depreciation, and Amortization) but any non-business related expenses which may be present. It is no secret that most small business owners incorporate certain personal expenses into their business. By factoring these out, a better picture of the health of the business can be derived. Since flight training companies are typically a lifestyle business, meaning that they will be owner operated, the owner’s salary will typically be added back as well, giving us the Seller’s Discretionary Earnings (SDE), which represents all of the economic benefit available to the buyer of the business. With the SDE or EBITDA for the past three years, a baseline can be established by either taking the average or weighted average, with the most recent numbers being weighted more than the older ones, of these three numbers.
This baseline number can be multiplied by the appropriate EBITDA or SDE multiple to arrive at a total value for the business. The question now becomes, “What is the appropriate multiple?” As we come full circle, the answer is, invariably, “It depends.” Generally, we have found that a well performing flight training company should attract a 3 to 3.5 factor SDE multiple. If you are using an EBITDA multiple the typical range might be a factor of 3.5 to 4.5. However, one must be very careful when looking at broad rules of thumb like this; they can vary greatly, depending on many factors. It is important, however, for the owner to be honest with themselves in recognizing the attractiveness of their own business when considering what kind of multiple it is worth. Is it in an attractive location? Close to a major metro center? What are the local demographics? What kinds of training aircraft are offered? What is the customer concentration? How long is the ground lease?
There are countless factors which can be considered when determining the attractiveness of the business, but the takeaway should be that an honest assessment of the company’s financials and its attributes, from a buyer’s point of view, should result in a reasonable expectation of business valuation. In the end, the buyer of a small business is essentially buying themselves a job. An owner/operator knows they are going to work in the business and they want to know how much they are going to make for their labor and return on investment. This means that terms and financing options will greatly affect the total price paid for the business.
Gael Marchal is on the FBO sales staff of FBOSales.com.
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