Blog

Introduction

This article describes two separate methods to value your house cleaning company. You might be surprised to learn that if you are selling a larger business, the banks will ultimately have the final say in the valuation of your business, based on guidelines set by the Small Business Administration (SBA). Once you know how the market values your company, then you’ll find that there exists tangible things you can do to influence and optimize the value of your company.

We sold a relatively large house cleaning business as a Going Concern some months ago. In addition, in the years preceding its sale, we maintained an open standing offer to buy smaller competing local maid services as Add-On Opportunities. As a result of those transactions, and despite our previous experiences in finance, we learned a lot which might be useful to other companies or individuals interested in selling their house cleaning company.

Choosing the Applicable Method for Valuing Your House Cleaning Company

A house cleaning company can be sold in one of two forms. In the most common type of transaction for the industry, the company’s accounts are sold as an “add-on opportunity”, and the buyer essentially begins servicing the Seller’s individual customer accounts. In such instances, the Buyer is most likely a competitor looking to add new accounts to his existing housekeeping business, or possibly someone seeking a jump start for a new venture. Under such circumstances, your employees may or may not be transferred to and retained by the new owner. The company’s physical assets, desks and vacuum cleaners, may or may not be included for an additional sum, although if they are, it is normally be for a nominal sum.

In the second less frequent instance, a company is sold as a “going concern.” Under this arrangement, the buyer steps in and takes over assets, employees, and customers, and keeps running the company – maybe better than you, maybe worse than you, maybe differently than you, but he buys it to grow it further and build value from by taking over your operation. Such an enterprise is valued as a multiple of the yearly cash flows accruing to an owner. Under such circumstances, the Buyer is often a manager/investor type with no industry experience.

A company sold as a Going Concern is worth more than one in which the accounts are sold as Add-On Opportunity, so every seller likes to think of his or her company as qualifying for sale as a Going Concern. Unfortunately, you as a Seller won’t directly determine the method applied to determine your company’s value. Buyers, and Brokers and Bankers, determine whether your company qualifies as a Going Concern by assessing whether it can generate enough funds to an owner for a comfortable salary, plus an additional sum to accommodate a return on equity, plus provide a 1.2x debt service coverage ratio.

The definition of “comfortable salary” will be determined by the universe of potential buyers, and will increase in amount as the value of the company increases. This is due to the fact that a buyer qualifying to purchase a $100,000 company may have lower earnings expectations and possibly lower personal living expenses than those of a buyer qualifying to purchase a $1 million company. As a seller, if you have any doubts about whether your business can qualify as a going concern, you needn’t wonder much. Simply invite some Business Brokers around to learn more about your company, and it will quickly become evident whether your company will qualify for sale as a going concern, or whether you should go it alone by marketing it as an add-on opportunity.

SECTION A

Valuing Your House Cleaning Accounts as an “Add-on Opportunity”

Does My Business Qualify?

Most house cleaning companies will not qualify for sale as a Going Concern, because they lack scale. Many more will not qualify for any type of sale. The industry is incredibly fragmented and suffers from an incredibly high failure rate, so if you manage to sell your accounts as an Add-On Opportunity, then you should consider that a success. Many companies end sadly with little of value remaining to sell when the business is wound up. These include part-time individuals who may have personally serviced just a handful of accounts, and companies which have provided such poor service so as to have chased off all but a handful of sulky underpaying customers.

The prerequisites for selling your accounts are that your customers must be happy and loyal, and they must be paying market rates. If they are not happy with you, then they will scorn your introduction of a Buyer. If they are not loyal, then your employees will intercept the customers, and foil your sale. And if they are not paying market rates, then you simply won’t be able to find a Buyer for them.

Who Are the Likely Buyers for My “Add-On Accounts?”

Your most likely buyer is a large local house cleaning company, who ideally may have previously acquired one or more sets of accounts. Indeed, many large housekeeping companies have standing offers to buy accounts of any competitor going out of business. Part of the problem with selling a smaller company is that business brokers will not take your listing and bankers will not finance it, making it hard to find buyers willing or able to pay top dollar for a venture which cannot support a buyer from the get go. So finding a Buyer is a prerequisite to formulating a valuation.

A common misconception by Sellers is that franchisees might represent interested Buyers for their accounts. For a paltry enough price, possibly, but generally a sale to such a Buyer is not worth the bother. The problem with any such transaction is entirely from the Buyer’s side: a franchisee will sour at the notion of paying cash for your accounts, only to turn around and provide a windfall profit to the franchisor in the form of having to pay franchise fees on the revenue from the new accounts. Under perfect circumstances, it would seem that a franchisor might be willing to foot part of the acquisition costs, but we have never heard of such an arrangement. From the franchisor’s standpoint, it would be difficult to influence the outcome of any such transaction, and so a franchisor’s reticence to participate is understandable.

Your accounts only have a value if you can find a Buyer. While a successful local competitor might be your best bet, if you are available to continue on in the industry in a management role, there exists another possible class of Buyers worth considering: an entrepreneur launching a start-up house cleaning company. For such a person, especially someone starting a house cleaning business from scratch with no previous experience, a start-up set of accounts and an experienced manager can prove tremendously valuable.

How Do I Calculate the Value of My “Add-On Accounts”?

If you qualify, then the market value of a collection of individual residential house cleaning customer accounts is 2 to 3 times the monthly revenue (not profits) from the total accounts. Of course, that assumes that you can find a Buyer, which may not be trivial, particularly if you do not live in a metropolitan area. If you cannot find a Buyer, then the value of your accounts is precisely zero. Conversely, if you manage to find two Buyers and negotiate with them simultaneously over several weeks, then you will be in a position to realize the optimal value for the accounts.

If you are negotiating with a savvy Buyer in the purchase of your accounts as an Add-On Opportunity, then your valuation will most likely be calculated based on a buyer’s actual future revenue, not on your historic revenue. For a Buyer, compensating you on the basis of a future multiple, allows him to mitigate the risk of purchasing unprofitable accounts. After the first visit the Buyer simply increases the price for any assignment which may be under-priced. On this basis he will keep or lose each account on its own economic merits, based on a minimum acceptable profit margin. While this structure forces a Seller to accept most all of the risks of the transaction, most Sellers will find that a Buyer is generally willing to pay a higher multiple under such a scenario.

The issue of future or historic revenue is complicated by the fact that only a transaction in which the seller and the buyer have similar cleaning standards, will result in a happy ending. If the seller specialized in detail oriented meticulous work, and the buyer tries to service the accounts with faster, not so particular cleaners, the already nervous clients will flee at a frightening rate. Conversely, if the seller provided fast, affordable service, then he will have appealed to price conscious customers. When the buyer upgrades the cleaning quality, he will also be forced to raise prices to cover the additional time invested in providing the service upgrade. Our experience shows, that a price increase levied against a price conscious customer is a sure way to lose an account. So if you are selling your accounts as an Add-On Opportunity, seek a company with similar service standards for the all around happiest of endings.

Assuming you find a Buyer, then how will you determine a price? As a starting point, consider a structure whereby a Buyer collects all revenue and remits to you 75% of cash proceeds from servicing your accounts over a three to four month period. Implicit in such an arrangement is the Buyer’s option to raise prices for any under-priced assignments, throughout that period. Additionally, this structure burdens the Seller with 100% of the risks of defection by clients, or by employees with clients, making it attractive to the Buyer.

As an example, let’s say you have sixteen customers, comprised of ten weekly customers paying an average of $100 per visit, and six two-week customers paying an average of $120 per visit. Your average revenue from this collection of accounts will be $1,360 per week, which translates to about $5,900 per month. If you are able to deliver 100% of such accounts to a buyer, then you might expect to realize total payments over a two to four month period of $12,000 to $18,000.

What Can I do to Maximize the Value of My Accounts?

In terms of whether you realize the top or the bottom of that range, there are steps you can take to influence the value of your accounts. However the transaction is structured, the Buyer will be concerned with the profitability of the individual accounts, and his own ability to retain the accounts, at least over the short term. Most Buyers will insist on the Seller signing a non-compete agreement, which promises that the Seller will never seek to provide house cleaning services to the accounts being sold. Also standard in such transfers is an indemnity clause which involves you reimbursing the Buyer for any losses arising in the event any of the accounts get nicked by employees. The Buyer may also insist on you signing a wider non-compete agreement not to provide house cleaning services in the geographic serviced area for a certain time period. It is of course up to you as the Seller how much you are willing to promise, but such promises can and should positively influence the value you receive for your company. If you intend to continue servicing any accounts in the area, then it is difficult for the buyer not to feel like he is suffering a case of adverse selection. If you don’t intend to continue in the industry, then there is no good reason not to agree to generous non-compete clauses.

Transferring your published business telephone line to the Buyer will enhance his ability to retain the customers and allow the Buyer to benefit from any residual advertising which may remain. Additionally, it holds out the prospect of collecting some peripheral return clients over time. Similarly, if you have a website, under some circumstances, transferring it to the Buyer can be valuable too. Both can enhance the value of your business, even if it is being sold as an Add-On Opportunity.

There are other advance provisions which can enhance the Buyer’s retention rate. Most importantly, regarding prices, if you have underperforming accounts, raise their prices immediately, because you are more likely than a Buyer to retain them following a price increase. In addition, you should consider personally introducing the Buyer to each client. We purchased accounts with an introduction and without, and found that as a Buyer, our retention rate was significantly higher with a personal introduction. If you are servicing clients yourself, you can also offer to clean along with the Buyer’s house cleaners for the first visit or two. If you have employees, you can take steps in advance to reduce the risk that they will run off with a portion of your clients, including reassigning any clients which you feel nervous about.

Finally, if you have dirty houses, clean them up, before you sell, or your Buyer will clean them once, and suffer so trying to impress his new customer so as to prompt him to raise prices across the board, which will have a mutually unsatisfactory result for all involved.

SECTION B

Valuing Your House Cleaning Company as a “Going Concern”

As mentioned in the Introduction, your business qualifies for sale as a Going Concern, if first the Brokers, then the Buyers, then the Bankers all agree that it qualifies. As a general guideline, if you are making a nice living off the company, without actually cleaning yourself, then you have achieved scale, and can sell as a Going Concern. In such a case, your business will be valued higher, and the methodology for valuing your business will be significantly different than if it were sold as an Add-On Opportunity.

Maximizing Value: Advance Preparations

Similar to hiring a home staging decorator to hide the clutter and put nice bright pillows on the couches to enhance the selling price of your house, there are window dressing type things you should consider in optimizing the value of your business as a Going Concern. It’s important to recognize that the motivations of a Buyer can be sometimes be different from someone willing to start a business from scratch. So begin by putting yourself in the shiny shoes of a new owner. If your office is shabby, consider moving to a nicer part of town and furnishing a bright and pleasant office in which a new owner can imagine himself working.

Since a Prospective Buyer may know little or nothing about your industry, one of the most valuable intangibles you will transfer with the Going Concern are systems for managing your company. These include training, evaluation, hiring, payroll, accounting, scheduling, and other systems for managing your day to day business. So if you wish to optimize the value of your company, make it less dependent on yourself by systemizing the day to day aspects of managing the company.

If you are selling your company as a Going Concern, some factors are not just window dressing, but will actually be considered prerequisites for the bankability of a sale. For starters, your business must be maintained as a separate legal entity two years preceding the sale. You also need a separate place of business, as running the company from your basement (no matter how convenient) will uniformly repel Buyers and Bankers. If your business location lease expires within the period of the bank financing, the bank may require the landlord to extend the lease. If you are running the company together with your spouse, consider expanding the universe of potential buyers away from only couples wishing to buy a business they can run together, by replacing one of you with an outside manager, who can stay and run the business together with the new buyer. Aside from enhancing the marketability of your company, this can actually make you richer, since your imputed wage is likely less than an actual wage which you might pay a manager.

Most of the preparations are long-term in nature and targeted at bolstering the financial performance of the company. Unfortunately, tax planning opportunities are often at odds with maximizing sales value. If you are selling your company as a going concern, Buyers (and Brokers) will be looking backwards at the last two years’ financial performance as shown on your tax return, so successfully selling your company for the maximum value requires significant advance foresight and may entail foregoing a tax planning opportunity or two.

An important aspect often overlooked is that, sadly, no one will pay you for growth. Not only will the Buyer not pay you for growth, he and the Bankers are likely to actually penalize you for growth by averaging the last two year’s earnings and applying a multiple to the result, arguing that high growth equals high risk. It may seem counterintuitive, but if you’re planning to sell you should be striving to grow your revenue by 10% to 15% in the year preceding sale, and bank any excess marketing funds. The numbers generated by such an approach will be perceived as lower risk and can result in a higher multiple.

While our experience with acquisitions demonstrates that purchasing accounts can provide a healthy boost in revenue and profits, you should avoid acquiring other cleaning companies during the year preceding your own sale. The Buyer and Bankers will invariably take the darkest view of any pro-rated financials you would prepare, and argue that the acquisition-induced fluctuations make your revenue and after tax returns more risky, ultimately penalizing your purchase price.

Lastly, if you have any key managers, consider adding a clause to their current employment contract where they promise to stay on with the new owner for six months after the sale at their current salary levels. The perceived advantage of this from the Buyer’s standpoint, reflected in the amount he is willing to pay for your business, may well compensate you for the incentives you will have to pay such a manager for the promise.

Calculating a Value

As mentioned in the previous section, a value is only applicable if you find a Buyer. And if you manage to find more than one Buyer more or less simultaneously, then this can be the single largest determining factor in valuing your company.

Assuming you have a Buyer, a house cleaning company sold as a going concern has a market value of between three and four times annual cash flow accruing to the owner. Most brokers will list it at three to four times Owner’s Adjusted Free Cash Flow, but after negotiations with the potential Buyer, you should expect that the sales price may end up closer to a multiple of three times. Ultimately, your price within that range will depend on the quality of customer accounts, and the systems in place allowing for the new owner to lead a carefree life.

The owner’s adjusted free cash flow includes the company’s profits after tax, the owner’s salary, depreciation and amortization, any interest expense and any provable in-kind or cash draw the owner may have taken. Below is a typical brokers’ list of how to calculate adjusted annual free cash flow to owner:

A note on add-backs: Buyers and Bankers are weary and wary of all but the most common add-backs. For instance, common add-backs that will not scare them away is the company paying for your own life insurance, having your own house cleaned once a week, or putting any gasoline expense relating to your personal vehicle on the company credit card. Of all these items, the only one which will uniformly be accepted as an add-back in calculating the income to the new Buyer is the owner’s health insurance. For the others you can mention them frequently as being extra perks of owning the business, and they may very well have a nice psychological effect on the Buyer, but they will likely not be considered in calculating the value of your company. From a financial standpoint, you will therefore be better off not running any such expenses through the company accounts.

The issue of Buyers not compensating you for growth is a trickier one to get around. You will still need to spend some marketing dollars so as not to raise all eyebrows, but if you spend barely enough to keep sales at a modest growth, you will be rewarded. It also helps with Buyer morale, and positively influences the ultimate price, if you also make it seem as if you’re not cutting back on any necessary expenses just before selling. No one expects you to spend any extra money on a company you have listed for sale, but no one likes to buy a venture where a lot of expenses are necessary off the bat due to the Seller’s thrift. For instance, we bought ten winter tire and changed the oil in half the vehicles in the four weeks before closing, which was a good investment in terms of Buyer goodwill.

The Brokers will also revise your last three years’ tax returns in order to stabilize them by removing any major non-recurring expenses or income. For this, they will rely on input from you, and on documentation you provide for each year to prove that these expenses are non-recurring in nature. If the new owner, conservatively, should not be seeing these expenses (for it is largely the expenses you want the brokers to accept), they will be allowed and deducted.

After stabilizing your tax returns, the Brokers prepare an Information Package about your business to show prospective Buyers. This package typically contains photos of the office and business operations, the list of assets to be included in the sale, and the stabilized Annual Cash Flows to Buyer statements and copies of the corporate tax returns for the last three years.

In addition, the Brokers will calculate a “Business Opportunity Analysis” sheet to show the potential Buyers the Return on Investment they can expect. This analysis is based on the Stabilized Cash Flow to Owner for the last full fiscal year, and will naturally contain a long disclaimer about how a new owner may experience different results due to different management practices. The analysis assumes that the Buyer is putting 20% down, and borrowing the rest of the purchase price. The assumptions about the loan will (or should) reflect current market rates at the time of the purchase. For the sale of our company in November 2006, the analysis was based on a 10 year loan with an 8% interest rate.

An example of a Business Opportunity Analysis can be found in Appendix A.

SBA’s Role in Determining Value

If you plan to sell your business as a going concern, you are unlikely to find a cash buyer, and the Bankers will either directly or indirectly influence the selling price. A typical buyer will use an SBA Loan to purchase any going concern, since that type of loan is typically the most affordable financing option. Even if you were to find a cash buyer, he or she will be competing with other SBA borrowers for your company, so the price will still be influenced by Bankers. So, while it may seem that Brokers influence business valuations, in reality they just understand the constraints and guidelines for SBA lending and use those to propose a listing price for your company.

For a Buyer to qualify for an SBA Loan to purchase your company, he or she must have good credit and a good personal balance sheet, so these conditions are implicitly assumed in establishing a sales price. The price the Buyer will pay for your company will be determined by the free cash flow which can be allocated to debt servicing for the loan, taking into account a typical buyer’s own personal cash flow and financial commitments. The business cash flow forecasts will be estimated based largely on the most recent company tax return.

Additionally, there are a few situations, where the SBA will refuse to guarantee the financing, such as sale situations with a formal consulting contract going forward with the seller, or a sale involving multiple corporate entities.

SBA Loan benchmarks and Potential Loan Value

The SBA has formula for calculating each potential borrowers worth, which is of some use to you as a seller in terms of understanding how each Buyer will be received by the banks. Each bank uses a slightly different form of this calculation, which is why Business Brokers recommend Buyers to contact several banks in parallel to seek financing.

As part of the final stage of negotiations, do not be shy to ask for the Buyer’s Personal Financial Statement, as prepared on SBA Form 413. He will have filled in this form as one of the first parts of his loan application process. This form lists all assets and liabilities, as well as the Buyer’s current sources of income and contingent liabilities such as car loans and mortgage payments.

The Bankers involved in extending the SBA guaranteed financing will most likely ask for a 15 – 20% owner carry as a loan condition. Additionally, the Bankers are likely to ask for personal guarantees from the Buyer, as well as a formal lien against the Buyer’s home(s) and other personal property, but that does not affect you.

The maximum limit for a house cleaning company to quality for a SBA financing is sales of $6 million for the last three years. The SBA commonly guarantees loans for purchases of existing businesses of up to $1.5 million. Using the average cash down of 20%, and an owner carry of another 20%, you start to price yourself out of the SBA loan market at an annual free cash flow to owner of $600,000. At this range, however, you also start to attract financial investors, and an experienced Buyer probably qualifies for a regular commercial loan.

Enhancing the Bankability of the Transaction

If you are selling your company as a Going Concern you are unlikely to find a Buyer who will pay cash without any financing and without asking for an owner carry to mitigate the transition risk. Therefore, enhancing the bankability of the transaction will directly result in a higher value for your company. When you have negotiated a price with the potential Buyer, and he puts it to a few Bankers to approve a loan for the purchase price, the last thing you want is for the Bankers to come back and tell you that the numbers do not support the purchase price you have so painfully negotiated, and call for a lower purchase price. As mentioned above, your business needs to be a corporate entity, and you need to have a separate place of business. While these are not necessarily deal stoppers, being deficient in either of these certainly does not enhance the bankability of the transaction.

The main focus of the Bankers will be your corporate tax return, and reconciling the corporate tax return up to your accounting files. An orderly accounting, preferably through QuickBooks, which the Bankers will be familiar with, will help smooth the transaction along. You will not be penalized for not using an outside accounting firm, as long as the accounting is done well. We went so far as to organize our QuickBooks accounts after the tax return line items, even using the tax return line items when we named our accounts. This way, there were no discrepancies between the two raising any questions. Of course, the tax return itself has to be immaculate, with nothing raising any questions either. You need to minimize the number of add-backs; related-party add-backs are of particular interest to bankers. You do not want interested Bankers, you want Bankers who review your financials and then slap the Buyer’s back, telling him what a wonderful deal he’s cut. With a little advance forethought, that may well happen, and you will be on your way to figuring out what to do with your sacks of proceeds.