Valuing Service Businesses Compared to Retail Businesses

Defining Service and Retail Businesses

The different characteristics of service and retail-related businesses play a large part in how they are ultimately valued. Retail businesses generally have a retail-oriented location that is open to the public and from which they sell goods or products directly to consumers. Service businesses may be operated from anywhere (including the seller’s home), and primarily offer services(such as cleaning, maintenance, or landscaping) to its customers. Some service businesses do sell products but focus on services. The differing traits of a service business versus a retail business affects their respective business valuations, as well as the optimal buyer best suited to purchase each type of business.

Location Critical to Retail Businesses

For any business that sells products or goods directly to the public, the location of the business is of paramount importance. With many retail-oriented businesses such as convenience stores, the first and most important question a buyer will have concerns the location. A buyer will be most concerned with the demographics in the immediate geographic area of the store, including nearby competitors and the residential or commercial growth. Moreover, a buyer will closely scrutinize the commercial plaza of the store. If the plaza is run down or losing tenants, then the buyer may not be interested in purchasing the business (no matter how well the store is doing).

Location Also Important for Quasi-Retail

Some businesses have characteristics of both retail and service industries. These businesses operate from retail locations but sell a ‘service’ instead of a product or good to the public. Examples of such businesses include gyms or laundromats which sell ‘services’ directly to the public from a retail location. No matter if the end product is a good or a service, whenever walk-in traffic or visibility to the public is important, the location of the business is of paramount importance. A visible location in a busy plaza with favorable and growing demographics will dramatically affect the valuation of the business.

A Strong Long-Term Lease Will Increase Valuation of Retail Businesses

  • A good location is only as good as the long term lease in place.
  • Before paying a premium valuation for a retail business, a buyer will expect there to be a long term lease (typically at least 3-5 years) or the chance to negotiate a favorable long term lease with the landlord..
  • This is because a buyer will want to be assured that they will be able to possess and use the leased place for a sufficient period of time in which to obtain a satisfactory return on their investment.
  • Moreover, a buyer will want to be assured that the landlord is ‘on their side’ in wanting to maintain the general upkeep on the exterior of the facility and the plaza itself (both generally the responsibility of the landlord).
  • Other attributes of a strong lease is the rate of rental increase over time, the exclusivity that the tenant has on selling their particular goods or services within the commercial plaza, and the transferability of the lease itself.
  • Many buyers of retail-oriented businesses such as restaurants will only seek to purchase those businesses where the annual rent is less than 10 percent of the total sales.
  • Given the other costs involved with operating retail businesses (namely payroll and costs of goods sold), the rent should not generally exceed ten percent of sales.

Service Businesses Not Concerned with Location/Lease

In contrast to retail-related businesses, service businesses may be operated anywhere and do not have ‘storefront’ locations that are open to the public. Examples of strictly service-related businesses include home healthcare companies, staffing agencies, and pool routes.  Such businesses may be operated out of the owner’s home or may be operated out of an office or industrial setting where customers are not expected to visit. Obviously, the cost structure of service businesses differs dramatically from retail businesses because service businesses have much lower occupancy costs (or none at all). On the other hand, service companies are at a disadvantage from retail businesses because they do not have a fixed place of business from which sales may take place at almost any time.

Valuing Service Businesses Compared to Retail Businesses

  • Because service businesses do not rely on their location (and on a favorable lease), they obtain business from their reputation, word of mouth in the community, and brand name.
  • The resulting intangible value (as demonstrated by its profits) is derived from the established relationships and reputation among its customers, staff, and the general public.
  • The proper valuation technique for service businesses is determining the adjusted owner benefit of the business, or true economic profit derived by the owner.
  • Then one assigns a multiple to the owner benefit in deriving the value of the business.
  • The physical assets (such as equipment, leasehold rights, or inventory) of a service business are usually not relevant for most service businesses.
  • Valuation ranges for service businesses differ dramatically based on a number of factors including their growth rate, margins, and to what degree the owner is involved in running the business.  
  • The proper valuation technique for retail businesses emphasizes the location, lease, and physical assets (especially inventory), while generally assigning a lower multiple to the adjusted owner benefit.

SBA-related Difficulties for Service Businesses

The Small Business Administration (SBA) makes it possible for many business buyers to fund the transaction via SBA-backed bank financing. For some service industries requiring specialized skill or licensing (such as electricians, plumbers, or construction-related businesses), the SBA will require the buyer to have a sufficient level of work-related experience in those industries. The SBA imposes these requirements in order to ensure that the buyer has a reasonable chance of being successful after buying the business. Without the requisite skills or licensing in these specialized industries, a buyer will have a hard time in obtaining SBA financing. For most retail-related industries, the buyer will not face such a hurdle when seeking SBA-backed financing.

Before selling your retail or service-related business, it is always best to value the business correctly and consider the factors that buyers will deem most relevant.

Give Martin at Five Star Business Brokers of Palm Beach County a call today for a FREE evaluation of your business.