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FEATURE: What's your store really worth?

Regardless of the opportunity, when it comes to placing a value on a family-owned supermarket, it pays to know the facts.

According to Robert Potts, CPA and partner at Cohen & Co., Ltd., a regional accounting firm based in Cleveland, Ohio, the actual value of a retail business is based on a number of variables.

"During an acquisition process a buyer must consider such factors as store location, projected sales and margins, supplier relationships, population trends, competition and market share, personnel and management, and technology investments, to name just a few," Potts says. "These, along with other crucial items such as cash flow, the condition and age of fixtures and equipment, and long-term leases, can either increase or decrease value, dependent on the relative weight and influence each has on the risk factors involved."

He continues: "Overall there are three basic methods of calculating the value of a business. They include appraisals, a comparable-sales approach, and earnings-based methods.

"The comparable-sales approach is seldom used in closely held retail and manufacturing businesses," Potts notes. "Appraisals are more prevalent in industries like real estate. They also come into play in situations where there are no earnings and a business is facing liquidation. Regarding comparable sales, it's tough to use this method in retail situations, because no two supermarkets or their market conditions are exactly alike."

The earnings approach

According to Potts, whose firm has represented several food companies, a commonly used method in valuing supermarkets is earnings-based.

"Keep in mind that there are numerous variations to the earnings approach. Many buyers and sellers may choose to calculate EBITDA, which determines earnings before interest, taxes, depreciation, and amortization, and others may feel that a multiple of cash flow is a more accurate account of value," he says. "Generally buyers require at least three years of financial information, plus reliable projections, to perform the valuation process and justify the amount they're paying for the business."

Potts adds: "When calculating earnings, it's common to 'normalize' the seller's operating statement, keeping in mind that many privately held companies claim a variety of nonoperational expenses for the seller, such as automobiles for the owners, life insurance to fund succession planning, etc. In addition, there may be unusual expenses, such as one-time legal fees or moving expenses, which deflate earnings. The buyer and seller may agree to recast earnings by eliminating such expenses from the financial statements."

Once earnings are established, who determines the multiple? "In the end the multiple, which is applied to earnings and varies by industry, is simply a function of risk," Potts says. "A higher multiple typically indicates lower risk, and vice versa. In retail today, we're seeing multiples ranging from a low of three to a high of eight."

Goodwill, often a subject of debate among buyers and sellers, can be an important factor in determining the final price. According to Potts, 'goodwill' is defined as the value over and above a normal return on the investment.

"One's position with regard to goodwill so much depends on whether you're the buyer or seller -- and whether the deal involves purchasing the assets of the business, or the stock," Potts says. "Many times the buyer prefers an asset deal because it allows them to depreciate goodwill and enjoy the tax benefits of such an expense. On the other hand, most sellers prefer a stock deal because of more favorable tax implications."

Potts notes: "Goodwill, which can include such things as the exceptional reputation of the business, a store's pharmacy files or other proprietary products and services, and occupying the most desirable location in town, must be identified before it can be quantified. Ultimately all the things that create goodwill are manifested into earnings.

"In working with family businesses over the years, I've often found that those which are professionally managed, vs. those that are 'personally managed,' command a higher multiple."

He explains, "Key people can be a major factor in the marketability of a business. For example, some stores are entirely too dependent on the owner, and when that owner departs, everything falls apart. A potential buyer views that as risk -- and that risk is legitimately factored into the final offer."

A retailer's perspective

Key to the growth of Findlay, Ohio-based Fresh Encounter is Todd Perry.

Perry is certainly no stranger to food retailing. After earning his MBA from Ohio State University, the executive spent three years working with the retail consulting firm Accenture, whose client list includes such companies as Walgreens and Meijer. Last year, with the encouragement of his father-in-law, Mike Needler, NGA's outgoing chairman, Perry joined Fresh Encounter and is currently responsible for business strategy, development, and internal project management for the 33-store chain.

"I'm really enjoying the supermarket business and have found it to be quite challenging," Perry says. "In moving through the learning curve, I've received tremendous support from my father-in-law and my brother-in-law, Eric Anderson, who's responsible for all of our marketing activities."

Recognized as one of the fastest-growing and most innovative independents in the industry, Fresh Encounter has expanded its operation by acquiring existing stores, four of which were purchased earlier this year.

"The economics behind building stores from the ground up are difficult to justify for our company, given the markets in which we compete," Perry says. "We estimate the cost of entering a new market to be twice as much for new construction as compared to purchasing an existing business."

According to Perry, acquiring existing stores demands a thorough due diligence process. That process includes the following steps:

-Access the target store's financial and operational data. "Specific attention is given to sales, gross margins, distribution, utilities, leases, and capital expenditures," Perry says. "One problem we face in obtaining this data is that many independents don't invest in audited financial statements. Therefore, we need direct access to the person who's worked on the numbers, mainly because there are different ways to classify products and expenses."

-Conduct market analysis. "It's important to understand the customers and growth potential of a given market, as well as the competition," he says.

-Poll the vendor community. According to Perry, "Tremendous data can be obtained from your wholesaler and vendors in regard to product movement and market conditions."

-Complete a facility assessment. "Our internal maintenance team examines all equipment and refrigeration," Perry notes. "Their findings often help us to determine how much to pay for a location."

-Evaluate through internal benchmarking. "We need to understand which of our individual stores best fits that of the target," Perry says. "We also compare the target store to our company average, with regard to all areas of the income statement and statement of cash flows."

-Develop assumptions. "This is one of the most important steps in the due diligence process," Perry observes. "We pull together our executive committee and debate all of the 'what ifs.'"

-Input data into the financial model. "Having a sound financial model gives us a consistent method for valuing locations," Perry says.

-Perform sensitivity analysis. "Our stores are very community-focused," Perry notes. "That means we must be sensitive to the brands and products that are important in each individual market."

While the growth of Fresh Encounter appears to be endless, Perry stresses that it has passed on deals that weren't right for the company and its 1,600-plus associates.

"There have been a number of opportunities from which we've walked away," he says. "In some situations we were dealing with poor lease terms where there were either not enough option periods, or the lease costs overall were too high. Others involved data integrity and being unable to pinpoint exact sales and performance numbers. We've also passed on acquisitions when we weren't able to secure financing terms that matched our specific needs."

Perry concludes: "Banks that don't understand our industry are often skeptical about loaning money to supermarket owners. Most of Fresh Encounter's financing is secured through small community banks who, along with NGA member banks such as LaSalle and National Cooperative Bank, are investing not only in our business, but also in our reputation."
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