Episode #367 – How To Calculate Your Salons Worth

Intro:

Do you feel like you were meant to have a kick-ass career as a hairstylist?

Like you got into this industry to make big things happen?

Maybe you’re struggling to build a solid base and want some stability.

Maybe you know social media is important, but it feels like a waste of time because you weren’t seeing any results.

Maybe you’ve already had some amazing success but are craving more.

Maybe you’re ready to truly enjoy the freedom and flexibility this industry has to offer.

Cutting and coloring skills will only get you so far, but to build a life long career as a wealthy stylist, it takes business skills and a serious marketing strategy.

When you’re ready to quit just working in your business and start working on it, join us here where we share real success stories from real stylists.

I’m Britt Seva, social media and marketing strategist just for hair stylists, and this is the Thriving Stylist Podcast.

Britt:

What is up and welcome back to the Thriving Stylist Podcast.

I’m your host, Britt Seva.

And today we’re going to talk about how to calculate your salon’s worth.

So there are a lot of salons owners out there who are hoping to one day sell their salon.

If you’re a stylist, I know the thought of that is scary, but actually if a salon sale is done really well, everybody wins and it can be really, really beneficial to the entire team.

This is not the first time I’ve talked about this.

If you’ve not already listened to Episode 277, it’s called How to Build a Salon You Can Sell.

I really recommend listening to that as well.

It tackles some of the other things that we’re not going to tackle in today’s episode.

So if you are a salon owner and you’re like, I do probably want to sell one day, listen to this one and 277.

If you just do a Google search for Thriving Stylist Podcast 277, it should come right up for you.

Now if you’re a stylist and you’re listening to this and you’re like, I’m not a salon owner.

I don’t ever want to be one.

I don’t have anything I want to sell like that.

My advice to you is listen up because this might be interesting for you.

If your salon does sell, I think it’s interesting to know what the terms look like.

You may get the opportunity to buy your salon and think about what that could look like and make sure that you are paying an appropriate amount for it.

So I think this will be very educational and informational.

The other thing I want everyone to keep in mind is our industry is very unique in that everybody who joins it is essentially an entrepreneur, right?

Even if you’re a commissioned stylist, yes, you are getting a paycheck if with your hourly salaried commission traditionally or whatever, you’re getting a paycheck from the owner.

However, in most salons I know, the stylist still has to generate some of their clientele.

Now I will say in the most successful salons I know, the salon is providing the bulk of the clientele.

When you look at the most profitable salons today, the salon is providing a lot of the clientele.

That being said, even if you were a stylist working in a salon that could provide your entire clientele, if you didn’t learn exceptional communication skills, or if you’re cutting or coloring or styling skills just never really refined themselves enough, you’ll probably not make it, right?

We’ve seen all of those stylists where it’s like, ugh, such wasted potential.

And that’s what makes all of us entrepreneurs, versus if we were all, if I had this podcast and it was called the Thriving Receptionist Podcast, you could be like a mediocre receptionist and do just fine.

This is not an industry where that generally works.

Now what’s interesting about our industry is it’s also a relationship-based industry, which makes selling a salon extremely difficult, extremely difficult.

I don’t know of a ton of salons that have sold for some of the numbers I’m going to talk about today, but I want to talk about how you could be somebody who would break records with the sale of your salon.

There’s a couple of salons that come to mind right now that I think 10, 15 years, when those owners want to retire, they could be in really good position to make some money doing that.

And it’s good to set yourself up now to get there at some point.

However, something for all of us to keep in mind is, because our business is so relationship based, there’s a couple of things to note.

One, reducing or eliminating your key man risk is critical.

And that’s something we talk about in episode 277.

Because you can’t really sell a clientele.

Decades ago, Stylist tried.

They were like, oh, I’m retiring.

You can buy my book of business.

But history tells us that doesn’t work.

And it especially doesn’t work now.

It worked 20 or 30 years ago when it was hard for clients to find new Stylist.

Now I can pull up my phone and find a new Stylist in 10 minutes.

It’s too easy.

And so we’ve seen it happen time and time and time again, where Stylist gifts their clientele to somebody or sells their clientele to somebody.

You can’t sell human beings and their interests.

They’re gonna go wherever they wanna go.

And so there’s not a monetary value to that.

Humans have free will.

So not a lot of value there.

When you look at it as something like a dental practice, somebody can sell a dental practice and make a lot of money doing it.

There was a dental practice that went up for sale.

I live in a small community.

You’ve probably heard me say that 100,000 times.

We don’t have a huge market to be connecting with here.

It’s like local family and friends, and that’s all you got.

And there was a dental practice that had been in the town for probably 30 years.

They sold a couple years ago.

Young husband and wife came in and bought it.

That business has exploded.

They took this dental practice that was doing just okay to something absolutely stellar, and I’m sure they paid a pretty penny for it.

There are some business coaches out there right now who are talking about sell a vending machine business.

You’re going to absolutely love it.

Or buy a vending machine business.

You’re going to absolutely love it.

Buy a dry cleaning business, and make it ultra sexy, and you’ll make a lot of money.

Buy a window washing business, and make it ultra sexy, and you’ll make a lot of money.

You can do that.

That does work.

Our industry is really different.

You can buy a salon and make it super fancy, and if the relationship and the connection isn’t there, it will still fail.

Versus with a window washing business, do you care how charming your window washer is?

Most of us, no.

So good marketing and great customer service is enough.

Our industry is super different.

So because of that, the monetary value is also incredibly different.

And so most of the general rules that apply when someone is buying or selling businesses do not apply in our industry.

So keep that in mind as we talk this through.

There are three different common methods that are used to value a salon’s worth, and one of them is the one I see most dominant.

Another is one I could see kind of emerging, but it’s not really there yet, and there’s one that I think hardly gets used because very few salons get to this place in space.

So let’s start with that one.

That one is going to be the income or earnings method.

It is one that is largely used outside of our industry and in a lot of businesses, but in ours, it doesn’t necessarily work great, and I want to explain why.

So the income and earnings method looks at a business’s ability to generate profits and cash flow into the future.

So not what have you done in the past, what have you done for me lately, and what does it look like you’ll do in the next 10 years?

So you can probably already see by that description why that’s problematic for our industry, because our industry does have that key man risk, and any investor, any bank that finances this, any business broker is going to say, if this existing owner leaves, can this salon stay open?

It’s risky, versus if the owner of a car wash leaves and some new owner investor comes in, it’s probably going to do just fine.

A lot of the customers are not even going to know there’s a new owner.

In our industry, they’re going to know in five seconds.

So there’s this huge key man risk that exists, and that makes this a problematic calculation, but we’re going to talk about it anyway.

So bigger companies use something called the EBITDA calculation.

I talked about it on the last podcast.

Very common for big company traditional sales, and it’s earnings before interest, taxes, depreciation, and amortization.

It looks at cash flow of business, challenges in our industry.

We don’t have a lot of EBITDA stuff going on.

Instead, we have something called seller’s discretionary earnings.

So in small businesses like hair salons, really the perk of being the owner is the discretionary earnings.

There’s not like these big, huge profit margins and stock options.

It’s not as complicated as that.

And so because the perks of being an owner are kind of just like the inside perks, we’ll talk about those in a second.

Instead of looking at the EBITDA, we look at the SDE.

So let me explain to you what the SDE is.

And it’s complicated.

It’s mathy.

So you look at pre-tax income, so basically gross revenue.

And generally speaking, you would take the salon owner’s production behind the chair out of that calculation.

Because if you’re selling the business, the assumption is you’re leaving.

So you can’t include your revenue that you produce.

It’s the revenue that’s produced beyond you, okay?

So pre-tax revenue, owner’s comp, interest, interest expense, I should say.

So let’s say you took out a business loan or something and you’re paying interest on that loan, that’s taken into account.

Depreciation and amortization.

So very common if you buy like salon chairs or new stations or something like that, computers for the salon.

Those are depreciating assets.

So you write off a portion of it over time.

Discretionary expenses.

So that’s the big one.

So as an owner, discretionary expenses are one of the best perks.

So having your health insurance paid for by the business, that’s a discretionary expense.

Your salary, your owner’s draw is a discretionary expense, and it’s discretionary, right?

So like you as the owner might be choosing $30,000 as your salary.

Maybe the next owner comes in and says, F the profit margin, and they want to take $60,000.

It’s up to their discretion.

That’s what makes it discretionary, right?

So your salary is discretionary.

There are a lot of salon owners who have a car registered to their salon business.

That would be considered discretionary.

Travel expenses, discretionary.

Anything that’s like not critical to the business staying open can fall into that discretionary category, like buying color.

If you are a salon that does hair color, not discretionary.

It has to happen.

But taking a business trip does not have to happen.

So that’s going to be more discretionary.

So all of those things get added in.

Non-recurring expenses.

So let’s say you have to hire a lawyer one time to fight some legal battle.

That would be a non-recurring expense.

It happened as a one-off.

Sure, it might happen next year.

It might not happen again for five years.

That gets added in.

And then you remove all of the one-time revenues.

So remember, we were looking at the gross revenue of the business.

You remove anything that was kind of like an outlier.

So let’s say the salon did 300,000 hours in revenue this year.

But 10,000 of that was because you hosted two cut and color classes in the salon and it produced $10,000 in education income.

Those are outliers.

It’s not a normal something that the business offers.

Yeah, maybe you say, well, we do it seasonally.

That’s still gonna be one time revenues because it is seasonal.

It’s not something you can always count on.

It’s not something the new owner can be like, and this is gonna be great.

They don’t know that it’s gonna be great.

It’s an outlier.

So that gets removed.

So we take that $300,000 in total gross revenue that the salon brought in, minus that 10K that came in from the education events, because that would be considered one time revenue.

Then you add in all those other things.

So owner’s comp, interest, depreciation, discretionary expenses, and non-recurring expenses.

All of those get added back in.

So this actually works in your favor.

So if a valuator were coming in, they’d say, okay, well, based on this SDE calculation, this salon does $300,000 in annual revenue, but the SDE is 358,000.

Because there’s enough cooking in the business for the owner to take care of another $58,000 in expenses.

So it shows that there’s profitability there, and there’s enough money for other cool things to be happening.

And that’s what that number represents, okay?

Now, let me pin in that for a second.

We don’t just look at that revenue.

The other thing that we look at is consistent record of historical growth and profitability, which can be a problem for salons.

Anybody who’s working on this will want to see a decade’s worth of sales and growth reports, and they want to see consistent historical growth and profitability.

Now, you can have, like, let’s say 2020 was a tough year for you.

Well, it was a tough year for everybody.

How did you bounce back?

So they’re looking for the full story, which is why they look for a pretty good range of business, and they want to see growth of revenue and profitability.

Desirable location.

Like, is your location on the up and up, so the down and downs?

Clean record and bookkeeping.

I learned from a business coach that if you have shoddy bookkeeping or creative accounting, that will kill the sale of your business before it even starts.

Highly favorable lease terms or ownership of real property.

If your lease is going to end next year, it will be very tough to sell your business.

I just watched a salon try and sell, and the sale fell through because their lease was about to expire, and so it was seen as a bad deal.

So if your lease is going to expire, not a good time to sell.

A long business history.

So if you opened your salon three years ago, it’s going to be a tough sell.

The other thing is employee tenure.

If you have a record of employees only staying with you for two years and leaving, it’s going to be tough to sell.

If you have booth renters only or primarily, it’s going to be tough to sell.

Up to date and thorough maintenance records.

So is your electrical up to code?

Is your water heater new and functioning?

Things like that.

And if all of those things in order, everything is looking good, like, wow, wow, wow, this looks like a great salon, the money you can make can be pretty good.

So this is for the savvy salon owner who’s really got it going on and can check all of the boxes that I just talked about.

There is a chance that SDE is the calculation that would be used for you.

And this is when multipliers come in.

This is when it gets really exciting to sell a business, and this is kind of the dream everybody hopes for.

So the SDE number I was just talking about was $358,000.

Right?

That was the math that we just played with.

So if this salon was a real salon that was trying to sell and it checked all those boxes, good location, long-term employees, really clean bookkeeping, everything is up to code and up to date, and everything looks great, tons and tons of business, growth, profitability, everything’s great, potentially their SDE of $300,000 could qualify them for a multiplier of 3 to 3.5x.

Meaning you would take the $358,000 and multiply it by 3 to 3.5.

So it could be a million-dollar sale.

That salon owner could potentially sell that business for a million dollars.

Now they’ve got to find the buyer who’s going to want to pay that or take out the loan to make it happen, but it is possible.

Now that multiplier increases as the SDE increases.

So if your SDE is $100,000, let’s say, so you run all of that math and you get $100,000, you’d be lucky to get a double multiplier.

So you, your SDE is $100,000, you sell it for $200,000.

So it depreciates pretty quickly.

If your SDE is $50,000, your business value is $50,000.

There is no multiplier.

You basically get an option to get out.

So you can see that there’s a lot at stake when you’re doing math like this.

It can be incredibly lucrative or end up in nothing.

And the numbers I just gave are from one company that does brokerages like this.

This happens to be called Beacon.

But if you were to work with a different broker, they might give you a totally different set of numbers.

But when you look at multipliers and SDEs, this chart gives you a sense of where you could potentially land if you check all the boxes.

Now, like I said, very rare are salons valued that way because of things, like I said, a lease that’s about to expire.

It’s a booth rental salon, non-employee salon.

They’ve had good years and bad years, whatever.

Very rarely does it end up looking like that, but it could.

So what we see a lot of is actually this asset method.

This is much, much more common.

So the asset method doesn’t require that forensic financing or look at assumptions about the growth of your business.

Is there tenure?

Does it look like there’s going to growth?

Does profit increase year over year?

It’s not necessarily looking at those things.

Instead, it just looks at assets and liabilities.

It’s super simple.

So assets would be tangible assets like the FF&E stuff.

So the furniture, fixtures, and equipment, that’s called FF&E.

Real estate owned by the business, if you own your building, that’s obviously going to be an asset.

Any inventory, so retail products you have, color that you have on hand, the computers that are at your front desk.

If you have computers, the iPads that are in the building, things like that, your shampoo bowls, all of that would fall into furniture, fixtures, and equipment.

And any cash in the bank could be a part of an asset assessment.

Then there are the intangible assets like customer list, brand recognition, online reputation, accounts payable, short-term debt, business loans, and accrued expenses.

So they do look at the big picture of what do you got, what do you owe, what’s on hand, but it is from a much higher level than the SDE calculation.

So the reason this method is common in our industry is it basically calculates what would it look like for this business to survive.

It’s not looking at growth, it’s not looking at long-term value, right?

For you to sell a business that’s doing $300,000 in revenue right now for a million dollars, the new owner would have to know they’re gonna get that money back, or no one’s ever gonna cut the check.

Very few salons today could prove, listen, if you buy this business, you can get your million back in the next five to seven years.

Very few salons could prove that.

So with the asset method, it’s more like, look, this is the value of the depreciated value of the fixtures and furnishings that are here in the space.

We got all this retail, you can have that, you can have the color, you can have the computers, and all of that is worth X.

Now, we talk about in episode 277, sometimes the money in the bank is included, sometimes it’s not, that’s part of the negotiation, but this is very, very, very common, and it surprises a lot of salon owners, because they’re like, oh my gosh, I built this beautiful business over 20 years, we do have these customer lists, but evaluator is going to decide the value of those things.

If a huge portion of that is people who see the owner, that’s going to be a problem, too much key man risk.

So there’s not a lot of sellable value in that.

So instead, a lot of owners are like, wow, so the depreciated value of the fixtures, furnishings, assets in my building is 25 grand, and that’s what they sell the business for.

And yes, it’s better than nothing, but it’s not much.

There’s also a lot of negotiating power for the buyer in that.

So the very, very common in the industry, but imagine the difference of making a million dollars or 25,000, it’s significant.

Okay, so then there’s also the market method.

This one is the one I think could be emerging.

I think our industry right now is at a place where it is starting to get much more serious, and we’re seeing kind of the end of the mom and pop era, and a lot of salon owners who are taking their business more seriously.

So the market method is very common in other industries, but not so much in ours because so many salons are special snowflakes.

So the market method is kind of similar to how the real estate market works.

So basically uses comps.

So it says, let’s find five other salons in this geographical area that have sold recently, and those salons should serve a similar customer base.

They should have a similar square footage.

They should have a similar profitability.

They should have a similar team size.

What did those businesses sell for?

So you can see why that would be really tough in our industry because very few salons are cookie cutter similar like that, versus when you look at the real estate market, there’s plenty of comps.

In most neighborhoods, it’s like, well, those two houses have the exact same floor plan, so we can give a pretty good estimate of what that should sell for.

In our industry, it’s tough because there’s so few businesses that are same z’s like this.

I do think in a few years, a decade plus, we’ll see more market method sales potentially happening, more sales based on comps, maybe.

But right now, asset sales are still going to reign supreme.

You can see, based on what I shared here, the best chance of you making really good money selling your salon is through that income and earnings method.

And the only way you’re going to make that happen is not just by the revenue, because you could see the revenue counted, but that consistent record of historical growth and profitability, desirable location, clean record and bookkeeping, favorable lease terms or ownership of property, length in business, long-term employees, up-to-date and thorough maintenance records, that counts twice.

All of those things are going to be critical because if you have that money, but you don’t have these other pieces, it’s going to be tricky.

So I hope that this is helpful.

One of the things that came up really recently, I want to close this episode by sharing, is that somebody said that it felt like I favored commission salons.

I am very open in understanding that this industry serves people who want to be independent.

I totally and completely understand that.

I know there’s challenges in being an employee.

I know there’s challenges in having employees.

The reason why I think sometimes it sounds like I favor commission salons is because the revenue and profit potential is higher.

I truly believe for both employees and for owners, if commissions are done properly, the way I pay out commissions is that employee stylists can earn up to 70% commissions.

So it’s very lucrative if done properly.

The other thing is it’s going to be tough to sell a booth rental salon for a million dollars.

And so the potential, especially if you’re an owner, is there.

If you want to have things like health insurance, if you want to have things like retirement savings, you’re not going to find that in an independent environment.

That being said, I think it’s a blessing that we live in an industry where you can be successful and independent.

I think that the Studio Suites market opening up was one of the best things that could have ever happened, because it gave the opportunity for those who do want to be independent to do it on their own terms and their own time and the way they want to do it, how they want to do it on their own schedule.

There is nothing better than that.

It also put the pressure on salon owners to level up if they want to keep growing in the industry.

I hope this has been an eye opener.

If you are a salon owner thinking about selling, I hope it’s been inspiring.

So much love, happy business building, and I’ll see you on the next one.