By - Jeremiah Grant
Last Updated - May 29th, 2024 10:07 AM
May 29
Did you know that the hair salon industry in the US alone is a multi-billion dollar giant, which was valued at $52.2 billion in 2023?
With this booming market, it’s no surprise that buying or selling a hair salon can be a lucrative opportunity. But how to value a hair salon using the right business appraisal services and determine its true worth? There’s a science to it, and using the wrong method could mean leaving thousands on the table. In this blog post, we will discuss the different methods used to appraise a hair salon and the factors or elements that can impact its value. Let’s get started.
The DCF method is a valuation technique that estimates the intrinsic value of a hair salon based on its projected future cash flows. It considers the time value of money, meaning a dollar today is worth more than a dollar tomorrow. Here’s a breakdown of the DCF method:
Explanation:
Project Free Cash Flows (FCF): Forecast the salon’s future cash flow after accounting for all expenses and operating costs.
Choose a Discount Rate: This rate reflects the risk and time value of the investment. A higher-risk salon will have a higher discount rate.
Discount Cash Flows: Each year’s projected FCF is discounted back to its present value using the chosen discount rate.
Calculate Terminal Value: Estimate the salon’s value at the end of the forecast period, considering future perpetuity growth.
Discounted Terminal Value: Discount the terminal value back to its present value using the discount rate.
Enterprise Value: Sum the present values of all FCFs and the terminal value.
Example:
A hair salon projects a free cash flow of $50,000 for the next five years, with a perpetuity growth rate of 2% and a 10% discount rate.
Year
FCF
(1/(1+0.1))^n
Discounted FCF
1
$50,000
0.909
$45,455
2
$50,000
0.826
$41,300
3
$50,000
0.751
$37,549
4
$50,000
0.683
$34,172
5
$50,000
0.621
$31,068
Terminal Value Calculation (assuming perpetuity growth rate of 2% and discount rate of 10%)
Terminal Value (TV) = FCF (year 6) / (Discount Rate – Perpetuity Growth) TV = $50,000 / (0.10 – 0.02) TV = $625,000
Discounted Terminal Value
Discounted TV = $625,000 * (1/(1+0.1))^5 = $350,783
Enterprise Value = $454,327 (Sum of Discounted FCFs and Discounted Terminal Value)
Pros:
Considers future cash flow potential.
Accounts for the time value of money.
Useful for valuing salons with unique growth prospects.
Cons:
Relies heavily on accurate cash flow projections.
Choosing the discount rate can be subjective.
Complex calculations and requires financial modelling skills.
Suitable for:
Hair salons with a clear growth trajectory.
Salons with strong historical financial performance.
Valuing a salon considering future expansion plans.
The Capitalization of Earnings (Cap Rate) method is another income approach valuation technique for hair salons. It focuses on a salon’s historical earnings and translates them into a present value based on a capitalization rate.
Explanation:
Choose Profit Measure: Select a profitability metric like Net Operating Income (NOI) or Earnings Before Interest, Taxes, Depreciation, and Amortization (EBITDA).
Determine Capitalization Rate (Cap Rate): This rate reflects the risk and expected return on investment. It’s typically derived from comparable salon sales or industry benchmarks.
Formula:
Salon Value = Profit Measure / Capitalization Rate
Example:
A hair salon generates a stable NOI of $100,000 annually. The cap rate for similar salons in the area is 8%.
Salon Value = $100,000 / 0.08 = $1,250,000
Pros:
Simpler to apply compared to DCF.
Less reliant on future projections.
Provides a quick valuation estimate.
Cons:
Ignores future growth potential.
Relies on historical performance, which might not reflect future trends.
Sensitive to the chosen cap rate.
Suitable for:
Hair salons with a stable historical income stream.
Salons where future growth prospects are uncertain.
Obtaining a quick valuation for initial negotiations.
2. Market Approach
A. Comparable Sales Method
The Comparable Sales Method is a market-based valuation approach that compares a hair salon to similar salons that have recently been sold. It assumes that salons with comparable features and financial performance will have similar market values.
Explanation:
Identify Comparable Salons: Look for salons in the same geographic location, size, clientele, and service offerings. Recent sales data is preferred.
Adjustments: Account for differences between the subject salon and comparables. This might involve considering factors like revenue, profitability, square footage, and reputation.
Valuation: Apply a price-to-sales (P/S) or price-to-earnings (P/E) multiple derived from the comparable sales data to the subject salon’s financial metrics.
Formula (using P/S multiple):
Salon Value = Average P/S Multiple * Subject Salon’s Revenue
Example:
Three comparable hair salons recently sold with the following details:
A: Sold for $1 million, Revenue: $500,000 (P/S = 2)
B: Sold for $800,000, Revenue: $400,000 (P/S = 2)
C: Sold for $1.2 million, Revenue: $700,000 (P/S = 1.71)
The subject salon has a revenue of $600,000.
Average P/S Multiple = (2 + 2 + 1.71) / 3 = 1.9
Estimated Salon Value = 1.9 * $600,000 = $1,140,000
Pros:
Relies on actual market transactions.
Relatively easy to understand and implement.
Provides a good benchmark for valuation.
Cons:
Finding truly comparable salons can be challenging. Adjustments for differences can be subjective. May not reflect unique features of the subject salon.
Suitable for:
Hair salons operating in an active market with recent sales data.
Salons with characteristics similar to those recently sold.
Obtaining a market-driven valuation for comparison with other methods.
B. Revenue Multiple
The Revenue Multiple is a market-based valuation method commonly used for hair salons. It compares a salon’s annual gross revenue to the market value of similar salons.
Explanation:
Gather Revenue Data: Determine the salon’s annual gross revenue.
Identify Comparable Salons: Find recently sold hair salons with similar characteristics like size, location, clientele, and service offerings.
Market Multiple: Gather the Enterprise Values (EV) of the comparable salons and divide them by their respective gross revenues to obtain revenue multiples.
Apply the Multiple: Based on the comparables, select an appropriate revenue multiple and multiply it by the subject salon’s gross revenue to estimate its value.
Formula:
Salon Value = Gross Revenue * Industry Revenue Multiple
Example:
A hair salon generates a gross revenue of $400,000 annually. Through market research, you identify three recently sold comparable salons:
A: Sold for $1 million, Revenue: $500,000 (Revenue Multiple = 2)
B: Sold for $800,000, Revenue: $400,000 (Revenue Multiple = 2)
C: Sold for $1.2 million, Revenue: $700,000 (Revenue Multiple = 1.71)
The Seller’s Discretionary Earnings (SDE) Multiple is a market-based valuation technique that focuses on the cash flow available to the salon owner after accounting for all business expenses and a reasonable salary for the owner’s management contribution. This owner’s discretionary earnings are then compared to the market value of similar salons to estimate the subject salon’s value.
Explanation:
Calculate Seller’s Discretionary Earnings (SDE): Analyze the salon’s financial statements to determine its annual SDE. This involves calculating net income, adding back non-cash expenses (depreciation, amortization), and adjusting for any non-recurring items or owner’s personal expenses.
Identify Comparable Salons: Find recently sold hair salons with similar characteristics like size, location, clientele, and service offerings.
Market Multiple: Gather the Enterprise Values (EV) of the comparable salons and divide them by their respective SDE to obtain SDE multiples.
Apply the Multiple: Select an appropriate SDE multiple based on the comparables and multiply it by the subject salon’s SDE to estimate its value.
Formula:
Salon Value = SDE * Industry SDE Multiple
Example:
A hair salon’s SDE is calculated to be $150,000. Through market research, you identify three recently sold comparable salons:
A: Sold for $1.8 million, SDE: $120,000 (SDE Multiple = 15)
B: Sold for $1.5 million, SDE: $100,000 (SDE Multiple = 15)
C: Sold for $1.2 million, SDE: $90,000 (SDE Multiple = 13.33)
Considers profitability to some extent, focusing on the owner’s cash flow after all expenses.
Relatively easy to calculate with proper SDE determination.
Provides a market-based valuation using a metric that reflects owner profitability.
Cons:
Relies on accurate SDE calculation, which can be subjective depending on how owner’s salary and non-recurring adjustments are determined.
The industry multiple may not reflect the salon’s specific risk profile or growth potential.
Less emphasis on growth potential compared to income approach methods.
Suitability:
The SDE Multiple is suitable for:
Hair salons with established profitability and a focus on owner’s cash flow generation.
Situations where market data on recent sales of comparable salons is available.
Obtaining a market-driven valuation for comparison with other methods, particularly the Revenue Multiple.
The SDE Multiple offers a valuable perspective but may not be suitable for all hair salon valuations. For a reliable valuation, it’s important to consider the salon’s specific circumstances, the chosen comparables, and the accuracy of the SDE calculation.
The EBITDA Multiple is a market-based valuation method commonly used for hair salons. It compares a salon’s profitability, measured by Earnings Before Interest, Taxes, Depreciation, and Amortization (EBITDA), to the market value of similar salons.
Explanation:
Calculate EBITDA: Analyze the salon’s financial statements to determine its annual EBITDA.
Identify Comparable Salons: Find recently sold hair salons with similar characteristics like size, location, clientele, and service offerings.
Market Multiple: Gather the Enterprise Values (EV) of the comparable salons and divide them by their respective EBITDA to obtain EBITDA multiples.
Apply the Multiple: Select an appropriate EBITDA multiple based on the comparables and multiply it by the subject salon’s EBITDA to estimate its value.
Formula:
Salon Value = EBITDA * Industry EBITDA Multiple
Example:
A hair salon generates an annual EBITDA of $120,000. Through market research, you identify three recently sold comparable salons:
A: Sold for $1.5 million, EBITDA: $100,000 (EBITDA Multiple = 15)
B: Sold for $1.2 million, EBITDA: $90,000 (EBITDA Multiple = 13.33)
C: Sold for $800,000, EBITDA: $60,000 (EBITDA Multiple = 13.33)
Provides a market-driven valuation based on real transactions.
Less reliant on future projections compared to DCF.
Cons:
Finding truly comparable salons can be challenging, especially for unique businesses. The chosen multiple can be subjective and depend on various factors. May not fully capture the value of the salon’s intangible assets.
Suitability:
The EBITDA Multiple is suitable for:
Hair salons operating in an active market with recent sales data of comparable businesses.
Salons with stable and predictable profitability.
Obtaining a market-based valuation for comparison with other methods.
Remember: A thorough analysis of the salon’s specific characteristics and the chosen comparables is crucial for an accurate valuation using the EBITDA Multiple.
The Adjusted Book Value Method is a valuation technique within the asset approach that focuses on the net fair market value of a hair salon’s tangible assets. This method is less common for valuing ongoing businesses but can be relevant in specific situations, such as when a significant portion of the salon’s value comes from its equipment or furniture.
Explanation:
Gather Book Values: Identify the book values of the salon’s assets (furniture, equipment, leasehold improvements) and liabilities (accounts payable, loans) from the accounting records.
Market Value Adjustments: Since book value may not reflect the true market value of the assets, an appraiser or valuation expert needs to estimate the fair market value of these assets if they were sold separately.
Adjusted Book Value Calculation: Recalculate the net value of the salon by replacing the book values with the fair market values for specific assets.
Formula:
Adjusted Book Value = (Adjusted Asset Values) – Liabilities
Example:
A hair salon has equipment listed with a book value of $20,000 according to their accounting records. However, an appraiser estimates the fair market value of this equipment to be $30,000. The salon also has $10,000 in outstanding liabilities.
Adjusted Book Value Calculation:
Considering just the equipment adjustment:
Adjusted Book Value = ($30,000 + Book Value of Other Assets) – $10,000 (Liabilities)
This calculation would be repeated for any other assets where the fair market value differs significantly from the book value.
Pros:
Relatively straightforward to calculate if the book values are accurate and up-to-date.
Useful when a significant portion of the salon’s value is derived from its tangible assets, such as high-end equipment or specialized furniture.
Cons:
Book values may not reflect the true market value of the assets, requiring adjustments and potentially additional appraisal costs.
Ignores intangible assets like brand reputation, customer base, or established location, which can be significant for a salon’s value.
May not be relevant for salons with minimal tangible assets or where the value lies primarily in its customer base or reputation.
Suitability:
The Adjusted Book Value Method is suitable for:
Hair salons with a substantial investment in tangible assets that contribute significantly to the overall value.
Situations where the book values are a reliable starting point and adjustments can be made with minimal complexity.
Providing a benchmark value alongside other business valuation methods, particularly the income and market approaches, for a more comprehensive picture.
B. Liquidation Value Method
The Liquidation Value Method, another technique within the asset approach, estimates the value of a hair salon if its assets were sold piecemeal in a forced liquidation scenario. This fire-sale approach represents the value of the salon as a collection of sellable assets, not as a going concern.
Explanation:
Estimate Asset Values: Determine the fire-sale value (quick sale price) of the salon’s assets, such as furniture, equipment, and inventory, if they were liquidated. This typically involves appraisals or using industry benchmarks for used equipment values.
Deduct Liabilities: Subtract any outstanding liabilities, such as accounts payable or loans, from the estimated fire-sale value of the assets.
Formula:
Liquidation Value = (Estimated Fire-Sale Value of Assets) – Liabilities
Example:
Imagine a hair salon needs to close down and sell off its assets quickly. An appraiser estimates the fire-sale value of the furniture and equipment to be $25,000, and the salon has $15,000 in outstanding liabilities.
Following are some important elements that can greatly impact your salon’s valuation.
Location
Prime locations that are easily accessible and are located in densely populated areas with well-developed parking spaces in well-off areas usually attract higher premiums. On the other hand, salons that operate in less conspicuous locations or where competition is intense due to the presence of existing brands might experience a decline in value. Demographics and retail expenditure in the particular geographic region also help in the process. A salon in an area that has high patronage will definitely be more valuable than a salon in an area that is not popular.
Client Base
The size of the customer base, the loyalty of these customers, and their profile are important for any salon. This means that the salon has a steady base of customers, which provides constant cash inflows, and hence, the salon will be more desirable to potential investors. Hence, using client data such as age, income, and spending patterns to determine the outlook for business growth is viable.
Reputation and Brand
A positive brand image based on quality services, customer satisfaction, and the establishment of strong and vibrant web pages can add a lot of value to the salon business. Brand awareness refers to the goodwill attached to the salon’s name, and this attribute impacts customers’ decision-making and ability to set high prices. A salon with an established brand name and good references may be expected to command a better price than a salon with a poor image.
Financial Performance
It is crucial to evaluate the salon’s financial position through financial statement analysis for valuation. Some of the most important financial ratios include revenue growth, profit margins, and growth rates. High profitability, good cash flow, and a record of steady growth suggest a lower risk for investors, which means a higher value for the salon. On the other hand, diminishing sales or slow growth are detrimental to its value.
Staff and Management
Well-trained and professional workers are always an advantage for any salon business. Word-of-mouth recommendations from satisfied clients are possible when professional hair stylists provide quality service to their customers. Leadership and management practices that provide efficiency in operations, development of employees, and good customer relations also play a great role in enhancing the value of the salon.
Salon Equipment and Inventory
Furniture, equipment, and product inventory are relatively easier assets to value but usually contribute a minimal proportion to the hair salon’s worth. The equipment type, age, and brand will be taken into consideration, and items of higher quality and newer will be valued more. However, the salon’s reputation, customers, and financial data are expected to be more influential in the overall valuation.
The hair salon industry has shown remarkable resilience and growth, especially as it rebounds from the challenges posed by the COVID-19 pandemic. In 2022, the market size of the U.S. hair salon industry reached approximately $48.3 billion, with over 994,000 registered salons employing 1.33 million professionals. This growth is driven by several key trends that are reshaping the industry.
One significant trend is the rise of sustainable beauty practices. Salons are increasingly adopting eco-friendly techniques, such as using natural and organic products, implementing recycling programs, and conserving water. This shift caters to the growing consumer demand for environmentally responsible services.
Inclusivity and diversity have also become focal points. Salons are striving to create welcoming environments for clients of all backgrounds, with professionals receiving training to cater to diverse hair types and skin tones. This trend is accompanied by the increasing popularity of personalized and wellness-focused treatments, such as scalp massages and aromatherapy, which enhance overall client well-being.
Technological integration is another pivotal development. Salons are leveraging digital tools for virtual consultations, online bookings, and AI-powered customer service enhancements, which streamline operations and improve client experiences. Additionally, the industry’s emphasis on social media marketing and influencer partnerships is proving crucial for attracting clients and promoting services.
Conclusion
Understanding a hair salon’s true value goes beyond square footage and stylist chairs. It’s about recognizing the potential for future growth, a loyal clientele, and a strong brand reputation. The valuation methods explored in this blog – from the DCF’s focus on future cash flow to the market approach’s reliance on real transactions – equip you with the knowledge to make informed decisions.
But going through these intricacies and arriving at a comprehensive valuation can be a complex task, and professional help is always advised. Arrowfish Consulting, a team of business appraisal experts with a proven track record in the salon industry, can be your trusted partner. We’ll help you leverage the right methods, analyze market trends, and ensure you achieve the best possible outcome, whether you’re buying or selling a salon.
You can always contact us for a free consultation to learn how we can help you and whether we’re a good fit.
Jeremiah Grant
Jeremiah Grant is the Managing Partner of Arrowfish Consulting. In addition to acting as a primary liaison for many of the firm’s engagements, He primarily focuses on business valuation and economic damages expert witness assignments, in addition to forensic accounting and insurance claims analysis.
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