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Tuesday, August 4, 2015

What Is My Store Really Worth?

The most rudimentary research will reveal that the valuation of businesses is an inexact thing.  With such a wide variation in methodology, of course, comes the problem that any result you reach is probably complete bollocks.  I’m sure I'll make no friends among MBA enrollment counselors with that statement.

Since nobody can agree on how to value a business, we’re left to reduce our analysis to the fundamental elements: A good or service in the capitalistic sense is worth only what a buyer with money in hand is willing to pay for it.  Of course, you can find an even wider spread of value that way — virtually any amount is potentially “in play” and you never know what maniac buyer might vastly overpay or what distressed seller might accept a pittance — but at least those values are by definition accurate.  If someone paid $N for a business, for at least one crystalline moment in time, damned if that business was not “worth” precisely $N.

In practice, one can iterate from there.  Upon repeated sales, most necessarily comparison sales due to the unlikelihood that one business would change hands repeatedly over a short duration, we can discard the outlying highball and lowball transactions, and a more realistic spread emerges for each business similarly situated to the type and scale under analysis.  Sandwich shops are worth $84k or so, brew pubs $500k, international airlines $24 billion.  There's some variance, of course, but you get the idea.

The value shown there doesn’t derive directly from the balance sheet of the business, of course.  In the hideously unlikely case that, say, the Los Angeles Lakers were mired in debt, they would still be worth multiple billions of dollars.  This starts with comps, since Steve Ballmer paid two billion for the lesser Clippers only a year ago this month.  But beyond that, the capability of any NBA or NFL team (or whatever sport you like) for generating cash flow, their branding and IP, their "team history" as an exploitable, all add up to a profit potential that is going to be well in excess of the assets on the positive side of their ledger even if the team is swimming in liquidity.  

How is the business worth more than it's, well, worth?  Some amount of that is back-of-the-napkin math that I've heard referred to as “soft value” — goodwill, customer footfall, brand awareness, and like such.  While soft value is absolutely a real thing even though it’s intangible, “hard value” is a much safer basis for valuation for the simple reason that, aside from virtual elements such as IP, it’s all “actual stuff.”  You have it.  You could put it in your truck and haul it off, were you so inclined.  Or, to be more blunt, put “goodwill” in one hand and defecate in the other, and see which hand fills up first.  In business, you don't have what you can't count.  I guess that makes brand awareness somewhat better than outright "goodwill," since metrics actually exist to measure its reach.

In one of the Facebook closed groups for game and comic store owners, there was a discussion that looked at valuation of businesses in our industry from a new angle.  It is a real eye-opener, and absolutely made me take a step back and look at my operation in a critical fashion.  The discussion question was: 

“If someone wanted to clone your store right across the street from you, how much would it cost them to do that?”

The first blush at this question goes to the aforementioned balance sheet.  What would a new buildout cost, then inventory on the shelves, staff labor during all that, administration, legal, permit hell, time elapsed, and so forth.  You can come up with a number.  

The point of the question, of course, wasn't to get us to do math.  It was supposed to turn our focus to the nature of our soft value, and how well developed it really is.  (Again, soft value is absolutely real.)  The question prompted us to contemplate whether we brought something to the business that can’t be duplicated by sheer brute force of money, by a newcomer arriving with a gigantic open wallet.

But I liked the question much more as a cold, cutthroat intellectual and economic exercise, because I prefer not to rely on soft value.  To be certain: I’m prouder than I can express with how amazing my store’s community is.  And I do try to improve DSG's soft value every day.  I just don’t think it’s fair to my customers to hang such an anchor around their necks.  It seems like a very short pathway from there to a state of mind where I would start believing that the community “owes me” a living.  The community does not, of course.  I have to find new ways every day to make my customers happy, to improve the value proposition DSG offers, however minuscule the increment.  If I do well, customers voluntarily engage in business with me, to mutual benefit, without having some nebulous altruistic “duty" imposed upon them.  At the end of the day, as I've said before, I have to pay that landlord in dollars of money, not "brand awareness."

So, I looked instead at the question as a function of the degree to which brute force, i.e. capital to burn, could overwhelm all the soft value and bring a newcomer store, a clone of mine across the street or even right next door, up to parity with me.

DSG’s buildout was $60k at first and another ~$40k over time.  So there’s a starting base of $100k.  Right at this moment, my inventory stands at about $160k in bottom-dollar, scrounge-it-up, max-discount-tier replacement cost.  There would be about $40k in labor and materials costs to assemble, deploy, and organize, including administrative, legal, compliance, and so on.  So, the low end of what gets the newcomer to where I am is only $300k, which seems like a lot (and reflects awesome growth) but isn’t that much for an industrial conqueror determined to have its way.  In “real business” money, $300k is a lark.

So if someone came to my plaza with that $300k in hand and had perhaps another $50k to burn on operational expenses and to fund their mistake lessons as they got their sea legs, they could clone me and then catch up to me. They could do it with impressive speed.

Once the newcomer achieved that, it would be war.  

A knock-down drag-out fight between equals would ensue.  The attrition would be catastrophic.  Both stores would spend six figures to the left of the decimal over the course of years chipping away at one another and fighting over a customer base that would quickly weary of the rivalry and bleed out of the hobby or migrate to other stores around town.  It would be a brutal, excruciating, expensive fight.

And that fight would never happen.

Why?

While I'd put my ownership group's ingenuity and my staff's congeniality up against anyone, any military leader will tell you, you don't enter a fight with an equal force. You enter a fight with an overwhelming force. You bring a focused hammer, designed to crush your enemy with as low cost to your own assets as possible. When you play Axis & Allies, a key learning moment is realizing you don't want your opponent's best units to get to take a second shot in a combat phase. You bring as much redundant firepower into the fight as necessary to ensure that it's a one-round blowout, attacking or defending, no matter how many infantry you have to proliferate to ensure that your key territories threaten single-round resolution to any comers. 

So it is with brute force.  The smart arrival would not bring $350k, intending to clone me up and operate at parity and compete.

The smart arrival, the business intending to crush me and take over, would bring $700k.

And they'd obliterate me.

They’d build a store at the next level of magnitude and outclass me from the moment they first opened the doors.  It would not be a fight, but an execution.

But… and you knew there would be a “but,” didn’t you?  The miracle of understanding strategy, both on my part and theirs, assures that they will never bring $700k and obliterate me.  That outcome, like the $350k fight, also would never happen.

“But Bahr,” you might ask, “You just explained why that strategy would work.  Why wouldn’t they do it?”

Because it’s not cost-effective.  It’s a strategy that would crush me, but it’s not the best option.  The winning strategy gets me to hand over the keys for $400k and walk away without a fight.  They get the same result, the same outcome, and it costs them three hundred thousand dollars less.  They’d save almost half of the budget it would have cost them to pry me out of the picture by force.

That $400k figure is not imaginary.  It is at least as real as those valuation numbers back at the top of the article.  It’s the most recent number my business partners and I agreed would be enough to get us to snap sell.  I’d have to confer with them again to ratify any offer, but with reasonable confidence I think we’d accept.  I can’t say that number would necessarily be the same in six months or a year, especially if DSG keeps growing, but that’s what it is today.  A new arrival with $400k cash money in hand and a serious intention to enter my market from an ironclad, established position would find himself or herself able to do precisely that.

And that is why warring entities parley.

In answer to the discussion question, my understanding of the foregoing is part of the unique value I bring to the business.  I bring a realistic and unflinching acceptance of the most exacting competitive arithmetic the business could conceivably face.  And in the face of that analysis, I conclude that my business, at least right now and today, is worth at least $400,000.  There we go.

In answer to the follow-up question, what would I do after cashing that big check and winding up the books?  I would first take my family on vacation.  Next, I would write the story of DSG until the point at which it no longer included me.  After that, many options on the table.  Probably some combination of opening a vintage arcade, perhaps even as a non-profit like the Pinball Hall of Fame, and writing prolifically.  I would explore my options for returning to the regular daily use of my law degree in some manner.  And for as long as DSG prospered under its new ownership, I would not return to the hobby trade, at least not in the retailer role, and at least not in my immediate area.  After all, unlike the savvy entrepreneurs opening Magic: the Gathering clubhouses every other mile, I try to avoid diving headfirst into a market that is already well-served to the point of saturation.

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