MARKET INSIGHTS

Oct 17, 2022

How to Value a Cleaning Business

Considering selling your residential or commercial cleaning business but unsure of how to calculate how much it’s worth? Or perhaps, you’re trying to understand the market value of your cleaning enterprise as you start thinking about retiring?

As a marketplace focused on helping small business owners sell to the next generation, we’ve see at least a dozen cleaning businesses each quarter, ranging from small residential operations with one crew to multi-crew ABRA-certified bio recovery businesses to commercial cleaning companies working with some of the largest grocery store chains in the country.

Luckily, you’re on the right track. Too many owners kick the can down the road in terms of understanding how much their business is worth until they’re in negotiations with a potential buyer of their business. If you’re ever curious about getting an up-to-date valuation of your business, feel free to take advantage of our complimentary business valuations. We can typically turn them around during the same week. In the meantime, read on to learn how to value a cleaning business.

What is a Business Valuation?

As we discuss in more detail in the Seller’s Guide to Small Business Valuation, the purpose of a business valuation is to break down a business’s historic financials, operations, and transferability to determine the fair market value.

In other words, what is the price that a small business entrepreneur will pay to take over ownership of the business. The purpose is not to determine the highest price that someone on this planet will pay nor the price that will sell the business the quickest. 

As we like to say, you could sell a house for $100K over the market value, but it may take you years of sitting on the market. On the other hand, you could give a house away for pennies on the dollar and never even hit the market.

A fair market value is designed to represent the average buyer of a business in a normal market. Sure, each business is somewhat distinct, but generally there are rules of thumb for pricing a business, just as there are rules of thumb that a lender will evaluate when working with a buyer to finance a transaction.

How Much Is My Cleaning Business Worth?

To calculate the value of your commercial or residential cleaning business, start by analyzing the past three years of your tax returns. Once you’ve consolidated these financial documents, the next step is to calculate Seller’s Discretionary Earnings for each year. For a quick refresher, seller’s discretionary earnings is a proxy for how much in earnings an owner-operator could receive from owning the business. 

In SDE, we add up the following:

• Net Income (reported to the IRS on the tax return)

• Interest

• Depreciation

• Amortization

• Owner Compensation (e.g., salary of the owner, healthcare and retirement benefits)

• Discretionary Expenses (e.g., kids on the payroll who aren’t actively working in the business)

We then need to normalize the SDE for common “edge” cases in a small business:

• If you own a shop for storing equipment or vans, are you under- or overpaying rent? Adjust the rent expenses to account for what you would charge the buyer of your business on an ongoing basis.

• Did you make a big purchase of a personal vehicle through the company? Make sure to add back the cost of the vehicle (and subtract any depreciation), as the buyer would not be forced to make such a purpose.

• Do you employ family members working as cleaners, crew managers, or bookkeepers? Adjust the payroll to remove family members who do not work and pay market prices to family members who would need to be replaced.

• Did you book PPP or EIDL as income? Make sure you remove any COVID-related loans from the income statement.

Lastly, we need to determine a fair summary of the SDE that a future owner can expect. Typically, this is a weighted average. In other words, we can’t simply pick the year with the highest SDE. We should average the last three years and weight the most recent year the heaviest, as things can change and typically the most recent year is the best depiction of where the business will be when a buyer takes over.

At Beacon, we use a somewhat complex weighted average formula, but we recommend owners performing a “back-of-the-envelope” valuation to weight the most recent year 50%, the second most recent year 37.5%, and the third most recent year 12.5%.

At this point, you’ll have a weighted average of SDE. Once you’ve calculated this, you’ll need to apply a multiple to your earnings to determine the value of your business when ignoring cash on the balance sheet.

What Affects The Valuation of My Cleaning Business?

Typically, a cleaning business is valued at 2 to 3x seller’s discretionary earnings. The exact multiple used is based on a number of factors. As you can tell by the numbers below, the multiple can vary widely and depends on a number of data points. At Beacon, we take into account over 150 data points. 

For those performing a quick valuation at home, we recommend the following approach:

• For businesses with less than $500K in gross revenue

  • Use a multiple of 1.5 - 2x

• For businesses with $500K to $1M in gross revenue

  • Use a multiple of 2 - 2.5x

• For businesses with $1M to $5M in gross revenue

  • Use a multiple of 2.5 - 3.5x

• For businesses with more than $5M in gross revenue

  • Use a multiple of 3.5 - 5x+

Curious about what can affect the value of your business?

• Commercial work: The recurring revenue of commercial work gives buyers assurance that customers won’t immediately churn on the day they take over. Commercial work is typically recurring, allowing them to predict how much revenue they will have in future months. Additionally, most commercial work is on longer timeframes and includes a bidding process, meaning the buyer may have a few years of “guaranteed” revenue.

• Contracts: Regardless of whether your business does commercial or residential work, having written contracts with customers is a huge bonus. Without them, buyers (and banks) have to take you at your word that most accounts are recurring on a weekly, monthly or quarterly basis. If you do have contracts in place, make sure that they are transferable.

• Owner involvement: If you’re a passive owner, you can often slide up to the top-end of the range for your revenue size. The number of potential buyers who can afford a business but do not have time to actively operate it is greater than the number of potential buyers who can afford a business and have time to actively operate it. As the saying goes, the more potential buyers, the better the price.

• Minimal family involvement: We see quite a few cleaning businesses where there are a number of family members involved in delivering the service. Having a spouse who helps with bookkeeping, route assignments, and tax filings is fine. But, having a number of children or nieces and nephews involved in active cleaning is a red flag to buyers, as there’s a good chance they may leave when you sell.

• W-2 employees: Both the number of staff and their tenure affects the valuation of a cleaning business. The industry is also notorious for having unverified or “under-the-table” workers. This can make it difficult for a buyer to arrange a bank loan for the business. Businesses that have employees who can pass I-9 verification and have been tenured for a few years trade at much higher multiples.

How Do I Increase The Value of My Cleaning Business?

There are a number of ways to increase the value of a business. For personalized advice, we recommend getting a complimentary valuation and speaking to someone on our team who specializes in the cleaning industry.

Absent that, there are a few big pointers for increasing business value:

1. Clean up your books: At the end of the day, income reported to the government is valued higher than “discretionary expenses” that a buyer won’t have to pay. Why? It’s easy to prove income reported to the government. It’s hard to prove that a phone bill is really for your family member who doesn’t work in the business.

2. Retain quality labor: Even if it costs more to the business, finding legal and high quality labor is crucial to maximizing business value. Good, tenured workers help de-risk the impact of a well-respected owner leaving the business and give banks peace of mind when lending to a buyer. Moreover, these teammates can help train the buyers up on “how things are done.”

3. Get contracts in place: Regardless of whether you work in residential or commercial, having written contracts with your clients is important for ensuring that the buyer can pick up where you left off. These contracts are also great written proof of the reputation that you’ve built.

4. Consider specialization: Cleaning businesses that focus on a niche, whether biohazard remediation, grocery store cleaning, or even casino cleaning, demand a higher multiple than those that do a bit of everything. Why? They typically are able to drive higher margins and larger average contract values than more “generalist” operations.

John McCleary

Transaction Advisor

Information posted on this page is not intended to be, and should not be construed as tax, legal, investment or accounting advice. You should consult your own tax, legal, investment and accounting advisors before engaging in any transaction.