How the Labor Market Impacts Sales Price

September 14, 2015

How the Labor Market Impacts Sales Price

When considering business value, most company owners think about their tangible assets – namely, buildings, equipment, vehicles and inventory.

It’s easier to attach a value based on age, condition, expected revenues and useful life. But what about intangible assets? Here, most people think about goodwill or the established reputation of the business.

An assembled work force is also an intangible asset that might not immediately come to mind. Although employees are very real in a corporeal sense, the productivity and revenue-generating value they bring to an enterprise is not always understood or assessed properly.

Some appraisers use the cost approach, namely, the expenses the new business owner would incur to recruit and train the assembled work force. Input needed for this calculation includes base payroll, average salary per employee, attrition rate and percent of payroll cost to recruit and train. The attrition rate is subtracted from salaries to get the adjusted payroll. Then percentages for recruitment and training are applied to the adjusted payroll to calculate the cost.

For a $1 million payroll, this value might be about $150,000, or 15 percent. Cost of recruitment and training specific to the industry should be used. However, the economic environment and labor markets don’t remain static and, in some cases, using industry standards is not adequate. Adjustments may need to be made concerning the present difficulty or ease of hiring and training.

Another method used is the income approach, which computes the present value of future earnings. This approach works well with professional services firms and other sectors where there is a direct correlation between specific employees and revenues. These firms also need to take into account retention rates and ease of employee replacement.

In the current environment, some industries might have a glut of employees while others are scrambling to locate enough workers. It all depends on the local labor force or the ability to move in new employees. Another factor is location. In areas with large layoffs, there initially may be more than enough available workers. But over time, many people move to other areas where there is employment, thus eroding the skill base.

Areas that once scrambled to attract companies might find themselves trying to bring in new workers instead. Finding skilled workers is a challenge for many companies right now.

Surveys by the National Association for Business Economics (NABE) and the National Federation of Independent Businesses (NFIB) in July 2015 reported that companies across sectors are having difficulty locating skilled workers.

In fact, 48 percent of the small businesses participating in the July 2015 Small Business Optimism Index reported that they had few or no qualified applicants for openings. Positions lacking applicants include accounting, information technology, construction and manufacturing. The NABE predicts rising wages in the face of this continued shortage.

Some industries are also facing the impact of Baby Boomer retirements. Even though more Baby Boomers are continuing to work after the traditional retirement age, many opt out of full-time employment. This situation represents a loss of skills, productivity and experience that can impact companies until younger workers catch up. Skilled trades, management, aircraft pilots, teaching, engineering and law enforcement are occupations that are projected to have possible employee shortages.

In valuing an assembled work force, the mobility, available pool, skill and education levels required, and competition are all factors that must be evaluated. How dedicated are the present employees? If the turnover rate is historically high, then change of ownership might not remedy that. How does the company compare to peers in this regard?

That information will provide insight as to the management abilities of present ownership. If a company has highly skilled workers or key employees, what is the impact if they leave? How easy will they be to replace? A simple example is a restaurant that loses its prized chef.

A productive, trained and loyal work force is essential to a successful business, no matter how excellent the products or services offered might be. Understanding how current economy and labor force trends impact a company is essential to assigning value.