What is your small business worth? You could pay a valuation firm thousands of dollars for a precise answer, or you could follow some rules of thumb and get pretty darn close for free. Like this.

Beauty salon basics

The beauty-salon industry is massive. According to a November 2008 report from the Professional Beauty Association, there are some 825,000 establishments in the U.S. generating an estimated $40 billion in annual revenue and employing 1.1 million people. Beauty salons and spas make up 69% of the pie; nail salons, 19%; and barber shops, the remaining 12%.

Salons are getting a trim in this economy. Publicly held Regis Corp. –with more than 12,800 locations spanning brands such as Supercuts and Sassoon Salon–saw same-store sales in the first quarter fall by 4.5%. Then again, vanity is a powerful force, and the beauty business is more resilient than most. (For an eight-part series on starting and running a hair salon, from permits to technology, check out “The Fundamentals Of Running A Beauty Salon.”)

The Main Valuation Drivers

Demographics: If a beauty salon is located in an older community, a young, hip establishment probably won’t be able to cash in on its cache.

Taxes: A beauty salon may rent stations to each stylist. This could pose a tax problem: The IRS or state authority may consider the stylist an employee versus a contractor, triggering an unexpected FICO tax bill.

Quality of the staff: Salons thrive on the reputation of their stylists. Unfortunately, they also suffer high turnover. Finding and marketing new talent adds costs.

Multiple revenue streams: Many beauty salons can’t live on hair-styling alone. They have to provide other services (waxing, massages and so on), as well as sell products (shampoos, gels, etc.), on which margins tend to be higher.

Competition: Barriers to entry in this business are small. The more crowded the market, the less an establishment may be worth.

Crunching the Numbers

Seven years ago, hair-stylist Judy started her own salon called Classics. Things have gone fairly well. Her location, about 1,800 square feet, is in a strip mall and attracts lots of foot traffic (it’s the only salon within a two-mile radius). The facility has 12 stations, a facial room and a waxing room. The lease on the property expires within six months. To boost sales, Classics aims to move a large amount of shampoos, molding mud and other products; in fact, Judy offers bonuses to stylists who sell more extra stuff, thus boosting margins.

Here’s a snapshot of Classics’ financials:

There are a few valuation approaches within the industry. Here are two common ones, courtesy of Tom West, a small-business valuation expert and author of The Business Reference Guide:

–A multiple of two to three times pretax income, plus inventory.

–Total revenue multiplied by 25% to 35%, plus inventory.

First, estimate the fair market value of the inventory. In the beauty business, products slip out of fashion fast, so bake in some obsolescence. A discount of 20% to 30% is not uncommon. Applying a 25% haircut, Classics’ inventory in 2008 is worth $22,500.

Next we need the right multiple of pretax income. The stronger the business, the higher the multiple.

In the strengths column, Classics is well-run and keeps a lid on overhead. Its 17% pretax margin in 2008 is fairly fat. The salon also boasts a diverse mix of services and products that helps shore up the top line.

As for weaknesses, Judy’s reputation is critical to Classics’ success; if she leaves, so will her customers. Also, after seven years of wear and tear, the place could use a makeover. Those upgrades will cost money. Finally, the lease on the building will expire soon. If rent should spike (though not likely in this environment), that will put a crimp in margins.

The final analysis:

Taking all of these factors into account, middle-of-the-road multiples seem appropriate. Running the two formulas gives us:

–2.5 times $89,956, plus inventory = $247,390.

–30% times $529,153, plus inventory = $181,246

Splitting the two figures, and giving an extra nod to Classics’ strong margins, something in the neighborhood of $225,000 is a probably good place to start.

Tom Taulli (@ttaulli) operates MasterCFO, which provides outsourced CFO services for tax preparation, valuations and financings.