11 Jun How Gift Cards Can Impact a Business Valuation

Written by: Andrew Hong CVA

(5 – 6 minute read)

What businesses use gift cards?

When performing a business valuation for certain types of companies, the Appraiser must consider the existence of any gift cards issued by the company and how those gift cards are going to be handled in relation to the transaction and purchase price. Gift cards are most often issued by retail and service businesses including (but not limited to):

• restaurants
• massage parlors
• hair salons
• wax centers

How are gift cards represented on the balance sheet?

Gift cards represent a prepayment for future services and products. On a balance sheet gift cards are represented as a liability as a company is responsible for providing prepaid services or products to whomever redeems the gift card. When the gift card liability is credited to the balance sheet, the cash paid to purchase the gift card is debited as an asset. As gift cards are not immediately redeemed, the existence of any outstanding gift cards must be considered in a proposed business acquisition (and in the associated business valuation). Gift cards may not always be listed on a balance sheet. If an Appraiser is conducting a business valuation on a company that (based on its industry) is likely to issue gift cards, the Appraiser must still confirm the outstanding value of any gift cards and how they will be handled in the pending sale.

How would gift cards impact a business valuation?

Since gift cards are normally represented as a liability on a balance sheet, their impact on the valuation depends on how the liability will be handled during the transaction. In a business valuation, any liabilities that will transfer to a buyer will lower the value of the appraised business as the new owner is now responsible for providing the prepaid services. In general, there are several different ways gift cards can be handled during a purchase:

1. The Seller will transfer cash to the Buyer to offset the gift card liability: In some cases, the Seller will include the full amount of cash for the outstanding gift cards, so that the Buyer will be compensated for honoring gift cards that they did not issue. In other cases, the Seller will only provide cash equal to a portion of the outstanding gift cards. This is because certain owners do not expect 100% of gift cards to be redeemed. In a business valuation, an Appraiser will include the gift card liability and certain cash assets in the Final Value. Should included cash fully offset the gift card liability, there is no net change to the Final Value:

2. The gift card liability will transfer to the Buyer but no cash is transferring to offset the liability: As the Buyer is now responsible for an additional liability, in a business valuation, the Final Value will decrease.

3. The Buyer and Seller will adjust the purchase price accordingly if no cash is included to offset the gift card liability. This provision is normally mentioned in a purchase agreement or a letter of intent to purchase. Essentially, at the closing of a potential company sale, the Sellers will determine the amount of outstanding gift card liabilities and will reduce the original purchase price to compensate the Buyer for the liabilities without transferring any cash. In this case, the Appraiser will not include the gift card liability in the Final Value so it can be compared to the unadjusted purchase price. Of course, any valuation report must note that the purchase price will be adjusted.

Service Businesses

For businesses such as hair salons or massage parlors, it is important for an Appraiser to consider that the value of the gift card does not equal the cost of providing the services. Therefore, the Appraiser may discount the gift card liability so that only the costs of providing the services are factored into the business valuation. These costs are determined through an analysis of any cost margins that are directly related to the provided services (i.e. labor costs, royalties tied with gross sales, supplies, credit card fees, etc.). Fixed costs such as rent would not be factored in as a business owner would incur these costs regardless of the amount of gift cards redeemed.

The chart below shows a hypothetical scenario where an Appraiser must normalize the gift card liability:

In this case, while the Company has a gift card liability of $10,000, the Appraiser will discount the included gift card liability to represent the cost of services, $4,200.

Franchises

When conducting a business valuation for a company that is part of a franchise, it’s important for the Appraiser to consider how the franchise and business owner handle gift cards. If the gift cards were issued by an individual business, they are treated the same way as any other gift card scenario we have previously discussed. However, for larger franchises, a gift card can be redeemable in any franchised location. In these cases, there often won’t be a store-specific gift card liability since the business may be redeeming gift cards that they did not issue and cannot track. Typically, business owners would receive some form of credit or compensation from the franchisor for these types of gift cards. If this is the case, the presence of gift cards would have no real impact on the final value. A business appraiser should carefully analyze the franchise disclosure documents for any business that is part of a larger franchise.

Conclusion

The existence of issued gift cards has an impact on the business valuation based on how the Buyer and Seller will handle said gift cards during the proposed transaction. Typically, a purchase agreement or letter of intent to purchase will describe how any issued gift cards will be handled in a company purchase. Barring any information from these documents, an Appraiser must ask the appropriate questions to determine how gift cards will be transferred to a Buyer.