Dream Business Brokers
When owners ask us about the value of their business, they often ask about multiples. Multiples are calculated by dividing the market value of similar companies that have sold by certain values found on the company’s financial statements. One of the questions a seller must ask is what is the basis of the multiple – what was it actually multiplying? There are lots of ways to value a business. The broker might have used adjusted EBITDA (earnings before interest, taxes, depreciation, and amortization) as the base value, or for a smaller business, they may have used SDE (Seller’s Discretionary Earnings – which is EBITDA + the salary/benefits for one full-time working owner). While industry databases often share multiples based on revenue, EBITDA, or SDE, Buyers are usually more focused on EBITDA or SDE multiples and less concerned with revenue multiples. If a company has EBITDA of $2 million, but sells for $4 million, for example, the multiple is 2X. Every business owner has heard stories about companies selling for multiples of 4X, 5X, or even 10X or higher, and they’re eager to hear that their company may be able to attract the same kind of offer.
But here’s the reality: multiples are often oversimplified and, frankly, not always accurately reported or understood. To know the actual multiple of a company’s value, you’d need to have insider knowledge of all the factors that went into the offer. And because sales data like that is often confidential, it’s difficult to know what made a buyer pay their offer price. Sometimes, a strategic or very motivated buyer will be willing to pay a premium price for a company that fits their needs.
Here are some of the factors that we know do affect a company’s value.
Industry Niche. Businesses that have more recurring revenue, industry tailwinds, and higher demand in the marketplace will attract a higher multiple. On the other hand, industries facing headwinds like technological obsolescence, foreign competition, or regulatory challenges will get a lower multiple.
Profitability. This is why we don’t simply use top-line revenue as the basis of value for a company; it’s possible to have millions in revenue but very little profit at the end of the year. Most buyers base offers on the EBITDA, or Seller’s Discretionary Earnings (SDE) or what they can expect to earn annually if they take over the business. This is the true bottom line for most prospective buyers. A consistently profitable company is very attractive to most buyers.
Specialization. Some companies produce niche products or own a specific valuable brand or intellectual property like a patent. Buyers are willing to pay a premium to acquire a company that has differentiated itself in the market and can charge more for its products/services than companies with generic offerings.
The same can be said for specialized certifications, licensing, permits, or other intangible assets that make it easier for a new owner to get new business. Some of these certifications can take years to obtain and create a barrier to entry for new competition.
Qualitative aspects of the business. Buyers are attracted to companies with strong infrastructure, skilled and experienced staff, and a management and sales team that doesn’t require as much owner involvement. It’s easier to acquire a well-run business, even at a premium price, than to invest the time and funds to build one up.
Finally, Potential. Most private equity firms and strategic buyers will look for companies they know they can grow. If they can achieve economies of scale, make the operation more efficient (and thus more profitable), expand the market, or introduce new products, they will be willing to pay for future upside, regardless of the company’s current profitability.
In the end, supply and demand determine a company’s valuation. Building an attractive company that will attract bids from multiple qualified buyers is the best way to ensure you sell your business for the highest possible price. Our policy has always been to create an informal auction process by aggressively promoting a business to the ideal buyers for a particular listing. We have found this process to yield excellent results when informed buyers recognize the hidden value of the business and present competitive bids.
