Determining Company Value Multiples
Jul 16, 2010
Reprint of Article Appearing in the New York Times on July 16, 2010
Determining Your Company’s Value: Multiples and Rules of Thumb
My firm recently met with a business owner who told us right up front that he had started his business six years ago with the intention of selling it. He came to our meeting prepared with tax returns and financial statements and also informed us that he would be willing to stay on in a sales role with a new owner for up to three years.
The business — a specialty subcontractor to the commercial building industry — did about $7 million in annual gross sales in 2009, had been growing rapidly every year since its inception, and showed $725,000 in Ebitda and $900,000 in seller’s discretionary earnings (S.D.E.). Everything about the business looked great.
The meeting continued to hum along nicely as the seller recounted the history of his company and listed its biggest customers and possible buyer candidates. We listened carefully, impressed by how thoroughly he had prepared for this day. Then we asked if he had a particular asking price in mind. His number, he said, was $8 million. If I had sound effects in my conference room, I would have cued the needle scratching across the surface of a vinyl LP.
So, what’s the problem with an asking price of $8 million for this business? The primary issue is that the price would be a multiple of 11 times Ebitda, or almost nine times S.D.E. according to the seller’s financial statements. Given the industry and the asking prices for similar businesses for sale across the country, those multiples are far beyond what most buyers would consider reasonable in today’s market.
While there are many factors that help determine an appropriate asking price — including competitive advantages, opportunities for growth and historic financial performance — multiples and rules of thumb can be a good place to start. Several resources are available for obtaining data on pricing businesses for sale, including Business Valuation Resources and BizBuySell.com. A business broker, intermediary or transaction adviser will have access to a number of resources for small-business deal flow data, as well.
Business Brokerage Press publishes an annual guide to pricing small businesses for sale in both a print and online version. Here are some multiples and rules of thumb for a handful of businesses from the latest version:
Manufacturing (annual sales of $1 million to $5 million): three to four times S.D.E. plus inventory.
Retail auto parts: 40 percent of annual sales plus inventory.
Commercial printers (annual sales under $2 million): two and a half to three times recast Ebitda.
Retail apparel: one and a half times S.D.E. plus inventory.
Wind farms: 10 times Ebitda.
Some industries have their own rules of thumb. For example, an authorized reseller of wireless phones and service is sometimes valued at 30 times monthly residuals. While there is no such thing as a “comp” (comparable) when it comes to selling a small business, looking at multiples for similar businesses in the same industry — and preferably in a similar geographic area or market — can be the next best thing.
One of the keys to a successful sale is to have a clear understanding of how buyers will value your business, whether it’s an individual or a strategic acquirer. More often than not, that value will come down to a multiple of the business’s earnings.
“We recently completed a survey of a broad cross-section of business brokers and merger-and-acquisition professionals,” said Dave Kauppi, a mergers-and-acquisition adviser and president of Midmarket Capital, in a recent blog post. “One of the questions we posed was, ‘What is the biggest challenge you face in your practice?’ We gave them eight choices including lack of financing, sell side deal flow, not enough buyers, etc. The top answer was seller value expectations.”
And so it was with the seller mentioned above. Multiples for a business like his are around three to four times S.D.E., resulting in an asking price that is barely half of his current expectations. He returned to our office about a week after our initial meeting to pick up his financial statements and tax returns. Something tells me he won’t be back as long as his needle remains stuck on a multiple that is simply too high.