The Multiplier Effect
Posted on July 12, 2018 by Danny Windsor
Randy Johnson had an important meeting in August of 1992 with Nolan Ryan. “They had a conversation that helped the 6-foot-10 Johnson learn how to harness his delivery. ‘At my height, you’re dealing with more arms and legs,’ the gangling southpaw said, and the tweak(emphasis mine) that came from Ryan, the Hall of Famer, eventually delivered Johnson to Cooperstown’s doorstep. ‘The one thing about landing on the ball of my foot as opposed to the heel of my foot was what helped me the most,’ Johnson told Ryan several years later. ‘I was always throwing the ball hard, but early on I was never consistent(emphasis mine) with my mechanics.’ Before that pivotal meeting with a then 45-year-old Ryan….Johnson, 29, had a 44-46 record. Afterward, Johnson went 259-120 and, like Ryan, managed to pitch past his 46th birthday. Johnson’s career 4,875 strikeouts are second to Ryan’s 5,714(Levine and Bierig, p.18).” A seemingly small tweak turned around Johnson’s career.
In his book, The Compound Effect, Darren Hardy says, “The Compound Effect is the principle of reaping huge rewards from a series of small, smart choices. What’s most interesting about this process to me is that, even though the results are massive, the steps, in the moment, don’t feel significant(Hardy, p.9).”
These same principles work for a business owner seeking to maximize the value of his company. One of the most common methods of valuing a company is the EBITDA method. EBITDA is simply a company’s earnings before interest, taxes, depreciation, and amortization. Other adjustments may be necessary and an excellent explanation is provided in our book, The Exit Strategy Handbook. Once EBITDA is determined, a multiplier is applied to determine the approximate value of the business. It is not uncommon for multipliers to be in the 4-6 range. Frederick Lipman said, “For each $1 that you increase your EBITDA during the valuation year, you should arguably receive an additional $4 to $6(emphasis mine) in sale price(Mills, p.46).” In other words, increasing EBITDA by just $ 100,000 can potentially increase the sale price from $400,000 to $600,000.
Every business owner should be constantly looking to tweak and move the EBITDA constantly higher to enjoy an increasing value due to the compound effect of the EBITDA multiplier.
*Levine, Bruce and Bierig, Joel, (July/August 2018) Baseball Digest
*Hardy, Darren, (2010) The Compound Effect
*Mills, Jerry, (2013) The Exit Strategy Handbook