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Your Business Isn't Worth a Multiple, It Earns a Multiple

By Dave Godwin, CBI

One of the first questions I hear from business owners considering a sale is:

“What multiple are businesses like mine selling for?”

It sounds like the right question.

Usually, it isn’t.

A business doesn’t automatically get a certain multiple because it operates in a particular industry.

A multiple is earned.

Consider two businesses that each generate $500,000 in annual owner earnings.

Business A:

The owner is involved in nearly everything. One customer represents 35% of revenue. Financial reporting is average. Growth has flattened.

Business B:

There is a management team in place. Customers are diversified. Financials are clean. Revenue is growing. A meaningful portion of the business is repeat or recurring.

Same earnings.

Very different businesses.

And very likely, very different selling prices.

Buyers Pay for Earnings. They Discount Risk.

SDE, EBITDA or adjusted EBITDA usually provides the starting point for valuation.

But the multiple applied to those earnings reflects something else:

Risk.

Buyers look at things like:

·       Revenue and earnings trends

·       Gross margins

·       Customer concentration

·       Recurring revenue

·       Management depth

·       Owner dependence

·       Employee stability

·       Quality of financial reporting

·       Supplier concentration

·       Capital expenditure requirements

·       Competitive advantages

·       Transferability of customer relationships

The stronger the business performs in these areas, the more confidence a buyer has in the future cash flow.

And confidence has value.

Sometimes the Owner Is the Biggest Risk

Entrepreneurs are good at solving problems.

That is usually how they built the company in the first place.

They know the customers.

They manage the employees.

They approve the pricing.

They maintain the key relationships.

They know where all the bodies are buried.

That can make for a successful business.

It can also create a problem when it is time to sell.

Because the buyer is asking:

“What happens when this owner leaves?”

If too much of the value walks out the door with the seller, the buyer has to account for that risk.

Usually in the price.

A business that can operate successfully without the owner is generally more valuable than one where the owner essentiallyisthe business.

Growth Matters. Predictability Matters Too.

Buyers like growth.

But they also like knowing where next year’s revenue is likely to come from.

Repeat customers, recurring contracts, stable margins and predictable cash flow can substantially improve the quality of a business.

Remember:

The buyer isn’t buying your past. The buyer is buying their future.

The easier that future is to understand, the more comfortable buyers — and often lenders — become.

Clean Financials Matter More Than Most Owners Think

A profitable business with messy financials can create unnecessary doubt.

And doubt rarely improves valuation.

Supportable add-backs, accurate financial statements and a well-prepared financial recast help buyers understand the true earning power of the business.

Clean financials don’t create profit.

They make the profit believable.

That distinction matters.

Ask a Better Question

Instead of asking:

“What multiple does my industry get?”

Ask:

“What would my business need to look like to deserve the upper end of the range?”

That is a much more useful conversation.

Because many of the things that influence value can actually be improved.

Customer concentration can be reduced.

Management can be developed.

Financial reporting can be cleaned up.

Margins can improve.

Systems can be documented.

Owner dependence can be reduced.

Recurring revenue can be increased.

But those things take time.

Which is why preparing a business for sale should ideally begin well before the owner is actually ready to sell.

One Final Thought

A valuation multiple isn’t the value of your business.

It is the market’s judgment about thequality, risk and transferability of the earnings behind it.

So if you are considering selling your company sometime in the next few years, don’t just ask:

“What is my business worth today?”

Ask:

“What could I change today that would make it worth more when I’m ready to sell?”

That question may ultimately be worth far more than another half-turn on a multiple.

And in a meaningful business, half a turn can represent a very meaningful amount of money.

Considering selling your business in the next few years?

Understanding what drives your business’s value is the first step toward preparing for a successful sale. I help business owners in Northwest Arkansas and Greater Tulsa identify risks, strengthen their preparation, and explore their options confidentially.

Request a confidential consultation to discuss your business and your goals.