.png)
This is the second blog in a two-part series on right-sizing your price expectations when selling your business. Today, we are going to talk about multiples. Multiples are the times factor in getting you from your EBITDA (earnings before interest, taxes, depreciation, and amortization) to your sales price. Clients always tell me about the “unicorn” friend who got 10X or 12X EBIDTA in connection with a sale—they are sure that’s what they will get too, but the reality is a little harsher.
Meet the Experts
I’ve gathered three experts to help me with this:
Laura Leopardi, a CPA and an Accredited Business Valuator, who is also certified in Financial Forensics, with 25+ years’ experience in analyzing the values of businesses in many different industries. To learn more about Laura, you can visit her website here: leopardivaluation.com.
Lisa Riley, PhD, CEO of Delta Business Advisors and Founding Member of Cornerstone International Alliance (Premier M&A firms serving the lower middle market), has helped hundreds of business owners buy and sell. Additionally, Lisa has been an active Board Member for the M&A Source, the International Business Brokers Association (IBBA), and the Arizona Business Brokers Association, and has had the honor of being elected as Chair for the latter two organizations. Click here to visit the Delta Business Advisors website and learn more about Lisa: https://www.deltabusinessadvisors.com/team/lisa-riley/.
Diane Thomas, who started and sold her own successful business in CA, and then purchased Premier Sales, where she has also helped hundreds of business owners grow value and exit. Diane also co-founded Legacy Advisors, which is a nationwide business continuity and succession planning firm. To learn more about Diane, you can visit the Premier Sales website by clicking here: https://www.premiersalesaz.com/our_team.htm.
Because these women offer such great insights…look for a Part Two and maybe a Part Three to this blog
The Basics
First, let’s start with some valuation basics.
PETERS: Explain the different types of valuation methodologies and how and when you use them.
LEOPARDI: There are three broad approaches to valuation: asset; income; and market. There are many valuation methodologies, which are applied based on the facts and circumstances. The valuation concept of highest and best use must be considered to comply with valuation standards and to avoid artificially deflating value derived.
- Asset-based methods are more appropriate for asset intensive operations that lack strong, consistent earnings.
- Income-based methods are more appropriate for highly profitable operations with lower investment risk.
- Market-based methods are appropriate to consider when a sufficient number of good comps are identified.
PETERS: What does normalizing adjustments (a.k.a. an “add back”) mean in a valuation, and why is this process performed?
LEOPARDI: First, it is important to note that not all normalizing adjustments increase normalized earnings or cash flow. Normalizing adjustments recast financial information to better understand future earnings potential. Nonoperating, nonrecurring, extraordinary, and discretionary transactions are eliminated or removed.
THOMAS: Normalizing/adjusting is conducted to show how the business may financially perform when separated from the current owner. There are times when the current owner has expenditures that are not essential or are discretionary benefits that a new owner would eliminate. Similarly, if the current owner owns the building but is not paying rent, we adjust expenses to include market rent because the current owner will charge rent to the new owner.
Now We Can Talk Multiples
PETERS: What is the average EBITDA multiplier?
RILEY: The average EBITDA multiplier is a ratio that indicates how much a buyer is willing to pay for a business based on its EBITDA. It is calculated by dividing the enterprise value or purchase price of a business by its EBITDA. The average EBITDA multiplier varies depending on the industry, size, growth, profitability, risk, and other factors of the business.
THOMAS: Right now, the multiplier ranges from a low of 2x to a high of 6x. Multiples have definitely dropped some. Businesses with EBITDA in excess of $1 million can expect to be in the 3 to 5x range–again, depending on the business industry, business model, recurring revenue, etc. Businesses with EBITDA in excess of $3 million can expect to be in the range of 4 to 6x. Understand that certain industries even with $5 million EBITDA will have multiples on the lower end because the market view is higher risk in that industry.
PETERS: Why do business owners believe that the average multiple is 8 or 10?
THOMAS: It’s misinformation or misinterpretation. I had a client hear on the radio that businesses trade at a 10 multiple on EBITDA. He demanded that I do the same for his business. I agreed to do so. However, after I explained that a 10 multiple on his EBITDA = $100,000 (compared to positioning his business for a buyer to be an owner/operator and sell based on Seller’s Discretionary Earnings x 2.5 = $450,000), he agreed to continue with a 2.5 multiple on a different factor. 2021 was the peak of the market and yes, there were even construction-related businesses with EBITDA in excess of $3 million selling for a 7 multiple on EBITDA. But, for every peak, there is a decline, which returns to a normalized multiple as we are seeing today.
RILEY: The average EBITDA multiplier for most businesses is lower than 8 or 10. If the average is 8, that would mean that ½ of the businesses sell for more than 8 times their EBITDA, and ½ sold for less. The median EBITDA multiplier also varies by industry, e.g., typically much lower multiples for restaurants compared to manufacturing multiples. Therefore, it is important to use industry-specific and market-based data to determine the appropriate EBITDA multiplier for a business, rather than relying on arbitrary or anecdotal numbers.
PETERS: What factors do lead to a higher multiple?
THOMAS: When we find the perfect buyer who’s looking for exactly what the business is. I represented a business with just under $1 million EBITDA with a recurring revenue model, and fantastic corporate customers resulted in $5 million—all cash.
RILEY: Higher multiple strategies are usually outliers that involve businesses that have exceptional performance, competitive advantages, strategic value, or synergies for the buyers. They may also reflect different valuation methods, deal structures, or accounting practices.
The Recent Impact of Increased Capital on Sales Prices
PETERS: How has the higher cost of capital impacted sales prices in the last year or so?
RILEY: The greater the cost of capital, the lower the EBITDA multiplier and the business value derived. This is because a higher cost of capital implies a higher discount rate for the future cash flows of the business, reducing their present value. Conversely, a lower cost of capital implies a lower discount rate and a higher present value of the future cash flows. Therefore, a business with a lower cost of capital has a higher EBITDA multiplier and a higher business value than a business with a higher cost of capital, all else being equal.
THOMAS: This is a very, very big deal. While there are buyers utilizing cash, every “investment” is still benchmarked against the risk-free rate. Right now, you can put money in a savings account and earn 4%, or more in a high-yield. So, the investment must produce a return adequate to take the risk. The higher cost of capital impacts two things:
- a business’s purchase price; and
- making certain business models, such as those that have a high working capital requirement, slow A/R, or high capital expenditure requirements, riskier and less attractive to buyers.
If You’re Thinking About Selling…
So, where does all of this leave a business owner who is thinking about exiting? First and foremost: get your head right, understand your business's value and potential sales price early on, and then depersonalize it. I know it’s hard, but you must. Also, give yourself a runway of 2-4 years before you want to sell to get your business in shape. Making a few minor changes may be the difference between a number you are happy with and one that has you grumbling.
