Multiples, Demystified

Multiples are tricky things to figure out when you’re valuing a business for sale. Lots of opinions are floating around, most stemming from imperfect information. Uncle Bob’s golf buddy sold his widget store for a million bucks based on a multiple of five! Such “buddy wisdom” can lead you astray. Unrealistic expectations can result in a price point that the market simply won’t support. Your business languishes with little to no buyer activity.

First Things First

So, what is a multiple to begin with? Basically, a multiple is a number by which you multiply the economic benefit enjoyed by the owner of a business. With large businesses, this benefit is frequently expressed as EBITDA, an acronym for Earnings Before Interest, Taxes, Depreciation and Amortization. While EBITDA makes sense in the M&A realm, where businesses generating $10 million or more in annual sales are exchanging hands, EBITDA isn’t always the best fit with for small businesses. Besides the difference in sheer size, the owners’ group frequently doesn’t play an active, hands-on role in the operation of these larger businesses. Think passive investors.

In contrast, Main Street businesses are frequently helmed by an owner/operator. It’s also relatively common for the owner/operator to run some personal expenses through the business. These could include their personal health and life insurance, the lease expense for a personal vehicle, which they don’t plan to convey with the sale of their business, or the cell phone plan for their family. After all, such practices are one of the benefits of being a small business owner. In essence, SDE (Sellers Discretionary Earnings, also known as Cash Flow) is EBITDA with a few adjustments, including owner’s compensation and personal, discretionary expenses.

There’s more to SDE than this, but that’s it in a nutshell. While multiples can also be applied to the business’ Gross Revenue, SDE shows how much income a new owner will have to live on and pay off pay debt service incurred by taking out a loan to secure the purchase. When done right, SDE is a buyer’s potential Return on Investment for a given business.

Multiples in Action

How is the multiple determined and used, besides Uncle Bob’s questionable tips? Let’s take a simplified example.

You would like to sell your small to medium-sized business, Widgets R Us. What price should you ask?

Ideally, there’s a lot of market data to inform this decision. In the field of comparable widget stores that have sold (based on sector, size, revenue, location, etc.) what is the average sales price? Say it’s $300,000.

Now, what’s the average SDE of those widget businesses that have sold? Say that is $100,000.

The multiple is the result of dividing the average price by the average SDE. In this case, $300,000/$100,000 = 3.

Let’s further say your business’ average SDE over the last three years comes out to $130,000 because your sales team is good at selling widgets. Nice! The price for your business would be $130,000 x 3 = $390,000.

Ze Plot Thickens

That is a pared down example. In real life, the process can be complicated by the quality (or lack thereof) of the financials, market trends, client concentration, how dependent the business is on you, and a host of other factors.

Keeping with the same example above, let’s say that you’re the genius behind your business’ eye-popping widget sales. Over the years, you’ve cultivated relationships with key clients who refuse to deal with anyone else at your widget shop. How does this effect the transferable value of your business? You’ll need to wrestle with such questions.

But Wait, There’s More…

Also keep in mind that multiples, no matter how fact-based, are not the end-all, be-all. A sophisticated buyer will also take into consideration the income they’ll be earning, after debt service, based on their down payment. This is known on as the Internal Rate of Return. An experienced broker can work with you to understand and interpret all this information. You can drastically help this process by having well organized, professionally-prepared financial records. At a minimum, we like to analyze the most recent three years of P&Ls, tax returns and a current balance sheet to get a clear picture of the performance of your business. Buyers want to study these in-depth, often bringing in their CPA or financial advisor, to understand what they’re potentially getting into!

If there isn’t a lot of useful data to go on, there are some tricks of the trade that are based on way more experience than Uncle Bob’s sample size of one or two stories. Brokers have access to information that isn’t available to the general public. They frequently have experience selling businesses similar to yours. The best sales data aggregates the actual sales price of businesses provided by financial institutions and certified business appraisers. They check and double-check the information that goes into making up the SDE number.

Onward!

It’s well worth your while to consult a knowledgeable expert to make sure you’re valuing your business at an optimal price to both sell the business and maximize your achievable profits.

Timing the Sale of Your New Mexico Business

timing-the-sale-of-your-NM-businessConditions are coming together that benefit both business buyers and business sellers. During the first month of January and into the first few weeks of February, we closed two businesses and put three other businesses under contract. While this is an impressive amount of activity for one month, 2015 is simply continuing the trend that began in 2014.

BizBuySell, the largest and most active online small business market place, keeps track of the pulse of small business acquisitions and sales across the U.S. It reported that business transactions reached an all-time high the fourth quarter of 2014 and increased 41% of the same quarter 2013. The service industry was the greatest beneficiary of this increased market activity, but restaurants and retail followed closely behind. Read more

Why is seller financing so important to the sale of my business?

Surveys have shown that a seller who asks for all cash, receives on average only 70 percent of his or her asking price, while sellers who accept terms receive on average 86 percent of their asking price. That’s a difference of 16 percent! In many cases, businesses that are listed for all cash just don’t sell. With reasonable terms, however, the chances of selling increase dramatically and the time period from listing to sale greatly decreases. Most sellers are unaware of how much interest they can receive by financing the sale of their business. In some cases it can greatly increase the amount received. And, again, it tells the buyer that the seller has enough confidence that the business can, indeed, pay for itself.

What happens when there is a buyer for my business?

When a buyer is sufficiently interested in your business, he or she will, or should, submit an offer in writing. This offer or proposal may have one or more contingencies. Usually, the contingencies concern a detailed review of your financial records and may also include a review of your lease arrangements, franchise agreement (if there is one), or other pertinent details of the business. You may accept the terms of the offer or you may make a counter-proposal. You should understand, however, that if you do not accept the buyer’s proposal, the buyer can withdraw it at any time. At first review, you may not be pleased with a particular offer; however, it is important to look at it carefully. It may be lacking in some areas, but it might also have some pluses to seriously consider. There is an old adage that says, “The first offer is generally the best one the seller will receive.” This does not mean that you should accept the first, or any offer — just that all offers should be looked at carefully.

Once you and the buyer are in agreement, both of you should work to satisfy and remove the contingencies in the offer. It is important that you cooperate fully in this process. You don’t want the buyer to think that you are hiding anything. The buyer may, at this point, bring in outside advisors to help them review the information. When all the conditions have been met, final papers will be drawn and signed. Once the closing has been completed, money will be distributed and the new owner will take possession of the business.

What can I do to help sell my business?

A buyer will want up-to-date financial information. If you use accountants, you can work with them on making current information available. If you are using an attorney, make sure they are familiar with the business closing process and the laws of your particular state. You might also ask if their schedule will allow them to participate in the closing on very short notice. If you and the buyer want to close the sale quickly, usually within a few weeks, unless there is an alcohol or other license involved that might delay things, you don’t want to wait until the attorney can make the time to prepare the documents or attend the closing. Time is of the essence in any business sale transaction. The failure to close on schedule permits the buyer to reconsider or make changes in the original proposal.

What can business brokers do – and, what can’t they do?

Business brokers are the professionals who will facilitate the successful sale of your business. It is important that you understand just what a professional business broker can do — as well as what they can’t. They can help you decide how to price your business and how to structure the sale so it makes sense for everyone — you and the buyer. They can find the right buyer for your business, work with you and the buyer in negotiating and along every other step of the way until the transaction is successfully closed. They can also help the buyer in all the details of the business buying process.

A business broker is not, however, a magician who can sell an overpriced business. Most businesses are saleable if priced and structured properly. You should understand that only the marketplace can determine what a business will sell for. The amount of the down payment you are willing to accept, along with the terms of the seller financing, can greatly influence not only the ultimate selling price, but also the success of the sale itself.

How long does it take to sell my business?

It generally takes, on average, between five to eight months to sell most businesses. Keep in mind that an average is just that. Some businesses will take longer to sell, while others will sell in a shorter period of time. The sooner you have all the information needed to begin the marketing process, the shorter the time period should be. It is also important that the business be priced properly right from the start. Some sellers, operating under the premise that they can always come down in price, overprice their business. This theory often “backfires,” because buyers often will refuse to look at an overpriced business. It has been shown that the amount of the down payment may be the key ingredient to a quick sale. The lower the down payment, generally 40 percent of the asking price or less, the shorter the time to a successful sale. A reasonable down payment also tells a potential buyer that the seller has confidence in the business’s ability to make the payments.