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Mar 1, 201812:12 PMExit Stage Right

with Martha Sullivan

The crux of multiples in business valuation

(page 1 of 2)

Multiples are always a hot topic when you gather groups of business owners, investment bankers, and/or other advisors. Folks want to know what’s going on in the market for buying and selling companies. Are the multiples going up or down? What multiple is that industry seeing?

Business owners often focus on “What did that guy get?” as a multiple. This frequently leads to “Well, if he got that, I must be worth this! (“This” always being a higher number than the other guy.)

On the surface, multiples appear to be straightforward. You take a measurement that’s a good proxy for cash flow — such as earnings before interest, taxes, depreciation, and amortization (EBITDA) — times the multiple and voila, you have the value of the business! Sounds pretty darn simple.

Bear traps are pretty darn simple, too. It’s best to know how a bear trap works, though, so you can navigate it and avoid getting caught on the wrong side of it.

Unlike bear traps that don’t care which bear it snared, multiples are very specific to the individual company. The offered multiple is fundamentally a measure of the specific investor’s perception of the risk that he or she is willing to take on for what he or she is investing in. The lower the perceived risk, the higher the multiple. Similarly, the lower the risk and higher perceived potential, the higher the multiple. (The buyer’s situation plays a key role in the multiple, which will be the topic of my next blog.)

Perceptions of risk are the reason one buyer could look at two seemingly identical companies with the same revenues and same bottom line and offer two incredibly different multiples. Consider these two fictitious companies in the same industry. Assume they have identical financial statements and EBITDA, but differ in the following ways:

Awesome Sauce Inc. Bitter Applesauce LLC
  • Fully operational and experienced management team with distributed decision making.
  • Diverse customer base.
  • Documented, state-of-the-art systems and processes with cross-trained employees.
  • Recipes, trademarks, patents, etc. legally protected.
  • Daily dashboards. Monthly financial statements issued by third business day. Clean annual audit.
  • All decisions made by or approved by owner.
  • 60% of revenue comes from single customer.
  • Systems are antiquated. Process knowledge in heads of owner and employees. No documentation.
  • No legal protection over intellectual property.
  • Financial reporting backlogged three months, with poor quality and accuracy.


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