I’m a Los Angeles-based business broker advising buyers and sellers on the transfer of businesses valued between $2M-$100M. We are currently in a thriving market with a tremendous amount of interested parties on both sides of the transaction. Businesses with increasing profits, predictable cash flows and stable operations are selling at the highest multiples we’ve seen since before the Great Recession. While well-run businesses can generally expect to find wide-ranging interest among private and strategic buyers, there is often a disconnect when it comes time to determine value, so I thought I would share my recent experience related to how we value small and medium-size businesses (SMB).
How Do I Estimate The Value of My Business?
I’m often asked, ‘what’s my business worth?’ Well, the good news is that it’s not very difficult to determine, and the technique that works for most small businesses relative to other methods (e.g. DCF, book value, revenue multiples, etc.) requires just a simple three-step process:
- Calculate Adjusted EBITDA
- Determine the Industry Multiple
- Multiply #1 X #2 – this becomes the basis of your target valuation
Step 1: Calculate Adjusted EBITDA
The sales price is most often a multiple of EBITDA (Earnings Before Interest, Taxes, Depreciation and Amortization), which is a good, but relatively rough measure of operating cash flow. Adjusted EBITDA is determined by starting with reported net income before taxes. You would then add or subtract back items to determine cash flow for the buyer. Common additions include depreciation, interest expense, owner compensation, one-time/non-recurring expenses (such as one-time expansion costs) as well as personal travel, meals, entertainment, health insurance, etc. Deductions may be included in cases when rental expense or employee wages are below market value. Most business owners typically run some personal expenses through the business, and why not, this is one of the advantages of owning your own business!
Buyers generally evaluate EBITDA over a three-year period placing a heightened emphasis on the most recent financial period (this is referred to as a Weighted Average Valuation). Here’s an example from one of my active deals:
In this case, this manufacturer has successfully increased sales and EBITDA each year since 2013, which is a fantastic selling point (everyone loves growth!). Since buyers will generally use a weighted average EBITDA to evaluate the business, we’ll do the same, yielding a Weighed Average EBITDA of $984K.
Step 2: Determine the Industry Multiple
EBITDA multiples vary by both the size of company with increasing premiums attached to larger companies. EBITDA multiples also vary by industry; the higher the typical industry profit margin, the higher the multiple, with 4-6X EBITDA being a typical range for manufacturing companies.
Typically, the multiple for any given transaction is determined by comparing the target to recent comparable transactions within the same industry (M&A Advisors have access to self-reported private transaction data.) There is no standard way to arrive at this multiple, but I prefer to use both quantitative (e.g. transaction comparables) and qualitative factors to help determine a realistic multiple range. For example, if the business has a long track record of successfully increasing revenue and profits, and has a strong competitive advantage relative to its peers, the multiple will be at the high end of the range. Conversely, if the business is not as well-established, if the seller is highly motivated, or future income is considered at risk, the business will likely sell at the lower end of the spectrum.
Step 3: Multiply the Weighted Average EBITDA by the Industry Multiple
Our example manufacturing company has increased earning over the past three years, so we can assume it will sell at the high end of the 4-6X EBITDA range. We then multiply the Weighted Average EBITDA of $984K by 6X (high-end of the comparable range,) yielding a target sales price of ~$5.9M.
Of course, there are many other factors that will determine the ultimate sale price. These commonly include the motivation of the buyer and seller, working capital in the business, whether or not there is buyer competition for the business, status and transferability of customer and vendor contracts, percent of revenue that is recurring vs. one-time, recent trends in profits, pricing, any deferred maintenance and new equipment that needs to be purchased, amount of cash paid vs. financing required, etc.
What Can I do to Increase the Value of My Business?
This can be a very extensive conversation and the subject of future blog posts, but here are the top 10 things that owners can do to increase the value of their businesses and prepare for an efficient sale:
- Recurring Revenue is very valuable – buyers love predictability and long-term recurring customers are one of the best selling points.
- Prepare a clean set of financials that easily reconcile to tax returns.
- Ensure key contracts, such as leases, are transferrable to a qualified buyer.
- Maintain focus throughout the sales process- the process generally takes 6-9 months and it’s imperative the business does not decline during this period.
- Constantly review all vendor agreements and costs, including credit card fees and equipment maintenance agreements.
- Ensure all equipment is in working order, and all maintenance is up to date.
- Ensure business processes and operational procedures are well-documented so a new owner can more easily transition.
- Identify potential synergies available to strategic buyers – costs that can potentially be reduced/eliminated by a buyer in the industry e.g. rent and admin. expenses, etc.
- Utilize social media to increase awareness of your brand and products.
- Hire a licensed business broker/intermediary to help prepare your business for sale – this will allow you to run the business day-to-day and help reduce stress and receive maximum value for your business!
Determining the value of your business is a relatively straightforward exercise once you understand the process and the essential elements. I hope you find this helpful as you consider the possibility of selling your business or making an acquisition. Please let me know if you have any questions or feedback!
Kevin Berson is licensed Business Broker with Kinected Consulting and is based in Los Angeles, CA. He specializes in helping business owners maximize outcomes in selling their businesses. He is also the founder of Kinected, a management consulting firm that advises companies with business development, strategy and mergers and acquisition diligence. Kevin can be reached at firstname.lastname@example.org.