In this article, we’ll provide an overview on valuation multiples, time required to plan an exit, and market timing.
Multiple of Profit v. Multiple of Revenue
Business brokers and M&A Advisors value businesses most commonly as a multiple of profit. Certain industries, such as accounting and tax look at multiples of revenue. This may be because costs are well known, unlikely to diverge much from business to business, or do not matter to strategic acquirers who know what their costs will be / can be.
Multiples Increase with Size
In general, the larger the profit, the larger the multiple. This is true for all industries. The rationale is that larger businesses are likely to have more time and money invested, better books and records, more employees, better management, less risk etc.
Multiple of SDE v. Multiple of adjusted EBITDA
Main street businesses are valued as a multiple of SDE (Seller Discretionary Earnings) which is adjusted profit including an add back for one owner’s salary at market rate. This shows a buyer their combined benefit from the business including profit, salary, and perks. Larger businesses are valued as a multiple of adjusted EBITDA (Earnings Before Interest, Taxes, Depreciation, and Amortization) which does not include any owner salary. These larger businesses are typically purchased by financial or strategic investors versus individuals. These buyers will either keep the owners on staff or replace them with new staff. Therefore, owner salaries will continue to be an expense for the new owners.
Multiples By Industry
Multiples may vary across industries, but multiples for mom and pop businesses under $1M in revenue (main street) are similar regardless of industry. Some exceptions might be in the tech sector. Multiples for larger businesses start to diverge by industry. An IT Managed Services Provider (MSP) and an HVAC company, each with $100K in profit, may sell for the same low 1.5-2 multiple. However, an MSP with $500K in profit may see a multiple of 5x adjusted profit resulting in a $2.5M value while a $500K profit HVAC company may see a multiple of 3x adjusted profit equaling $1.5M.
Unprofitable Businesses for Sale
Brokers’ and M&A advisors’ audience of buyers are shopping for cash flowing businesses. Most buyers are not interested in stopped businesses or unprofitable businesses since future profitability is conceptual. By selling before proving profitability, these businesses send a signal that achieving profitability is very difficult. Specialists handling startups, pre-revenue, and pre-profit businesses for sale must have a deep network of strategic buyers to have any chance.
Time Required to Sell
Most exit planners advise business owners to perform exit planning ideally 5 years prior to an exit. Buyers want to see a minimum of 3 years of improving financials, clean books and records, systems, recurring revenue, repeatability, low owner dependence, growth potential, etc. All buyers would love the perfect business. Some are realistic and can handle some risk, while many are conservative to the point of rarely executing an acquisition. The selling process can take 12 months or more even for main street businesses. For startup, pre-revenue, or pre-profit businesses, the window may need to be extended to 36 months and the chase of success is very low, unless there is at least a positive revenue trend.
Timing of a Sale
Timing the market is never a good idea. Efforts to sell a business should be driven by personal needs and goals of the owner/s, not by waiting for favorable market conditions. That said, if market conditions, or industry downturns make it infeasible to sell due to lack of demand or inability to achieve a price that enables a sale (to cover debt for example), then owners may have to continue to build (if profitable) or close the doors (if bleeding cash with no clear turnaround).
Building Value
There are 8 value drivers that make a business valuable. Certified Value Builders use this model to increase the value of a business. This is not only useful for endgame planning, but will even help owners with no exit in sight build resilience into their most valuable asset.
- Financial Performance
- Valuation Teeter Totter
- Hub & Spoke
- Switzerland Structure
- Growth Potential
- Monopoly Control
- Customer Satisfaction
- Recurring Revenue
