multiple valuation

 

 


How to value a business based on multiple of Owner Benefit

 

What Multiple?

Typically, small businesses will sell in a one-to three-times multiple of this figure. Now, this is a wide range, so how do you determine what to apply? The best mechanism I have found is that a one-time multiple is for those businesses where the seller is "the business." In other words: "as out the door goes the seller, so too can go the customers." Consulting businesses, professional practices, and one-man businesses come to mind.

Businesses that have a strong track record, repeat clients, historical pattern of growth, more than 3 years in business, perhaps some proprietary item, or an exclusive territory, a growing industry, etc., will sell in the 3-times ratio. The others fall somewhere in-between.

So now the big question: what number/multiple do you apply to the Owner's Benefit number? The answer is simple: nearly all small businesses will sell in the 1-to-3 times Owner Benefit window. Of course, this is a very wide range.

Also, the actual total Owner Benefit figure will impact the multiplier. As the Owner Benefit number increases, so too will the multiple. As an example, a business generating $200,000 in OB, may be worth a 3 times multiple, but one generating $500,000 or $1,000,000 can be worth a four or five times multiple.


The Rules to Apply To Establish A Multiple:

You also want to calculate the Return on Investment (ROI) that you can expect to achieve when buying a business. Let's say that you have $100,000 for a down payment. If you go to Las Vegas and let it rip on "17 black," well you should be entitled to enormous odds. Wouldn't you agree? On the other hand, if you invest it in commercial real estate, which is a solid, stable investment, then 10% return on your money seems about right, doesn't it? In fact, when the real estate market heats up, the return can diminish to 5% or so, and still investors are satisfied.

Buying a business is clearly a greater "risk" but definitely far less than gambling it at a casino and so you should expect something in-between. I've always felt that a 25% return on your investment should be the minimum and you can, if negotiated well, get as high as 35% -50% ROI.


If You're New At This, Here's What To Do:

  • If you don't know how to read an income statement, then learn. It's important for this process. It's simple, and can be done quickly. Work with your accountant, if necessary, to determine the true Owner Benefits of the business. Be careful about the add-backs. Make certain that any benefits being added back are not necessary expenses needed to run the business. You can only add back something that has been expensed. Calculate a multiple in the 1-3-times window based upon the business's strengths and weaknesses. Note that the multiple will increase along with the Owner benefit figure. Determine your investment level and an acceptable ROI. Understand that value is personal. If the business is right for you, it is all right to pay a slight premium, but not to drastically overpay.
  • Consider applying other valuation formulas simply as a test to your figure.


Professional Valuations: Do You Need One?

For most small businesses, hiring a professional to perform a valuation is not necessary. First of all it is expensive, and more often than not, it simply does not reflect reality. I read a valuation recently on a local company handling specialized telecom components in a very restricted marketplace doing $700,000 a year in sales and netting $100,000. The valuation started off: "The company is focused upon the specialized B2B telephony arena and operates within a broad industry which generates annual revenues of $42 billion in North America. Leading competitors include Nortel, Cisco….." I threw out the entire report after reading that one sentence. Why? How on earth can you possibly compare a $42 billion dollar industry and a $700,000 local distributor of telephone systems? Don't waste time or money getting a professional valuation done for a small business acquisition. Let the seller do that if they so choose. If you want to look at a variety of scenarios, there are some very good, inexpensive software packages available that will do the same thing at a fraction of the cost.


The Key Points:

  • Remember that valuations are not scientifically based; they're subjective. Use a variety of methods. Owner Benefits is the number on which to base your multiple Uncover how the seller established the asking price Valuation is a personal formula - What's the business worth to YOU?
  • Consider the potential return on your cash investment

 

 

Final Word: Never, ever buy a business just because the price is right - first and foremost be certain that the business itself is right for you!