As you begin the process of selling your business, it’s important to make sure that you have a grasp on the current market landscape. While conducting general market research is a starting point that allows business owners to get a pulse on the industry, it often leads to misunderstandings and raises more questions, particularly as owners try to get a feel for what similar companies are selling for.
For example, a successful construction company owner once shared that after completing initial research, he found that a competitor recently sold for 2.5x its revenue or 8.0x EBITDA. Understandably, he thought this meant his business would sell for the same or a comparable multiple, as both companies were similar in size and operated in the same industry. While this is a common belief, it’s essential for business owners to understand that this is not always the case.
To fully understand a multiple, one must understand what is in a multiple.
A multiple determines the value of a business relative to the revenues or earnings that it generates. While named a revenue multiple, the key determinant is actually the company’s earnings. For example, if two similar companies each had revenues last year of $1,000,000, but Company A had earnings of $100,000 and Company B had earnings of $50,000, would you expect to pay the same multiple for both? Company A, based on earnings alone, should get a higher price in the market because of its higher earnings.
Another key determinant of a market multiple includes growth expectations. Let’s assume Company A and Company B have the same level of earnings, but Company A has identified an expanded use for its product that it intends to utilize. Company A has determined that it expects an increase in growth of 10 percent over each of the next two years as a result of the new product use, while Company B will still have low and steady growth of 2 percent. Because of the increased growth expectations, with all else being equal, Company A should get a higher price in the market.
Even if two companies do have similar quantitative factors, such as earnings margins or growth expectations, qualitative factors also play a role, including risk. Questions to ask to determine the level of a company’s risk include:
- Is the company highly dependent on one individual?
- Is the company reliant upon one supplier for its materials?
- Is a single customer responsible for a significant portion of the company’s sales?
- Did a new competitor just enter the company’s market?
- Is the company currently involved in any lawsuits?
While these are just some of the risks that can play a role in a multiple, a thorough risk analysis should be prepared to have a complete understanding of other potential factors.
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If you need assistance determining a fair and competitive value of your company, or for more information about Bennett Thrasher’s Valuation services, contact Rob Taylor, Gina Miller or Brett Dixon by calling 770.396.2200.