Selling a Business – The Valuation Conundrum

If you are the owner of a small business, at some point you have likely asked yourself, “I wonder how much my business is worth.” Perhaps you’re considering selling, bringing in a partner or investor, thinking about estate planning, or maybe you’re just curious if your business strategy is adding value.  To the owner, the process of valuation is subjective and emotional. However, to the buyer or the investor or the advisor, the valuation process is far more objective.

How do you Value your Company?

Valuation is both a science and an art.  There are multiple ways to value a company (Discounted Cash Flow Analysis, Multiple Analysis, Net Book Value method, etc.)  but all these valuation methods are subjective as they rely on subjective inputs - estimates for everything from the rate of sales growth to the company’s salary costs for the next five years. These assumptions make any valuation an educated guess at best.  

One of the most popular methods to value an owner-operated business is “An Adjusted EBITDA Multiple” method. A survey of private companies conducted by the Pepperdine University in their report “2021 Private Capital Markets Report” further confirms the pervasive use of this method.

EBITDA is a proxy for cashflow and the adjustments to EBITDA are typically to normalize for non-recurring and owner-related expenses.

What is the Multiple for your Business?

That depends on the size of your business and industry.  According to the Pepperdine University report, the following charts provide a proxy of EBITDA multiples paid.

Median EBITDA Multiple Paid by Deal Size                     

Multiple by EBITDA Size and Industry

Companies that are larger in size generally command a higher multiple as they are considered to be established and less risky, similarly smaller companies are considered less established and riskier.  Multiples by industry vary as industries with higher potential growth will have higher multiple values.  The average multiples are based on thousands of transactions that have been completed. 

So, will the Business Owner simply get the Multiple as per the Charts above?

Most likely not. 

Business owners often have spent decades growing and nurturing their business and they often place too much emphasis on sweat equity or they ascribe value to the personal goodwill associated with the business both of which are not commercially transferable. As a result, their estimation of value is often higher.  Whereas a potential purchaser is more interested in the cashflow that the business can generate. This largely depends on how the business has been operated over time and whether the business owner has either knowingly or unknowingly implemented value enhancers in their business. 

Also, no two businesses even in the same industry are alike, there are operational differences that could potentially lead to valuation differences.

What can an Owner do to Improve the Value of their Business?

There is a valuation range that a business owner can reasonably expect for their business.  Whether, it is at the low-end of the range or the high-end of the range will depend on the steps he or she has taken to improve the value of their business.  The following are some of the ways in which a business owner can improve the value of their business:

1.     Implement next level management

2.     Frequent planning process to grow the business

3.     Demonstrate consistent revenue growth

4.     Demonstrate consistent EBITDA / Cashflow growth

5.     Ensuring a diversified customer / supplier base

6.     Scalability of business model and operating systems

7.     Implementing financial and operational controls

It is often not possible for a small or mid-sized business owner to implement all of the value enhancers, but even implementing a few of them can go a long way in improving the value in the eyes of a potential purchaser and enabling the business owner in getting a multiple towards the high-end of the valuation range.

How can Distinct Capital Partners help you maximise the Value you Obtain?

The team at Distinct Capital Partners have advised hundreds of business owners in the sale of their business.  Before we even sign an engagement with a prospective seller, the team at Distinct Capital will perform a review of the business to determine its potential value.  We ensure that the owner has a good understanding of value expectation for their business and how their business will be viewed by a potential purchaser.  We have often advised the potential seller to wait for a period of time, if possible, to enhance the value of their business.  In any circumstance, we will work with you to ensure that you will get maximum value for your business.