Using Multiples to Value Your Business
Q: I'm considering selling my business. Before deciding to place the business up for sale, I'd like to estimate the value of the business in order to assess the potential proceeds as well as to evaluate incoming bids. There seem to be standard multiples for valuing small businesses. What are these multiples, and where do I find information on them?
A: There is an abundance of available data on common industry "multiples" that can be used to estimate a business's value. Over time, valuation experts and investment bankers have observed trends in the selling price of businesses. Multiples are simply a summary version of these trends. They are industry-specific and generally used for smaller businesses.
For example, one source puts forth that legal practices are valued at 40 to 100 percent of annual fee revenue, with an "earn-out" potentially required. Another says that landscaping businesses are valued at a 1x to 1.5x multiple of sellers discretionary earnings, plus the value of the equipment. To illustrate, a landscaping business that had owner's salary of $40,000, owner's car expenses of $10,000, miscellaneous owner expenses of $5,000 and equipment valued at $30,000 has total sellers discretionary earnings of $55,000. Using the above multiple, plus the value of the equipment, yields a business value of $85,000 to $112,500.
However, while multiples may be useful in providing an immediate ballpark of a business's value, they do not substitute for a comprehensive valuation analysis. Multiples are shortcuts to value, based on the simplification of more in-depth valuation methodologies. In the valuation industry, multiples are the equivalent of a business plan developed on the back of a napkin. This is primarily true because no understanding of the data underlying the multiples has been performed, and thus neither the data integrity nor comparability with the subject business can be evaluated.
Gertrude Stein said that "a rose is a rose is a rose," but the same cannot be said of a business. Valuation multiples provide a guideline for the price of the average business in a particular industry, but without due consideration given to the unique attributes of an individual business, a geographic location or the current economic environment. In addition, simply using multiples to value a business means that no benefit can be made in terms of truly understanding how to increase the value of the business should you decide not to sell it.
For any serious potential seller, I recommend that a truly comprehensive valuation be performed. During a comprehensive valuation process, a deep understanding of the business itself, client base, employees, industry focus, practice areas and competitors is developed. One or more standard valuation methodologies are then used to estimate the value of the business. During the process, you will realize that understanding the drivers and diminishers of value in your firm is the significant benefit of a valuation. And the end result is that you understand the value of your business rather than of an unknown average business in your industry.
Edward Karstetter is the Director of Valuation Services at USBX, a middle market investment bank. His practice provides a comprehensive range of valuation and financial advisory services to privately held and publicly traded clients. During his career, Karstetter has worked on more than 100 valuations and M&A transactions, totaling more than $4 billion.
The opinions expressed in this column are those of the author, not of Entrepreneur.com. All answers are intended to be general in nature, without regard to specific geographical areas or circumstances, and should only be relied upon after consulting an appropriate expert, such as an attorney or accountant.