Business Valuation

Multiple of Revenues

This “method” is more a method of easily communicating what a buyer is offering to purchase than a true method for valuation. A simple example would be if a buyer offered to pay a seller 1 times revenue it means that if the revenues of the seller’s company are $2.0 Million for instance then $2.0 Million would be the offering price. If a buyer offered .8 times revenues or 80% of revenues then the offering price is $1.6 Million. There are different periods and therefore methods of revenue measurement. One method, more historical, is measuring the “trailing” 12 months of actual activity. Another method, more forward looking, is using the booked or pro-forma revenues, which combines actual with scheduled for the current business cycle. It can be important to understand how the buyer is measuring particularly if the business is adding customers over the entire course of the business cycle. A trailing 12 month measurement may understate the true near term revenue potential. If the business is not growing year over year it is not going to make much difference which measurement the buyer utilizes.

The reason that a multiple of revenues has been commonly accepted is that, particularly with tuck-in acquisitions, is that in the models that buyers use to run financial analysis, revenue commonly is the independent variable around which the other critical variables are manipulated to run sensitivity or “what if” scenarios. The analyst is seeking to understand how changes in offer price, gross margin, drop-thru, net customer retention, other risk factors, etc affect the return on the acquisition investment. The financial analysis should define an acceptable range for a purchase price. Then, as discussed, a simple way of communicating an offer to a potential seller is an offer % of revenues. This is a “cliff notes” version of the process a financial buyer might use to evaluate a tuck-in acquisition. Keep in mind a couple things; understanding a fully burdened EBITDA of your business may be of less importance because they are making an assumption of a “drop thru” or contribution margin on the revenues acquired. The critical factors in their analysis that drives what they are willing to pay you are retention, revenues per customer, pricing or any other perception of risk.

Multiple of EBITDA

A strategic buyer may do the analysis differently. They may want a better understanding of the adjusted EBITDA because your business becomes their business at the outset so in essence your profitability becomes their profitability. They make not make an assumption of a drop thru margin on an integrated customer. Their analysis might be more of a comparison of the two alternatives available to them; one, to buy your business and grow it or start a business from scratch and grow it themselves. This type of analysis is more complex and it is extremely important that the information that you give them is accurate and easily understood. The basis for an offer from a strategic buyer might very well be a multiple of adjusted cash flow and the rule of thumb is 5 times adjusted cash flow. So if, on an adjusted basis your cash flow is 20% of revenues, then a strategic buyer might be able to justify paying 1.0 times revenue.

That being said a buyer may be willing to offer something above the rule of thumb; 5 times cash flow, given their motivation. As just mentioned, a strategic buyer has to compare the alternative of acquiring a platform and growing it or starting from ground zero. In doing that type of analysis is more complex and more subjective. They have to ask questions like “what is the value of having employees already in place” or “what is the value of the specific local market knowledge of the people” or “what is it worth to us to not have to book start up losses to the income statement” or “what is it worth to bring in the industry knowledge and not repeat the mistakes that someone else has made” or “what is the value of a turn key business”? The answer to those questions is more subjective and presumably there is value there that is over and above the value represented by a multiple of cash flow. Is so, presumably there are questions to put to a strategic buyer when upon receiving an offer. What are the underlying assumptions that drive their offer? What is the adjusted cash flow assumption you are using? Is the buyer assigning a premium? This does not necessarily mean that a strategic buyer will offer a premium but certainly that rationale for trying to leverage one is understandable.

One last point to consider re: a strategic buyer. Some of the exercise is subjective analysis which can be formed impressions, even superficial ones. It is critical that the financial information that you give a buyer is clear and understandable. You may even want to prepare a document scheduling out all the adjustments they should make to arrive at an adjusted cash flow number. That means all the privileges of ownership, all the one time and nonrecurring expenses in the last year maybe two years. Do their thinking for them. It is important that the statements that you make about the business are factual. It is important that the impressions that you create cast you and you business in a positive light. These things taken in a positive light can help create a favorable subjective assessment or impression of the business to the extent that it could impact the offering of a strategic premium.

In closing you made have talked with others that have sold and perhaps even what the sold the business for. A word of caution here; when you are talking to someone that sold their business ask them if they were happy with the ways things turned out and if the were treated fairly. This may be far more useful and accurate information than if they tell you what they sold for as it may not be accurate information as the person is likely not going to tell you that they sold for less that they actually did and the opposite is a distinct possibility given that it is psychologically more comfortable to over represent the facts. Using such “facts” in negotiations in your own deal could be detrimental to a successful outcome.

Valuation Myths

I have heard it said before on different occasions that your business is likely worth more to you than it is to anyone else. It is kind of like the notion that no one thinks their kids are ugly. I think this is quite true as I have seldom seen a seller think that their business is worth less than what they were offered, as a matter of fact that has never happened to me. You as the seller assign a value from a financial perspective, you assign a value because of the lifestyle it affords you, whether you realize it or not you emotionally ascribe a value to your business. These are reasons to keep your business, not to sell it because a buyer is not intentionally going to look to sustain your life style nor help you with your sense of accomplishment. They will offer you what it is worth to them and nothing more.

Consider a buyer that is a publicly held company, they can’t pay more than what they can reasonably justify as it is their fiduciary responsibility to the shareholders to not do so. If they don’t uphold that responsibility then they will not be long in the position. That is why they employ detailed financial models to reasonably predict what the financial outcomes will be as they have this shareholder obligation. Now that does not mean that they will automatically make you their best offer the first time around.

The 2nd common myth is that there is a "going rate". I can tell you that it is not necessarily the case so if you have that in the back of your mind as a working assumption, that is not necessarily so, especially to a financial buyer and particularly for those of you that are less than $500K. This is not to say that the right combination of factors may come into play and that you will get 1.0 if a buyer is interested in the trucks, equipment and they ate in good shape or if a strategic buyer comes along it may very well happen. It should not be considered a given however. It will also be more likely to happen if retention is excellent, revenue per customer is high, reputation in the marketplace is quality, and your information is accurate and easily understood.

My business is unique, the results are great, and therefore my business should command a higher price. There are instances when the seller’s business and service delivery model is so different than that of the buyer, that buyer will not consider making an offer because they know that once they integrate the customers and transition the business process that they will destroy the very elements that created value for the owner and the customers. Large financial acquirers with standardized business processes and those processes create value for their customers are not going to remake their business model to fit your company typically unless they have a standalone strategy in mind.

It is wrong for a seller to assume that he gets paid for all the synergies a buyer can create with cost efficiencies, elimination of redundant costs. That is not exactly true, because the value created for the buyer by the things that the buyer brings to the table doesn’t belong to the seller. That value is not locked up in your company just waiting to get out. It only comes about when the buyer can leverage what the buyer has brought to the table. This is not to imply that a buyer will not make you an offer increased offer because of expected synergies, but do not expect that as a given because to the extent that they do they will be giving away value that should be going to their shareholders. Remember they are stewards of the business that belongs to the shareholders. Privately held companies may view the appropriation of synergies differently.