If I had a dollar for every time I’ve been asked, “What’s the multiple?” I’d be rich!
When a business owner asks what’s the multiple, the real question is: what’s the multiple for HIS/HER business? And every one is different. Is the multiple for Microsoft the same as the multiple for Apple? Is the multiple the same for GM as for Tesla? No not at all; and why is that? Each organization may be in the same industry, but each organization is unique and buyers evaluate those subtleties.
In this article, we are going to talk about the top factors that influence YOUR multiple. The range of multiples for sale transactions that include only tangible and intangible assets along with goodwill is roughly 0 to 3.5 times earnings. Where are you?
What is a MULTIPLE?
A multiple is just the rate of return upside down.
If I have a $100,000 profit and we select a multiple of 2 that means the selling price is $200,000. That is:
- Multiple of 2; the return on investment is the inverse $100,000 / $200,000 = 50%.
- Multiple of 2; the payback period is 2 years; It takes 2 years of profits to pay back the purchase price.
- Multiple of 2; an investor needs a 50% rate of return to pay $200,000 for that $100,000 yearly stream of profit.
So when determining “what’s the multiple?” we are really saying “what rate of return will a buyer need to buy that stream of profit?”
Multiple of WHAT?
If one business owns their real estate free and clear so the business pays no rent; and is run by a man whose wife is a CEO of Big Public Co. so he doesn’t need to take a salary, it might show a very big profit. Is that business actually doing better than the one down the road, with the same revenue, that pays rent, and pays a GM a market wage to run it?
Maybe, maybe not. To compare and evaluate businesses against each other the income statements get adjusted or normalized to reflect the profit a self-sustaining entity produces. It needs a facility, so how much would any owner have to pay for that space? It needs a GM so how much would it cost to get a competent GM at market rates?
Income statement adjustments include removing any unrelated revenue and expenses – eg. the vacation rental property in the same company, the one-time PPP forgiven, the one-time fraud that was prosecuted.
And, all necessary expenses are adjusted to market rates.
The resulting adjusted profit is what buyers/investors/bankers/IRS are using to assess what your business is worth.
What’s INCLUDED in the multiple?
In divorce and succession cases, often the transaction includes everything on the balance sheet and goodwill: that is, cash, A/R, AP, long-term debt real estate, inventory, and goodwill (a function of profit).
In sales to outsiders of owner-managed enterprises, we typically base the selling price on a cash-free, debt-free package. The multiple includes fixed assets, average parts inventory and goodwill only, and it is sold PLUS unit inventory and PLUS the real estate.
As a result, the same business could have very different multiples depending on what is included in the measure.
What’s your MULTIPLE?
Buyers, valuators and bankers use a multiple of PAST results as an estimate of FUTURE results so they look at averages of the past. One single good year is usually not enough to motivate a buyer to pay more.
The most important factors (IN ORDER OF IMPORTANCE) that drive the multiple for your business are:
1. Adjusted Profit!!
Number 1, the MOST important factor! How much does the business make?!
How profitable is it in dollars? More dollars are more dollars!
How profitable is it in percent of revenue? $400,000 profit from $4 million in revenue is very good (multiple goes up), but $400,000 from $20 million in revenue is barely sustainable (lowers the multiple). Profit compared to benchmark is key – at or above industry benchmark gets the highest price.
Fluctuations…. Ideally, buyers want to see consistent upwardly trending revenue and net profit. Big fluctuations drive multiples down.
Everyone had a couple of great years in 2020 and 2021 – what do buyers think of that? Buyers look at the trend in profits over the years. With covid years some buyers are throwing out those years entirely and looking back at 2017, 2018, and 2019 to estimate the future earning power of the organization. I like to blend the before and after because I believe the future will be somewhere in the middle.
2. Geographic Location
TIED with #1 MOST important factor.
Two identical organizations with identical results in two different locations will very likely have different multiples.
Buyers pay more for organizations in more urban areas with more amenities.
In smaller centers, more remote areas, or seasonal areas, buyers have to be enticed to relocate there, OR they have to be willing to take on the risk of monitoring a distant organization. In either case, the buyer expects to be compensated for this risk with a lower acquisition price, which is…. A higher return on investment and a lower multiple!
If a business is located in a region people want to move TO, the multiple will be higher than one located in a region people are leaving. Think Idaho vs. California.
3. Product Lines Carried
If the profitability and the location look good to a buyer, the very next question always is – What lines do they carry?
Well-known reputable lines are worth more than poor quality or little-known names and manufacturers.
4. Staff
Staff is what makes our businesses profitable! And, buyers know that good staff is the key to success.
There are two types of arm’s length buyers: Owner-operators and investors. Investors are looking for organizations with a proven GM in place who is likely to stay. As the organizations get larger, finding owner-operator buyers with sufficient net worth to acquire the enterprise gets harder and harder. If you are selling a larger enterprise, or a rural enterprise, consider hiring a good GM who can run your organization in your absence. A good GM increases the pool of buyer candidates significantly, which increases the price you will get.
Staff in General:
Long-term skilled staff means that customers will continue to be satisfied beyond a change in ownership.
High turnover, in-fighting, and long-open vacancies truly reduce the value of your organization. If you are working through this situation, it is very likely affecting your overall profitability (see #1!) and it will pay off for you to resolve it as quickly as possible!
5. Books and Records
- CASH: Actual cash coming into the business can be a very nice thing…. But if it doesn’t make it to the tax return, it doesn’t make it to the selling price! Any multiple x $0 is ZERO DOLLARS. Pay your taxes, or someday when you sell your business for less, know that you have already received the difference!
- CURRENT STATEMENTS: Are your tax returns up to date? Can you provide year-to-date, reliable internal financial statements within about 2-3 weeks of each month’s end when your buyer and their banker ask for them? A lack of credible financial information will reduce the selling price.
- USEABLE: If you have an income statement with dozens of accounts with tiny balances, your buyer CAN NOT use this to do any analysis! Nor can you, so your profitability is likely suffering in the interim. Financial statements are the scoreboard of your business. They need to reflect industry standards for groupings and categories so that buyers can easily see what’s going on and calculate performance metrics like gross margin, personnel as a percent of revenue or gross margin, etc.
- INVENTORY: Parts inventory is effectively stacks of money sitting on your shelves. If you can’t sell that inventory, it is worth NOTHING. Buyers are looking at your inventory for obsolete, dead inventory by the thickness of the dust on it. Clean it up and get rid of old inventory. Buyers often won’t pay for anything over two years old.
THE MULTIPLES:
In my experience and as evidenced by various databases, the most common multiples for this industry are 2-3.5 times adjusted profit before tax and amortization, including fixed assets, parts inventory and goodwill, PLUS unit inventory, and PLUS real estate. All other assets and liabilities remain with the seller. This is for a seller with profit on benchmark in a decent location.
Buyers’ decisions are affected by the economy as well, and the uncertainty and volatility of the current economy are making buyers much more cautious. This means if you want a sale fast, a lower multiple is probably needed.
One mitigating factor is that people have more money than ever and like every other period of chaos, this too shall pass. People will always search for a path to wealth and buy businesses. The most important thing you can do for the highest multiple when you exit is to ensure your profits meet or exceed industry benchmarks after paying all expenses at market rates.
Stacey International is a group of credentialed, knowledgeable, experienced senior executives focused on helping business owners buy and sell businesses. If you are ready to exit or just starting to think about it, give us a call. We can help you get the highest possible selling price now or in the future. Let’s connect.