Unravelling Transaction Multiples, Business Valuation Mysteries
Often, the story originates from a friend or neighbor during a conversation that might stray into the world of transactions and business valuations. After all, the number of deals in the U.S. topped 13,500 in the twelve months ended June 30, 2019 (up 7.2% from the prior twelve-month period) according to FactSet. One major driver is the significant number of owners selling their businesses as the wave of baby boomers address succession and retirement.
“I hear Bob got 12 times,” he or she says in a hushed tone, as if they’ve just confessed to armed robbery. “Can you believe that?” At which point you can be forgiven for being skeptical.
In the world of private transactions, there is often limited information and much speculation. This is to be expected because business valuation can be challenging and opaque – a combination of established methodology and sound judgment.
The theory is relatively straightforward: What is someone willing to pay today for a series of future cash flows? But after that, it can quickly veer into the world of discount rates, weighted average cost of capital (WACC), and other obscure concepts.
It is important to not lose sight of the big picture. Here are five valuation tips to help you maintain perspective:
- Focus on what’s adding value (not the multiple). Recurring revenue, a diversified customer base, long-term contracts, management depth, low capital expenditures, profitability trends, and barriers to entry all add value to your business. If you focus on what adds value and the process you undertake to sell, the multiple you achieve will take care of itself.
- Every business is different. While it’s tempting to apply the same valuation multiple to every business in a particular industry, it just doesn’t work that way. Other deal multiples are merely a data point. Your business is different from your competitors’ (and that’s a good thing). You don’t want to be painted with the same brush.
- Value does not equal price. Valuation is a theoretical number, while price is what two parties agree on. Specific buyer motivations, timing, the sale process undertaken, capital availability, your personal objectives, that big contract you just won; all of it has an influence on price in the moment.
- Buyers purchase the future, not the past. While parties tend to focus on historical financial statements when negotiating price, remember: they’re only a guide. The future is what matters, and that’s what is being purchased. The more confidence and visibility you can provide into the future, the better your valuation.
- Pay attention to working capital. It’s boring, I know, but working capital is the engine of your business. Most owners do not manage or monitor working capital as closely as they should, often with material value implications. Managing your receivables and payables more closely, for example, can extract significant value without asking anyone to write a check.
So, with all of this to say, don’t let your friend or neighbor drag you into the mud of multiples speculation without understanding the facts.
*This article was originally published by Ken Tarry of Sequeira Partners on June 14, 2019. It has been adapted for BCC’s use with Sequeira’s permission.