The silly but most accurate answer is the price at which a buyer is willing to pay and a seller is willing to take for his business. Unfortunately, this does not help any of you with valuing your business. So let’s drill down a bit.
B2B CFO® has published a book called “The Exit Strategy Handbook.” There is a chart on page 47 that I want to show you. From one set of financials, a company was valued as follows:
|Asset Market Value||
|Insurable Value (Buy/Sell)||
|Fair Market Value||
|Financial Market Value||
|Synergy Market Value||
Your response is probably the same as mine was the first time I saw this: What the heck! Now what do I do? Our ultimate goal is to get the largest possible value for your company. If you talk to any business broker or M&A guy and they will tell you that Fair Market Value is the most often used method of valuing a company and fair market value is described as: EBITDA times a relevant multiplier. EBITDA is Earnings before interest, taxes, depreciation and amortization (we use this number rather than net income because it is easier to compare one company to another). The relevant multiplier is a factor partially defined by the industry your business is in and partially by the state of your company.
Given this methodology, how do you raise the value of your company? Raise your EBITDA and raise the relevant factor. You understand how to raise EBITDA: more sales, better margins and less operating costs.
How do you raise the factor? We will be talking a lot about this in future posts. The short answer is make your company look better and better able to operate without you, the owner. The factor adjusts a lot based on perceived risk of the buyer. The more risky his investment, the less he is willing to pay – or the smaller the multiplier. Here are a few items that your buyer will look to when agreeing on the right multiplier:
- How long has the company been in business?
- Is any one customer more than 8% of total sales?
- What happens if the owner/founder is no longer in the business?
- Are processes and business operating procedures documented?
You get the idea.
Let’s see how this factor affects the final value of a company. Assume your company has EBITDA of $1.5 million.
Granted, 2 would be a very small multiplier and 10 would be very large. But we see businesses selling at both numbers. We need to talk about what you need to improve your multiplier. You can see that a bigger number will have a profound effect on your retirement.
Have a great day.