The Valuation Multiples

Summary

In this conversation, Chris Sater and Brandon Bourgeois discuss the intricacies of business valuation, focusing on the concept of multiples. They explore how to set expectations for sellers, the importance of financial metrics like EBITDA and SDE, and the impact of industry standards and economic conditions on business valuations. The discussion also highlights common pitfalls in the valuation process and emphasizes the need for clean financial records and strong operational systems to enhance business value. Ultimately, they stress the importance of understanding market dynamics and preparing businesses for sale.

Takeaways

• Setting clear expectations is crucial in business transactions.
• Understanding multiples is key to valuing a business.
• Financial metrics like EBITDA and SDE are essential for valuation.
• Industry standards can vary significantly and affect multiples.
• Economic conditions, such as interest rates, influence business valuations.
• Clean financial records can enhance a business's perceived value.
• Customer concentration can impact the risk and value of a business.
• Sellers should avoid relying too heavily on anecdotal industry averages.
• Buyers and sellers must navigate their expectations carefully.
• Preparation and understanding of market conditions are vital for successful transactions.

Titles

Chapters

00:00
Setting Expectations in Business Transactions

05:49
The Importance of Financial Metrics

12:14
Impact of Economic Conditions on Multiples

17:55
Common Pitfalls in Valuation

23:49
Final Thoughts on Business Multiples

Keywords
business valuation, multiples, financial metrics, industry standards, economic conditions, business brokers, seller expectations, buyer considerations, financial practices, market variability

Transcript

Chris: 0:00

All right, yeah, today we're talking about multiples, all kinds of different avenues and areas of the multiple. But, you know, we'll start out by why do we even have a multiple, right? We're going to value a company using the multiple. So we're going to introduce you to why multiples exist. We'll talk about using them and what are we actually multiplying. We'll talk about industry standards and how buyers view multiples. That's going to be a big one that we get into. Yeah, welcome to the show. My name is Chris Sater. I am joined with my co-host, Brandon Bourgeois. We are business brokers. with Sunbelt Business Brokers here in Louisiana. We cover a vast territory over to Florida, East Texas, a little bit in between everywhere. So yeah, let's talk about multiples. Brandon, why don't you kick us off and How do we even dive into this conversation on getting started with multiples?

Brandon: 0:48

That's a fun one and happy to start. The biggest thing we always explain to sellers is what is a multiple and a buyer? Because it's how do you value a business? Everyone has thoughts in their mind. Is it awful gross? Is it awful gross profit? Is it awful the net? Is it awful how many employees you have? Whatever metric comes to mind, I've heard every shade under the sun. But multiples are where the majority of deals are done based on the value of the company. That is the key. And that's the big metric, especially the bigger you get, the more important your multiple is going to be because that's how you define what your company is worth. As you said. So first thing is, what is a multiple? Where do you find it? Well, the first thing to start with, the basic is the analysis of the cash flow. What is the business making? Whether you use SDE, seller's discretionary earnings, or EBITDA. One of the two, you find that, you define what that number is, and from there, you apply a multiple. That takes that number and multiplies it by how many? One, two, three, four, et cetera. And then typically, that's kind of the base value of the company. So first thing we as business brokers, M&A advisors do is, we need to see three years tax returns and a current P&L and start that process, identify what that is. And from there, it gets into a whole another tree, you know, branches everywhere, how to properly identify the multiple and then two, how to calculate it. And then three, how really how to apply because there's going to be other factors besides just what the financial data is, that how you kind of come to the conclusion. There is no one set way, which is what makes it fun, but also challenging at times because people will view everything different. So that's where our expertise, having done multiple deals, COT plays together, no pun intended.

Chris: 2:21

Yeah, absolutely. Absolutely. Talk to me about like, you know, you mentioned a couple of different bottom line numbers, EBITDA, SDE. Why use one versus the other? Before we even get into the multiple, what we're going to multiply by, why would somebody use EBITDA versus SDE? And what does that look like from a buyer and for a seller? And then for us, importantly, as a broker, which one are we going to use and prefer in any given instance?

Brandon: 2:50

Great question. And I heard it best said by a man on LinkedIn a long time ago, and my dad always said this too, kind of not the same exact word, but very much paraphrasing each other. When you're buying a smaller business, let's say under two, two and a half million for ease of use, you're really buying a job. You're buying a company that's employed, but you're buying a job because you're going to work in that business 40 hours a week or more. You use SD, seller's discretionary. Very small companies provide a lot of benefits to the owner. You know, they run their car, cell phone, health insurance, what we call a lot of add-backs to a cash flow multiple that the company's paying for to help the owner out. So you can expense it, right? I mean, why not? We all do it. When you see EBITDA, you're not just buying a job, you're buying a company. You're buying a real business where you're going to manage a lot of people. And typically, you may work in it, quote unquote, 40 hours a week. But very often, you may not be there every day. You may have a manager that does a majority of the operations. You may have a controller handling the account. You may have a service manager handling field work versus a back-end staff. That's when EBITDA is more applied. And EBITDA does have adjustments and multiple, you know, discretionary add-backs you can add in. You know, very often the company does have some company expense for the owner's car, family, some travel. But it's not going to be, I guess... voluted as a lower main street level business, that two and a half million dollar SDE is more common because you add all those compensation. You're going to add more of the seller's role because you're going to be in that role running the business. Whereas EBITDA, you may not add back a manager's salary because the manager is a key component running that business forward to kind of water it down real simply to your answer.

Chris: 4:24

No, absolutely. I completely agree with you. It really depends if that owner's role needs to be filled. If the owner's taking a large salary, $150,000, $200,000, whatever the case may be, but the buyer's going to have to come in and not only replace him, but also add some more functionality or responsibilities to another person. But that's probably going to be a better source of the starting thing that we're going to multiply by, right? We haven't even gotten to the multiple. But yeah, completely agree. Let's talk about, you know, how do we even come up with the multiple next? We're going to talk about, there's obviously industry standards. You could look at an industry as a whole. We as business brokers have the availability to run comps and see what an industry as a whole, what that multiple is. You know, it's going to vary. It's never going to be the same number. At least I've never seen it. seen it that way. But there are standards for each industry. Talk to me a little bit about what you've seen in your years as a business broker as far as what the multiples should be based on the industry and how that varies.

Brandon: 5:30

Great question and loaded question. In my 13 years, typically if it's an owner-operated business 40 hours a week, let's say the SDE is around 200 to 300, you're looking at two to maybe three times based on industry. And I think the hardest part in running comps that we see and explain to owners is the word on the street is, oh, my friend got a 10 times as multi. It's not, that's very, not that common. Maybe you get to a big Wall Street brokerage house where you're doing $100 million. Yeah, you might get a 10 times multi. But for the average business owner on the street with an HVAC shop with maybe five technicians and the owner working, you're not going to get 10 times. So what are you going to get? Well, say John down the street got, he said he got five. Well, did John have real estate involved in that purchase because that would make the multiple seem bigger right now if we take the actual real estate value out and analyze what they just paid for the business very often you see that two to three range and it's based on how involved the owner is as we said earlier if the owner's 20 hours a week in the field 20 hours in the office that tells a new buyer hey I don't have to be as skilled as you in the field to do the work so that might get a little better multiple you got more trained staff better technicians whereas if hey I am the business I am let's say I am the appraiser of an appraiser company and it's me your probably going to get one time because you are the business. I can't buy you as a person. And I can't put all your knowledge in my head in a short time, so I can't pay a larger multiple. Even if you're making, let's say, $200,000 like we just referenced for the agent, you're probably going to get $200,000, maybe $250,000. And very often in that case, you're going to have some form of an earn out on the back two or three years to have customer retention because you are the owner. You are the value. If I pick up the phone and say, it's Jim's appraisal business, and the next day Brandon picks up the phone, are the same clients going to say, hang on a second, you're not Jim. I know Jim does a good job. How do I know you do a good job? So that's That's one of the many layers of the onion you have to peel back when doing a multi. And I've had to tell some people before, hey, you are the business. You're not going to get four times. Even if you make a lot of cash flow, you are the business. And that's the issue. What does someone buy? What are they getting? Blue sky, assets, personnel. If you are all that package combined... you're not going to get a bigger multiple.

Chris: 7:38

I agree. I think multiples are going to vary by industry, right? They are. It's really based on what that industry has to offer. Different industries have standard multiples. It's going to be based on risk. It's going to be based on their growth potential, and it's going to be based on their cash flow stability. Service-based businesses that often have lower multiples, it's because they're relying on key individuals, right? Whereas tech companies, they've built this system. They're going to command those higher multiples because of the scalability of what they've built, right? You can send that out nationwide, and sometimes you can even send it out throughout the world. You've built this product that has these huge scalability factors, and that's what's going to get you to those 8 and 10 times, 12 times, these crazy valuations that we've heard. If you have a service business in a local regional market, how much can you really scale without adding a new location in a new market? And I think that kind of plays a large role in what the multiple are able to be. I

Brandon: 8:38

agree. And I also add to the factor that it's about how much can you pay back out of the business. No one's going to buy a business that takes 10 years to pay back. 12, 15, 16 years. That doesn't make sense. So it's not worth the money. Typically, the multiple is how long it's going to factor in how long it takes you to make debt service. Now, we've talked about this before. SBA loans have a 10-year AM, sometimes a 25-year amortization based on the asset value. We can get into that another day. But it matters because SBA If you're going to say you'd spend a million dollars to buy a business and it takes you 15 years to pay it off, it's hard to make a good return on your investment to do that. So if you price a business with a crazy multiple, no buyer is going to be willing to take that risk. They can go get a job at the state for 80, 90 grand a year and not have half a million to $2 million note on the back of their head, right? I mean, look at current interest rates, nine and a half, 10% for SBA. The multiple matters. Even if the industry standard multiple is five for your industry, but it can't meet debt service because of current rates, no Yeah, I think interest rates kind of play a part of multiples, right? Because a

Chris: 10:00

multiple could be, you know, three to four if the interest rates are four or 5%, but I think the multiple changes if interest rates are nine to 10%, right? It's based on cash flow, debt service, right? So multiples change over time, even within industries. And I think that's when we run comps, that's why we see these kind of, even within one industry, we'll see a vast change of multiples, especially over a period of years.

Brandon: 10:26

Especially if private equity gets involved, you know, that like the big HVAC, all mean electrical service boom that we saw, you know, coming out of the COVID, Some people were getting paid crazy multiples. And it was great for those people who were able to sell at that time. Rates were low. It allowed financing to be stretched really far. It helped a lot of people. But at the same time, what something sold for five years ago isn't always a great comp. You get to factor in economic conditions. How structured was that business? Well, John got 10 times. John's business is different than Jim's business. John may have only worked five hours a week and had multiple managers running the same form, you know, just like that. Jim's over here working 40 hours a week. As an investor, you're saying, hey, if I want to buy a company, I don't want to buy a job. I want to buy a company that's already running and got programs, systems, key employees in place. So that varies the multiple. And that's why it's so subjective too. If anybody listening, it's a very subjective opinion. 10 people get 10 different multiple analysis from two to 2.2 times, 2.5 times. It could vary. You have to be willing to work with the broker and understand every situation is going to be a little bit different. It's not like going and buying a house down the street, running the comp in the neighborhood, and getting within a 1% or 2% difference. It's not that simple.

Chris: 11:44

Yeah, because there's a lot of factors that a company can do. If you compare two different companies that have the same EBITDA, they're in the same industry, there's going to be different ways to value them, different multiples based on those. And some of the ways that you can improve your company's multiple, there's different factors that you can do is keeping your financials clean. If your financials are clean compared to a company B who's got, they just do journal entries every month and you really can't tell what's going on. A buyer is going to be willing to pay a lot more for that company, at least a higher multiple, based on what they're able to analyze and see in the trend. And so having organized financial records, that's going to make due diligence smoother, and it's going to increase buyer confidence. So that's going to make your multiple higher. I'd say even one step further is having audited financials. That can justify a higher multiple. It just adds that layer of trust and credibility to what's being put out there to be able to ask for that higher multiple.

Brandon: 12:47

I would agree. And I would even add SBA getting pre-qualified. When you speak to a broker, get it listed, let us get it SBA pre-qualified with a lender. When you can put that stamp on a business, someone, a buyer looks at it and goes, man, a lender already reviewed these financials. That means the bank feels comfortable making a loan on it. That's a massive jump in the right direction. It also opens up the buyer pool, as we've mentioned in other videos, if you've been listening. It's so important to let us do that and get it prepared. It's like selling a house to some degree. You're not going to sell the house with old paint on the wall. You got to touch it up a little bit. Getting that pre-qualified stamp on it gives people a sense of confidence. And to add to the multiples, you mentioned having good financials. What about customer concentration? What is your diversity of your base of your income coming in? A lot of times, different companies have different customer concentrations. And if you've got all your customers, say 80% of your business comes from three people, you're one customer away from losing a lot of value in that company. And I think a lot of owners don't always look at that. Well, let's say Jimmy's been a great customer on 20 years. That's right, because Jimmy's known you since you started the company. What happens if Billy buys the company and they don't quit? That's a big risk for Billy. He could lose a major customer just like that. There's a lot of factors that go into that. And even carving out parts of businesses. Realize when you sell your business, you're going to sign and not compete. Sometimes if you only want to carve out a portion due to a different industry, that's going to affect the multiple because the buyers think, is this person going to be competing with me? Is there going to be crossover? How do we even clean the books up if we're doing a carving? That's a hard part as well to figure out. You know, our financials commingle from different entities. It's so important to have those good financials. It's so important to talk to someone like us before to get these items figured out in advance. Because the best thing you can do about getting a valuation and figuring out your multiple and to bring back to that point is knowing where you start. If you want to get 10 million for your business and you're only worth five, how do you get the 10? Well, you know the multiple got you. We got your EBITDA set up. We know we're getting you to five. Well, how do I get the 10? How much do we need to grow that bottom line cash flow number? Now you have a metric you can meet. As a business owner, we love metrics. We'd love to know what it's going to take to get from A to C. And once you get A figured out, as in the EBITDA or this SDE, you now know how to get to C. That means either got to expand where I got to add locations, I have to scale, or I just got to raise my prices a little bit, increase my bottom line, and show that historically. And then that multiple grows. And then that multiple grows, you can get the price you want.

Chris: 15:08

Absolutely. And I think along with that is establishing strong operational systems, having policies and procedures in place. That way, when a buyer steps in, they understand the playbook that this business already runs by. They don't have to rely on the number two guy who may quit tomorrow. You don't know that. Again, we go back to trust and reliability and kind of building in those factors that are making it attractive for a buyer. So yeah, you definitely raise the multiple, your multiple by putting those Let's

Brandon: 15:40

talk about adjustments. I think that's a key part we kind of mentioned, but we didn't really hit it home on the nail thing enough. We talked about ABAX a little bit, but there's a lot of things that owners don't think about adding back. One-time expenses, one year, maybe a legal issue. Maybe there was a down year in financials because a hurricane came through and waxed you for five months. That's all within reason. So don't be scared if you had some years up and down. We make adjustments for that and reconcile within the most previous and past years. You're not going to get dragged down for something five years ago. Don't expect that. And the same could be true for you had a bad year recently. But if it's something that can be explained and adjusted for, That's okay. But people need to understand that there's going to be adjustments. And this is where buyers think have the biggest gripe. If you talk about buyers seeing it differently than sellers is the adjustments in the ad. I think a great example of that is when we had family businesses, they're fine if the family members get in a paycheck and not work in a business. Oh yeah, you can add that back, sure. But how often do we see family members in a business where they're overpaid? The salary may be 20, 30% inflated because, you know, maybe dad wants to take care of his son, his daughter-in-law, etc. We can make adjustments for that. Because honestly, if you go to hire someone in the open market, you're not going to pay someone 20, 30% more just because, just because. If there's competition and there's good availability, you're going to hire someone for the best price you can get them for. So very often we can add back parts like that that increases the EBITDA multiple. Now, some buyers will push back, say that's not possible. That's where you have someone like us to work there and say, hey, look, no, it is industry standard. Here's some comps. Here's some examples of people that are in the same multiple. Look. It's okay.

Chris: 17:16

Yeah, absolutely. There's so many things that go into getting to what EBITDA or SDE is. I've got some clients, they want to add back things from the previous year where an employee, they say he wanted to retire. He just hasn't retired, but he's not needed in the company, and they want to add back his $100,000 salary. That's probably not going to fly to a buyer. They're going to say- Yeah, they're going to say this guy was needed for something. What did he do? And you can get dive into that and do a deep dive on what his role and responsibility with the company is. But I'd say on average, sellers try to, once you start that conversation of what are your ad backs, they get a little aggressive and it's our job as brokers to kind of rein them in because we're going to see it from the buyer's perspective first off. And if it's not believable or if it kind of throws away the trust that you're trying to build of all these over egregious ad backs I'd say that's probably a bad place to start a relationship with a buyer and a seller.

Brandon: 18:15

It is. And the banks, let's make this clear, the SBA lenders we work with, they're more than happy to work with AVEX. They truly are. They understand they're a person. And sometimes, you know, these are many family-run businesses. These are not Wall Street audited, publicly traded companies where you can't just have nepotism involved, where people are getting salaries for fruit. That's not going to happen. So it's okay. And we work with them and they can identify them and they'll add them back, especially if you can prove them. For example, You know, I own, say I own another business and I'll let the company pay for X amount of meals that are obviously for me and my wife and kids to go out and have dinner together. I can show receipts and back it up. The bank's not going to worry about it, right? They're not. Now, if I claim I'm doing $100,000 in cash I'm hiding because I'm paying, you know, paying my nephew who's not there on payroll, but he is. I mean, yeah, you're going to have a kick. You're going to have the bank say, well, hang on a second. There's got to be bank statements or something to verify this. This was actually paid out of the company, whether you took it out directly, you wrote a check. whatever. But it's important for us to at least identify and make a buyer comfortable when they come through the door. If you start throwing, like you said, all kinds of random stuff at a buyer, now they feel like the multiple is inflated. Now they feel like the multiple has made the price inflated. Now the expectations are inflated, and it's not worth proceeding further.

Chris: 19:29

Let's jump over to talking about some common pitfalls when buyers and sellers are using the multiples, as we call it. You mentioned it earlier, that 10X that he heard down the street of his friend or neighbor sold his company for. I think a lot of sellers rely too heavily on what we call industry averages. Maybe business did sell for 10X or even 5X, let's say, but it may have been during a private equity roll-up when things were hot. If it's three or four years after that, it doesn't mean it's 5X anymore. They may have done what they're going to do. They're still looking for add-ons, but you may have missed that wave where they were willing to pay whatever they got to pay because they've got to roll something over or they got to do what private equity does. What have you seen in regards to like using industry averages too much and kind of having to deviate from that

Brandon: 20:19

I got a great example for you. My dad, who did this for 25 years, always said this, the market will dictate what your business is worth. One person telling you he might be interested or said something is not the market. That is one factor. When you're doing an average, yes, industry trends may say, hey, two is very common. But in reality, the market's going to dictate what your multiple truly is. We price it at the multiple we think is appropriate. We use industry standards to get a line. We put our own professional opinion into that multiple. A lot of comps we pull do have broker submitted comps, I don't always know every ounce of that SDE number or that EBITDA they give us. I can't make sure that, hey, this guy really did a good job or did he just inflate it, right? Let's be honest. But the market will dictate. And if you want to use a multiple that's higher because you've heard everybody else is doing it, that's fine, Mr. Seller. But just know that when every buyer walks, what the market is telling you is that multiple is not going to fly. That multiple is not going to work for them. And that's why you haven't sold yet. We've had many businesses we've dealt with where the owner wanted too much. And we don't mind trying because maybe we're wrong. We're not perfect. We don't always know exactly what the market's going to do. But when you get more appropriate within certain guidelines... typically you will get more buyer interest and you will possibly get a sale. And that's important to keep that in mind.

Chris: 21:34

Yeah, absolutely. I think understanding why certain businesses receive higher or lower multiples, it helps set expectations, right? That's kind of what we're looking to do here. We're not saying Forex, your business is absolutely a Forex. We're trying to find a gate or a ballpark, right? So we're viewing past sales kind of in a given industry, helping benchmark those. It helps us provide a reasonable valuation of where things are based on the economic climate, things like that. Kind of takeaways for sellers from this conversation today are the right multiple is going to depend on your industry, but it's also going to depend on your financial performance. And mostly it's going to depend on perceived risk, right? And I think a lot of risk can be mitigated by preparing financials and kind of improving your valuation in that regard.

Brandon: 22:20

Absolutely. And understanding what the market is. We got an inquiry yesterday from someone looking to sell a restaurant. It was like, what are the buyers doing right now? I haven't heard a lot, but I'm curious. Got a restaurant I need to offload. She worked with us previously. It's like, yeah, we are getting different flows of buyers, but there are buyers that want to make the right investment for the right size. I'm working for a restaurant right now. We're on a $2 to $2.25 million valuation, working on negotiating the offer. There are good restaurants being sold, for example, for an industry that may have a harder multiple to get because often the owner is the restaurant, right? Or is the key chef or is the key bray. And that's a problem. But the way we're structuring it, we're getting a pretty good multiple for a very good business. But it makes sense because the financials are super clean. It's got great systems in place. And it's well run. And he's willing to stay on as a partner. All those factors allow for a higher multiple, higher acquisition price, and long-term success, which is why you can achieve it. It's not always common for every business in every industry. It does vary. And if you're listening, we're stressing this to you because it's important to come in with eyes open. And the market will help dictate. And we can provide recent market data too. But be aware, it's what someone's willing to pay you for your business is what it's really worth. You can have the highest price you want out there. You might get one offer. You lower, you might get 15. But would you rather have 15 offers to pick from or only one offer where you got to sit there and say, I don't love this person or don't love this structure, but it's the best I can get? The price isn't always worth it. Quality of life, total consideration. Keep all those things in mind. That's what the multiple is going to help us get.

Chris: 23:50

The higher price or that higher offer may come with a lot of contingencies, seller financing, and difficult due diligence. So it's important to consider the full offer when you're evaluating offers.

Brandon: 24:03

No, you're right. And just because so-and-so said they may have sold a restaurant or may have sold this business, that's one person. You wouldn't say that's the norm or the average. This is why you asked to speak with someone like myself or you, Chris, where we can pull different data points and pull experience and say, conservatively, you're multiple in the peer. If we're getting a little liberal, it may be higher up here. But if you fall in this range with the right structure, you need to be prepared because very often the first, second offers are the better offers you're going to get. It doesn't mean they're perfect. No. But if you're and premium price, premium offers come with a lot of contingencies. In a more relaxed price, much more flexibility.

Chris: 24:41

Absolutely. Absolutely. Well, I hope everybody was able to learn a little something about multiples today and especially us as business brokers, how we use them in evaluating companies. Hope you're able to, as you're looking to sell a business, take something away from this that says, hey, if I want to get my multiple up, here's A, B, and C that I need to start working on today. If you've got any questions, please don't hesitate to reach out to Myself or Brandon, we're here to help. And we love working with business owners to help get your business ready for sale when you're ready. It's always on your timeline, not ours. So appreciate you listening in today and hope everyone has a great one.

Brandon: 25:18

Absolutely. And one friendly reminder, we do analysis, not evaluate, give you a market idea. We don't charge for that. Give us a call and let us give you a baseline where you're at. Don't wait till it's time to be done. I know Chris kind of gave the closing, but I got to get this in there. Please call us. Let us help you set a baseline for what you need. Don't wait till it's the day you need to sell and we're captive what the multiple can be.