Thursday, December 15, 2011

Business Sales Multiples

First we need to figure out what multiples we are talking about and what we are using them for. There are multiples of gross sales, seller’s discretionary earnings (SDE), earnings before interest and taxes (EBIT), earnings before interest, taxes, depreciation and amortization (EBITDA). Multiples are also used as general rules of thumb. For this article I will concentrate on the methods used for the purpose of the sale or purchase of a business.

Multiples of gross sales are the least accurate as they do not account for the quality and profitability of a business as they tend to be averages for classes of businesses. Some business owners know how to run a business and make excellent profits while others barely survive. These multiples are generally used for business categories that have large numbers of the same type of businesses, such as franchises.

Multiples determine the relative value of the business’s cash flow, but they do not measure the business asset value. I use a multiple to determine only the cash flow portion of the business. An asset bases analysis is a separate part of the appraisal.

For a sale of a business we need to know the SDE and the EBITDA In other words, the net income plus the seller’s discretionary earnings, interest, taxes, depreciation and amortization are necessary. This number should represent the amount of money a new buyer would expect to have available after purchasing the business. Interest and taxes will depend on how the business is financed and run. Depreciation and amortization are tax credits and the money remains in the business.

Differences in businesses will require use of different multiple values. Manufacturing businesses will have a middle of the road value while construction companies will have a multiple of about half and some high demand businesses may be double. Size matters, as larger businesses will have larger multiples.

Changes in economic conditions don’t change the basic multiples I use for appraisals. As economic conditions grow or deteriorate the gross sales and adjusted net profit of a business will go up or down thus increasing or decreasing the businesses value. I also use certain economic changes to adjust the net profit based on such things as growth or decline in sales over prior years, businesses having customers that represent a large percentage of their business and other cash flow influences. I very rarely find reason to adjust the multiples I use for an appraisal and I have been doing this for over 20 plus years.