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Industry business valuation multiples.

An owner of a midsize (30-employee) private company recently asked me, "What is the industry valuation multiple for our industry?"

There isn't one. At least not a credible one. Some advisors, writers and business owners try to peg a multiple for an industry, but it's rather arbitrary--even silly. At least for companies with less than, say, $500 million in revenue. Here are the reasons:

1. Factual data about the price and terms at which small and midsize private businesses sell is very difficult to find. This is because the businesses are almost all private and the data are not released to the public. Similarly, the data are not compiled anywhere. There are two exceptions to this:

a. When the acquirer is a public company. This will be a minuscule subset for almost every industry. Still, when these transactions occur, some meaningful data can at times be gleaned.

b. Some "business brokers" will anonymously and blindly submit their "done deal" data to one of two databases of business sales--BizComps and PrattStats. Although these data are interesting and "worth a look," few industries have enough data points to allow meaningful extrapolation. More significantly, the data are not reliably inputted. Of course, this doesn't stop Inc. magazine from attempting to compile and annually publish valuation data from these datasets.

2. Businesses sell for a wide range of values for a vast array of reasons. Even if ample quality data were available, they would be of little value.

To illustrate point #2, my firm has proprietary data on five business purchase-sale transactions in the metal heat treat industry.

Here are the summary data:
Selling   Multiple    Multiple of   Multiple of
Company   of Sales   Gross Profit      EBITDA

A           1.25         4.39           6.14
B           0.99         0.998          N/A
C           0.64          N/A           3.43
D           0.33         1.41           N/A
E           0.71         1.78           N/A

The selling companies' revenues ranged from a high of $135 million to a low of $600K. Only two of the six companies were profitable. Sale prices ranged from a high of 1.25 of sales to a low of 0.3. For the two profitable companies, the purchase price multiple of EBITDA was 6.1 and 3.4.

Are these data meaningful to the hopeful seller? Well, the range of values is quite large. I guess one could simply shoot for the highest multiples, but this completely ignores the reality of what the market will bear for the particular characteristics of the selling company. Note that Company E in the table, which was not profitable, sold for a higher multiple of revenue than the profitable company C.

If the owner of a heat treat company were offered 50 percent of revenue and 10 times EBITDA, is it a fair price? Should the seller accept it? Again, it depends on the characteristics of the firm. If the subject company has significant revenue that's growing rapidly, but very low earnings, maybe not. The examples can be infinite.

What if the company that earned the highest multiples in the sample dataset left money on the table because it did not handle the sale in a manner that would yield maximum value?

In short, simple answers to complex questions such as "what price is fair" just don't serve us well. A credible expert in the purchase and sale of private companies can assess the characteristics of a particular company and estimate market value. Just watch out for firms or advisors that charge large lump sum up-front fees. They have incentive to tell you an inflated estimate to get you to hire them.

Private, profitable businesses that have little or modest growth typically sell for three to five times earnings--depending on the industry, size, proprietary nature of the products and other characteristics of the business. But again, for companies with high or growing revenue and modest profit, these EBITDA multiples may not provide meaningful guidance. High growth can command earnings multiples well in excess of six.

For more data on the drivers of and detractors from value, purchase a copy of Path to Absolute Maximum Sale Price, published by Acquisition Advisors.
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Publication:The Business Owner
Geographic Code:1USA
Date:Mar 1, 2011
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