Multiple of Earnings Confusion in Valuation When Selling a Business
Posted by Kipp Krukowski on Sat, Jan 30, 2010 @ 12:47 AM
I have had the opportunity to be a speaker at multiple events of the years covering various topics of
selling a business. One of my favorite questions to ask the audience of business owners is what they feel is a reasonable method of
business valuation. This is an open ended question that gets a lot of different opinions. I hear various multiple of revenue and various multiple of earnings numbers. It is entertaining. To be honest, I do not fault the business owner for not having a good understanding. They are experts in their business providing a service or manufacturing widgets, not business valuation. However, sometimes they have a number stuck in their head that they receive from an unreliable source and this number results in them never selling their business.
For the record, as a business broker, I have never been a fan of the multiple of revenue valuation technique. For example, a multiple of revenue may take the company's revenue and multiply it by a percentage. So for example, if a company has revenue of one million dollars and the multiple of revenue is 100%, then the value is one million dollars. The problem with this method is that it does not separate a business that is very profitable and one that is losing its pants. This method gives them the same value. The buyers that I talk with buy businesses to make a living or to receive a certain return on their investment. With this in mind, a multiple of earnings has always made more sense to me.
When it comes to using a multiple of earnings, one must be careful that everyone is speaking the same language. When one says "earnings", do they mean net income, EBITDA, seller discretionary earnings, or even something else? Let's look at an example. Let's say that a business had these following characteristics:
Selling Price = $600,000
Net Income = $100,000
EBITDA = $150,000
Seller's Discretionary Earnings (SDE) = $200,000
In this example, seeing that the business sold for $600,000 it would be a multiple of six times the net income, four times the EBITDA, and three times the SDE. Same business. Same selling price. Different multiples. These numbers are purely for illustration purposes and businesses of different industries, earnings levels, and other situations may have higher or lower multiples.
Something to think about: A casual conversation at the golf club could have someone selling their business at six time earnings. If you take this multiple and apply it to the wrong earnings description, you may overpricing your business. Likewise, the reverse could happen and you leave money on the table.
A business valuation is an important part of the process of selling a business.
