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Understanding Multiples
The Secret Sauce in Creating Value
By Rick McDonald
In its simplest meaning, a Multiple is simply a figure applied to the “free cash flow” within your business that reflects the confidence a buyer has that the cash flow will not decrease.
Or even better, may increase after they have bought the company and you, the founder/owner, have departed (or at least no longer “own” the company). This is then multiplied by your business’ EBITDA for the business value.
To get a realistic expectation of your Multiple you need to know how it is developed.
It’s important to understand that the “cost of capital” affects what a buyer may pay for a $1 profit. So that means interest rates affect Multiples.
So does supply and demand. Today, there is an abundance of Private Equity money waiting to be deployed and the pressure to deploy this capital is immense.
No Private Equity fund wants 60% of its raised capital working hard, and 40% sitting in cash diluting overall returns to its investors. They need that money put to work, thus putting upward pressure on Multiples at the moment.
And most importantly, the quality of a company affects the Multiple a buyer will use in determining valuation.
The lower the risk to the free cash flow they are purchasing, the higher the Multiple they will use in assessing valuation.
Growth and the growth potential of companies also affect the range of Multiples a company will have.
The size of a company is also a factor. The larger the company, the more diverse the risk factors are, and thus a buyer has more confidence the cash flow will not be disrupted by any one business component.
This includes the depth and breadth of the management team, and in most cases, the diversity of customers, reducing the reliance on any one customer.
So, the larger the business, the larger the Multiple.
For example, small businesses expect a Multiple in the 2 to 4 range, lower middle-market companies expect Multiples between 4 to 7. Middle market companies expect Multiples to be in the 8 to 12 area, large private companies may see a range of 12 to 15, and larger, publicly traded companies are often found in the 18 to low 20 range.
So the key to increasing value, particularly in the lower end of the lower middle market business (running the gamut from the $5 or $6 Million to the $20 or the $25 Million business) is to increase your Multiple. If you position the business correctly, you will attract buyers willing to use the higher range Multiple in your space. It’s simply financial leverage.
Increasing the Multiple by 1 or even 2 is like doubling your sales - and moving the Multiple is likely much more realistic than doubling your sales!
Here’s what this looks like for this market segment:
So the first order of business is to understand how a Buyer (NOT you!) views your business. Get into the habit of looking at your business objectively, from the outside in.
Understand the risks a buyer perceives in your business, then go to work on the areas of greatest concern. Have the specific goal of creating a realistic case for a Buyer utilizing the higher end range of a Multiple applicable to your size business, its EBITDA and its growth prospects.
Do that, and the value of your business can be increased by 30 to 50% or even more!
Remember to get your copy of the book: “Exit The Family Business”. It walks you through exactly what you need to do to increase the value of your business and be prepared for the transaction of your dreams.
Plus take our 10-minute Exit Valuation Survey to see the current status of your business and how prepared you are for a sale.
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It's time to face the truth. If you don't plan your exit correctly, you could end up working until you die. Your journey to a successful sale and increasing the value of your business by 30-50% starts with taking our Exit Valuation Survey. This tells us exactly where you are now, the exact performance of your business, and what you need to do to improve. You can access your buyer Risk Report and speak to our analyst team on a complimentary call to discuss your results, increasing value and exit options.
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*The Lower Middle Market is comprised of businesses worth $5-$30 million, typically having EBITDA of $1 million - $4 million.
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