Using “multiples” to value a business may be a disservice to both the seller and buyer. “Multiples” may not represent the real value of the business.
Buying a Business: What is the Real Value of a Business?
Multiples are generally median or average values published in the BBF MLS or in Pratt Stats/Deal Stats. However, these are just convenient “midpoints” that do not represent any specific transaction. These multiples are based on historical information, a different market area, a different economic environment, a different seller’s perspective, etc. Unless the transaction being “valued” is truly an average transaction, then using these multiples is misleading.
These multiples are applied to recent historical financial performance of the business (transaction being contemplated).
What is the “real” value of a business? Standard concepts/definitions used credentialed valuation specialists to value a business are:
- The “Present value of future economic benefits to be derived by the owner of the business.”
- The price that would be agreed on between a willing buyer and a willing seller, with neither being required to act, and both having reasonable knowledge of all relevant facts.
Future economic benefits are important relevant facts in valuing a transaction and are based on:
- The Industry: Is it in a growth, mature or declining stage
- The Market Area: Is it growing, stable or declining with respect to population, household income, etc.
- The Business: Growing, stable or declining
- The Terminal Value: An estimated economic benefit to be realized at divestiture
- The Owner: Reasons for exit
A Real-Life Example:
This was a rapidly growing business in a mature industry but in a growing market. The following graphs show historical performance and statistically projected growth.
This business should have been “valued”, given knowledge of all the relevant facts, based on future economic benefits. Even though the industry was mature the market area was growing in both population and economic prosperity and the business was growing due to identification of a niche in the market, good management and “sweat equity”. This resulted in increasing transactions, stable to slightly increasing revenue per transaction and increasing gross revenue. Bottom-line was increasing also due to reduction in early year start-up costs. There were substantial future economic benefits in the business.
Nonetheless, the buyer wanted to focus on multiples of historical performance. Why?
Jim Bolinger
Truforte Business Group
Mr. Bolinger’s career has spanned 45 years working in finance, organizational strategy, business planning and as a small business owner. Positions have included:
- Senior Manager, Audit Services Division, International CPA firm
- Vice President and Chief Financial Officer, large community hospital
- Partner, national consulting firm focused on strategy as well as mergers & acquisitions
- Managing Partner & Co-founder, national consulting firm focused on strategy, business planning, mergers & acquisitions and business valuations
- Business Broker, Truforte Business Group
Education:
- MBA with Honors, University Notre Dame
- Bachelor of Science in Business, Indiana University.
Publications and Presentations:
- Selling a Business? Avoid These Mistakes, Southwest Florida Business Today (February 2021)
- Why Now is the Best Time to Buy/Sell a Business, Above Board Chamber webinar (November 12, 2020)
- Preparation Boosts Success When Selling a Business, Southwest Florida Business Today (August 2019)
- Buying or Selling a Business: Strategies and Tactics (SCORE, South Bend, IN and Fort Myers, FL)
- Medical Practice Valuations, Executive Checklist Series (an Arista publication)
- So You Want To Start A Business (SCORE, Fort Myers, FL)
- Understanding Financial Statements (SCORE Mentor Boot Camp, Southwest Florida)
- Leading Change/Managing Transitions: The Human Factor (Indiana Society of CPA’s)
- Sustainable Collaboration: Precedents to Success, Executive Checklist Series (an Arista publication)