Multiples of Valuation in the Current Economy

Valuation2

I attended (if one considers sitting in front of your computer an act of “attending”) an interesting webinar earlier in the week sponsored by the International Business Brokers Association (IBBA).  Darren Mize of CGF Financial, a firm that specializes in preparing independent business valuations and serves as a valuable resource to the business brokerage community, reviewed the current state of valuations in business sales.

One of the issues Darren addressed is the perception that multiples change from good to bad economic times and that the change in the multiple is what affects the valuation of a company.  However, what he showed from an analysis of sold businesses from the PeerComps database was that the average multiple of Seller’s Discretionary Earnings (SDE) for business sales over the past 10-year, five-year, and one-year periods varied by insignificant amounts (For the uninitiated, SDE is defined as the full earnings cash flow to the owner or EBITDA plus the owner salary and benefits.)  The averages are as follows:

10 Years – 2.77x SDE

5 Years – 2.75 x SDE

1 year – 2.76 x SDE

This confirmed what I had been hearing from some of the old timers in the business brokerage community who’ve been through a number of economic cycles: multiples don’t change, company performance does, and a firm’s value goes up or down depending upon how they’re doing.  IBBA quotes a statistic that the average multiple of SDE for all business sales in good and bad times is 2.3.  The difference between this number and the PeerComps numbers are, I suspect, due to the fact that PeerComps is a database of sold businesses compiled by banks where the transactions were financed by SBA loans.  Businesses that are sold with bank financing will always fetch a higher multiple than those that are not.

This then begs the question: how does one maximize valuation in a slow economy?  Well, it’s done the old fashioned way.  Run your business well.  Internally, get your costs under control and make sure your operating ratios are at industry standard. If you do that, then you’ll maximize earnings.  Externally, work on diversifying and reducing the concentration of your customer base and get rid of the deadbeat clients. This will both increase your earnings and—more importantly—lessen the perceived risk associated with your business. This is important since firms with less perceived risk always command a higher multiple.  In general, stop worrying about whether or not the present time is yielding the highest the multiple, because it will not change.

2018-01-05T14:44:51+00:00