Business valuations in a sale are based on the interactions of several important factors. We have outlined the ten key factors to consider.
- Operating Cash Flow – The number one determinant in business value is income or owners operating cash flow. Generally, this includes the following: net income before interest, taxes, depreciation, amortization, excess owner salary and benefits and onetime extraordinary charges. Buyers will quote offers as a multiple of this number, usually known as adjusted EBITDA. For example, a manufacturing business with EBITDA of $1 million dollars might sell for 4.5x EBITDA or $4.5 million dollars. The actual multiple paid in a transaction depends on the level of the EBITDA as well as the other factors noted below.
- Size – larger businesses, in terms of revenue and profits, tend to sell for more on a relative basis. The larger a business is the less risk. Whereas a small regional business might sell for four times cash flow, a large national firm might sell for ten times cash flow.
- Customers – having numerous high quality and dependable customers is preferred over just a few large customers. Customer concentration negatively impacts value.
- Management – a quality team of managers and employees that can operate the business without the owner(s) will have a higher value than one primarily dependent on the owner. Two areas where this is most important are customer relationships and technical expertise.
- Trends – a company that is growing will have more value and be easier to sell than a company with a downward trend in sales and profits. Reversing a downward trend is key to improving business value.
- Intellectual Property – technical expertise, unique software or other intellectual assets that give a company a competitive advantage will enhance value relative to similar companies without these assets.
- Assets & Liabilities – while most valuations are based on cash flow, things like accounts receivable, inventory, fixed assets, accounts payable and debt can all impact value. A weak balance sheet can point to underlying problems with cash flow.
- Capital Investment Requirements – does the business require large infusions of capital spending every year or are these expenditures relatively low and infrequent. Generally, valuations are adjusted based on these needs.
- Industry – valuations vary widely by industry. For example, some high tech companies might sell for two times as much as a similar sized manufacturing business.
- Professional Representation – a business represented by a professional business broker or M&A advisor should generate multiple buyers, offers and term options which tend to increase business selling prices. BMI’s Professional Licenses and Certifications
Cash flow is the primary determinant of business value, but the other factors noted can make or break a successful transaction. The type and circumstance of different buyers will lead to varying views on each of these factors. Business owners considering a sale of their business should evaluate their company and make improvements as time allows prior to going to market.