If you’re trying to figure out what your business might be worth, it’s helpful to consider what acquirers in today’s market environment are paying for companies like yours.
A little internet research will probably reveal that similar businesses trade for a multiple of your pre-tax profit, which is Sellers Discretionary Earnings (SDE) for a small business and Earnings Before Interest, Taxes, Depreciation, and Amortization (EBITDA) for a slightly larger business.
Obsessing Over Your Multiple
Searching for this multiple can transfix Wealthpreneurs. Many owners want to know both their multiple and how to increase it. For example, if your business generates $1 million in profit, and it trades for four times profit, it’s worth $4 million; if the same business trades for eight times profit, it’s worth $8 million. That’s a big difference!
Obviously, your multiple will have a profound impact on the proceeds you receive from the sale of your business, but there is another number worthy of your consideration as well: the number your multiple is multiplying.
How Profitability Is Open to Interpretation
Most Wealthpreneurs think of profit as an objective measure calculated based upon arcane rules written by accountants. But when it comes to the sale of your business, profit is far from objective. To properly estimate the value of your business, its historical profit should be modified by a set of “adjustments” designed to estimate how profitable your business will be for a new owner.
This process of adjusting your historical profit and how you defend these adjustments to a potential acquirer is where you can dramatically increase your company’s perceived value.
Here’s a simple example. Imagine you own a company with $3 million in revenue and you pay yourself a salary of $200,000 per year. And, let’s assume you could get a competent manager to run your business as a division of an acquirer for $100,000 per year. You could reasonably make the case to an acquirer that under their ownership, your business would generate an additional $100,000 in profit. If they are paying you five times profit for your business, that one adjustment has the potential to earn you an extra $500,000 upon the sale of your business.
You need to be able to make a strong case for those adjustments that will increase your adjusted profit and, by extension, the value of your business. Importantly, this is more art than science, and you need to be prepared to defend your case for each adjustment. Note: Proposing too many adjustments may create concern for many prospective buyers.
Some of the most common adjustments relate to owner and other family member compensation and benefits, self-charged rent (for example, if you own the building your company operates from and your company is paying higher-than-market rent), start–up costs, one-off lawsuits or insurance claims, and one-time professional services fees.
Your multiple is important, but the subjective art of adjusting your SDE or EBITDA can identify a significant amount of additional perceived value when selling your business.
