Tuesday, 19 February 2013

Unlocking the Mystery of the Business Multiple

Establishing a price to market a Business is not an exact science. 

There are many different methods such as the Asset Valuation Method, Critical Factors Method, Debt Capacity Method, etc. whereby different experts can come up with different opinions.

However, if identifying a Business' value is not an exact science, it really should not be too complex?  It isn't! 

The reality is that what motivates most buyers to purchase a Business is the opportunity to earn the income the Business is generating.  We believe that the Cash Flow Method is the most practical way to establish a Business' value.

As part of the Cash Flow Method's calculations, it utilizes a vague and ambiguous term called a Multiple.  Let me explain what this term means.

Most people are familiar with the term "Cap Rate" which is short for Capitalization Rate which is commonly used to help establish the value of income producing Real Property.  For income producing Businesses, a Multiple is the exact same, but only in reverse. 

In laymen's language, the term Multiple means that a business selling for a 1.5 Multiple will generate a 66% Return on Investment for the Buyer.  A Business that sells at a 4.0 Multiple would offer the Buyer a 25% Return on Investment.  A 2.5 Multiple represents a 40% Return.

There are a number of factors that can positively or negatively affect a Business' Multiple. An example of a few are:

Asset or Stock Sale
Barriers to Entry
Cash or Terms being offered
Type of Industry
Customer Base
Demand for Product
Environmental Risk
Excess Earnings
Franchise or Independent
Key Personnel
Length of Operation   
Location, Lease and Rent
Market Share
Proprietary Product
Social Desirability
Stability of Income
Stability of Revenue,            
Condition of Furniture, Fixtures and Equipment

Like most property owners, many Business Sellers feel that their Business is unlike any other.  They are usually correct.  However, that is not reason enough to justify a higher Multiple.  Most of the time, what generates a higher Multiple is a Business with Excess Earnings, Key Personnel in place, or a Proprietary Product.

Do you have a small business question you would like answered about this article or others?
Bill Sivell is a salesperson with VR Windsor Inc. [www.vrwindsor.com] 519-903-7807, which sells businesses to buyers across Canada and around the world. His 14-year career includes diverse senior management positions in marketing, advertising, sales management and operations management. His blog appears every Tuesday.


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