UPDATE (January 1, 2021): Linked new Pepperdine Private Capital Markets report and updates to the text.
Business owners often wonder how much they would be able to sell their business for. Beyond the simple answer of "whatever a buyer is willing to pay for it," the answer is not easy to come by. For this reason, accounting and advisory firms are able to charge a premium for providing an estimated valuation of a firm. These professional services firms evaluate factors such as a company’s performance, review the strength of the industry, and use detailed financial analytics to produce 100-page reports with a very simple punch line: the company’s fair market value. But a full-blown valuation is not required to get a general sense for how much your company might be worth. Here are a number of key factors that buyers will be examining to determine how much they would be willing to pay:
Cash Flow — In most cases, buyers acquire firms to get access to future cash flows, so this is the starting place for determining a firm’s valuation. Adjusted EBITDA (net income + interest, tax, depreciation, amortization, and other add-backs such as above-market salary and one-time expenses) is most commonly used as a proxy for cash flow, though it is a less accurate reflection in asset-intensive businesses. The data is not typically from just one year or the last 12 months but instead a weighted average of Adjusted EBITDA over a period of time. One can arrive at a ballpark valuation by applying a multiple to Adjusted EBITDA that varies based on the size of the firm and its industry.
Revenue Quality — Quality revenue helps to safeguard continued cash flows well into the future, and the plain truth is that there are certain characteristics of revenue that make it more or less appealing to buyers. Revenue from a large number of subscribers is generally preferable to that coming from a few large projects, which is why software-as-a-service (SaaS) companies can command such high multiples on their earnings. But a SaaS model is not required for high-quality revenue, which can also come from companies that receive a large percentage of their revenue from repeat business. Buyers are often more interested in companies that show slow but steady growth than those experiencing rapid growth because it makes future earnings easier to reliably predict.
Customers — A large number of longstanding customers is ideal. This is an indication that a company is not overly reliant upon a few customers — who might take their business elsewhere or undergo financial hardships that interfere with their ability to continue to be a reliable source of revenue.
Competitive Position — Buyers will be keen to understand the degree to which a company has a competitive advantage, which can come in the form of brands, patents, technology, cost advantages, or other factors that increase the likelihood of that the company will be enduringly profitable
Industry Growth — Industry growth has been shown to have an outsize impact on the growth of companies within a given industry, so buyers will be paying close attention to industry trends and projections.
Track Record — The longer a company has been around, the longer it is likely to stay around, so buyers will place a premium on established businesses. This also provides them with additional data points, such as their performance through past economic downturns.
For a free, no-obligation, and confidential discussion about how these factors apply to your business, please send an e-mail to rknauer@eaglepeakcap.com or fill out the form below — I would be glad to give you a call at a time convenient for you. Thanks.
Further Reading
Pepperdine University — 2020 Private Capital Markets Report (See page 41 for Adjusted EBITDA multiples.)
Corporate Finance Institute — Overview of A Quality of Earnings Report
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