The most common way to value a privately held business is as a multiple of last 12 month’s earnings before interest, taxes, depreciation, and amortization (EBTIDA), adjusted to remove one-time revenues or expenses and to normalize owner’s compensation.
As a simple example – let’s say your business has net income of $1 million, which included expenses of $50,000 in interest, $50,000 in deprecation and a salary for yourself of $400,000, although a salary for a non-owner CEO would be in the $200,000 range. In this scenario, your adjusted EBTIDA would be $1.3 million -- $1 million net income, plus $50,000 in interest, $50,000 in depreciation, plus $200,000 to adjust your compensation to a market level.
If you hear someone use a term like a “six times multiple,” it generally refers to a valuation that is six times the company’s trailing 12-month adjusted EBITDA.
A recent industry survey indicates that the average multiple for lower middle market businesses sold in the second quarter of 2018 was 5.9x adjusted EBITDA.
The appropriate multiple used to value your company is derived from recent sales of comparable companies, but can vary up or down, based on a range of factors specific to your company, including, for example, revenue growth, track record, brand, client base, margins, leases, inventory, intellectual property, and a host of other issues.
However, bear in mind that the value of your business as stated on paper using a realistic multiple is still a hypothetical amount. The true value of the business is how much one or more buyers will pay for the business -- and no two buyers put the exact same value on a company.
It’s easy to fixate on a price for the business, but terms are just as important as the price. All cash at closing may be more attractive than a higher valuation that includes some delayed or contingent payment. The way the sale is structured can also impact your tax bill, driving after-tax value up or down. Working capital adjustments, escrow, your non-compete, and many other issues can all play a major part in the real value and attractiveness of a transaction.
Finally, the way in which you market and position the business, and find and manage potential buyers is also an important driver in obtaining value for your business. An effective sales process, organized financials, and a credible road-map to grow the company can all help increase value.
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