Determining Business Value

What does a buyer really “buy” when they buy your business? Is it your assets? Your reputation? Your team? Your customer base? The answer to all of these is yes, and no. The only reason any of these have value is if they will continue to create cash flow profits for the years to come for the new owner. After all, what good are a building, machines, or customers if they do not generate profits?
As we know, accountants have come up with about 17 different measures of profits (another full employment ploy on their part, no doubt). The one that matters here is EBITDA (Earnings Before Interest Taxes Depreciation and Amortization). That is the best measure of cash profits of a going concern for most businesses. Using EBITDA makes comparing businesses possible as it controls for financing, corporate form and accounting practices related to assets which all can vary.
So what does a buyer look do with EBITDA? In the simplest sense they use a multiple of EBITDA to give the business a value. The higher the multiple, the stronger they expect earnings to be going into the future. In most cases, the multiple they use on EBITDA ranges from 3 – 8. Now that is a huge swing in possible values. A company with EBITDA of $1 million could be worth anywhere between $3 million and $8 million!
The multiple varies based on any number of factors. The Christman Group LLC (a firm that specializes in exit planning for entrepreneurs) offers their top ten factors that have an impact on the size of multiple you can expect when your sell your business:

Number 10: Industry Outlook
If the outlook for the industry is bright, the price goes up. Buyers look hard at the outlook for a company’s gross margins, future growth projections, international economic factors, etc.
Number 9: Depth of Management and of the Sales Team
If an owner wears all of the hats, including generating most of the sales, the price will go down. A strong and experienced management team to operate the business is key value driver.
Number 8: Customer Base
If a company has limited customer concentration with no single customer representing more that 5-10% of revenues the price goes up. If the customer base is made up of “blue chip” companies, the price goes up too.
Number 7: A Good Story to Tell
Telling a company’s story is critical in helping the buyer recognize the full value of a business. An extensive confidential offering memorandum that describes the business operation, the marketing and sales programs, its organizational structure, its facilities and equipment, its financial performance, and provides a financial analysis including a believable 5 year financial forecast.
Number 6: Stage of Industry Consolidation
If a company’s industry is experiencing consolidating with the big companies getting bigger through acquisition, prices for smaller companies will rise.
Number 5: Company Track Record
If a company can show a track record of consistently growing profits and sales, buyers will pay more.
Number 4: Type of Business
A manufacturing company with a proprietary product will sell for more than a job-shop manufacturer. A distributor that adds value by offering installation, repair, and/or engineering/design will sell for more money than a non-value-added distributor. A service company with a special expertise will sell for more than a similar service company without this expertise.
Number 3: Revenue Size
The larger a company’s revenues, generally the higher the price. A business with $25 million of annual sales will sell for more than a company with $5 million in sales.
Number 2: Market Position
A company that dominates its market or has a unique niche in the market will sell for a premium over other companies that do not dominate their markets.
Number 1: Having Multiple Buyers
When there are multiple buyers bidding on a business, the price of the business will exceed the price paid for a business that is sold without competitive bids.