Using Pricing Multiples to Value a Business for Sale
If you're considering selling your business, the first step is understanding its value to third-party buyers. To determine the fair market value, potential buyers must consider the industry, financial performance, stage of development, competitive landscape, growth opportunities, and much more.
One method of benchmarking the value of a business is to compare it with similar businesses that have recently sold. Business owners and buyers rely on industry-specific revenue and cash flow multiples to gauge what a business is worth relative to recent sales prices.
This "market-based" approach to valuing a business is the most common among main-street and lower-middle-market businesses that are reasonably profitable. Other approaches include income-based and asset-based valuations that may be more appropriate in certain situations.
Read on for an introduction to multiple-based market valuations. To read about the various valuation methods, see How to Value a Business.
How Pricing Multiples Work
Valuation multiples are common corporate parlance, used to compare companies with different levels of profitability and liquidity—they allow investors to make more informed decisions about which businesses to invest in by providing them with an easy way to understand how valuable each one is relative to others.
Commonly used multiples are revenue or sales, and cash flow (SDE or EBITDA), which can differ across industries for various reasons.
Multiples are expressed as either absolute values (e.g., 10x), ratios (e.g., 10% PE), or percentages (e.g., 10%) and provide a quick way for investors, potential acquirers, and business owners to get a view into how much a company is worth.
A valuation multiple is calculated by taking the value of known businesses—such as public businesses and businesses that have been sold—and dividing it by the relevant metric. For example, the revenue multiple for a company generating $500,000 in revenue that sold for $1M would be 2.
In the private business for sale marketplace, pricing multiples work the same way. Business sellers can derive multiples from sales price and financials of similar businesses that have recently sold in the same market.
Revenue vs. Cash Flow (Earnings) Multiples
The two most common ways to compare business valuations is by looking at revenue and cash flow multiples. Revenue measures how much money a business has brought in over a period of time, net income deducts any expenses incurred during that time, and cash flow takes into account the company’s (more specifically, the owner's) cash position as a result of operating activity.
For most owner-operated businesses, cash flow (owners' benefit, or discretionary earnings) is the metric of choice for benchmarking a business’s value. Buyers of these businesses are most interested in the earnings they will pocket to justify the sales price. For businesses with earnings under $1 million, Seller’s Discretionary Earnings is the appropriate cash-flow metric. Larger, professionally managed companies will likely use EBITDA.
That said, revenue multiples can be helpful in situations where a business has purposely chosen to have low profitability in exchange for rapid growth. A buyer may choose to benchmark the business’s value on revenue, and purchase with the intent of reducing costs and improving margins.
Industry Variations
When determining the value of a company, it is important to consider the industry or vertical in which the business operates. Businesses within the same industry or vertical tend to command similar multiples. It is important to develop a peer group of representative businesses.
Businesses within the same industry have similar characteristics in terms of operating complexity, competition, capital requirements, and financials. As such, their business valuation multiples tend to be similar. For example, restaurant businesses will typically have an earnings multiple around 2, due to the complexity of the operation and competitive nature of the industry. On the other hand, an automated car wash business will fetch a cash flow multiple well over 4, due to the higher barrier to entry and more hands-off operation.
Industry or vertical-specific multiples for public companies can be found through a quick Google search. Finding multiples for privately sold businesses is much more difficult, as these sales are generally confidential. You can get great high-level analysis in BizBuySell’s quarterly Insight Report and industry multiple tables.
Finding Comps for Your Business
If you’re planning to make an exit, or just looking to get a rough valuation, finding comp data can be challenging. BizBuySell’s marketplace is a great place to start. You can get an idea of the pricing multiples sellers are asking for by checking listing prices and cash flow, then doing a little math. If you’re not already a BizBuySell member, create an account for free and set up alerts specific to your industry and location.
To find comp data for sold businesses, see BizBuySell’s valuation center. We have several options depending on the level of granularity you are looking for.
Adjusting and Improving the Multiple
Buyers of small businesses seek a variety of qualities when choosing where to spend their money, including financial stability, growth potential, and sound management practices. Varying conditions of two very similar businesses will mean each may sell at materially different multiples. So, what do buyers looks for, and how can owners improve their business value?
Financial Performance
Obviously, the financials come first. The value of a business on the private market hinges on its ability to give the buyer a return on their investment. Therefore, anything business owners can do to improve the earnings will pay off handsomely. Opportunities to cut costs and improve operational efficiencies should be implemented well ahead of selling. Every dollar added to the bottom line will be multiplied in the business’s value.
Ease of Operation
The greatest factor in the multiple a business will fetch relative to its peer businesses is the ease with which a new owner can run it. If a business relies on its owner working 80 hours a week, expect offers to fall well short of industry average multiples. Buyers are not looking to "buy a job".
Businesses with daily operations managed by employees are far more attractive to buyers and will command a higher multiple. This is why one of the most important stages of exit planning for any business owner is to relinquish control of daily operations to trusted employees. When that is not feasible, some owners will hire and train a manager. The less reliant a business is on the sweat of its owner, the more valuable it will be to buyers.
Growth Potential
Business owners are best positioned to offer insights for potential buyers on how their business can grow in the future. There may be untapped potential in untested marketing tactics, or new products or features that customers would buy. Having specific, unutilized growth strategies to offer interested buyers may help sway them towards accepting a higher pricing multiple and sale price.
For more approaches to getting a higher sales price, see How to Increase the Value of Your Business to Sell It. To get insights into pricing multiples and information on applying them, see our section on Business Valuation.