Reasons Your Business Ain’t Worth 10X + A Few Ways to Get a Higher Multiple
We work with a lot of individual buyers. They’re a great group of scrappy entrepreneurs many of whom have built businesses from nothing and frequently have left legacies for their families. They’re, in my mind, the single most important group of individuals in America. Entrepreneurs keep the economy going. They’re also one of the reasons we love what we do.
Often, however, we have to reset valuation expectations. 10X EBITDA multiple valuations on companies are the vast exception to the rule. They’re the stories that make movies or end up as part of Facebook’s crazy portfolio (Oculus VR or Whatsapp anyone?). Here are a few valuation expectation resetting principles and a few of my thoughts (for what they’re worth) on how to improve your multiple.
Size.
Simply put, your business is probably just too small. The smaller the business, the less of a chance of finding a buyer willing to pay a premium. Many of the points that follow are contributing factors to the overall problem that your business is just too small. When you manage a company with at least $2MM in EBITDA, it’s not only much easier to sell, it’s much easier to get a higher valuation multiple. Private equity groups looking for a buy would rather spend $50MM and get a solid business, than risk $5MM to $10MM to buy mediocre.
The solution: find ways to grow. There are only so many expense-cutting exercises in which a business can engage. Every company has a minimal fixed/variable cost structure from which to work. If costs can be easily cut without harming too much personnel, then by all means, cut off the foot so the entity can survive. Otherwise, bottom-line growth will need to be the focus. Perhaps engaging in your own roll-up or acquisition spree is one strategy you could use to grow.
Cycles.
The nature of some businesses are naturally more cyclical month over month. Depending on the market sector you’re in, the buyer will have to gauge the risk on the type of cycles they’re buying. Such cycles might be the result of any number of internal and external forces, including:
- Product/service seasonality
- Contract length and variability
- Payroll and expense tracking (if you’re running accrual vs. cash though, this cyclical issue should be somewhat mitigated)
- Manufacturing variability
Some cycles will be inherent in any business, regardless of how the owners look for ways to control them. For instance, a conglomerate of Christmas tree farms in Western Washington will likely have 100% of revenue collected in the last 6 weeks of the year. However, some businesses can work to improve seasonal issues and thereby improve the consistency of profits flowing into the business during any given year. Here are a few ideas:
- Improve accounting. We’ve worked with a number of folks who claim to be using accrual-based cost allocation, but when we dug into the books, there were areas where they were missing it. In particular, they were not properly accounting for payrolls which represented a huge expense for the business. As a result some months had more payroll periods they really shouldn’t have, which made the month-over-month numbers fluctuate more than expected.
- Diversify. We’ll talk about this a bit below.
- Press Buyers/Suppliers. Some companies are beholden to the whims and treatment of suppliers. For instance, market leaders can often “lean on the trade” forcing buyers or suppliers of goods to wait longer than a standard net 30 days for payment. Amazon does this, but there was some push-back. Again, if done right, such cycles should be taken care of in accrual accounting. This practice is also extremely helpful in ensuring working capital isn’t restricted.
Diversification.
Diversification in business could be far reaching. Typically diversification in customers and suppliers dilutes the power any one entity or individual can exert on the business. Buyers are willing to pay a premium for this type of assurance, including larger multiples. When such an assurance is excluded, acquirers will often require hefty earnouts, equity hold-backs and deal terms that wholly favor the buyer against unforeseen changes in customers and suppliers.
While easier said than done, the simple way to increase your company’s multiple is to diversify your customers and suppliers. Find more people with whom you could potentially work and who may have a sharp interest in your product or service. Diversifying not only will help you garner a higher multiple when it comes time to sell your business, but it will also provide shareholders a greater peace of mind in the meantime as the business’ position in the market will be be on much more solid footing. Diversification also might mean moving into horizontal or vertical integration, depending on your internal strategy. Integrating in these ways may help to diversify your internal products or services, smooth earnings and otherwise help to boost your company’s valuation. Be careful though. Such a strategy could dilute the company’s ability to perform. It’s better to be the market leader at one thing, then the market follower at several things.
Debt.
The working capital and asset needs of various businesses differ widely. Some companies require massive investment in infrastructure and working assets. Example industries could include large manufacturers and transportation businesses. Debt can be helpful in financing these large and often needed purchases. However, it can be an albatross if not treated wisely. In some cases, ESOPs and internal behavior reminiscent of the LBO’s of the 1980’s may douse a buyer’s lust for acquiring the company.
Deb is a necessary evil, but keeping it limited is often essential for boosting valuation multiples. Remember asset valuations are typically NET of all debts. That is, the business will be acquired as a going concern, assuming all debts are absolved. Just because your balance sheet is loaded with debt, doesn’t mean the business is worth an extra $1MM because you simply added the additional burden of creditors in front of the stockholders.
Some smaller companies with highly strategic acquirers have offered ridiculous multiples for their target businesses. But the exception is all-too-often replaced as the rule. Don’t get caught in that trap. I would love your feedback in the comments section below.
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