Several of your business-owner friends retire and hit the golf course. You plan to follow suit and prepare to sell your own profitable business, but you’ve heard conflicting stories and have no idea what your business is worth. One friend owned a $15MM revenue manufacturer serving OEMs and sold his business for 5.5x EBITDA (earnings before interest, taxes, depreciation and amortization). Your other friend, who owns a $6MM revenue subscription-based tech company, sold his business for 4x REVENUE (which equated to 10x EBITDA). They are both well-run businesses with strong, consistent financial growth and margins. So, why did your friend who owned the smaller company get a higher multiple for his business?
Industry & Size
Industry is a key factor in how a business is valued. Across different industries, valuation varies – some are a multiple of EBITDA (industrial services, manufacturing and distribution companies, for example). Others are valued on a multiple of revenue (like software, technology and some B2B service industries). As a general rule of thumb a subscription-based technology business will sell for a higher multiple than a similarly sized manufacturing company. The technology business has a high recurring revenue stream and great margins which often allow the business to scale quickly, hence the higher valuation. The manufacturing business is valued lower because revenue isn’t as predictable and growth is often slower in this type of business – restricted by how fast a company can add productive employees and new customers.
Size matters. It’s often the strongest indicator of overall value within a specific industry. Generally speaking, larger companies are worth more. In an apples-to-apples comparison of two similar widget manufacturing companies with no significant value dingers, one with EBITDA of $2MM and the other with $7MM of EBITDA, the $7MM EBITDA company will get a higher valuation. Why the difference? Typically, the larger company has a proven track record and developed systems/infrastructure in place that inherently reduces risk.
In addition to industry and size, the following areas also significantly impact valuation.
- Customer concentration
- CAPEX requirements
- Seasonality or cyclicality
- Strength of management team
- Steady, reliable cash flow
- Growing margins
- Long-term contracts
- Employee base (unions vs. non-unions)
- Industry barriers to entry
- Proprietary products
To learn the details of these variables, check out these blog posts, Value Drivers vs. Value Dingers: How you can get the most money for your business (Part 1 and Part 2).
If you’re considering the sale of your business and want to better understand how your company is affected by valuation variables, we’d love to give you a free consultation on what your company is worth – 704.295.0102.