What Is Your Small Business Worth?
For small businesses under $20m in sales, there are two ways that businesses are generally valued. The first and more common method is the Multiple Method. The second and less commonly used method is through a rule of thumb. The third more academic way to value a business is a discounted cash flow (DCF). However, if you come across a buyer trying to put together a DCF for your business under $20m in sales, they are probably green and have a freshly minted MBA using a method better suited for larger transactions with more information.
The multiple method is actually quite simple. You calculate the Adjusted EBITDA of your firm and then times this number by some multiple.
$1m Adjusted EBITDA x multiple of 3 = $3m valuation
The question becomes what multiple is your firm worth. Unfortunately for small businesses, there is not great data or comparables. The data that tends to be more available is for larger transactions and public companies. This information is not close to being representative for small privately held businesses. For example, the average P/E multiple for a publicly listed company in your space has little connection to the Enterprise Value/EBITDA multiple for a small privately held business.
Where can you go to figure out your business’s multiple? There is really no great source. Sometimes small funds or news sources post transaction details online and these sources can be a valuable source of knowledge. However, you usually won’t be to find more than a few transactions so don’t put too much weight on any one source. Valuation Resources also has links to a number of sources that are somewhat helpful. A lot of these reports don’t have enough data and the individuals filling out the surveys tend to be private equity funds and investment banks that tend to pay slightly more than other acquirers.
Beyond trying to find comparable transactions online is to just know the general range. For businesses between $500k and $5m in revenue the EBITDA multiple range tends to be from 2 to 6.5. The only time you see a number higher than 6.5 is when the business is either a high growth firm, has extremely high recurring revenue, or is something closer to a technology startup. Also the only time you see a multiple below 2 is when the firm is in distress or below $750k in EBITDA.
According to Pratt, the median Enterprise Value/EBITDA multiple for a $0 to $1m EBITDA firm is 2.34. The median Enterprise Value/EBITDA multiple for a $1m to $5m EBITDA firm is 4.17. Again, this data tends to represent buyers with deeper pockets. These firms tend to meet rather specific metrics that line up with the interests of PE funds.
According to Pepperdine Capital Markets Report 54% of brokered transactions as of 2014 failed to sell within a year of going on market. What is the point? The data represents completed transactions. Rather few small businesses transact, because the market is inefficient and funds can’t target these size businesses (see this article) .
Beyond the size issue, small businesses just tend to have more volatility (risk). Most small business buyers account for this volatility in their purchase price offers. This practice drives down prices.
The second valuation method is a rule of thumb method and every industry has a different rule of thumb. You can find a complete list of rule of thumbs for small business transactions in this book: Business Reference Guide.