Extraordinary multiples – fact or fiction?
Your business owner friend is boasting about how they got a 10 multiple on the sale of their company. Fact or fiction? For most companies, this would be fiction. (Or, to give your friend the benefit of the doubt, perhaps it’s a multiple of net income rather than the more standard EBITDA.)
But for some businesses, especially in today’s strong seller’s market, extraordinary multiples can really happen. Point in case, in an earlier strong seller’s market, we were able to get well over a 10 multiple on EBITDA. And while I must make the standard weight loss ad disclaimer—results not typical—I can provide some insight as to why some companies achieve these extraordinary numbers.
The biggest factor is probably scale. How well is your company poised to get to the next level? Companies that earn higher multiples have a high potential for growth, through their own merits as well as through buyer synergies.
A good example is a company with a patented product but weak distribution network. If a strategic firm with existing distribution channels believes you’ve built a better mousetrap than what’s available in today’s marketplace, they’ll pay a premium because they know they can increase sales by getting those products into their existing end markets.
Synergies are a significant factor in a multiple. It’s your business plus their business, but one plus one can’t equal two; it’s got to equal three or more. A couple of examples:
A colleague of mine worked with a large company in the organic bakery space. This was a hot, trending market, not a stale industry, and initial estimates suggested the business would sell for around $60 million to $70 million. But the seller offered a high growth product and the buyer was able to trim millions in duplicate costs plus had national distribution vs regional, the business ultimately sold for roughly double the projected value.
At Cornerstone, we represented a company that had a whopping $58,000 in assets, the biggest chunk of which was the owner’s Land Rover. But the intangible assets were the real value, reflecting years of slow and patient relationship building in a complex foreign market.
When our client had to turn away business from a $3 billion organization, citing a non-compete contract with a competitor, the $3 billion corporation offered to buy them instead. The 800 hundred-pound gorilla had three options: leave one of the largest markets in the world, languish slowly for years while a competitor soundly outpaced them, or buy this little but powerful firm.
The buyer would have loved to have paid just a three or four multiple, but they understood the value. (And perhaps more importantly, we understood the value too.) After negotiations, they paid a 33x multiple with 50 percent cash a close.
Fast forward four years, and the remaining competitors are doing next to nothing in sales because they can’t break through the cultural and bureaucratic barriers. Meanwhile, the buyer has annual sales of over $150 million. As it turns out, that extraordinary multiple was still a great deal.
Here are three other factors that drive higher multiples:
A proven management team can help grow the business, provided they have the freedom to do what they want and the capital to make smart investments.
I recently read someone who suggested lower middle market companies were like speedboats, compared to the upper middle market’s cruise ships. A smaller business with a good management team can grow faster and change direction quickly. That makes them more valuable to investors looking to high potential opportunities.
Buyers value documented business processes and replicable systems over business knowledge that has to be passed from one person to another. Proven systems reduce risk and create a business that is instantly more scalable.
Finally, good clean books drive value. Buyers perceive less risk when they can easily get their arms around your financial reporting and pull whatever data they want to understand the business and how it works. If you’re big enough, invest in an audit for the last few years before you sell.
The above items will help you drive above average multiples when you sell your business, but sometimes, nothing beats good old fashion competition from other buyers. Just because a buyer can pay more due to synergies does not mean they will, especially out of the gate. If your M&A Advisor can run an efficient process that brings real competition, it will force the buyer to play his hand during negotiation and drive significant value for you.
By Scott Bushkie
With more than 20 years in the Mergers and Acquisitions (M&A) industry, Scott is a recognized leader in the field, providing exit strategies, business valuations, and M&A advisory services to business owners in the lower middle market. He has successfully executed sales to domestic and international buyers, private equity firms, family offices, and strategic buyers.
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