Why Are You Focused on Your EBITDA Multiple?

Every business owner thinks their business is worth far more than it really is. But God forbid they think a business they are buying is worth what the same owner believes he/she values it to be. For whatever reason, they choose not to use the same logic in valuing the business that they did for someone else’s. I wonder why.

When I’m engaged in these types of discussions, ultimately, I’m asked what multiple (of EBITDA) they could obtain from a buyer. I’m sure they are thinking my answer is going to be a multiple of 5x, 6x, or possibly 7x.

However, I never answer this question. It’s not even the right question to ask. Is my business sellable? That’s the right question.

If the answer is “Yes,” we have a second question. How do we make the business even more sellable or more attractive to a buyer?

Business owners control whether their businesses are sellable or not. Making the business more attractive improves the odds of sellability, and that is controllable too.

Attributes Tilting the Odds Toward Sellability

There are three important factors that increase the chances of not only selling a business but obtaining a higher purchase price if the owner focuses on three primary objectives. Even if the owner is not looking to sell soon, achieving the following objectives will lead to a far more sellable and enviable business in the eyes of interested buyers.

1. The business is not fully dependent on the owner

This is a nail in the coffin for most small businesses, especially with sales under $3 million. Many of these smaller businesses are heavily dependent on the owner. Success or failure depends on the actions of the owner. And that’s because the owner has not built a team around himself that can run or manage the business.

My favorite litmus test for this attribute is pretty simple. I ask the business owner what would happen if he/she walked away from the business for three months. What happens to the business? Most answers are the same–the business would begin to crumble. Problems would go unsolved. The best customers might go elsewhere because of the tailored service they get from the owner.

Building a solid business model that’s repeatable and not fully dependent on the owner will be far more sellable than one that is not. In this scenario, the owner should be building, strengthening, or expanding the brand. His team should be the ones executing the ideas of the owner. That’s sellable.

However, this is especially difficult when the owner likes to be involved in every decision of the business. Letting go is hard.

2. The Business is Not Dependent on One Big Customer or a Handful

A high concentration of just a few big customers is risky. Potential buyers will be concerned too.

We need to throw in customer segments too. If a business is highly dependent on one customer segment of a large market base, this also hurts sellability.

I have found one workaround to the one-big-customer problem. Get a contract. A long one. Assuming the customer has a strong balance sheet, this can help offset the high concentration of one or few big customers.

3. The Underlying Business Reveals a Strong P&L and Balance Sheet

Buyers love positive trends on the P&L. That includes rising sales and solid and consistent gross and net margins. Net working capital as a percentage of revenue is steady and reveals minimal excess inventory. The majority of large accounts are current and rarely go past due.

If the scenario I’m describing does not exist, perhaps the owner needs to wait until the right strategies are put into place to improve the financial performance of the business.

A great P&L and balance sheet may not guarantee the highest multiple, but one can expect the business will not be on the market for very long.

Revisiting the Right EBITDA Multiple Question

“What’s the EBITDA multiple for my business, given the industry I’m in?” That’s not the right question.

The better question is, “What are the odds that I sell my company?” If high, “How can I increase those odds even more?”

Knowing the answers to these questions and then acting on them will ultimately lead to the EBITDA multiple taking care of itself.