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HOUSTON BUSINESS REVIEW
TUTORIAL ON SELLING YOUR BUSINESS: “Valuation - Earnings and Multiples” Part IV
By Ralph Fain
Ralph Fain is a principal in the brokerage firm, R/Fain Group. Mr. Fain also has over 20 years of broad business experience with Fortune 500 companies. R/ Fain Group is a professional business brokerage firm which confidentially represents the interests of various sellers and buyers. Each week Mr. Fain will give tips on Business Brokering, and how to sell your business.
Our last article dealt with the impact of “multiples” on the determination of the value of a business and also with the criticality of understanding “earnings” – how derived and how defined. We showed the importance of this by illustrating the effect an identical “multiple” had on the owner’s asking price by its application to differing “earnings” figures. As you may recall, the example illustrated a company with the following “earnings” figures (ref HBR Nov 05 Issue No. 2 for additional detail):
Earnings Type and Amount Multiple Asking Price
Net Income $200,000 2.5 $ 500,000
EBIT $350,000 2.5 $ 875,000
EBITDA $440,000 2.5 $1,000,000
SDCF $760,000 2.5 $1,900,000
The effect of applying a consistent “multiple” to a different “earnings” figure resulted in possible selling prices ranging from $500,000 to $1,925,000 – a huge differential to the owner. Today’s example will look at the same “earnings” figures but from a different perspective.
In this new example the owner believes his business is worth $800,000; he has arrived at this figure because one of his industry associates has told him that companies like his sell for 4X “earnings” and the owner believes “earnings” and Net Income are identical terms (thus 4X $200,000 = $800,000) – obviously this owner is not working with a business broker or other advisor as he has violated at least two of the cardinal rules (too much reliance on industry “rules of thumb” and not understanding the specific definition/derivation of “earnings”). Look what happens to the “multiple” with the same set of “earnings” figures and the $800,000 asking price as in the above:
Earnings Type & Amount Asking Price Calculated Multiple
Net Income $200,000 $800,000 4.00
EBIT $350,000 $800,000 2.29
EBITDA $440,000 $800,000 1.82
SDCF $760,000 $800,000 1.05
Clearly, if this business could be purchased for $800,000 it would be extremely advantageous to the buyer (probably not what the seller had in mind) as the business pays for itself in a little more than a year (as per SDCF).
One other thing is equally clear - the seller of this business needs the assistance and guidance of a professional business broker to ensure he receives his maximum sales price (a price approximating the $1,925,000 in the first example)and to ensure he avoids all the other potential pitfalls encountered when selling a business.
The lessons here are – beware of industry “rules of thumb” and industry standards as your sole pricing criteria as they can cost you substantial dollars (the difference in the sale price in the above example could be $1.4MM – a significant number!) and know which “earnings” figure you are working with in the specific and know how the “earnings” figures and “multiples” are defined and derived in industry calculations. Having this understanding (or better yet, working with a broker who possesses this and other valuable and comprehensive knowledge) will save you much time and money.
See you next time in this same space for our next article. As always, should you have any questions or require additional information please feel free to contact the R/ Fain Group at 832-646-0832 or via our web site.
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Ralph Fain Archive
- Buying a Franchise – Part 2 (March 2007, Issue No. 3, Thursday Edition)
- Buying a Franchise – Part 1 (March 2007, Issue No. 2, Thursday Edition)
- The 12 Step Process (August 2006, Issue No. 4, Thursday Edition)
- “More Fundamentals on Selling” – Non-Competes and Earn-outs (July 2006, Issue No. 2, Thursday Edition)
- “More Fundamentals on Selling” – Part III (June 2006, Issue No. 3, Thursday Edition)
- “More Fundamentals on Selling” – Part II (June 2006, Issue No. 1, Thursday Edition)
- “More Fundamentals on Selling” – Part I (May 2006, Issue No. 1, Thursday Edition)
- “Asset Purchase vs Stock Purchase” – Part II (February 2006, Issue No. 1, Thursday Edition)
- “Asset Purchase vs Stock Purchase” – Part I (January 2006, Issue No. 4, Thursday Edition)
- “Other Factors to Consider When Selling” – Part II (January 2006, Issue No. 4, Thursday Edition)
- “Other Factors to Consider When Selling” – Part I (January 2006, Issue No. 3, Thursday Edition)
- “Sale Structure – Stock Sale” Pros and Cons (January 2006, Issue No. 2, Thursday Edition)
- “Sale Structure – Asset Sale” Pros and Cons (December 2005, Issue No. 5, Thursday Edition)
- “Selecting A Business Broker” (December 2005, Issue No. 3, Thursday Edition)
- “Earnings and Multiples” Part IV (December 2005, Issue No. 1, Thursday Edition)
- “Earnings and Multiples” Part III (November 2005, Issue No. 4, Thursday Edition)
- Earnings and Multiples” Part II (October 2005, Issue No. 3, Thursday Edition)
- Earnings and Multiples” Part I (October 2005, Issue No. 2, Thursday Edition)
- “Valuation – What’s My Business Worth” Part II (September 2005, Issue No. 2, Thursday Edition)
- “Valuation – What’s My Business Worth” Part I (September 2005, Issue No. 1, Thursday Edition)
- Preparing Your Business for Sale/Enhancing Value – Summary (August 2005, Issue No. 3, Thursday Edition)
- "Enhancing Value – Financial Perspective Part VII" (August 2005, Issue No. 2, Thursday Edition)
- "Enhancing Value – Financial Perspective Part VI" (August 2005, Issue No. 1, Thursday Edition)
- "Enhancing Value – Financial Perspective Part V" (July 2005, Issue No. 4, Thursday Edition)
- "Enhancing Value – Financial Perspective Part IV" (July 2005, Issue No. 2, Thursday Edition)
- "Enhancing Value – Financial Perspective Part III" (July 2005, Issue No. 1, Thursday Edition)
- "Enhancing Value – Financial Perspective Part II" (June 2005, Issue No. 4, Thursday Edition)
- "Enhancing Value – Financial Perspective Part I" (June 2005, Issue No. 2, Thursday Edition)
- “Preparing Your Business For Sale – Part IV(B)” (May 2005, Issue No. 4, Thursday Edition)
- “Preparing Your Business For Sale – Part IV(A)” (May 2005, Issue No. 1, Thursday Edition)
- “Preparing Your Business For Sale – Part III” (April 2005, Issue No. 4, Thursday Edition)
- “Preparing Your Business For Sale – Part II” (April 2005, Issue No. 3, Thursday Edition)
- “Preparing Your Business For Sale” (April 2005, Issue No. 2, Thursday Edition)
- Tutorial on Selling Your Business “Why Am I Selling”? (March 2005, Issue No. 5, Thursday Edition)
- Why a Business Broker (March 2005, Issue No. 3, Thursday Edition)
- Buying and Selling Businesses (and Related Topics) (March 2005, Issue No. 2, Thursday Edition)
- Who Is Ralph Fain? (March 2005, Issue No. 1, Thursday Edition)
- Utilizing A Broker, Benefits To Seller (February 2005, Issue No. 4, Thursday Edition)
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