In Exit Strategies, Valuations

By Scott Bushkie

As the old saying goes, you can’t compare apples to oranges. I always think of that when business owners talk about the multiple they hope to receive when selling their business.

Sometimes, a business owner hears someone got a multiple of 6x or 8x for their business. So of course they want the same results. But what they don’t know—what doesn’t get shared over a round of beers—is what that number was multiplied by.

A multiple of 8x net income without any adjustments or addbacks could be the same as a 3x EBITDA including the working capital. And that, ironically, would be well below today’s market for many businesses with sales of at least $5 million.

The Market Pulse Survey, a quarterly report sponsored by IBBA and M&A Source, asks advisors to share the most common multiple used for businesses they’ve recently closed. For Main Street companies (businesses with values of less than $2 million), most deals are calculated as a multiple of seller’s discretionary earnings (SDE). For the lower middle market (businesses valued between $2 million and $50 million), multiples are based on EBIDTA. To explain…

Main Street: SDE is the business’s net income, plus all the economic benefits that go to the business owner. Typical addbacks include owner’s salary, health insurance, personal expenses, interest expense on long-term debt, depreciation, amortization, income taxes, and any unusual one-time expenses paid that year.

According to the Market Pulse report, the median multiple for Main Street deals under $500,000 is 2x, most often calculated on SDE. Also of note, for most Main Street deals, the seller typically keeps the working capital in addition to the value.

If you have a $300,000 SDE at a 2x multiple, the value would be $600,000. In addition, the seller would keep the receivables and cash and the buyer would purchase the useable inventory at the seller’s cost. If that business had $50,000 in inventory, the total value of the deal would be $650,000, plus the net receivables (A/R – A/P), minus the long-term debt.

Lower Middle Market: For larger deals, however, most transactions are based on a multiple of EBITDA including working capital. This is very different from SDE without working capital.

An EBITDA (Earnings Before Interest Taxes Depreciation and Amortization) calculation uses most of the same addbacks (personal expenses and one-time/nonrecurring costs, etc.). But instead of adding back the owner’s salary, this calculation leaves in an expense for a fair market salary. For example, if you have a salary of $225,000, but the fair market (what you’d have to pay to hire someone to fill your role) is only $150,000, the addback/adjustment would be to add $75,000 to the bottom line or EBITDA calculation.

On the flip side, if that same business owner was only taking a $50,000 salary, we would have to subtract $100,000 from the bottom line or increase the salary to $150,000 to come up with a normalized EBITDA calculation. Similarly, large adjustments are often made for fair market rent, as many business owners hold the real estate in a separate LLC and pay themselves rent.


Working Capital: In a Main Street deal, buyers typically set up their own line of credit to finance the business operations. But that’s not how lower middle market deals are structured. You have to sell the car with gas in the tank.

According to the Market Pulse Survey, the current median multiple for businesses valued at $5 million to $50 million is 5.1x EBITDA, most often including working capital.

Let’s say the normalized EBITDA on a $20 million company is $3 million. At a 5x multiple (for simple math) That means the company is worth $15 million. That value typically includes your 12 month average for receivables and inventory, while the buyer assumes your 12 month average for payables and any accruals tied to the ongoing operation of the business. Most transactions are on a “cash free/debt free” basis. Which means in the above scenario that the seller would also be able to keep the cash in the checking account (as long as it is not tied to customer deposits) but would also have to pay off any long term debt with the sale proceeds.

High Low. The more expenses you add back to base number, the lower the multiple. SDE calculations have the most addbacks, followed by EBITDA. But a net income calculation doesn’t include any addbacks, so that’s why the multiple appears so high.

So when it comes to multiples, beware of forming your price expectations on limited information. If you’re wrong, you’ll either leave money on the table or price yourself out of the market.

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