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Business Multiples to Value a Business

phlgirl

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Does anyone know of a good source for business multiples?

Any opinions as to their value or lack thereof? I have been told they can be useful as a rule of thumb - of course a full financial analysis would need to be done prior to purchase.

Have been searching online but have not come up with much.

Any input appreciated.
 

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White8

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I just googled it as well and didn't find much. My data has come from various brokers in my area as well as the average multiplier calculated from the web listings of businesses in the same industry in my area. From what I have seen, they are the primary basis for setting price when dealing with a more astute seller or broker. Some private sellers seem to pull numbers out of the sky. One of the benefits of the multipliers and knowing the average for the industry and area is you can show a seller with a higher multiplier that the business is overpriced based on the other businesses in the area.

As you mentioned a full financial analysis is a must before the purchase. The multipliers can be applied to various profit figures real and imaginary.
 

australianinvestor

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I have a strong view on how business valuations should be carried out, and I think multiples are NOT the way to go. They might be an extremely rough rule of thumb to help you guess the value of a business, but if you're buying one, I'd steer clear of this method.

There are a couple of other methods you need to know.

The first, and in my opinion, the most important, is the calculating what the stream of cash flow into the future is worth in today's dollars. Google "present value", "net present value" and "time value of money". Study it well. It will take a while to learn the concepts, but anyone can do it and it is very valuable to know.

It is just a method that recognises, unlike an accountant's financial statements, that a dollar tomorrow is worth less than a dollar today. It allows you to factor in risk, and ultimately values the business as an INVESTMENT. It ultimately doesn't matter that it might own millions in "assets"... if the cash flow is poor, you value it lower. It's like asking yourself "how much am I prepared to pay for this stream of cash flow, based on a certain level of risk that I perceive it has"". You're buying future income, not just a business.

Second, you need to know the accounting methods. I started to write about book value and so forth, but accounting text books cover this better than I can. Also pay attention to the values of assets listed on the balance sheet. Inspect the assets as well, and compare. Make sure the right depreciation methods have been used correctly. Get your accountant to explain this.

Most importantly, due diligence. Investigate the business as thoroughly as you can, make sure you verify everything, don't take anyone's word for anything, question your assumptions, and make your own decisions. If you do your homework, and work out what the business is really worth to you as an investment (not what people consider some sort of multiple to be for a business they've never seen).

Oh, and get accountants and lawyers on your team. They'll be worth every penny. Remember also that accountants and lawyers might not be investors, so make your decisions as an investor, and ask their professional opinions on legal and accounting matters, not whether it's a "good investment". That's your job :)

Do your best, and you'll give yourself a better chance

Good luck!

Daniel.
 

JScott

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The first, and in my opinion, the most important, is the calculating what the stream of cash flow into the future is worth in today's dollars. Google "present value", "net present value" and "time value of money". Study it well. It will take a while to learn the concepts, but anyone can do it and it is very valuable to know.
I have to disagree somewhat with this...for a couple reasons:

Net Present Value (NPV) is an indication of whether an investment is positive value or negative value to the investor. It gives no indication of whether a particular investment is better or worse than other investments, and also gives no indication of whether an investment is a good investment for the business (only that it's positive value); in other words, it doesn't take into account the opportunity cost of the investment.

A good example here is that a couple years ago, when Microsoft had about $50B in the bank, and didn't know what to do with it, a number of people (some very smart) suggested that Microsoft should start a bank, and literally start making consumer loans. If you had done an NPV or discounted cash flow analysis, you certainly would have found it to come out positive (indicating that this is an investment that should be considered). But, had Microsoft done this, they would have seen lower returns on their $50B investment than would have been acceptable to shareholders, and it likely would have reduced the value of the company. A decision based on NPV in this case would have been a very bad one.

The other problem with using NPV for large, strategic investments is that it's success is highly predicated on being able to accurately determine the discount rate, which is the discounted future value of income. So, if you can put your investment in a CD earning 5%, the discount rate is at least 5%. But, how do you know how much you could potentially be earning on that money if you don't know all your potential investment opportunities? And, more importantly, the discount rate is likely to change year-over-year, and (unless you're Warren Buffet who claims he can do it) it's very difficult to estimate changing discount rates.

Lastly, NPV doesn't take into account risk. Some people like to adjust the discount rate to account for risk, but -- as can be proved mathematically -- adjusting the discount rate to account for risk doesn't work as expected. So, risk needs to be accounted for in other ways.

Anyway, NPV certainly has it's place, but it's more appropriately used to evaluate project investments, not large-scale corporate acquisitions.

That said, I do agree that there are better ways to value a company than using multiples (it has many of the same issues as NPV and discounted cash flow analysis), but funny enough, in my experience, the complicated math and financial analysis is often not much better than someone with experience going with the basic financial statements and their gut.

I also agree with you that these are important concepts that all investors should be thoroughly familiar with!

Just my $.02...
 

australianinvestor

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Hi JScott,

Thanks for your considered response to my post. I started to go through and address points individually that you raised, but it was a mess! Here are a few comments:

- NPV has some issues, but I disagree with a few assertions you make about risk. There is an extensive method of calculating risk, and for lack of time (and a Greek alphabet on my keyboard), it's a bit difficult to explain here :)
- You mentioned NPV doesn't give a comparative indication between investments. Agreed, but comparing NPVs of multiple investments is what does. An NPV of $1m on one investment is better than an NPV of $500K on another.
- Opportunity cost is a completely different kettle of fish. As an investor, it's our job to assess that and allocate our capital to the best investment for our portfolio. It cannot be considered when determining the value of a single investment. It can only be considered when making allocation decisions.
- NPV is more commonly used in project evaluation. There's no reason it can't be used as a tool (in conjunction with others) in investment allocation decisions involving whole companies. As long as there's time, cash flow and uncertainty, it is likely the NPV can be used to create some sort of meaningful result.
- The biggest problem I see is accurately forecasting cash flows, especially in long-term investments.


I'm interested to know more about the mathematical proof you mentioned regarding risk. Discounting a cash flow more heavily due to uncertainty/risk simply means reducing the present value of it by a factor of r. Because we are unable to be certain of the cash flow due to risk, we value it lower, and rightly so. If NPV doesn't take risk into account, what does the discount rate do, precisely?


Thanks for the detailed reply, it's a great debate topic :)

Daniel.
 
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phlgirl

phlgirl

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I have a strong view on how business valuations should be carried out, and I think multiples are NOT the way to go. They might be an extremely rough rule of thumb to help you guess the value of a business, but if you're buying one, I'd steer clear of this method.
Great point. I would never use multiples alone to value a business. However, just starting out, I am hoping to get a better understanding as to what the industry standards indicate. I was thinking that, perhaps, by browsing standard multipliers, I might be able to narrow down the types of businesses, which may or may not provide the type of return for which I am looking.

For example, I would be less inclined to spend time looking at business types which have a multiplier of 10, as the chances of something like this meeting my cash flow (return %) needs are very slim.

Thanks for making that point. It is very important to note that it is merely a rough rule of thumb.
 

JScott

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Discounting a cash flow more heavily due to uncertainty/risk simply means reducing the present value of it by a factor of r. Because we are unable to be certain of the cash flow due to risk, we value it lower, and rightly so. If NPV doesn't take risk into account, what does the discount rate do, precisely?
I shouldn't have said that using discount rate to account for risk isn't possible...it is. The problem is that it's very difficult, and the proof I was talking about indicates not that discount rate can't be used to adjust for risk, but that if your discount rate modifications for risk are off by just a little, your NPV ends up off by a lot. So, the issue is more that it's a difficult thing to get right.

In my experience, risk is best factored in by adjusting future cash flows to account for the risk you foresee. This can be done by creating multiple NPVs with different adjusted cash flows to figure out your best and worst case scenarios.

Again, just my experience...
 

australianinvestor

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I shouldn't have said that using discount rate to account for risk isn't possible...it is. The problem is that it's very difficult, and the proof I was talking about indicates not that discount rate can't be used to adjust for risk, but that if your discount rate modifications for risk are off by just a little, your NPV ends up off by a lot. So, the issue is more that it's a difficult thing to get right.

In my experience, risk is best factored in by adjusting future cash flows to account for the risk you foresee. This can be done by creating multiple NPVs with different adjusted cash flows to figure out your best and worst case scenarios.

Again, just my experience...
Thanks for the clarification :) I agree with being off by a bit making you way off. It's just like navigating in a plane or a boat. A one degree error, over a long distance, could mean you are nowhere near the destination.


I also like the mention of multiple NPVs. Exactly how I do it. NPVbc for best case, NPVwc for worst, and NPVex for expected or average.

You can also do cool sensitivity analyses in spreadsheets. If cash flow decreases in year 2, how does that affect the NPV?

I love this stuff :)
 

australianinvestor

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Great point. I would never use multiples alone to value a business. However, just starting out, I am hoping to get a better understanding as to what the industry standards indicate. I was thinking that, perhaps, by browsing standard multipliers, I might be able to narrow down the types of businesses, which may or may not provide the type of return for which I am looking.

For example, I would be less inclined to spend time looking at business types which have a multiplier of 10, as the chances of something like this meeting my cash flow (return %) needs are very slim.

Thanks for making that point. It is very important to note that it is merely a rough rule of thumb.
Thanks for the compliments :)

The reason I don't use multipliers as an easy way to bracket the value of an investment is (besides reasons already explaines) because I stick to industries I understand and know well. All the investment opportunities I look at in one of a few industries have the same multiplier, which negates its usefulness to me.

The best way to learn this is practice. Analyse a lot of deals, and you'll be able to make quick decisions. Look through a newspaper or ebay. Initial analysis is to weed out the MANY poor investments, and make a small set of investments which you can focus more detailed analysis on. You'll get a good feel for the process once you do it a few times.

Are you working on a specific deal at the moment?

:)


Daniel
 
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phlgirl

phlgirl

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We have narrowed our search to service industries, for now. This has us looking primarily at car washes & dry cleaners. Have seen numbers on a few limo companies and a gym but nothing that would work for us there yet.

We are definitely in the beginning stages and have lots of homework to do. I am finding the whole process fascinating.

In the past 2 weeks, we have seen a package of 4 dry cleaning sites and then a collection of car washes, which are available either individually or as a group. These two offerings are the best we have seen, based on initial numbers and preliminary research.

I am open to any input/discussion on how to better prepare/evaluate. :)
 

andviv

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phlgirl, my brother is interested in a gym. They offered him one but I have no clue how to help him define what is the right price to pay for it. I will be following this thread closely as well.
 

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phlgirl

phlgirl

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Hey Andviv,

As a few others have mentioned here, I think it really comes down to the return percentage which would acceptable to a given buyer.

There are industry averages, as to what is 'typically' paid for a certain business type (X times earnings) but I do not think this would factor much into what one might actually be willing to pay.

Like so many other things we discuss on this forum, I suppose it all comes back to your goals/plan. If the business generates the return you need, or provides the growth potential you want, then it is worth considering. Once you find a business which claims to produce what you need, then it is all about getting comfort (due diligence) that these claims are valid. Here, not only would you need to validate the current numbers but also get as much of an understanding as possible of the future market trends in the industry & the level of hands-on management required, etc.

Learning by the day over here..... will let you know how things progress.

If your brother is serious about the gym, I would encourage him to post the scenario here. It seems that there are at least a few people here who have some great knowledge/experience in this area.
 

andviv

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well, let me rephrase the question... what is the X factor for gyms?
In the current scenario, the deal is being offered as 1 yr profit. Of course, that was just the initial asking price, but we don't know what the real numbers are. In this case, and this is just an example, they are asking $40K and the pro-forma numbers say this business gives you $40K in profits in year 1.
 
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phlgirl

phlgirl

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Yea, I don't know, Andviv. That was kinda my original purpose in starting this thread.... looking for a good source for business multiples.

The best lead I have so far is a book called the Business Reference Guide. I am told it has details on almost any business imaginable, including standard multipliers.

Will let you know once I pick it up.
 

kimberland

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phlgirl,
I always benchmark off the industry leader.
Their multiples are in any stock screener.
Their annual reports and analyst commentaries also give me a heads up on issues that I should be looking at for my local player (i.e. if the cost of gas swings earnings in the big player, odds are they will with the little player too).

I base valuation on NPV calcs
but for a quick and dirty, I've looked at multiples before.
 
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phlgirl

phlgirl

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Hey Kimber,

That is a great idea, thanks! I will definitely keep that in mind.

I suppose my question there would be who do I look to, as the leader, when it comes to things like dry cleaners and car washes?

I am going to have to do some homework on the NPV. Must admit I have not thought much about that concept since college.
 

kimberland

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fanocks2003

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Does anyone know of a good source for business multiples?

Any opinions as to their value or lack thereof? I have been told they can be useful as a rule of thumb - of course a full financial analysis would need to be done prior to purchase.

Have been searching online but have not come up with much.

Any input appreciated.
You can use your bank as a valuator also. Let me explain (and you decide if this is feasible for you, this is just an example on how to get a valuation done):

If you have a business that has made business for at least 1 year then you can go to the bank and see what kind of interest rate they would give you for a business loan if you where to get one. If you could 8% in fixed interest rate then look at your earnings and divide the earnings by 8% and you will get a fair value if you where to go to investors in order to sell shares in your business. I have done this myself and few investors argue with the banks valuation (banks are professionals).

If the bank give you a fixed interest rate of 8%, then that would mean your business should be sold at a multiple of 100%/8% = 12,5 times earnings.

Isn't that fair, JScott and everybody else? Am I wrong in my approach?
 

unicon

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Feb 23, 2008
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When you are buying a business (legally) you are buying a balance sheet.

Lendors are primarily collateral based and secondarily cash flow based.

Balance Sheet vs Income Statement

Net Worth vs Cash Flow value

Objective vs Subjective

Postioning vs Activity

In small business the valued would be net assets plus two times annual cash flow (net income). This would be a standard valuation framework in its simplest form.

Dealing with cash flow there are a thousand indicators to evaluate opportunity and growth, this is not an exact science. Negotiation is the skill to gather the financial backing which determines added value.
 

fanocks2003

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When you are buying a business (legally) you are buying a balance sheet.

Lendors are primarily collateral based and secondarily cash flow based.

Balance Sheet vs Income Statement

Net Worth vs Cash Flow value

Objective vs Subjective

Postioning vs Activity

In small business the valued would be net assets plus two times annual cash flow (net income). This would be a standard valuation framework in its simplest form.

Dealing with cash flow there are a thousand indicators to evaluate opportunity and growth, this is not an exact science. Negotiation is the skill to gather the financial backing which determines added value.
So I can go to the bank and ask them to give me a loan against 60-70% of the collateral and don't have to give any cashflow secured against that?

Then in what way would the bank recieve their interest and initial investment back? I don't follow.

Ask a seasoned investor who purchases a company or commercial real estate and they would ask the same thing. The bank, of course (not in every case though), want some collateral. But the bank will absolutly ask you how they will get their money back. Every month that is. You will be forced to show a plan on how you are going to pay the bank back (without them having to seize assets and have an asset sale).

Let me give you an example:

You want to purchase a home for yourself, ok? You find your dream home and the selling price is $100,000. Every year you have a disposable income of $4000. The bank is willing to lend you 60% LTV based on that disposable income. They give you a fixed interest quote at 10% annually. In this case (to simplify calculations) you will get an annuity loan for 30 years.

This means you will be able to get a loan worth $4000 X 60% = $2400 / 10% (Cap Rate) = $24,000. Far away from the $100,000 selling price. You will have to pay, out of your own pocket, $100,000 - $24,000 = $76,000. That means a down-payment of 76%.

The bank will look at your earning ability first of all, they will (of course) check your creditworthiness etc. Collateral in this case will be the property (of course).

This is how they examine a deal. The same thing applies with a business. It doesn't matter if the business has collateral worth $100 million dollars. If the business earns only $10,000 NET every year you will not get a loan in the neighborhood of $60-70% of collateral. Cashflow always decides the loan size. And other variables that comes with it is creditworthiness and the ability of paying the loan service costs.

I am not trying to be rude here, but earnings are number one in line when deciding if a deal is worth it's salt or not. Banks is and always will be: value investors (cashflow first), not capital gains investors (capital gains from selling assets). There is a hugh difference.

Often times the building value (in the case of real estate) is far lower than the inflated selling price. The same goes with a business inventory. The purchase price of the inventory often goes down in value because of use. That would mean real trouble for you as the business buyer if the loan was based solely on the collateral (I would guarantee you would be forced to pay the bank every year in order for them to have their marginal of safety).
 

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unicon

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The thread is about valueing a business which includes both the assets and income stream. One does not exclude the other. If you are buying a business you do not exclude the assets.

The cash flow slant shifts as you get larger, but cash flow can be transitory it is not fixed that is why banks want collateral - the guarantee.

I used to get hard money loans all the time with no income on a small scale.

Obviously cash flow is true power but with massive assets you reach critical mass and have many choices. The balance is permanentcy vs transitory.
 

fanocks2003

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The thread is about valueing a business which includes both the assets and income stream. One does not exclude the other. If you are buying a business you do not exclude the assets.

The cash flow slant shifts as you get larger, but cash flow can be transitory it is not fixed that is why banks want collateral - the guarantee.

I used to get hard money loans all the time with no income on a small scale.

Obviously cash flow is true power but with massive assets you reach critical mass and have many choices. The balance is permanentcy vs transitory.
Unicon I am not arguing against banks wanting collateral. What I am arguing against is that cashflow wouldn't be the first thing a bank would like to look at except from creditworthiness and collateral. Without cashflow there really is no reason for a lender to lend. Unless he hopes you will default so he can gain your collateral. Such a person or institution is not a true lender. Speculator would be the true word for it. And as far as I understand banks are conservative in nature, far from speculation mode. Collateral is only one tiny piece of the whole lending scenario. Without cashflow you are toast no matter what collateral you have.
 

GreenHouses

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Interesting thread.

Here is a business buying guide that I am considering buying... its at: www.diomo.com

I'd be interested if anyone has anyone used this and has any feedback on it? Good, bad or otherwise. It looks comprehensive and very reasonably priced, and there's a version of it specifically for Australia too. :)


I use ratio analysis quite a bit when assessing listed companies as potential investments. I use a number of performance hurdles to narrow the field from 1,000+ to about 30.

Then with the shortlist, I not only look at the most recent values of the ratios and numbers, but also compare the numbers from year to year and against other companies in the same industry. I'm looking for consistent growth and improvement, as well as good performance. eg. I'm looking for a company with a relatively high net profit (in $ and % terms), AND for that net profit to be consistently growing & improving.

There is a concept called STAEGR (Stability of earnings growth) and this is one of the factors I look at. As the name suggests, it calculates how predictable the earnings growth has been. I look for a high value here because its an indicator that the company has good economics.

For more information on this concept, visit www.sherlockinvesting.com or www.conscious-investor.com

I use the ValueSoft program which can be purchased at sherlockinvesting.com

There's also a really cool function (called STRET) in ValueSoft where you plug in a few values, including the return you'd like to get, and it tells you what price you need to buy at, given the values you've plugged in, to achieve the return you want. You can of course alter the variables and see how that affects your expected return / target purchase price.

In addition to assessing the numbers, I read through company announcements etc because it gives an idea of what you can expect more of in the future. I'm looking for: a stable board of directors who have "skin in the game"; organic growth; profit targets consistently met or exceeded etc etc.


ps: I have no association with any of the above-mentioned web-sites, aside from having purchased ValueSoft several years ago.
 
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phlgirl

phlgirl

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Nice post, Greenhouses! +++

I do not have any experience with the guide you referenced but we have been using this one:

http://www.businessbookpress.com/catalog/b901toc.htm

We find it Extremely useful. It has a few pages on each industry and provides current ratios on expenses, details on how the business type tends to fare in recession conditions, many different tools for pricing, etc.

Best of luck in your search.
 

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