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The Multiplier Effect: Small Adjustments Make a Big Difference in the Sale of a Business
by Collective 54

For business owners who may be thinking about planning a business transition in the near future, it is important to understand how personal and one-time expenses in the business will impact the value that they will receive. Because the business is worth only what a future owner expects to receive in cash flow from owning the business, it is important to consider the types of expenses an owner runs through the business and how those should be documented for the future owner in order to calculate the true future cash flow.

In the context of selling your business, it is very important to understand the impact of a consumption mentality. Businesses are usually sold on the basis of “recast” cash flows or EBITDA (earnings before interest, taxes, depreciation, and amortization). The process of recasting the earnings involves adding back one-time or non-recurring expenses, along with personal expenses that are clearly documented. Few owners document their personal expenses each year, and most buyers are unlikely to allow such add-backs without it.

Recast EBITDA is then multiplied by a factor called a multiple. This multiple represents a prospective buyer’s perception of the riskiness of your business and the rate of return he or she requires on the investment in your business. The less risk perceived, the higher the multiple; the more risk, the lower the multiple. Multiples vary by industry, by business, and by size of business, and there are many factors that go into the buyer’s thinking.

Let’s look at two examples of how multiples work:

  • Recast EBITDA $1,000,000 X multiple of 5.00 = $5,000,000 potential sale price
  • Recast EBITDA $1,250,000 X multiple of 5.00 = $6,250,000 potential sale price

Note that the small difference of only $250,000 in EBITDA at this multiple represents a $1,250,000 increase in potential sale price or business value. So every $1 of earnings equates to $5 of business value.

In addition to having an attractive EBITDA and projections that demonstrate sustainable earnings, other qualitative factors, including the lack of business dependence on the owner, market share, depth of management, processes, procedures, and intellectual property, can impress the buyer, lower the perceived risk and improve the multiple as in this example:

  • Recast EBITDA $1,000,000 X multiple of 5.00 = $5,000,000 potential sale price
  • Recast EBITDA $1,000,000 X multiple of 6.25 = $6,250,000 potential sale price

As you can see above, due to the multiplier effect, an increase in the multiple from 5 to 6.25, due only to qualitative factors or lower risk, also represents a $1,250,000 increase in the business value or sale price!

With ample time and good advice, most businesses can greatly improve their opportunities for selling and the value they will receive. We strongly recommend that owners seek comprehensive, holistic advice in preparation for any sale — whether internal or external. There is no substitute. This is most likely a once-in-a-lifetime transaction, and you cannot afford to make a costly mistake.

Based on our experience, we believe the only way to maximize your business value, as well as increase the likelihood for a successful ownership transition, is to be prepared. Being prepared not only involves time and seeking the best advice, but it also starts with owner education and planning.

Collective 54 is the only national peer advisory network for owners of professional services firms, focused exclusively on growing, scaling and maximizing firm valuation. In fact, Collective 54 has the most exclusive access to the highest-caliber professional services business owners in the world. Collective 54 gives you access to truly independent, unbiased and expert advice on the most critical priorities facing a business owner, to help you successfully exit your firm.

Sources: BTA & Streets of Wall, 2020