Here are the approaches buyers will use to determine your company's current value and prospects for growth.
Once you have built a business to a level of sustainability, it's inevitable that you will begin to think about the prospect of selling the company. In a recent column, we discussed the importance of building your business with an eye towards selling it. Even if you intend to continue to grow your business for the long term, it's often the case that you can maximize value when positioning the business for an eventual sale.
But how does an entrepreneur, intrapreneur within a larger company, or investor think about how the business should be valued to an outside party? How would a potential buyer of the business think about the valuation? Can you apply a multiple to your current profits to approximate a value? These are the questions that many of our business partners have. Here's a quick overview of how prospective buyers might determine a value for your business.
The EBITDA Multiple
One of the most common ways to approximate a company's valuation is to use a multiple of EBITDA, or earnings before interest, taxes, depreciation, and amortization. The typical EBITDA multiple may be higher or lower based on the size of your company, its profitability, its ability to support debt, the scalability of your business model, market growth, and general macroeconomic factors.
Timing can influence the current EBITDA multiple and valuation. During turbulent economic times, when the availability of debt is constricted (e.g., 2009), valuations remain constrained, even for businesses that demonstrate strong value drivers and growth or profit potential. Conversely, selling a less-than-stellar tech business in 1999 could have yielded an unreasonably high valuation relative to cash flow generation.
For example, in 2010, private equity fund 3G Capital purchased Burger King for $4 billion (9.0x EBITDA). 3G focused on refreshing Burger King's brand, regaining lost market share, and developing a strategy for international expansion. 3G took the company public in 2012 with an $8 billion valuation (13.6x EBITDA).
Business owners should stay informed of the current multiple range as well as the 3-to-5-year historical industry average when determining the ideal timing for a potential sale. Timing the exit with market trends can have more weight than other factors, especially in a sale to a financial buyer that often relies significantly on the availability of debt to finance a transaction and less on potential synergies.
Determining Your Multiple
Evaluating public companies in your industry can provide a range of current multiples based on EBITDA as a percentage of enterprise value. But public company multiples differ slightly from private company multiples. The ability of an investor to control a private company may increase its multiple, but lack of size or liquidity may decrease a private company's value.
Developing a good approximation of the value of your business puts you in a better position whether you choose to grow or sell. It's helpful to evaluate strategic investments by understanding the impact they may have on the company's valuation. And, if you do find an interested buyer, you can easily determine whether a potential deal is in the right ballpark for a potential sale.
KARL STARK AND BILL STEWART are managing directors and co-founders of Avondale, a strategic advisory firm focused on growing companies. Avondale, based in Chicago, is a high-growth company itself and is a two-time Inc. 500 honoree. @karlstark