Business ValuationNovember 2, 2020by Business Valuation TeamMultiplier Effect Help Ensures Business Value

The multiplier effect is crucial to all businesses: a small adjustment makes a huge difference in sales; hence personal and ad-hoc expenses will have a great impact on the overall business value – this must be taken seriously by business owners who are looking to sell their businesses in the future as a buyer sees the worth of a business only in its expected cash flow.

It becomes important for business owners to consider the types of expenses in an operation and the proper ways to document these expenses so that the true future cash flow of their businesses can be accurately worked out for potential buyers to consider.

The multiplier effect can be explained using the consumption mentality in the context of selling a business:

Usually, a business is usually sold based on the amount of recasting the Earnings before Interest, Taxes, Depreciation and Amortization (EBITDA) – or simply, the cash flow. This involves adding non-recurring or one-time spending and other documented personal expenses back into the overall business value. Here, it is crucial to note: buyers do not accept personal expenses that are not clearly and properly documented prior to the business valuation.

This amount of recast of the EBITDA is multiplied by a factor – the multiple, which represents a buyer’s perception of the risk level of the business and expected rate of return upon his/her ownership of the business. This multiple is usually influenced by the industry, the business and its size, and all other possible relevant considerations of the buyer. Hence the lower the perceived risk, the higher the degree of the multiple, and vice versa.

The following demonstrates how the multiple works in two scenarios:

  • Amount of recast of EBITDA = $1,000,000

Multiple = 5.00

Potential Sale Price of Business = $1,000,000 x 5.00 = $5,000,000

  • Amount of recast of EBITDA = $1,250,000

Multiple = 5.00

Potential Sale Price of Business = $1,250,000 x 5.00 = $6,250,000

The above scenarios shows clearly that, with the same value of multiple, a relatively small difference of $250,000 in the amount of recast of EBITDA gives a $1,250,000 increase in the business’s potential sale price – which signifies $5 of business value for every $1 of earning.

Besides an attractive amount of EBITDA and positive projections, a business can show its sustainable earnings through its market share, depth of management, intellectual property and the lack of business dependence on its existing owner. A buyer will be impressed with all these qualitative factors and hence lower his/her perception of the risk level of the business, which then increases the value of the multiple.

The following two scenarios demonstrate the explanation:

  • Amount of recast of EBITDA = $1,000,000

Multiple = 5.00

Potential Sale Price of Business = $1,000,000 x 5.00 = $5,000,000

  • Amount of recast of EBITDA = $1,000,000

Multiple = 6.25

Potential Sale Price of Business = $1,000,000 x 6.25 = $6,250,000

It is again clearly shown that an increase in the multiple by 1.25 marks a $1,250,000 increase in the potential sale price of the business, following the influence of the mentioned qualitative factors or perhaps the lower risk levels of the business.

Steps To Take To Maximize The Value Of A Business:

This means having a vigilant attitude towards ensuring the business’s competitive edge in the market; developing it for growth and expansion; and protecting its largest asset.

It is strongly advisable that all business owners do a detailed review of their businesses prior to considering any forms of business transitions and transactions. This will help surface issues pressing for attention to be rectified, improved or removed; and it should be done prior to the scrutiny of potential buyers from within or outside the company.

To start, search for weaknesses in the business – undocumented policies and procedures, inadequate written job descriptions, missing corporate meeting minutes, insufficient employees, non-compete agreements, customer bad debts and etc.

Next, check and ensure that all financial records are properly done and recorded according to the Generally Accepted Accounting Principles (GAAP). At this point, it is worthy to consider hiring a certified professional accountant, or a CPA, to perform the financial audit or review. Such a move will be rewarded when there are plans to sell the business to a public company or a private equity group. Three years of regular audit and review will place the business owner in a positive light amongst all the potential buyers, and hence drive the business value to its maximum.

Final Words

Business owners who have been treating their businesses as a lifestyle and/or ignoring the drivers of the value of their businesses, will need years to adequately address and rectify the influencing factors to maximise the overall business value.

Generally, all businesses can improve their selling opportunities and fetch a positive business value when their owners spend a sufficient amount of time and resources to adequately address all concerns and issues.

It is hence advisable for business owners to look for a holistic and comprehensive consultation when preparing for any forms of business transition or transaction. There is no other way as this may be the transaction of a lifetime that is not worthy of the slightest mistake out of carelessness.

Contact us to discuss about your business value.