Small Business Valuation, What is a Valuation Multiplier?

In business valuation for the sale of large and small business, it goes without saying that a business with a multiplier of four is going to be twice as valuable as that same business with a multiplier of two.  It therefore becomes extremely important to select the correct multiplier when valuing a business.  If you choose a  wrong multiplier you will only be fooling yourself as most Buyers are well informed by the time they buy.

The average multiplier for all businesses with a value below one million dollars is between 2.3 and 2.7 depending on the database source.  This multiplier is applied or multiplied against what is known as Owners Discretionary Earnings. Owners Discretionary Earnings is every way the owner makes money i.e.  Owners Salary, Owners Benefits, Profits, One time expenses, plus Interest and Depreciation.

Small Business Valuation, What is a Valuation Multiplier?

How do I Calculate a Multiplier?

Intensive businesses, such as independent restaurants and auto repairs shops, that tend to wear down an owner often sell for 1.7 to 2.5.   Profitable retailers often have a multiplier of 2 to 3.   Service businesses with repeat customers sell around 3.  Businesses with long-term contracts such as some government contractors, long-term service contracts, etc. can sell for 4 or more.  Finally, businesses in very ‘hot’ industries or high growth businesses, such as software companies starting a successful implementation phase, may sell for higher multiples.   Larger and/or more profitable businesses will sell for more than small or less profitable businesses.

Generally, the multiplier is calculated by looking at risk and how the business will continue to generate cash flow for the new owner and the perceived desirability and growth prospects of the firm.  For small businesses the employment opportunities of the buyer may also be a factor.  (If the owner can make $100,000 per year as an employee they may be less likely to buy a business generating $75,000 of discretionary earnings).  This is similar to the concept behind bonds or bank accounts.  Junk bonds pay more interest than government insured savings accounts in order to attract your investment dollar.  Of course, you will never lose principal on the government insured savings account.  Small businesses are very risky and carry a large discount usually in the 20% to 50% range.  The safer the business the higher the multiplier.  The higher the multiplier the higher the value and price when it comes time to sell.  

Gregory R. Caruso, Esquire, CPA, CVA
Harvest Business Advisors
www.harvestbusiness.com
gcaruso@harvestbusiness.com