The Magic of Multiples: How Business Owners Can Create Value

Pot f GoldCreating value is a fundamental goal of business owners. In most cases, a business owners single largest asset is the value of his or her business. In many cases, it is essentially his or her only asset of substance. Yet few business owners really understand the value of their business or how they can create wealth by increasing that value.

Landscape business owners often ask me about simple approaches to valuation. I am somewhat hesitant to respond to those questions because valuation is anything but simple. Owners often draw wrong conclusions about the value of their business from simple approaches, especially when they hear rumors about what some other supposedly similar businesses have sold for.

Valuation is often calculated as a measure of expected future cash flows discounted for risk factors. That calculation can be done using a variety of methods, but the simplest one is “multiples.” Under this methodology, the expected cash flow, often defined as earnings before interest, taxes, depreciation and amortization (EBITDA) from the business (based on actual history adjusted for future expectations) is multiplied by a multiple. Different types of businesses with different types of customers sell for different types of customers. There is typically a range of multiples a business owner might reasonably expect to get if he or she sold his or her business, with a less desirable company likely to receive a multiple at the low end of the range and a more desirable company likely to merit a multiple at the high end of the range.

It may be possible to dramatically increase the value of your business by doing two things at the same time: growing your business and growing your multiple.

Let’s go through an example. Suppose in your business segment, businesses typically sell in a range of 3 to 4 times earnings before interest, taxes, depreciation and amortization.

Suppose further that you have a business whose EBITDA is $1,000,000 and the multiple your business would likely sell for is 3. That suggests a valuation of $1,000,000 times 3 or a total of $3,000,000.

Let’s also suppose you could make some changes and grow your business’s EBITDA to $1,500,000. Those same changes (and some others) might move your multiple to the high end of the range or 4. That suggests a value of $1,500,000 times 4 or $6,000,000, double the initial value.

In this example, the steps that enabled the business owner to grow his or her business’s EBITDA by 50% included many of the same steps that moved the multiple by one-third. The end result was a doubling of the value of the business. The business owner has created $3,000,000 in additional wealth.

If you are a business owner, isn’t that a strategy worth thinking about?

That is the premise behind the Wealth Building Summit to be held October 21 in Louisville, Kentucky during the week of GIE+EXPO. We hope to see you there. Early bird registration closes soon. Visit WealthBuildingSummit.info for more information.

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