Do Multiples Matter?

If you've spent any time talking with entrepreneurs, investors, or Dr. Google, you will know that Multiples are talked about often. Part of our obsession with Multiples comes from mainstream media — "Company ABC was sold for 10X" or "Tech Company DEF had a 100X Multiple."

Because these numbers show up in the news nearly every day, we tend to take for granted what it takes to actually achieve these types of results. In this article, we'll answer the question: Do Multiples Matter?

Multiples 101

Before we dive into the discussion, what exactly is meant by the term, "Multiple." According to Dr. Google:

"A valuation multiple is a financial ratio that compares two financial metrics to calculate a company's value and make it easier to compare companies with different characteristics. Multiples are often used by financial analysts, stockbrokers, investment bankers, and other professional advisers."

In short form, it's a ratio. For example, if the Gross Annual Revenue of a business is $1,000,000 and it sells for $3,000,000, the Multiple is 3 ($1MM times X = $3MM, where X is equal to 3). In other words, the company was "sold for 3X Gross Annual Revenue).

Context is Important

Context is important and in the case of valuing and selling businesses, it's critical. Let's take an everyday example and one of my favorite beverages: coffee. If you go to Kwik Trip and buy a cup of coffee, it will cost you $1.50 to $3.00 depending on the size. However, if you go to Starbucks, a cup of coffee (excluding all of the fancy options) will cost you $3.50 to $5.50.

We know that the quality and experience of getting a cup of coffee at Kwik Trip is different than that at Starbucks. It's not an apples-to-apples comparison because Starbucks is positioned as a premium coffee vendor whereas Kwik Trip has positioned around value. (I actually much prefer Kwik Trip coffee - if you haven't tried it, I highly recommend giving it a shot.)

The taste, parking, interior decor, and pricing reflect a completely different experience. Everything down to the software, POS system, and staff training are completely unique to each operation. So, we can't really compare the two brands side-by-side without discussing the other key factors mentioned above.

The same applies conceptually to Multiples. If you go to Google and find the Multiple for your industry, you're leaving out important information such as:

• How was the Multiple applied to the business? Typically, Multiples are applied to Gross Annual Revenue (Sales), Net Operating Income (NOI), or Seller Discretionary Earnings (SDE). Without the additional context, you would be applying a Multiple blindly, rendering it useless.
  

• Digging deeper, if it was applied to say, Sales, there are significant differences between industries on how to go about applying these Multiples. Some industries apply the Multiple to Sales, whereas others apply it to NOI, and yet other don't even use Multiples and doing so would give your position away as a green entrepreneur, thus eroding your negotiation power.
  

• FF&E + Inventory: FF&E (Furniture, Fixtures, and Equipment) along with Inventory can have a critical impact on a valuation. So, if you're only applying the multiple to Gross Sales or NOI, you may be leaving a large portion of the value out of your final calculation.

So, What's the Point of a Multiple?

So far, I've come down a bit hard on our friend, the Multiple, but they do have a use. Once a business has been properly valued, searching for Multiples in similar industries and sectors can help validate the valuation. The gold here is that it prompt your advisor to dig deeper into your financials in the event that the numbers seem off.

This isn't to say that Multiples will always validate a valuation, but they certainly can be useful indicators when something seems off. In addition, if you're only looking for a rough ballpark — say, plus or minus 20%, the Multiples you find online may be able to give you a starting point for value. However, be careful not to put too much weight on this type of calculation, especially given that selling a business is most likely the most important financial decision you will ever make.

If you've been considering selling your business and would like to enlist the help of a professional, starting with valuation is a critical first step.

To your success,

Jason Huett Business Broker | CEO

Collaborative Commercial, LLC.