In an earlier post I dealt with EBITDA a formula for determining the earnings of a business. Once we have determined the EBITDA or true cash flow of a business the next step to determining its value is to apply a Multiple of Earnings. We can find this value in a number of places. A first stop would be to consult the Business Reference Guide published annually by Business Broker Press.
Another good source of information is a database of business sales. Such a database is maintained by the BBF (Business Brokers of Florida) our State Association. From this database we can draw on actual sales and determine typical Multiples of Earnings for various business types.
There are also other databases that compile sold statistics such as Pratts Stats. There is typically no public record for the sale of a privately held business. This means that useful statistics are proprietary and subject to membership or use fees and dependent on voluntary reporting.
Industry organizations and even the sellers themselves can also provide guidance on the standard multiple for the Industry in question. Finally many experienced Business Brokers will rely on a “gut check” before arriving at a Multiple of Earnings. Having done their research they will apply their own judgment and knowledge of the subject business to determine if the multiple is realistic.
Once a multiple has been arrived at it must then be applied to the EBITDA. Using this Example from my earlier post we will determine the likely selling price of Company B.
For the sake of this exercise we will assume a multiple of 4 times EBITDA.
Because we already determined that the most recent years earnings are the best reflection of the Companies performance and because our analysis shows that the earnings are continuing on this track for 2014 we will use the EBITDA figure of $1,200,000.
Applying the Multiple of Earnings we get.
$1,200,000 x 4 = a likely selling price of $4,800,000
Business Brokers often prefer to offer a range of value rather than a set number. In this case a Broker might suggest a range of $4,500,000 to $5,000,000 with the likely selling price falling within this range.
While the Multiple of Earnings Method is not the only valuation method available it is considered to be the most accurate as it relies on real world data to arrive at its conclusions.
Anthony John Rigney PA
Anthony is a Board Certified Intermediary and licensed Real Estate Broker Associate in the State of Florida. He is currently active as a Business Broker operating out of the City of Jacksonville.