The old valuation guides were useful because they gave brokers a starting point. They recognized that restaurants generally sell differently than HVAC companies, and pharmacies differently than machine shops. That still has some truth because industries have different risks, capital requirements, and growth characteristics.
However, experienced buyers today rarely ask, “What is the industry multiple?” They ask, “How confident am I that these earnings will continue, grow, and convert to cash?”
The multiple is really a reflection of perceived risk. As risk increases, the multiple decreases.
The difference isn’t simply the industry. It’s the quality and durability of the earnings.
Sophisticated buyers tend to evaluate questions like:
- How predictable are future earnings?
- How much customer concentration exists?
- Does the business depend on the owner?
- Is revenue recurring or transactional?
- Are margins stable?
- How much capital must be reinvested?
- Is the industry growing or shrinking?
- What are the barriers to entry?
- How likely is disruption?
Each “yes” to a favorable characteristic reduces risk, and lower risk generally produces a higher multiple.
One of the biggest misconceptions among business owners is believing their business is worth “three times earnings because that’s what others in their business have sold for. In reality, two similar companies with identical cash flows can differ in value by millions of dollars because one has management, recurring contracts, diversified customers, and documented systems, while the other revolves entirely around the owner’s relationships.In a nutshell, what we have observed over the years is that buyers don’t actually buy businesses—they buy future cash flow. The business is simply the mechanism that produces it. The more certain, transferable, and growing that cash flow appears, the higher the multiple they’re willing to pay.
For more information and insight into how this might pertain to your business, call me at 888-565-6468 so we can chat about the possibilities.
Jim King