Why Market Multiples Differ For “Seemingly” Similar Companies?
Ever wondered why two seemingly similar companies sell at different multiples of SDE or EBITDA? What factors are buyers considering which results in sale price differences? Here are some company characteristics that push a market multiple higher or lower:
- Documented Revenue/Earnings Trends
Buyers are willing to pay more for companies which are able to show verifiably consistent upward revenue/earnings trends than companies with questionable financials and downward trends. Characteristics leading to a higher multiple might include:
- well-documented financial statements and tax returns are essential;
- cash, COGS and business expenses are appropriately documented;
- non-essential, non-recurring expenses are minimized;
- detailed report of business assets (tangible and intangible) and liabilities is available; and
- the business has “prequalified” lendability.
- Growth Potential
Buyers are willing to pay more for companies with high growth potential than companies perceived as having low growth potential. The reasons are high-growth-potential companies generally have the following characteristics:
• create exceptional customer value;
• exploit high-growth market segments;
• are innovative;
• have a strong brand identity;
• create product/service differentiation; and
• invest in the development and delivery of new or enhanced services.
- Low Cost and Ease of Scalability
Buyers are willing to pay more for companies that can scale up easily/quickly and at relatively low cost. Conversely, capital-intensive companies are often high-cost/difficult-to-scale businesses that require significant reinvestment to increase capacity. Ways to enhance a company’s scalability may include:
• use technology to create employee efficiencies;
• focus on reducing/eliminating redundant tasks;
• offer value-added services or develop competitive advantages that increase profits;
• standardize service offerings to reduce capacity constraints; and
• identify ways to access quality candidates for potential new hires.
- Diversified Customer Mix
Buyers value a diverse customer mix with little concentration. If a company relies heavily on a single or few customers, the company risks:
• major impact from the loss of a contract;
• lacking leverage during contract negotiations and being forced to accept a less favorable contract;
• payment delays that may significantly affect cash flow; and
• customer audits that lead to disputed claims. - Low Company-Specific Risk
Buyers are willing to pay more for low-risk companies than high-risk companies. In addition to the factors above, Low-risk companies tend to be those with:
- Longevity (5+ years in business);
- Substantial hard asset value;
- Owner retirement;
- Absentee ownership;
- Stable management team in place;
- Long-term quality employees and customers;
- Apparent competitive advantages;
- Proprietary or exclusive products;
- Up to date assets and premises in superior condition;
- Highly favorable lease terms or ownership of real property;
- Desirable location;
- A high demand enterprise (manufacturing, distribution, or business to business service);
- Favorable seller financing; and
- Easy to understand motivation for selling.
The Bigger Picture
It is quite common for buyers and company owners to perceive the market value of a specific company in terms of market multiples based on prior sales of similar companies. But, when comparing the company to “similar” companies that have sold, they may not consider information about matters such as documented revenue/earnings trends, growth potential, scalability, customer mix and company-specific risk of those prior sales. Understanding these factors is critical to arriving at the most probable purchase/selling price for a company.