If you own your own business or spend any time keeping up with the news, you are probably used to hearing about a peer or competitor selling their company for “x” times revenue or EBITDA. Understandably, you may be curious and be compelled to calculate what your company might sell for using the same multiples. While this might be tempting, there is unfortunately, a catch.
Applying the revenue and EBITDA multiples to your business to calculate a value is otherwise known as the Market Approach in business valuation. To provide context, the Market Approach measures the value of a business based on prices set by market participants in actual transactions that have taken place in the open market. Here’s the catch: Caution should always be exercised when using this approach to ensure you are getting the highest possible price when you decide it is time to sell your business.
At a high-level, the Market Approach should be used when other companies are considered comparable to your company (e.g. size, industry, geographic market coverage, risk and growth potential). However, as no two companies are identical, transaction multiples may need to be adjusted to reflect any differences between the companies compared. Nonetheless, using peer and industry multiples is a good preliminary step to determining what your company is worth, but should not be used to tell the whole story.
Applying appropriate multiples to your company’s revenues and earnings (EBITDA) would give you an idea of what your business is worth. For the purpose of this blog, we refer to a business as the core operations of the company, excluding any passive income earned through investments. One area business owners should be wary of is leaving extra money on the table – upon the sale of a business, the business value would include a target level of net assets (i.e. assets net of liabilities) to maintain normal business operations. This is known as the “target working capital”. If the actual net assets are above the target level, the seller would expect to be compensated for the difference; likewise, the buyer would pay less for the company if the actual levels are below this target.
Business advisors typically assist business owners in determining what the optimal level of working capital would be so that the owner is in a better position to negotiate with the prospective purchaser on which assets should be counted as an add-on to the original offer for the business. This is normally achieved by looking at the company’s historical levels of working capital on a monthly-basis, for the last two years through discussions with management and the company’s executive team. The objective of this is to provide support on assets that would be considered redundant to the business operations – one common example of a redundant asset would be short-term investments such as marketable securities and GICs.
Once the business value has been negotiated and a target working capital has been set, the seller would need to remove all financing debt in the company to arrive at a price for the shares. As you may have noticed, the price for the shares may be very different from the value determined for the business depending on the amount of net assets and debt the company holds. Therefore, while you might hear peers saying they sold their company for “x” times revenue or EBITDA, it may be misleading as their company’s net assets and financing levels could be very different from yours.
In summary, it is essential to know what was paid for the core operations of the business and what was paid for the “extra” assets in the company before any conclusions are made regarding the value of your shares. Otherwise, you risk losing compensation for the extra cash and other assets sitting in your company that your buyer would ultimately benefit from.
If you are thinking of selling your business, or acquiring another, we strongly suggest speaking with one of our trusted Chartered Business Valuators to ensure you are getting the best price.
 Earnings before interest, taxes, depreciation and amortization.
CPA, CA, CBV
Partner - Advisory Services
Mike has over 25 years of experience providing accounting and business advisory services, with a focus on the Canadian insurance industry.
CPA, CA, CBV
Alex Wong is a partner at Smythe Advisory and is focused on being a trusted business advisor to his clients.
CPA, CA, CBV
Director of Valuation Services
Paul Woodhouse focuses on providing financial advisory and litigation support services to clients.
CPA, CA, CBV
William Tam is a senior manager at Smythe Advisory, and is focused on providing valuation and financial advisory services to his clients.