Timing is a critical factor in selling a business. It can significantly impact valuation and the number of potential buyers. In a strong market, both are likely to be higher. The current market is strong, with tailwinds from a good economy, historically cheap debt, and increased competition amongst buyers. However, there are signs that we may be at or nearing the end of the cycle.
How to Tell the Market is Healthy
The following questions can give business owners a temperature check on the market:
- Are companies growing?
- Are companies being acquired?
- Are large competitors entering the market?
- Is the industry receiving positive press coverage?
- How are laws, policies, demographic shifts, etc. impacting the industry?
Questions to consider when assessing company-specific opportunities and risks in the current market include:
- Are there specific growth opportunities that require support or funding?
- Are there specific risks that could be mitigated with changes to resources or skills?
In addition to market factors, timing a sale should also be guided by a business owner’s personal preferences.
How Market Dynamics Impact Value
As there are fewer groups seeking to buy companies during down economies, multiples tend to decrease as well. Business owners who miss the opportunity to sell in a strong economy may spend significant time and effort to continue to grow a business, only to realize the same company valuation in a down economy that they could have realized at a smaller size in a stronger market.
This chart illustrates this specific example:
EBITDA | Multiple | Enterprise Value | |
Now (Good economy) | $1.5 million | 6x | $9M |
Future (Bad economy) | $2.25 million | 4x | $9M |
Industry-specific dynamics can augment or diminish the general economy’s impact on a company’s valuation. Selling when the industry is strong often results in a larger number of interested buyers and a higher multiple price. Selling in a strong market to a buyer with greater resources and ability to weather a market/industry downturn can secure a business owner’s net worth while also improving the company’s long-term viability and growth trajectory.
Changes in the capital markets can also significantly impact business valuations. Cost of debt is a critical factor in leveraged buyout structures that private equity (PE) buyers typically use. As the cost of debt goes up, PE firms may need to reduce purchase prices to hit their return targets. Selling to a buyer with more resources that is better able to withstand economic cycles may make sense.
How to Maximize Multiples
Many business owners believe that growth alone drives multiples, but many other factors impact value as well. Multiples for different businesses may be wide-ranging and are influenced by a variety of things, including the general economy, industry-specific dynamics, and competition amongst buyers.
Buyers may consider the factors below when determining the attractiveness of a company and, in turn, the multiple that they may be willing to pay for it:
- Size (you tend to get an increased multiple after passing certain size thresholds, e.g. $1M and $5M EBITDA)
- Brand position
- Total market share
- Margins
- Scalability of the business model
- Customer churn
- Customer concentration
- Product differentiation
- Barriers to entry
- IP
- Handling of market changes
Valuation multiples for small businesses have historically averaged around 5x, with adjustments up or down based on economic conditions and competition in the market. The appropriate multiple varies for each company and industry, depending on their unique characteristics, but in the current market, multiples being paid for small businesses are higher than is typical. How long the bull market for small businesses will last is unknown, and business owners who are emotionally and mentally prepared to sell should consider selling now to realize maximum value and reduce risk.