Selling Your Business

At this point, it's an old wives tale that small businesses sell for one times revenues.  I met this morning with a client to review a business valuation I had prepared.  He told me a few of his friends told him about the one times revenue rule of thumb.  That means if your business has $1 million in sales, the business will sell for $1 million.

Part of my process in preparing a business valuation is reviewing sales of comparable companies from a database of business sales compiled from business brokers.  I showed the client four recent sales of relatively comparable companies.  The top revenue multiple was 50% of revenue.

Looking more deeply at this sale with the highest revenue multiple revealed that this company also had the highest cash flow relative to its selling price.  This multiple is called selling price to seller's discretionary earnings (P / SDE).  This is a multiple based on the cash flow of a business.  Given two businesses with equal sales, the one with the higer cash flow will command a higher price.  That certainly isn't rocket science!  If you want a somewhat useful rule of thumb (as much as any rule of thumb can be useful), small businesses typically sell for 3 to 3.5 times discretionary earnings.  This particular client's industry was selling for more like 4 times SDE.

I had a conversation with a business broker last Thursday.  He told me cash flow rules in terms of selling valuations.  He further went on to tell me that banks will no longer finance valuations built on revenue multiples or pro forma (projected) cash flows.

Multiple of revenue valuation can now be archived in history with "per click" internet site valuations, and other dot com valuation fantasies.  Reality is back.