RGIII is the most exciting Redskins player in forever. At least, I don't remember anyone as exciting. With him, they can score from anywhere on the field. Without him, they're back to where they have been for the last ten years. They'll be lucky to score twenty points per game in a league where it takes thirty to win consistently. To be competitive, the Redskins need RGIII. Of course, with a leaky offensive line, he's going to take hits like last week's almost every game. I'm still looking for a good insurance policy on him, but I think the price just went up.
Tell me why I'm valuing a business, and I'll tell you whether the owner thinks my value is too high or too low. When he's buying out a partner, he'll say I'm too high. If he's selling his business, my value is too low. Being a valuation professional is like being an NFL referee. Someone thinks you're wrong 100% of the time.
Business owners love to cite revenue multiples when bragging about the worth of their businesses. Almost every time I complete a valuation for a potential business sale transaction, the owner tells me about his neighbor, who got some ridiculous sales price for his business. He'll tell me his buddy got 1.5 times annual revenue. He doesn't understand why his dog poop pickup business isn't worth the same. He then follows with the argument that his franchisor says companies like his go for between one and two times revenue. Of course I never get to see the actual sales agreement for his buddy, and the franchisor won't reveal the names behind their figures.
Revenue multiples are a popular way to value businesses, because they are simple and don't require much information. All you need is annual revenue and the multiple, and you instantly have the value of your business. What could possibly be wrong with such a simple method? A lot.
Let's examine the basic logic behind revenue multiple valuations. It goes as follows. Find a revenue multiple for your industry from some credible source. Apply it to your business, and you have a credible valuation. There are three fatal problems with revenue multiple valuations. First, revenue multiples assume that all businesses of similar size in an industry will sell for the same amount. Does this make any sense?
Let's assume we have two identical doggy poop pickup businesses. They both have $1 million in annual sales. The only difference is that your doggy poop business makes a $100K per year profit after expenses, and mine loses $100K per year. We look up a revenue multiple and find that it is 75% of annual revenue. We take our annual revenue of $1 million and multiply it by our 75% multiple. Both are our businesses are worth $750K. Does it make any sense that a business that loses $100K is worth the same as one that makes $100K? Of course not.
If you have a little sophistication in the valuation area, you might say, “Frank, your business really is worth the same to a buyer as my business. A buyer will understand that your business is poorly run and will improve operations.”
I agree that a buyer will fix my operations after the purchase. But why should he have to go to the effort to fix my business, when he could have bought yours for the same amount? I agree that the valuation of my business will be somewhat more valuable for its potential, but it certainly isn't worth as much as your finely tuned operation.
The second issue with revenue multiples is its application to past revenue. Businesses are sold on future revenue not past revenue. The only time past revenue is relevant is when it assists an accurate projection of future revenue.
Let's again assume we have our two doggy poop pickup businesses with $1 million in annual revenue for this year. Let's even assume that our 75% multiple has been blessed by some dude standing behind a burning bush and handed on down on stone tablets to us. Let's even assume our businesses will have the same profit this year. Surely our businesses are worth the same $750K. Surely not.
What if my business serves neighborhoods in an area about to have significant job layouts, and your business is located in Washington, DC, land of the big handout? What is likely to happen to my revenue next year compared to yours? Of course, my revenue is likely to decrease. Our businesses are not worth the same amount. Yours is worth 75% of next year's revenue as is mine. But your revenue will be higher than mine. Thus, you business is worth more.
I have been working a lot valuing government contractors lately. In researching revenue multiples, I noticed that they were all over the place. The data spread was really wide for any annual revenue range. What did that tell me? It told me that the businesses will the highest multiples had the best sources of future revenue. In government contractor speak, they had the biggest contract backlogs.
The third problem with revenue multiples doesn't just apply to revenue multiples. It applies to any other type of multiple like cash flow, earnings, or EBITA. These multiples come from studies of business sales. The problem is that you can never see what's behind the statistics. Business sale statistics are like sausages. You don't know what goes into them, and you probably don't want to know.
Two businesses could each have been sold for two times revenue and even sold for the exact same dollar amount. However, one deal might have been all cash, while the other might have been for a long term note payable. The reported sales price in the study is the same, but wouldn't you rather have the all cash deal as a seller? So were these sales really for the same amount? Sometimes businesses are sold for stock in the buyer. If the stock in the buyer is over-valued, how reliable is the sales price reported in the studies?
All of these disparate sales are ground up and stuffed into a sausage blend of multiples. These multiples don't really seem that reliable, do they? Multiples, in general, are best used as confirmations for valuations using better methods. Tell your neighbor that you'll believe his valuation when he moves out of your neighborhood and finds a better class of friends – like Mitt Romney. Otherwise he's likely exaggerating.
RGIII, after apparently passing post concussion tests, will start this week's game against the Vikings. I used the word, apparently, because how could he possibly be mentally well if he agrees to play behind that offensive line? I'd love to see a mortality table on playing quarterback in the NFL. You need a concussion to be crazy enough to play quarterback in the NFL.
As always thanks for reading. For real tax and accounting advice, see our main S&K web site at www.skcpas.com. Until next time, let's do it to them before they do it to us.
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