EP 90: Q1 2023 Business Valuation Market Data Insights

Ed Mysogland  0:34  
Welcome to another episode of how to sell a business podcast. And I'm your host, Ed Mysogland. And this is that time of the quarter, where we talk about market multiples. So the most recent deal stats just came out last week. And I wanted to share a little bit about its findings. So I often get calls from accountants, attorneys, coaches, financial planners, people that are working with small business owners and and everybody wants to know what's going on in the market, and what are the market and multiple same. So this, this is an opportunity for you and for them to see what's going on across the markets. Okay, so here we are with the deal stats value index of the first quarter of 2023. And the first thing that I want to draw attention to and by the way, I will have a link to this download. And if you head on over to YouTube, you can see this presentation in its entirety. So the first thing I want to draw attention to is in the third quarter of 22 versus the first quarter of 2023. The EBIT DOM. So earnings before interest, taxes, depreciation and amortization of private targets, decreased from five, a multiple of 5.6, down to four. And that's a that's a pretty significant drop. But, again, if you look at the cost of capital, that that could explain a lot of why, you know why the multiple dropped as well as you've got cost of capital as well as risk, you know, risk in small business as a result of, of capital and supply chain and such could have caused the decrease. So a decrease in multiple in indicates that there's an increase in risk. Alright, so now let's look, let's move here to two net sales multiples. So the funny thing is, in 2022, was the highest ever recorded at 89%. So that's almost one times revenue, if you think about that, and from from having done this business for 31 years now, that is, that is an insane number. I mean, most, most businesses do not trade it 89% of revenue. So you could see that there was a lot of, you know, a lot of people making some pretty aggressive purchases at the tail end of 2022. But you but now you see that it's kind of reverted back to the norm. So it dropped from 89% of revenue down to 58%, which is roughly median. So, so I guess my point is that, that what we're seeing in the market multiples are not necessarily what we're, and let me back up. When we when we're looking at our business owners, and we're communicating and we're communicating value. A lot of times what we're finding is, you know, they're, they're using bad data, or they've heard bad data, I can tell you that some of you know being an appraiser for as long as I have, it's not it's not normal for for, for big swings like this to be used as a proxy for value. There are reasons why I can get up to these types of multiples, but I don't want to say there are extenuating circumstances stances, but there's reasons why there are attributes of the business that cause it to increase in value, or increase the multiple for for the value and just it just depends. But for a median multiple to jump as high as it did for quarter three and four of 2022 to me that's going to be an outlier, at least at the moment. We're seeing that values have kind of reverted back to normal, at least what what I think is normal, because small businesses tend to have generally the same amount of risk. And before you jump all over that comment, I say that from a median multiple standpoint, there are reasons why a business will, why that multiple will increase or decrease depending on the specific attributes of the business. So I'm only speaking as far as as median multiples. Alright, let's take a look at EBIT on margins. This is also another remarkable number, and EBIT on margins. So that's EBIT up so early before interest, depreciation, and amortization, when you think when, and that's divided by revenue, and so that margin there is, you know, if if, if a business is running 10 to 15%, that's a really pretty healthy company. As far as I'm concerned. There's opportunities for upside to help the businesses increase that margin, you know, post sale, that that that's a reason why a buyer would buy is because there's, there's room for upside. But in this case, the EBIT on margins have have gone. And this is again, back to quarter number one, I mean, up to about 25%. So 25% of of every of every dollar is going to EBIT da. To me that is, I haven't seen that. Ever. Not. I've seen companies have it, but I've never seen as a median that you're talking roughly 25% of EBIT margin, as a first quarter of 2023. is running that high. And in fact, it's the highest recorded figure ever, by deal stats. And so, so to me, I'm, I'm having a little bit of Bill pumping the brakes on why is this happening. And so, that's a big number. And I'm not certain, it's sustainable, because it typically, you're typically running anywhere from, like 10 to 15%. Is, is is normal. 20% is a really well operating company. But 25% as a as a median seems high to me. But nevertheless, the data is what it is, and, and as 2023 progresses, we're going to figure out whether or not you know, this is sustainable. Okay. The other interesting thing is, out of all the sectors that steel stats tracks, they did, what we found is only two, two industries increased, and multiple, and that is information technology and finance and insurance, everybody else went down or stayed the same. So next. Next, I wanted to talk about, you know, just the, the multiples, you know, in the multiples from, from net sales, I mean, you can see that, you know, it's generally a general rule of thumb is between 45 and 55% of revenue is probably a good is probably a reasonable multiple. And what we found in, you know, in this analysis is, that's probably, that's probably a pretty good number. You, when you when you get to YouTube, or once you download this, this report, you'll see that the that generally speaking, the, the multiples are not, there's not a whole lot of variability to it. There'll be some peaks and a little few peaks and valleys but generally speaking, when you average out, when you average it out, there's not a whole lot of a lot of change. So as we look at as we look at the the privately held buyers and sellers, it is generally speaking, flat, and which is which is which is good from a if you're a user of or you're trying to determine the value of your business or your clients business. That's a that's, that's good because you're probably able to advise or understand that, that as a market multiple of revenue roughly 50% As of now Not a bad number to at least get started with. So let me see, I wanted to move into.

Ed Mysogland  10:16  
And when we talk about changes over time, certainly business value will change, it doesn't, what we found is the multiples don't change a whole lot, but the earnings margins do. And I think one of the key takeaways from from this podcast and and I've said it many times before, you know, I wouldn't focus, at least on the small, smaller businesses, I wouldn't, I wouldn't hold on to market multiples as much as I would be focus on the earnings margins. And the reason I share that, or I'm an advocate of that is because the, you know, on the smaller business, the risk generally stays the same. Okay? That it's, it, it's a high risk environment. And but it always has, but the biggest thing is, Have you fixed the engine of the business. And if you have, then, then that's where you focus, that's where you get the greatest, the greatest bang for your buck. So let's just say you have a multiple of four. All right, and you have you have, if you increase the margin 10%, on on a on a on a market multiple four by 10%, that's 4.4. If you have $100,000, and you increase, you increase it by 10%, you increase it to $110,000. And now you apply that for multiple that's, that's a four times, four times that Tet that, that increase of $10,000. So you can see that the focusing on the margin will do far greater good than focusing on what our multiples doing. I wanted to show the median. And what I was, what I was saying earlier, was if you look at the end, what we're looking now is median selling prices through revenue. So selling price divided by net sales, you can see that the majority of if you go line by line, and let's just take construction, for example, this is 10 years worth of data, and 44% 42% 44% 46% 42% 40% 42% 42% 46% and 49%. So you can see that, generally speaking, we're you know, you know, 10 to 20% plus or minus really, really is that net, or that selling price to net sales, multiple. And so, and that's kind of what I want to, I want I want to make sure that you take that away is that, again, at this level, the multiples are not nearly as volatile as they are moving upstream. When I say upstream, you know, upstream is the lower middle market. And the reason that the the multiples change so much is because they're often strategic buyers, and those strategic buyers look at businesses different than somebody that's buying themselves a job. So when the strategic buyer is buying there is there are synergies that that they are willing to pay either at certainly probably more than fair market value. But my point is that when you start looking at that the multiples that they're paying the reason the reason that they're able to pay increased multiples is the synergies alright. So they So, the risk decreases for the for the synergy and therefore the value goes up. And again the in those cases the market data is imparted the the the value is imputed into the multiple. So, so strategic and fair market value buyers are are and financial buyers are to two really different different types of buyers. I will tell you that if you're going to consider selling your business. You're gonna say well, what what are the strategic buyers pain? Well, it really just depends. Oftentimes we when we take a business to market, especially where they're where it's a larger business and we expect that that the only candidates are going to be strategic buyers. We often don't put an asking price on it because we don't know. We don't know the value to that respective buyer. So until we take the confidentially take the business out and do the process, we won't know, you know, what, what a strategic buyer would pay. And so, as a result, that's the only, that's the only way you can really determine what strategic value would be. And what I would say is, I always get pressed on, you know, how much over and above a financial buyer is it? You know, the rough rule of thumb, I would say, and again, take it with a grain of salt is anywhere from, you know, 15 to 40%, over and above financial buyers. Alright, so let's go back now to our multiple so now we're talking about the the median selling price to sellers discretionary earnings. And when I say discretion, sellers, discretionary earnings, it's this. This is the calculation and, and in an episode, coming shortly, I'm going to break down how you calculate what's called Ste sellers discretionary earnings. But here's the formula. So you add your net income, your depreciation, and amortization and your interest if you're a C Corp, add your taxes. And that gives you your EBIT, da numbers earnings before interest, taxes, depreciation and amortization. You then add your officers comp for only one officer. So you you add a fair market or you add the the officers compensation, any payroll taxes, any benefits that are paid specifically to you know, that that owner, and then you add any discretionary or non recurring expenses. And what do I mean by that? So discretionary expenses means you're running you have your, your kid on on the payroll and your kid. Yeah, you're paying him for full time work, but he's working part time. Now something like that. That's a discretionary expense, your cell phone, private cell phones. If you are running any personal expenses through it now, by the way, I strongly encourage you to be able to prove to prove this don't swag it so don't sign swag. Scientific. What's the acronym swag is scientific, scientific wild ass guess you do not want to do that when you're dealing with SDE. So, so your discretionary expenses non recurring expenses, like for example, business I was looking at had storm damage. And so they had a one time event where they had some flooding. And while insurance Well, insurance will take care of it, you know, they they had a bunch of expenses that that had to be paid. And they clearly put it on there on on the on the company. And so that was a non recurring expense. So that you so you add that and so when you add the those four components together, you have sellers discretionary earnings. So now, when we're looking at that the median selling prices, and we just did construction, so we'll we'll keep it consistent, you know, the multiples for construction are two points, and this from 2013 through year end, 2020 to 2.4 2.5 2.6 2.3 2.4 2.1 2.3 2.2 2.4 2.4. So you can see, just like the, the the selling price to net sales, it's it, it remains fairly constant, which is not, you know, it's it for having done this as long as I have that's not surprising. So, back to what I was originally saying, focus on the earnings, not the earnings multiple and, and, and you'll be fine. But my point is that generally speaking, multiple stay, I want to reinforce us again, that multiples generally at this level, generally stay fairly consistent. And, and it turns into the earnings as as the you know, the really the determining factor for for value. And I would be remiss if I didn't say you know business value is comprised of three things, one, earnings to risk, three growth, all right. So when so We We know what our earnings are, I just told you how to calculate it. We know what our risk is because we have the multiples. Now it's up to the buyer as far as what is what do they perceive as growth. And again, you probably can't get, you can't get

Ed Mysogland  20:15  
until you know who that buyer is, and what they are going to do, you don't really know what growth is, you know, there's, you know, there's some argument that these multiples kind of already impute growth. And in this case, you know, I'm looking at it from the standpoint of, you know, they just think that the business is probably, you know, there's no hockey sticks here, they're probably just going to continue operating in the normal, ordinary course of business, and that's fine. But I want you to make sure that you understand that, that these multiples tend not to change. And in fact, I'm, I'm in the middle of writing an article about just this, that, you know, why? Why at this level, we we hang on, so tied to, to market multiples, when in fact, there's there's not a whole lot of change. So and I'll keep you posted on on when I released that. Okay. These multiples again, I don't think you're going to see that there's there's many changes, I'm just going through through these, through these charts want to make sure that, that I don't I didn't miss anything that would be of importance. One of the things that I did want to, to share is that discounts from asking price to sale price, you know, typically, typically, it's been running around, around 5%. But what's interesting is that, that in 2022, it was closer to 12%. And I say that only because I think there's a there's a higher, there's a greater number of buyers that are in the market looking for deals. And I think when you when you start getting more activity and more feedback on your on the respective business. Yeah, we tend to see that, that, you know, there's there's somewhat of a discount. The The interesting thing is, early in the podcast, I was just talking about how high multiples were and how high the earnings margins were. And yet, you know, we're, we're, we're getting these this discount, could you imagine what would happen if it wasn't discounted. So, again, it's not a, it's, I share that only from the standpoint of, you know, the more versed you are, as far as what creates value in your business, the greater opportunity, you will to to the greater chance you have of not having to, to discount in order to sell. Okay, the average, the average days on the market increased increased to 282 days in 2022, which is second highest in the in the, in the decade that's reviewed. So that, you know, I always say, tell everybody, I mean, it's a six month, six to 12 month ride in order to get that done. And since we're, since we're talking about times to sell, I would be remiss if I didn't share, you know, the when you sell a business, I mean, part of the sale process is a transition that happens afterwards. And what does that mean? Well, that means that you're going to have to provide some level of transition from, you know, from the time of closing till the time that businesses adequately transitioned over. And what does that mean that only you can tell me that? I don't know. But I can tell you that there are a lot of there. Anybody that's buying a business wants to make sure that the business is, you know, adequately transitioned. And so I always tell I always tell everybody probably takes 30 to 90 days to kind of gear up to sell. It takes nearly nine to 12 months to sell the business. And then you should probably anticipate 30 To 30 to 180 days after that to sell so I mean, you're talking really about, you know, an 18 month to two year process in order to effect usually sell the business. So, so as you're doing your planning, I mean, keep that, keep that in mind. Okay, so as we, as we, as we conclude, you know, market data, market data is fairly consistent. I mean, I do think that you understanding your value is probably the most important component. When we do our market analysis, I mean, we're pulling from from organizations like deal stats, and then we adjust your business based on what we see. So, So, what I'd like, I guess, from, what I want to make sure that you take away is that, it's really important for you to understand the value, alright? If there are industry experts, in the, in your particular industry, that's a good, good person to have a conversation with, on what deals and what, what businesses are selling, for, if they know. The other, the other thing you might want to do is avoid listening to people in in the space that have sold, because they're there multiple, often business owners botch up the, the multiple that they, you know, that that they're selling for, alright, so, so what they think, is their EBIT, da model, and I'll give you a perfect example. We had a company, our business are saying that he's he, his buddy sold for 20 times EBIT, da, and, and there was no way that this business could, it wouldn't pencil out, it couldn't afford to, to sell for 20, much less 10. And so anyway, we, we were so we started, we started digging in a little bit on on why that was and any rate one, one, the the multiple that they used the EBIT, da, it was a net income, multiple, not an EBIT, da number. And on top of that, it was an unadjusted EBIT DOT number. So, so my point to you is that you need most of the time. The mistakes are are, you don't know, you, you don't know, the context of the multiples. And so, so from from where I sit, those are the things that I want to know is this is empirical data I can go in and I can say this is this is what we have, this is what it shows that businesses are selling for, here's why you're above or below what is selling for in the market. Now, when we go actually take the business to market, that's a different story. We may have, we may have strategies to to Yeah, to capture strategic buyers, private equity groups, things like that, where we we take off the asking price, because they're, I mean, they're professional, they're professional buyers, they know they're going to have their own value and how that business is how that business is going to be a one plus one equals three type business. And so from from from our standpoint, we just want to make sure and the last thing I'll share is that I can tell you that 87% of the people that that do any kind of value work, at least from from out of this shop and we've done over 2200 deals, I will tell you that they sell because they understand what the buyer is looking at. So as we conclude, understand your value whether you're selling, whether you're selling or whether you're considering selling down the road, it's always good to understand what levers to move in order to increase your value. If I can help in any way, shape or form, I will always let you know when I have to turn the meter on. But I get emails every day of asking different things about about value in the market. So we have an open shop and like I said, we'll let you know if we have to turn on the meter. So thanks so much for listening, and I'll see you next week.