What Multiple To Use In Valuing A Private Business

“What is the value of my business?” “What is the right multiplier to use?” – these are questions we hear time and time again from anxious business owners trying to determine what to expect when selling their business in New York or any city,” says Achim Neumann, President, A Neumann & Associates, LLC, a New Jersey based Mergers & Acquisitions advisory firm  “however, short of putting the business up for sale, there are various alternate means to establish a value for a business.”

The total Fair Market Value (FMV) of a business is sum of a company’s market value inclusive of its debts, minus any cash and cash equivalents. There are multiple methods of calculating the FMV, however, never relying on just one single ‘multiplier’. Rather, most professionals use a weighted approach to valuing a company, by applying methods of asset valuation, income-based approaches, and market comparisons. By applying 5 to 7 different valuation methods, weighting them properly with a cross check against expected returns for an investor, a qualified business valuation in New Jersey expert will certainly be able to predict the FMV fairly accurately.

In establishing a value, factors like customer or vendor concentration, company and industry growth rates, profit margins, size of the company and strength of the management team come into play. Such factors are typically captured in an interview with the business owner and are then assessed individually and considered in totality when determining the evaluating factors.

For example, a company’s customer concentration with a single customer representing more than 50% of the company’s business, dictates a different deal structure than a more commonly distributed customer revenue. Alternatively, companies with little customer concentration operating in attractive growth markets such as medical, or utilizing unique processes or materials, typically can demand higher than average valuations.  

It is common practice to utilize the most recent trailing twelve to thirty-six months in calculating the FMV, with some weight also given to future projections. Good business valuation in Connecticut firms typically consider a 7 year time frame – the past three years, the current year and three years into the future. For example, if the company has experienced a temporary decline in cash flow due to a customer loss, an average over such time span may be more appropriate to use. Reviewing such time span, also allows to detect growth or decline trends.

Additionally, it is common to normalize cash flows to adjust for non-recurring revenues and expenses (e.g., litigation expenses, professional fees, etc.), non-business/personal-related expenses (e.g., owner’s car leases, payments to non-working family members, country club fees etc.), non-market facility lease rates and/or owner compensation above or below fair market value.

However, adjustments typically not accepted by investors are ineffective marketing campaigns, R&D expenses due to failed product launches or bonuses paid annually but considered “discretionary.”

Finally, it is important to note the difference between Fair Market Value and Shareholder Value with the shareholder value defined as the FMV plus cash and cash equivalents minus third party debt (e.g. bank debt and capital leases).

In sum, applying a single multiplier is never a good approach, and will easily lead to an incorrect valuation approach. Accredited business valuation firms are fully aware of such, and thus, always use a multiple, weighted valuation approach.