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The multiple (e.g., 5x or 7x) indicates how risky an acquirer views a company's cash flow. It represents the number of years of normalized EBITDA the acquirer is willing to pay. Factors like customer concentration, management quality, and financials impact this risk perception.
For any business seller, a strong understanding of the multiple of their earnings will help them understand the value of their business, based on what a buyer is potentially willing to pay, and how that number is derived.
How Multiples Work In Business Valuations (Ep. 309)
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Suggest questionThere are so many terms, philosophies, and methods regarding business valuations that many owners tend to ignore, or they delay addressing their company’s valuation until they want to sell, which is often too late.
In the previous theme, we covered how you can measure and monitor the value of a business–by integrating it into your company’s financials–while you own it. In order to do this, we need to understand how a company is valued and the key concepts and levers that influence that value.
Arkona co-founders Ryan Tansom and Pat Hobby are back to kick off the next theme: Demystifying Business Valuations. They explain the difference between intrinsic financial value and strategic transaction value and how they relate to normalized EBITDA, multiples, enterprise value, equity value, and finally how much money is going into your pocket after a sale (net proceeds). During this episode, Ryan and Pat unpack how companies are valued so you can begin to see–and run–your business like a financial asset.
WHAT YOU WILL LEARN:
-Why knowing the value of your company today is crucial to view–and run–your company as a financial asset.
-That intrinsic financial value +/- the purpose of the deal = strategic transaction value.
-Why the intrinsic value of a business is based on its cash flows.
-Why planning into the future using the intrinsic value of the company increases the options you will have when you actually want to sell.
-How to get a premium over the intrinsic financial value of a company.
-How the purpose of the deal and the buyer impact the transaction value.
-The difference between enterprise value, equity value, and net proceeds.
-How normalized (or adjusted) EBITDA works, how to calculate it, and why it matters.
-Why knowing the value of your company in real time helps you make decisions and in line with your long-term goals.
-The THREE numbers you should focus on in order to increase your net proceeds in the future when and if you decide to sell.
PODCAST INTERVIEW QUOTES:
05:50 - “The value of a company is based on it’s cash flow in the future." – Pat Hobby
17:00 - “You’re looking for a normalized EBITDA over the last couple of years.” – Pat Hobby
26:00 - “[Multiple] is the number of years someone is willing to pay you for your company." – Pat Hobby
32:55 - “Find out what it’s worth [your business].” – Pat Hobby
34:00 - “People don’t understand why they’re doing what they’re doing.” – Pat Hobby
About Ryan Tansom
Dr. Craig Everett is on the show today to dive deep (in a way that a normal business owner can understand) into the world of valuations, where they come from, and how the research he leads at Pepperdine University is helping shed light on the middle and lower private markets.
Dr. Craig Everett is a finance professor at Pepperdine University and contributor to the Pepperdine Private Market Capital Projects and Executive Director for the Pepperdine Most Fundable Companies. In this episode, Dr. Everett explains why it's important for every business owner to understand their cost of capital, why weighted average cost of capital (WACC) matters, and why multiples are so high right now in the M&A space. Expand your financial literacy and learn more about how to view your business as a financial asset in this episode with Dr. Craig Everett.
WHAT WILL YOU LEARN:
-Why it’s important, as a business owner, to understand how to value a business while you own it.
-What drove Dr. Everett to teach finance after years of consultant work.
-What cost of capital truly means and how to use it as a rule of thumb to determine whether you are growing the value of your business or if it is in decline.
-How your weighted average cost of capital (WACC) fits into clearly understanding your multiple.
-Dr. Everett’s definition of Company Specific Risk and all the factors that go into it.
-Why venture capitalists are moving back to early stage companies.
-Why multiples are so high right now.
-Why your valuation varies depending on the exit you are taking.
-Why people are choosing an exit to a private equity deal versus IPO.
PODCAST INTERVIEW QUOTES:
22:30 - “I want my students to sit in on financial meetings and understand what’s going on.” – Dr. Craig Everett
25:30 - “What’s your cost of capital? It’s amazing how many people say zero.” – Dr. Craig Everett
44:10 - “The revenue multiples are crazy right now.” – Dr. Craig Everett
49:20 - “VCs are now moving back into early stage companies." – Dr. Craig Everett
56:45 - “They wanted to come up with a different approach to come up with the cost of capital." – Dr. Craig Everett
ABOUT CRAIG: In addition to being an assistant professor of finance, Craig Everett is also the director of the Pepperdine Most Fundable Companies Initiative, which is a prestigious national startup competition. He is the primary researcher and manager for the Private Capital Markets Project, which publishes a quarterly Private Capital Demand Index and Private Capital Access Index, leading economic indicators. Craig is one of the leading authorities in finance, specializing in private capital markets, entrepreneurial finance, venture capital, business valuation, and financial literacy.