Valuing Companies

Valuing companies is both a science and an art. Two very reasonable people might look at the same business and wildly disagree about its value. And at the end of the day value is subjective: something is worth whatever someone is willing to pay for it.

We value companies based on seller-discretionary earnings, SDE. That basically means: after all expenses are paid, how much is left over for the owner? We then apply a multiple to SDE.

Figuring out a multiple is what we’re estimating when we think about things like:

  • Are you growing, flat, or declining?
  • Do you have a lot of small customers or a few big customers (by revenue)?
  • How long have you been around?
  • What’s your churn?
  • What’s your conversion rate from visit to trial (if applicable)?
  • What’s your conversion rate from trial to paid (if applicable)?
  • How common is your tech stack? (i.e. can we find talent to continue building out the product relatively easily)
  • Do you have any annual contracts?

When you buy a business you’re buying an asset. And the value of an asset is the cash it’s going to bring in.

So we’re always trying to guess (and it is a guess!) how much cash will this business bring in in the future?

The multiples we tend to see are 2x-4x, but your multiple will vary wildly inside or even outside that range based on the specifics of your business.

And this all assumes we’re buying 100% of your business for cash, paid on the day of closing.

That can happen, but it’s not always common. There are a lot of other ways to structure a deal that can make sense depending on the seller’s or buyer’s preferences.

At the end of the day, the seller is buying some level of risk for some estimated return. The more risk, the lower the price. E.g. paying out 100% of the purchase price on the day of closing would yield a lower total purchase price than, say, 80% paid at closing at the remaining 20% paid over a year via a seller’s loan.

There are also other intangibles to consider:

  • Does the buyer want the seller to stay on for a period? Maybe purchasing a block of hours that expire as 1 month/6 months/1 year etc.
  • Is there an earn out? I.e. is some piece of compensation put aside and paid out as the businesses completes certain goals post-acquisition?
  • Does the seller want to maintain some % of the business, to participate in any future upside?
  • Does the seller want to sell and walk away with zero obligations once the deal is closed?

We can work with all of this to create a deal that makes sense for both of us. We just wanted to note that there are more things to discuss and consider than the acquisition price (though we realize that’s almost the only thing that’s talked about in the media).