What Your Company is Worth: Don't listen to your golf buddies

How much is your business worth? This episode breaks down the basics of business valuation, including key factors like EBITDA, industry-specific multiples, and asset value. You'll learn how different industries are valued, how to recast your financials, and what drives higher or lower multiples.

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TRANSCRIPT:

Welcome to Integrated Insights with ICCG. For more than 30 years, our team has

partnered with small business owners to prepare for and navigate the business

transaction process. Pull up a chair as we share stories and insights from our

experience on all sides of the M &A table. All right, welcome back everybody to

another episode of Integrated Insights, VicyCG. My name is Michael.

I'm your host today here with Grant. Today we're gonna be talking about the value

or what companies are worth. So we have a lot of business owners come to us.

Probably one of our most frequently asked questions, right? We've done a couple of

those episodes, but probably our most frequently asked question is, Grant, what is my

company worth? How do we start answering that question? - Yeah, there are some

industries that are valued typically differently than others.

Your service industry sometimes are a function of gross revenue.

Some distribution businesses are a function of gross profit depending on what type of

distribution it is, but for the vast majority of other companies, it is going to be

the higher of a multiple of EBITDA, of cash flow, that you're going to get on an

annual basis or the value of the equipment or the fixed assets.

And so the best example of the fixed asset one is a car dealership.

The car dealership may be worth several million dollars for the cash flow,

but the real estate that it sits on might be worth a ton of money.

We talked to an indoor soccer stadium, not too long ago.

And the real estate that they're on is just very, very expensive. And so for

somebody to come in and buy their business, they'd have to buy that property.

And there's just no way that the business is worth even the close to the value of

the real estate. That happens a lot with like these Montessori schools or daycare

centers, they build them, and then the value of the business, the cash flow of the

business is not tremendous. It's good, but it's not as much as the value of the

real estate. But most of the time, we're getting to a multiple of cash flow.

And the way that the industry calculates cash flow is generally something called

earnings before interest taxes, depreciation, and amortization,

which is EBITDA.

Look, people are wising up, and I think Warren Puppet actually threw EBITDA under

the bus the most, but I think most people understand that the assets are generating

some sort of cash flow and then they need to pay a multiple of that cash flow.

And the way that's generally calculated, and I'm going to use some simple sort of

math here, but if your company is,

let's just say somebody comes in and they say, "We're going to pay five times

EBITDA," and let's just say your EBITDA is $20, then five times would be $100.

What they want is they want a 20 % return on the investment, because I'm buying the

company for $100. Every year, I'm going to get $20 in return. So,

a five times EBITDA is really anticipating a 20 % return. That's just how it works.

And so how predictable is that 20 % return?

You know, I might be in a big war and I might think, "Well, maybe it's very

predictable." And so I might be okay with a 15 % return.

Well, now my multiple will go up. And if it's unpredictable, see also like a

construction company, then, you know, and I've got new customers, every single

customer is a new customer in a construction firm, mostly, then, then it's not

predictable. And so I'm not going to pay five times because for me to get that 20

% return, I need a little bit more predictability. And so I might pay three and a

half times EBITDA. And so that's kind of the basis. And I know that's really,

really a lot of tech speak, technical speak. But I think most people deal with the

valuation as a function of cash flow. That's great.

That's great. So you dug into EBITDA a little bit as the term what it stands for

and some of the history there. And talk about talk about what else is done to that

EBITDA number? Talk about the recast process, what kind of items are recast out,

and how that plays into the pre -multiple number that we come to? Yeah,

and just, you know, I mean, it's a great reminder. We have developed a little, just

a real simple tool that we give to people who are trying to figure out what is my

recast right? Now, what is my normalized EBITDA or what is the EBITDA that a buyer

might be looking at? And so if you're listening to this podcast and you want a

copy of that, then, you know, get in touch with us and we'll send you it. It's

not rocket science. It just basically you get your P &L and then you add some

things back that are are the definition of EBITDA, you know, interest taxes,

depreciation, and amortization. And then you have to recast or normalize that EBITDA

or that cash flow for items that the buyer is not going to need to pay.

In other words, if there's a one -time cost that you threw in repairs

then you you you probably could add that back. Yeah,

like what we saw recently was an installation of a security system. Yeah, there you

go every year. That's right. Yeah, that's $72 ,000 installation, right? And now it's

a few hundred dollars a year, you know, just as a monitoring cost. I think, I

think, you know, the most common one is related party transactions. So things that

are your, your owner's wages, you know, maybe overstated from,

you know, what the normal price of that kind of skill level is. It could be that

you got, you're paying family out of there. You could be paying your alumni

association dues. You know, you could be traveling Europe,

and probably trying to run through some personal expenses through your P &L to lower

your tax bill, basically. And I know that's not what you're supposed to say, but I

think that the way that we justify it is not really by saying they have personal

expenses. We say them, "Those are only elected items that will probably not be

elected by the buyer.

- Yeah, not a lot of argument there in those cases, right? People see those ad back

items and they're like, "Oh yeah, that makes sense." - Right, and so here's, so we

just looked at a financial statement of a company just the other day, Michael

remember, where they actually put out a report that talked about recast items that

would get the owner an orange suit,

right? I mean, he would be going to jail and the broker that was hired was

basically giving that report out, right? And that's just stupid,

right? And

So that's why we don't say, you know, these are personal expenses. We don't say,

"Oh, you know, we have, you know,

$250 ,000 of receipts that we don't deposit in the bank account so we don't have to

pay taxes." You never say those kinds of things to anybody. You don't even infer

it. And so you have to be careful what you include in include in that recast piece

there because it is discoverable and you don't want that information to get in the

wrong hands. They owe you at that point. To be clear, when we're advising clients,

we're making sure those items are booked. And then we're also not trying to recast

them out because they shouldn't

So, you know, we don't tell our clients what to do with regards to that. We let

their CPAs and tax advisors and lawyers, you know, make those final calls. But we're

realistic in making sure that the information that's communicated to buyers or

potential buyers is not going to get them into trouble. Yeah,

that's great. That's awesome. So that's a little bit of a deep dive into the EBITDA

piece. So let's talk more about the multiple side of it. So multiple ranges are

different by industry. Obviously, a company is going to be up and down on that

range depending on the performance of their company. Talk about those factors a

little bit. Give some examples, maybe of a couple industry differences on range, as

well as what's going to make somebody fall higher versus lower on that lighting

scale. Yeah, I was joking with somebody just yesterday about About multiples and you

know, you never want to believe your golf buddy on on the multiple that he

received, right? You know, if it wasn't for country clubs and golf courses You know,

our job would be so easy Because The stuff that's talked about is just crazy.

We hear 18 times multiples and all kinds of nonsense out of people.

And you have to deal with a very unique situation before you start dealing with

anything in excess of 10 multiple. And I would say it happens,

we've certainly seen it. We sold one of our companies for a greater than a 10

multiple, but there was some unique circumstances and so they were revenue models

that were different.

There's a romance to some revenue models that just get larger returns.

And so, if you've got a higher net income than $10 million a year,

then you can achieve a higher multiple than if you have a $2 .5 million EBITDA.

And certainly, if you have a $250 ,000 net income,

you're going to be on the lower end of that industry scale for sure. Yeah.

That's why PE groups are around, right? That's why they do what they do a little

bit to get to those tiered multiple levels. Talk a little bit more about that,

about tiers and how the different levels they can get at higher multiples. Yeah. I

mean, you know, of the PE groups all the time. I mean, and really, some of it's

deserved, to be honest. But one of the most fun guys that we've gotten to meet,

a super wealthy, very successful PE group, a PE guy out of Boston,

he said, "You always contrast the motives of a PE group. They're pure motives.

And that is they are doing what they're doing to make money. And the way they make

money is they will buy a company, they'll buy 10 companies that have $1 million

EBITDAs. And then they will sell it as $110 million company and get higher multiples

because of the scale that that I just told you. So they may pay three and a half

times and then sell it for five or six or seven times because it's a $10 million

EBITDA. If you've got over $100 million of EBITDA,

you're getting way up the food chain and people are then have the eyes on

accumulating a few of those and going public and the public market has crazy

multiples of EBITDA. So just to put you on the spot a little bit on that range

question, talk about the multiple range for say oil and gas industry versus

landscaping. How do those ranges differ And what's kind of the why behind that

differentiation? - Yeah, that's such a great question because people always want to

know that. And the reality of it is, is you have to go deeper. Because if you are

dealing with consistent customer base in landscaping that's maintenance,

that is predictable, that the logos don't change.

In other words, customer base is consistent and it's repeat revenue and all you're

gonna get a higher multiple than if you're doing lawn and landscape where 70 % of

your revenue or your net income comes from custom design and installation because you

don't do that twice for the same customer generally. And the oil and gas industry

is exactly the same. You have all kinds of pieces and parts to that industry.

There's well -servicing, there's testing, there's all kinds of repeat business as well.

And then there's the whole exploration piece of that, which is up and down like

crazy. And then down like crazy. I guess the most boring part of that industry is

just the accumulation of royalty interests.

A lot of times the pricing is not even on EBITDA because it's just royalties and

so it's a

I mean, you know, it's hard to be nailed down to any particular multiple, but

again, I'm gonna go back to the very first few minutes of the podcast and I will

say the most predictable you can make it, the higher the multiple can be. And,

you know, I will tell you, probably 15 to 20 years ago, we saw consolidation in

the lawn in landscape business that were giving out 14 and 15 times multiples.

And the whole reason, we saw that in the pool building industry as well, which was

crazy.

And of course, most of those roll -ups failed eventually, but the people that

actually put those deals together and took them to the public market, they make bank

and then left these companies holding the bag and and the share price is just just

tanked and so I would tell you that that you just have to be every situation is

unique every company is unique and it depends on the revenue model yeah so if a

business owner is primarily servicing an oil and gas industry, something like that,

something that just the consistency isn't there to support a higher multiple

necessarily, say manufacturing supporting the oil and gas industry. If a business

owner has a goal to get to a certain, even a certain multiple, certain total

valuation, how would you advise them to move toward that and to maybe increase the

multiple to do so. - Yeah, you know, we're in Texas,

right? And so, for the most part. And so we deal a lot with people that serve the

oil and gas industry.

We generally, like in the manufacturing companies that we've sold and we've done

quite a few of those,

it is always, I'd say it's always, I would say 90 % of the buyers out there want

more diversification outside of the oil and gas industry. They love the gravy,

but they don't want to rely on it. And so they want production work for,

for example, the aerospace

You know, the other types of manufacturing, you know,

that's needed in this area.

You know, and again, I mean, you know, again, if you're a manufacturing guy and

you're serving the willing gas industry and you're doing something that is needed on

an ongoing basis all the time, You know, you're manufacturing valves or you're

dealing with pumps that are being replaced every year. That's different than,

you know, machining equipment for the drilling rigs because that dries up in a big

way. So what about, this is something we haven't really talked about yet on this

episode. But what about succession planning? How does that factor into this

conversation? How does that affect the value of a business? Yeah, that's really,

really difficult. And so, let's just say Dad is wanting to sell his business to,

let's say, as to like a son and a daughter in the business.

And he wants to sell the business because he doesn't have as much retirement assets

as he wants to retire, right? Common situation is most valuable asset is his

business. And so he needs some money off the table for him to walk out the door.

And so, you know, What's the company worth?

We have lots of complex discussions because ultimately it's a closed transaction.

He's not taking it to market. And so he's really not going to figure out exactly

what that company's worth. You don't want to overprice it and burden your kids with

a bunch of debt. At the same time, you want to and to your maybe have other kids

and so you want to be you want to be fair to those other kids and not give it

to those two kids right and so you know those are hard conversations and and I

would say there's an emotional side of determining what that value is it's kind of

like asking somebody what's enough you know but but that comes into it for sure.

And there's ways that we help in that scenario where you've got the son and

daughter, let's say, that are in the business, but then you've got another kid

that's not,

then maybe there's a way that you can set up the transaction to where that other

kid that's not involved in the business is taken care of, not by ownership interest,

but by some sort of an amount that's set aside for that particular,

for that particular, I guess, beneficiary. And so, yeah,

those are squishy. Takes a lot of conversation. Make sure that now you're not

dealing with your financial goals only. You're dealing with your heritage goals,

right? Your legacy goals. So what about a different version of a similar conversation

there? Say a business owner comes to you running a great company. Say last year

they hit $5 million EBITDA in the previous two years.

They've just been improving and increasing that EBITDA consistently over the year.

But that business owner has his hands in every piece of the business. And he's the

person pushing down the pedal. He doesn't have that manager ready to kind of take

the reins and do that for him. How does that play into the value conversation? Is

that impacted? Do they slide up and down that scale? What does that look like?

Yeah, I think you have to sit down and I remember sitting down with this one guy

and his impression is that he does everything. But if you ask everybody else in the

company, what he does is he comes in, creates a problem, solves a problem and then

goes home and thinks he's done everything the whole day, right? Sounds like my That

is exactly what his senior management told us.

And I mean, this was a pretty good size company and they, you know, look,

nobody appreciates what what entrepreneurs do to create a business.

They just don't. It's hard to appreciate it unless you've been in that in those

shoes. At the same time, you know, you have to be realistic and understand that a

buyer is going to have to pay for labor, bad word maybe,

pay for expertise that is going to accomplish what you do on a daily basis.

And so it's not going to be exactly the way that you do it. But, you But if

you're doing, I mean, pick a just a nominal thing, like if you're the only guy

that can repair the machinery because it's as old as you are, and all the young

guys have no clue, then your business is dependent on you and either they're gonna

have to replace the machinery or going to have to find another you. And that's

expensive. And they're going to factor that into the price for sure. That's great.

So we've talked a lot about kind of the financial pieces that play into the

conversation. But obviously, there's that sliding multiple. So what are some of the

other non -financial factors that we haven't talked about ready that play into where

you land on that scale? Yeah, we actually have a slide that we use in our initial

pitches that we give people that have different factors that produce a premium and

different factors that produce a discount.

It's not of it all, but it includes things like, you know,

concentration of sales. I mean, if you have one customer, then, you know,

it's, you lose the one customer and the buyer is SOL,

right? And so it's just, you know, there are, there are other factors.

Some of it is geography, you know, if you're in, you know, podunk and you just

can't get there. And there's no skilled labor around there. There's no,

there's no way that you can hire sophisticated people because they don't want to

live in the middle of the desert. Then, you know,

it's difficult to sell that business. Well, we talked on previous episodes about the

due diligence process and what that looks like during that business transaction

process, but how can a business best prepare for that so that they're ready when

it's time to do a transaction? Yeah, and I'll tell you, this goes back to what you

just asked me just a minute ago, because it is time and time again,

We give the buyer enough information to make an offer and let's just say they offer

$10 million for the company. Well, then we give them their answers to the due

diligence questions and it is different or it makes the initial information most

misleading enough to where they come back and they go, "Look, if we had known this,

then we would never have offered as much as what we did. And so we can only pay

$7 million for the company now." And that's not going to meet the client's goals.

And so we've just wasted several months. I would say the best thing you can do is

have advisors around that are actually preparing the initial information that you give

them consistent with the way that the due diligence information is going to be

revealed. In other words, when we put together that, you know, everybody calls a

package or SIM or whatever you want to call it, a deck, when we put that together,

we're basing it on the information that ultimately is going to be given to the

potential buyer in the middle of due diligence. And we're confident that whatever is

going to come up is not going to contradict that information at the very least. And

honestly, Dave, who's been on this podcast last week and we'll be on there next

week. I'm sure he's famous. I mean, I cannot stand the saying that he says,

but it's brilliant. He says, "Bad news doesn't get any better with age." And I

always used to think that being cagey was going to kind of win,

you know, like you kind of, did we get away with hiding this kind of information

or did they not see it? And therefore they, you know, gonna, Dave is,

Dave is just so great in the way that he says, look, let's, we're not going to

lead with the ugliness of this deal, but we're going to make sure they understand

that it's there before they make an offer so that there's not going to be any re

-trades.

Dave and I own a commercial property and yesterday a real estate guy calls me up

and he says, "Hey, I understand that you guys own this piece of property. We'd like

to buy it." And we want to know whether we can make an offer on it and whether

you would entertain the offer. And I said, "Look, if it's not my wife and kids,

it's for sale. And so he said, "That's great.

We really appreciate it. We'll get back to you with an offer." I said, "Wait, wait,

wait, wait, wait." I said, "What you need to know is on the northeast side of that

piece of property, there used to be a gas tank right next to the next door

property, and it leaked over onto our property and you're going to need about $100

,000 of remediation costs.

So factor that in. So I immediately told him that because I know that before that

thing is going to be sold, they're going to find that out. So they might as well

know upfront and factor that into the cost of the property. You see what I'm

saying? And it's the same way, and when you're selling a business, you don't want

to hide the fact that there's some hair on the deal in some way.

You want to make sure that before people make an offer, that they factor those

things in so that when the due diligence comes in and they get all the answers,

they Letting know that that exists and they're not going to retrade on the price.

And that conversation is different from what we were talking about earlier and where

information that will get somebody wearing an orange suit, the first things are not

things that are going to impact the future of the business, right? That's correct.

And I'm backing on the road. Yeah. Yeah. Awesome. Well, that's about all the time

we have for today. Grant, anything that you'd like to add before we wrap up? Yeah.

Yeah. You know, I would tell you that, you know, it never hurts to know what your

company is worth. And so asking that question is a great question to ask.

But I would say what's more important is asking yourself, what do I need to walk

away with? In other words, forget price, you know, after taxes,

after debt is paid off after fees and legal fees and all that kind of that,

what do I need to walk away with and let us determine what the price needs to be

in order for you to achieve that because it involves structure and all kinds of tax

planning because ultimately if we think we can accomplish the price that is needed

to get you what you want net net net, then then you might have a transaction on

your hands. That's awesome. Yeah. And I would just add to that it's hard to set

that goal of what you want to walk away with if you don't even know where you're

at, right? So we can help with that conversation as well. And like you've said on

previous podcasts, you know, ultimately we want to get paid when the deal closes,

but We're not looking to make money on people up till then. So come sit down with

us, you know, okay? There's always a seat at the table and we're happy to help you

figure out where you are and start moving toward where you wanna go, right? Awesome,

well, hey, Grant, thanks for joining me today and that's all the time we got.

- Let's go.

- And that wraps up another episode of Integrated Insights with ICCG. Be sure to

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