I recently asked George Rossolatos, founder of Riverdale Capital and a 10-year veteran of the private equity space, to give me a range of how much a typical small business with $1 million in pre-tax profit (Earnings Before Interest, Taxes, Depreciation and Amortization or EBITDA) would sell for today.
“Much is dependent on the risks and opportunities inherent in a given business and industry, but a common valuation guideline used for companies that size is four times EBITDA, two-thirds of which is paid in cash up front at closing and one-third of which is held back in an earn-out that’s tied to hitting certain milestones you and the buyer agree to over a couple of years,” Mr. Rossolatos says.
“It’s important to remember that the range in practice is much broader and an earn-out isn’t always required, but a valuation and deal structure like this is quite common.”
Sound lower than you thought?
Mr. Rossolatos explains.”There is often a mismatch between what some business owners think their businesses are worth and what someone is willing to pay for them. Companies with $1 million in EBITDA are still too small to be material for most large acquirers, so the universe of buyers is smaller. At $1 million in EBITDA, the founder is still very likely to be a big part of the business or significant customer concentration may exist, so there’s more risk for the buyer, which means buyers often hold back some proceeds in an earn-out to ensure the owner stays on for a transition period to mitigate those risks.”
What advice does Mr. Rossolatos have for owners looking to increase the value of their businesses? “The best thing you can do is grow your EBITDA,” he says. “Valuations of multiples tend to increase as the size of the business increases. A business with $5 million of EBITDA would command a higher multiple, likely in the range of five to six times EBITDA for a comparable risk profile.”
When it comes to your multiple, size matters.
John Warrillow is an entrepreneur, author and speaker who has started and exited four companies. He most recently transformed Warrillow & Co. from a boutique consultancy into a recurring revenue model subscription business, which he sold to the Corporate Executive Board in 2008. He is the author of Drilling for Gold (Wiley, New York 2002), and in 2008 he was recognized by BtoB Magazine’s “Who’s Who” list as one of America’s most influential business-to-business marketers. John’s newest book Built To Sell: Turn Your Business Into One You Can Sell was released Feb 1, 2010.