How to determine the right multiple for your business

Understanding the true value of your business is an important aspect of successful financial management and long-term planning. While the basic formula for valuation—profits times a multiple—might seem straightforward, the defining factor lies in determining that multiple. This article explores the various factors that influence your business's multiple, offering insights into how you can enhance this critical piece of your valuation. By examining real-life scenarios and key business attributes, you'll better understand how to accurately assess and increase the value of your enterprise.

I have a valued client—let's call him Brian. Every year, we meet for lunch to discuss the financial performance of his business. Inevitably, our conversation veers towards the topic of business value, and it's the one topic we just can't seem to agree on!

Brian looks at the business's assets, while I focus on the profit and cash flow it generates. I often tell Brian that if a business's only value lies in its assets, it's nothing more than an organised liquidation. Perhaps one day he'll accept my advice and pay for the lunch!

To state the obvious, businesses that attract the best prices are those that have potential buyers—no different from selling a house. What makes a business most attractive to multiple buyers is its likelihood to generate a good return on investment with minimal risk. The multiple of profits is simply a way of expressing this level of confidence or risk.

For instance, owning a toll bridge represents a near risk-free asset. With little to no competition and high barriers to entry for potential competitors, along with an almost captive customer base, you can be confident of low risk. Consequently, buyers will be willing to pay a strong multiple for such an asset, making it desirable for pensions and other long-term investments. The multiple reflects this level of confidence.

On the other end of the scale, consider a highly profitable but non-transferable business like a brain surgeon. While it generates significant profits, it cannot be sold as a typical business would be.

Where your business falls on this value scale—ranging from 0 to maybe 40—is determined by many factors. I often ask clients, "What businesses do you admire, and what would you be willing to pay for them and why?" Applying the same criteria, they should consider why someone would buy their business.

Leaving aside the toll bridges and tech businesses, for a solid trading business, the typical range is three to eight times earnings. Factors such as good growth, recurring customers, efficient management and sound operations all push up the multiple.

Conversely, businesses dependent on one-off orders, driven by commodity prices, relying heavily on the owner's presence, requiring significant capital or proving difficult to grow will attract lower multiples.

In practice, businesses will exhibit a mix of these attributes, meaning there are areas to nurture and areas to rectify. Some areas may yield near-instant results, while others might take time to reach the most desirable point.

Many business owners tend to cut costs when approaching the time of sale to show higher profits. However, this can be counterproductive. Attracting a higher multiple is often worth more than maximising profits.

Maximising the multiple requires a planned and structured approach, which may take two to three years to implement. It is never too early to start this process, and a proactive approach can lead to significant rewards in the future.

At Crowe, we specialise in helping business owners navigate the complex business value and strategic financial planning environment. Our corporate finance services are designed to provide you with expert guidance and actionable insight to make smart decisions that deliver lasting value. Whether you’re looking to achieve the most from your business’s multiple or prepare for a future sale, our team is here to support you at every step. Talk to us today and find out how we can help you achieve your financial goals and secure a future for your business.