So you decided to acquire a small business. That’s great! Buying a small business (less than $500k in EBITDA) can be an excellent way to start an M&A program, add tangible financials to a new business, build a customers base, and more. While there are plenty of benefits to acquiring a small business, there are also a number of risks. One of the largest risks is overpaying. Acquirers often find themselves asking – How do you value small acquisition targets?
When valuing a small business, comps are usually hard to come by. Public companies, “blockbuster” deals, and industry statistics usually don’t correlate to (very) small business valuations.
For example, large public companies usually trade at an P/E ratio of 10+ and private acquisitions usually price at 4-9X EBITDA. According to the Pepperdine University 2015 Capital Markets Report, the average purchase price for a company with $1 million in EBITDA was 4.5x while deals with over $50 million EBITDA were purchased for over 8x EBITDA. The study also looked at how sector plays into valuation (see image below) but, they don’t have very strong stats on deals that do under $500 thousand in EBITDA.
In their Q1 2016 Insights Report, BizBuySell.com “aggregates statistics from business-for-sale transactions reported by participating business brokers nationwide”. In Q1 they tracked 1,840 transactions with median revenue of $478,000 and median cash flow of $110,000. The average multiple of cash flow on those 1,840 small business transactions was less than 2.5x cash flows, a substantial drop from the 4.5 average for $1 million businesses.
So next time a seller (or business broker) tries to compare their sub $1MM EBITDA business to that deal you just read about in the WSJ or that high flying large cap, feel free to bring them back to reality. Maybe ask them -How do you value small acquisition targets? Remember, it’s important to negotiate a deal that is fair for all parties involved, not just the seller.
Do you have any tips or advice for valuing small businesses? Please feel free to share and comment.
Ben Kotch is a managing director and investment committee member at Acquis Capital, LLC, a private investment firm that specializes in acquisitions. He has extensive experience with both private and public companies. Ben graduated with an economics degree from Bentley University where he concentrated in entrepreneurship and law.
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