Most business valuations are determined by applying a company’s multiple to its EBITDA (Earnings Before Interest, Taxes, Depreciation, and Amortization). Simply stated, the valuation equation is: Value = EBITDA x Multiple.
This equation tells us there are only two ways to grow business value, either by increasing EBITDA or increasing the multiple. Granted, your goal as a business owner should be to increase both your EBITDA and the multiple. However, focusing more on growing your multiple is a much better strategy to accelerate business value, as explained below.
Presume we have two businesses in the same industry that have identical EBITDA of $2 million. Company A has a multiple of 5, while Company B has a multiple of 7. Despite having identical EBITDA, Company B will be valued $4 million or 40% higher than Company A. Why? The market views Company B as a more attractive investment because Company B has greater intellectual capital.
Strong EBITDA growth can accomplish the same outcome, but there are pitfalls to seeking growth for growth’s sake. Instead, by focusing on improving your multiple you commit to growing your company’s intellectual capital, which means you develop more effective employees and internal systems that are crucial for sustained, healthy growth. Furthermore, by focusing on growing intellectual capital, you create a knowledge infrastructure that will most likely improve financial performance—that is, it will increase EBITDA. And when both the multiple and EBITDA are growing simultaneously, business value increases dramatically!
At Regal Wealth Advisors, we give our small business owners the tools and knowledge to strategically grow the value of their most important investment. We offer the skills and knowledge of two Certified Exit Planning Advisors, Mike Zimmerman, President and Founder, and John Packer, Small Business Director. Mike and John are a uniquely equipped team with decades of combined experience in wealth management and small business consulting.
We invite you to contact our office at 717-838-3178 and schedule an appointment to learn more about how our exit planning process—a process that focuses on growing your multiple--can be your most important business strategy.
By John W. Packer, CPA, CEPA, MBA