About Multiples of Revenueby Roland Davis on 06/04/18
People talk about multiples of revenue. Sure, one can take any price and divide it by the annual revenue of a business and obtain a revenue multiple. A $1 million sale price divided by $750,000 in annual revenue equals a 1.33 revenue multiple. Right? Nothing inherently right or wrong in talking about multiples of revenue.
But revenue is a very poor indicator of value. It’s like talking about price per square foot for a home. Sure, price per square foot is interesting, and one way to conceptualize value or price, but the square footage itself does not drive the value. The price per square foot value of a home is driven by OTHER factors, such as the age, construction materials and quality, lot size, condition, neighborhood, and geographic location. Location of a home is the primary driver of value. And so the value per square foot could swing from $10 to $1,000.
The buyers will want to know the revenue, but also about the growth rate, profit, profit margins, customer concentration, management, industry, etc. But it all gets down to what each buyer thinks the business will or can earn on the bottom line profit (more particularly, really, cash flow). What people are willing and able to pay for a business is a function of the profit they expect the business to generate.
Below is a chart that shows median business sale prices as a multiple
of revenue. As one can see, businesses sell for a fraction of revenue.
Selling price/revenue multiples DO vary by business type, however, basically because profit margins vary by business type. Manufacturers will, on average, have higher profit margins, i.e., profit as a percent of revenue, than retailers and wholesalers. That’s why the former sell for higher multiples of revenue than do the latter.
So unless you are in a super-charged industry that is enjoying
hyper-growth and buyers are paying ridiculous prices, even for companies
that are not even profitable, don’t bother with multiples of
revenue. Let’s talk multiples of earnings.
Article Written by David L. Perkins Jr. is the Managing Director of Acquisition Advisors.