As company value is often the most significant component of a business owners' overall net worth, you can guess that I gets asked this question a lot! This month I'm very excited to have Dr. James Lea speak to our clients and friends about family business and succession planning.
As the first post in the series, I thought I'd talk a little bit about the concept of value. While doing some research I came across a great post about the differences between public company value and private company value. In the post entitled 'Does Size Matter?' the author, Marc Emmer, makes a very good point about a phenomena that I see all the time – private companies tend to trade at multiples of 5 to 6 times earnings whereas the broader S&P index trade at 14 times earnings. His fundamental point is that the S&P companies have two things going for them:
- They have figured out how to scale to a mass market – whatever it is – whereas most smaller to midsized private companies (e.g. $200m and below) still cater to a niche market.
- They have access to capital markets – which furthers their ability to be very good at #1.
I experienced this first hand recently as I was looking up public company comparative values for a client that runs a Software as a Service company. The range in values – even in the public market, caused me to scratch my head.
In my experience, most of our business owners have sold in the range of 4 to 8 times earnings. 4 times earnings is typically a business that has a product or is in more of a commodity like industry. 8 times earnings is typically a business that either has a unique product or service that the buyer is willing to over pay for a variety of reasons. Most often because the buyer believes that they can significantly increase company value over time by expanding the company into new markets or by combining the product or service with its own to make a '1+1=3' scenario.
Regardless, ultimately the buyer is the determiner of value, not the seller. If we don't end up going into a double dip recession, there is evidence, based on a recent Boston Consulting Group study, that we will see an uptick in M&A activity (click here for the survey) based on our current market conditions, as most buyers that experience positive returns on acquisitions made the acquisition at this point in market. That's the positive note. The negative note is that, based on age demographics (e.g. lots of baby boomer business owners) there is likely to be more companies for sell in the coming years than ever before, so more competition for a smaller buyer pool.
In the remaining posts in this series I will discuss different ways to value your company and to ultimately maximize value. The first step is to realize that the trading multiple of a 'like' public company is probably not going to be the best determiner of value for you – as it will set unlikely expectations. Start the process with a little homework regarding private company sales and values.
