How Much Is Your Business Worth? Probably Not What You Think

But the problem is people have this number in their mind and even when reality is staring them in the face, they've already spent the money, right, on a lake house, on a boat, and the difference between two million and five million is life changing, right? A huge difference, having three million dollars more in the bank. Brokers are to blame, expectations are to blame, and unfortunately reality is the truth.

Yeah, it's a little bit of delusion, right? If you're pulling numbers out of thin air, they might make sense to you. It might be a bit of a wish or a dream, but there's actually a formula. I think we're going to get into the formula later on for how you make these calculations. But I worked for an agency owner and he was doing 4 million, not making a ton of margin, but wouldn't have sold for — 20 million was the number in his head.

It's an inflated valuation out there which was just not grounded in reality. So where does it come from? How do owners get there? Why is it so disconnected from reality? Well, there's three places and all of them are pretty tragic, Jon, right? They hear a story, whether it's at a barbecue, golf course, or whatnot, and one of their buddies sold for 6X. Right? 6X is the multiple, and we'll get into what that actually means, right?

And now everything needs to sell for 6X. Right? So that's the expectation now. What they didn't know is that their buddy had, you know, a substantial recurring revenue, 30% margins and a team that ran without them. They didn't hear that part, right? They just heard 6X, and that was in between bites of a brisket sandwich or, you know, between golf swings or whatnot, right?

And so I really think that, you know, when buddies are telling their story, it should come with a Surgeon General's warning, right? And that buddy at 6X, you know, is one of the very few that happens. So that's the one percenter. Second place is that they confuse revenue with value. So four million dollar ad agency with very little margins and looking for 20 million, right? That's 5X off of revenue. Buyers don't care about revenue. They care about the bottom line. They care about consistency.

They care about cash flow. Those are the things that matter, not revenue. Revenue hardly ever plays any part of the valuation. The third thing is that they want to charge a buyer for their suffering. They want to charge it for the legacy that they built. 15 years of sweat equity, missed birthdays, sleepless nights. A buyer doesn't care about that. A buyer pays for the machine and unfortunately your tears, your blood, sweat and tears, they don't show up in the cap table.

And I'm going to give you an extra bonus one. Number four is brokers. Brokers are the worst at valuing things. They want to get you top dollar. That's the only reason they exist, is to get you top dollar so their fee gets top dollar. So when you're selling for $3 million and the broker has a 10% fee, that's $300,000 the broker for buying you a buyer. If it goes down to 2 million, in reality, the broker loses $100,000.

Their fee is now $200,000. They're always going to say, hey, I think you can get this and we'll see what happens. But the market never lies. The market wants what it wants and that's the way it goes. It seems like it's a mixture of poor education or information, delusion and a little bit of emotional attachment to everything that's been built up. When you combine those things together, it gets crunched up into a, hey, 20 million, that's my number, which makes no sense to anybody.

Let's delve into the mechanic. Except for the owner. Right. Well, except that they'll never realize it. You hold that number in your head and you never get there. It doesn't become a sellable thing at that point. Let's delve into the mechanics. How does a buyer actually determine what a business is worth? You and I have been through this process and we're actively engaged looking at businesses. I find it super interesting, but how does a buyer determine value?

It's a very boring answer. It's a multiple of earnings. It's adjusted EBITDA times the multiple equals the price. Adjusted EBITDA meaning that you might have heard it as a seller's discretionary earnings, SDE, those kind of things. Essentially, if my adjusted EBITDA is one million and I have a multiple of four, then that is four million. That's the price of the company. The multiple is where every dream is made and where every dream goes to die.

So that four million in revenue with one million EBITDA and he wants $20 million, that's a multiple of 20. Nobody in their right mind is going to pay for that. That's where that came from. A $1 million to $10 million business, typically we'll see between 2 and 5X, which is the multiple, so 2X, 5X is a multiple of adjusted EBITDA or SDE. But that's not a range, it's a chasm.

There's a big difference. So if I have $500,000 of EBITDA and I have a 2X or 2 multiple, that's a million dollar check. If I have a 5X or 5 multiple, that's 2.5 million, right? That's a difference of 1.5 million. It's the same business on paper, but it's a completely different boat. You know, we're not buying a dinghy anymore, we're buying a yacht, right? I think the wrong question is, you know, what's my business worth? The right question is, what's my multiple and how do I get it to increase? Right? How do I go from 2X to 4X, right? That could mean millions of dollars out there, right? And that's the lever. Almost nobody is pulling it as to how do I get there. They're too busy yanking on revenue, which by the way, it doesn't move the needle. What moves the needle are gross profit margins, net profit margins, recasted or adjusted EBITDA.

And that's why we talked about revenue being a vanity metric a few episodes ago, right? Like it really is. Revenue doesn't amount to a hill of beans when you're actually turning around to sell your business. But yeah, let's keep digging. What moves the multiple? What makes a buyer pay 4X versus 2X, for example? Well, I think there's eight factors, right? So this is your sticky note material. Hopefully we re-listen to this podcast, but here's the first four, Jon.

I'm gonna write them down. Owner dependence. Okay. Right? Owner dependence. If your business cannot function without you, your multiple drops like a cinder block, right? Buyer is buying a business, not the privilege of having a job with overhead, right? And also, if everything depends on you, it's extremely risky, right? And that lowers the multiple as well. Risk lowers the multiple every time. So we gotta get the business running without you and that will increase your multiple significantly.

Second one is revenue concentration. If 30% of your client, one or two clients is 30% of your revenue because you're doing a business with your cousins, there's a real risk there. That's losing 30% of annual sales, which drags down your adjusted EBITDA, right? So one client leaves, the whole thing leaves, you know, the whole thing just falls apart like a poorly assembled IKEA bookshelf, right? The third thing is recurring or contractual revenue.

So in construction, that would be called a backlog. But also, you know, making sure that we have recurring, you can set your watch to it, you know, revenue. And if 70% of the revenue lives there, you're on a different planet, right? But if you're starting at zero every single January, the multiple's not gonna be there, right? We need to have a backlog. We need to have predictability.

So anything that is boring, predictable, low risk, that's gonna help increase your multiple. So some of these projects... If more thing, these like high earning projects where you have to bid via RFP and you're going through that process over and over and over again, I mean that creates uncertainty, right? In terms of income, sometimes a business model where it's simplified and it's regular and recurring is, I mean that demonstrates the consistency you're talking about.

It does, right? But some of those RFPs might be for a five year duration. So then it becomes recurring revenue. There is some good to that, folks, but if you're constantly having to go out and get the next sale and get the next sale and get the next sale, you're absolutely right, Jon. It's going to lower your multiple. And the fourth thing is cash flow consistency. Go ahead.

We have one more point there because that goes back to the owner as well. A lot of the time it's the owner going out and winning that business, either handshake deals or they're the ones with the relationships and the locale. So you've got to think about that a little bit in terms of if you're removing yourself from the equation, how old is a buyer coming in, understand that, oh, well, we can count on that sales flow for continual ongoing revenue.

So just obviously things to think about as people are preparing. Absolutely. I mean, we worked with one client who was very much owner dependent and we actually increased expenses by bringing in people to take away a lot of the tasks that that owner was doing. So now we were reducing the owner dependency. We also made it a point to diversify the customer base. And so when the person sold, it sold for 1.5X more than it would have just two years previous before doing that.

Right. So worth the cash hit. Absolutely. Absolutely. Yeah. 10,000%, you know, or 10,000%, something like that. It was crazy. So, I think the fourth thing was, is cash flow consistency, right? So we want to make sure that, you know, there's no seasonal panic, that payroll isn't a magic trick in the off season, those kind of things. We want to try to smooth out cash flow as much as possible.

We want to make it boring, predictable, on-time cash flow, using Profit First methodology. So if you are seasonal, right, you've already saved up all your money and now it's predictable cash flow coming in. You have enough money to pay your bills because you've seen it, those kind of things, right? And so, and I cannot stress this enough, the market pays a premium for boring. It always has, it always will.

Awesome. Okay, that's four. What are the others? Let's keep rolling. Clean financials, Jon, right? If the books need a guided tour and an interpreter, it ain't going to happen. I've seen it where books were a mess, tax returns didn't tie out to the financial statements, and it cost somebody a multiple of two. I also saw it the other way where you can hand the potential buyer everything on a platter, everything's clean, everything's wonderful, and they paid an extra three multiple because it's all on how it was gift wrapped.

Think of it as being, I hate to use this term, but audit ready books. They're ready, they're good, and that's what's really going to give you a leg up on your competition. Numero seis, number six, team depth. We have a real management layer. Do we have a visionary, an integrator, department heads? Are they helping us make decisions? Now we have a leadership team structure. That's what we need.

Your leadership team, you, your spouse, and your cousin Jerry, right? That's the difference, right? We are looking for turnkey. Turnkey is premium, you know? So we wanna make sure that we have a team that can make those decisions. And a great way to think about that is if you left and went on a trip for four weeks, would your company run without you, right? And if your company would run better without you, right?

then that's what's gonna get a great potential buyer that's gonna pay for a huge multiple. Seven is growth trajectory. So revenue is not the underlying factor, but we wanna see that the curve is going from left to right in an upward type of direction. That also means that we need to make sure our profitability is increasing as well, right? A lot of people, and that's in the episode of revenue, is that they will sacrifice their bottom line to increase their sales.

Don't do it. Right, we wanna make sure that we are doing, we are scaling things profitably. Yeah. That's the key. Right? We see a lot of businesses on that point. We see a lot of businesses that suddenly have a great year and think, oh, I'm gonna sell. And so maybe they're doing 500 one year, 550 the next year, then 900 the following year. And then they use evaluation.

EBITDA, the SDE, whatever, and then they're using that 900 as the multiple. Would a seller look at it that way? Because it's, you know, they're suddenly having a great year, they think the valuation's gone up and they're gonna get more. That's not necessarily the case though, is it? No, Jon, a seller will look at it that way. Hey, we'll take our best year ever, right? And then give me a multiple of four off of that one.

A sophisticated buyer will take the last three years. What's your run rate? Is it an abnormality? They might weight it a little bit more towards that 900,000, especially if you're forecasting it's 1.2 million and you're four months into it and you're hitting your targets. That's something that you can go to as well. But yeah, the seller, the broker will tell you, you know, base it on the 900,000 year, right, and a buyer would come in and say not so fast, right?

And then the last thing, numero ocho, is industry and market dynamics. SaaS, for example, goes 8 to 12X whereas landscaping is 2 to 3X. Right, you can't change your industry and you can't change your height either, right? And so that's just the way it is. It's also the eye of the beholder, right? So the market is what the market is, right? And sometimes markets get crazy and sometimes markets are cold. Right. Gotcha. So yeah, and that makes a ton of sense. A lot of what you just described, I mean it sounds like years of work. If an owner is like three years say from wanting to sell, is that enough time to put all that in place?

We typically say it takes three to seven years to get ready to be sellable, right? But three years is doable, right? It's not comfortable, but it's enough. So you know, year one, you know, I like to call that the unsexy year, right? Where you're going to clean your books, you're going to restructure your owner's compensation, you got to have Profit First running, document the processes that currently live in your head and would die with you in a car accident, right?

That's what we need to do. Start getting out of owner dependence, right? Nothing really changes outside, everything changes underneath. We want to make it boring but life-changing and that's what the first year is. Year two is the team year, right? We're gonna hire, promote the people who run the business when you're not in the building, right? We want to build up a leadership team so that we can remove you and have business decisions made, you know, for you and that's really gonna show that a potential buyer that, hey, I want to just buy for the cash flow.

I just want to buy for the ATM. I don't want to run this business. I want to have a team that's going to run it for me. Right. And they know what they're doing. And so they're going to get reps under their belt, right, by doing it that way. But the problem is that owners have a really tough time delegating. They have a really tough time, you know, knowing what to do and allowing their teams to make mistakes or to figure things out on their own.

Right. But this is gonna be probably the biggest factor in you getting a higher multiple, is by allowing your team to do that. And then year three is the proof year. You got two years of clean data, consistent growing financials. The leadership team now has gone into their move and it really will demonstrate that the business operates without you. You wanna diversify your revenue and you're really starting to build the buyer's narrative.

What do buyers wanna see? Well, I've got predictive global cash flow, I've got recurring revenue, I have a backlog, those things, right? And you're not even selling a pitch, right? You're selling proof that this works, that your business is a viable thing for a potential buyer, right? And so if this happens, that's when you can start talking about 4-5X, right? If you're not prepared, you're gonna be stuck at your 2X.

This segment is brought to you by Backyard Barbecue Capital Partners. Brian, have you heard of them? Unfortunately, yes. I read their pitch deck. Very impressive. Was it on a paper plate? Nope. It was on the back of a placemat from a steakhouse. That tracks. Their motto is, Your business is worth what you say it's worth. That is the entire problem with this episode in one sentence. They quoted me seven times revenue for a line.

Marketing agencies trade at 1 to 2X. But they said I was special. Of course they did. They also offered to handle the diligence themselves to keep things efficient. That is called fraud. They called it streamlined. Jon, walk, no, run away. They said you'd say that. They said you were jealous. Of what? Of their methodology. Their methodology is asking Steve. That's what I said. They said exactly that.

Backyard BBQ Capital Partners. If your fractional CFO tells you not to use them, that's the first informed opinion you received in the entire process. So I shouldn't sign? Right, right. Okay. Gotcha. That makes sense. I think a little bonus information for sellers too. Most buyers will have what's called a buy box where they sit down and they, because they'll be looking and someone will be looking for years to purchase the right business.

And so they create a buy box with all the right criteria and it's a number of things you mentioned, right? What is the SDE? How many employees? How many years in business? What vertical is it in? Contracts in certain or customer concentration. They'll even go into the price they're going to pay, how much to pay a deposit, how quickly do they pay that deposit back. And they put that generally in some sort of spreadsheet and they have this buy box that they set their weighting to make their call based on all those different criteria.

Is there anything that a business can do just to kind of shape things beyond what we just said, obviously you've gone through all the different mechanics of how those multiples are created, but a three year plan, understanding all the factors of multiple, is there anything else that can be done? Like just thinking through how things are transferable, how the business is sold, asset sale versus an outright purchase of the business.

Anything like that people can do to prepare as well? Well, I think you need to start assembling your advisors. You need personal advisors, business advisors, so that you know exactly, you need outside perspective on things that you can improve. Right? And what you're gonna do with that money once you sell. Right. Right. So, businesses have a buy box and it's, you wanna be the belle of the ball.

Right? You don't even want it to be a question when you put your listing out there or when word gets around that you're looking to start the next chapter of your life. Right, you wanna have everything ready to go. Have your due diligence ready to go. You have all your ducks in a row and that way you can make a nice clean exit and if you have a nice clean exit, you're gonna get top dollar for it.

Yeah, and if you do view it from the lens of a buyer's buy box, I think you get extra insight. Like one example is, you know, we're looking all the time and you dig in, a lot of people want an asset sale versus a share sale because you don't want to buy liabilities in the company, you don't want to buy any potential legal issues. With an asset sale, somebody's just coming in and buying the assets, but when owners and sellers are creating contracts, they don't necessarily think that their contracts need to be transferable.

So that's something you can plan for, right? Like if you have transferable contracts when you make all your deals, then somebody coming in and making an asset purchase, those transferable contracts then go with the business that's purchasing their organization. So that can help. I mean, that's one of the things that we look at because if the contracts aren't transferable and then you have to go in and have conversations with people that you've sold work to, there's a risk there that you don't get the revenue that there is on the books and in the forecast.

So yeah, just some thinking as they go through and plan. All this is great for people who knowingly, thoughtfully are preparing and want to sell their business. What about owners who say, well, I'm not selling this, so it really doesn't apply to me. Exit planning is good business. It applies to you most of all if you don't want to sell. Exit planning is about having options. If I have a job with overhead, I don't have a lot of options at exit.

I'm just gonna shut down the garage, shut down the company, and that's it, because it was a great job for me. I provided for my family, other families, but you know, it's all owner-dependent. So nobody else is gonna buy it, right? So when you're doing these things, here's what's really nice about it, is that if you have lower owner dependence, you get your weekends back. If you have a great team depth, there's no meltdown when you leave to take a kid to the orthodontist or go to Italy for three weeks.

If you have clean financials, you're making decisions based on data, not vibes. If you have consistent cash flow, you can sleep at night without a stomach ache. Building a sellable business isn't about selling, it's about building a business that doesn't need you to survive. So what happens if one of the five D's happens to you where, God forbid, you were to get into an accident, if you have a sellable business, something that runs without you, that's still going to provide money for your family for years to come. Whereas if it's all on you, that thing could collapse immediately. And then not only do you have insurance and medical bills and all that kind of stuff, but you have no income coming in.

Right? So, every owner will exit eventually. Right? Whether it's voluntarily, accidentally, medically, or in a wooden box. Right? Everyone exits. I'm not selling is not a plan. Right? It's a postponement. Right. So, the universe doesn't care about your plan. It will exit you on its own schedule if you don't pick one first. Right. Awesome. So, if somebody's listening, they realize they've got no idea what their business is actually worth, what's the first move?

What do they do? Get a real number, right, not a guess, not what your buddy got, not what you need it to be for the retirement math, right. Back of napkin formula is the adjusted EBITDA, which is your net income, plus your salary, plus your wife's salary if you're paying her, plus personal expenses through the business, and you subtract that out to what you'd have to pay a real CEO to do your job.

So if you're making $500,000 and you would get somebody to run it for you and it's $250,000. That's the difference, it's $250,000 that you add, which is a good thing. And then multiply it by three, let's take an average. And then if you're excited, you might be in good shape. If you're nauseous, congratulations, you just identified the most important product in your business for the next three years.

And then score yourself brutally on the eight factors. And again, these are owner dependence, revenue concentration, recurring revenue, cash flow consistency, clean financials, team depth, growth trajectory, and your industry. Nobody else has to see this scorecard, right? This is for you. And it's really take it as a fact that hey, from this day forward, this is what I know I can work on. From this day forward, if I work on these things, the only thing I'm going to do is put more money in my pocket later on, right?

We eventually exit. And owners who run this exercise come out with a clarity they've never had, right? And knowing is half the battle, right? So I'd rather not guess and I'd rather know where I stand and where I can improve. Yeah, it really puts a focus on what you need to change to be a really solid business doing the right things. Even if you go through the exercise, just to check your numbers and see where you're at. It's going to give a lot of focus on what you need to improve to be a better business. Awesome. Really interesting episode. That's great. Ryan, what's the takeaway here?

Jon, the takeaway is that a buyer doesn't pay for your suffering, your blood, sweat, and tears, right? They're paying for the machine. And the more automated the machine is, the better valuation you're going to get, right? Your sleepless nights, your missed soccer games, it doesn't matter unfortunately when it comes to someone buying your business, right? What survives are the eight factors that I told you about, right, and work on those and you're gonna do okay. You can't change your industry, but you can change the other seven, right? That's the big thing and industries go come and go and leave and vote. So don't worry about it, right?

Maybe now's not the right time to sell. Maybe in three years it will be, right, and then you'll get a higher multiple just based upon that, right? The difference between 2X and 5X isn't luck. It's about preparation and the longer the runway you give yourself, like I said, three to seven years, the better off you'll be, the higher the multiple you'll be, right? And the number one thing is don't listen to your buddies at the barbecue, right?

Get a valuation, stop guessing, and get a roadmap and start working on that plan. Awesome. Great episode. Super interesting. This should be piquing everybody's thought process. That's great. Well, we'll see you next time. All right, sounds good. Adios. Peace out. That'll do it for this episode of From Burnt Out to Bought Out. If anything we talked about today hit home, do us a favor. Share this episode with another owner who needs to hear it. And if you're sitting there thinking they're talking about me, good, that's the first step.

Head to the show notes and book a free triage call with our team. No pitch, no pressure, just a real conversation about where you are and what's possible. You can also find us on LinkedIn and at WeAreSynergySolutions.com. New episodes drop every week. Until next time, stop running the treadmill and start building something you can actually sell.