Determining Valuation
Typically, a business will sell to purchasers (whether they are an M&A or a Newcastle Consolidation transaction) at a "Multiple" of revenue or Earnings Before Income Taxes, Depreciation and Amortization (“EBITDA”) plus the appraised value of any real estate and real property applicable to the business. Most buyers would prefer to eliminate real estate and any personal real property by transferring title via Quick Claim to the business owner. Other standard variables such as the business’ prior year revenue growth rate, short and long term liabilities, and management retention affect the small company’s valuation. Variables specific to the industry sub sector may also alter valuation.
The next important thing is the Multiple of earnings. Typically, small privately held companies will sell at .8 to 1.2 times revenue or 3 to 5 times EBITDA. The Multiple is dependent on the industry sector. A Multiple of 3 to 5 times EBITDA is also known as the "Price Earnings (PE) Ratio."
There is an unlimited way to determine the price earnings ratio in a private market, but only one way in a public market. The public market will determine the PE ratio through basic supply and demand, so the small business owner doesn't have to be concerned about setting an arbitrary PE Ratio.
Of course one should always try to improve the PE Ratio, before the sale. The higher the revenue growth rate the higher the PE Ratio, the higher the sale price. The only way to increase a PE Ratio is to increase the growth rate of revenues and lower expenses, now and into the future. Yes, you can use pro forma financial projections to conservatively estimate the annual revenue growth rate, with or without additional management and or additional capital. However, illustrations of growth rates using GAAP compliant pro forma financial projections with an influx of new management team members and additional capital is a very positive catalyst to determine the PE Ratio, which becomes an added advantage to ultimately increasing the sale price.