Part 3: Consider Valuation Factors Outside Your Control
How do market timing, interest rates, tax rates, and other factors affect your business’ valuation?
In the last post, we discussed strategies for better measurement and improving your EBITDA. Following those guidelines can help you improve your multiple as well, recalling that business valuation = multiple * EBITDA. A better EBITDA and internal factors such as IP, asset base, your supporting management team, and your specific situation will influence the multiple a buyer is willing to pay.
But, there are many factors outside your control that can greatly influence the purchase multiple. Below are some of the most pertinent ones.
1. Comparable businesses and transactions:
Buyers will typically look at businesses and transactions comparable to yours as a gauge of what others have paid for similar businesses. Buyers will look at transactions in your industry, size range, geography, etc. to determine what a fair market value for the business is. This approach is somewhat similar to buying a house: you look at what other houses sold for in the neighborhood, in a similar size, in similar age to roughly gauge what you may be willing to pay for a house.
Most businesses cannot change the industry, geography, product line, etc. Therefore, these factors determining your valuation multiple is mostly outside your control. But, the M&A world and multiples tend to move in cycles and you can try to time the market so that you sell in an upcycle rather than down cycle. Therefore, it is worth noting here that the current environment is one of the best for sellers. Transaction multiples across most industries are at an all-time high, driven in part by low-interest rates, low taxes, and one of the longest economic expansions in history.
2. Interest Rates:
Many buyers will finance the transaction through some form of a loan. The interest rates charged by banks for these loans can significantly influence the valuation of your business. A lower interest rate means that the buyer can afford to pay you more for your business, driving up the multiple he/she is willing to pay. Drawing on the house-purchase analogy again, if your mortgage rate is lower, you can buy a more expensive home.
In fact, if you want to ensure the best future for your business, make sure you understand how the buyer is financing the transaction and their plans for operation – too high of an interest payment can imperil the business and your legacy.
It is worth noting that in the US interest rates are currently the lowest in history. This low-interest environment started at the end of the 2008 financial crisis, but many economists are skeptical it can continue in the face of more than $27 trillion of US national debt.
Lower taxes drive up business value because they allow the owners to retain more of the business profits, raising Free Cash Flow (recall that EBITDA is a proxy for cash flow, and Free Cash Flow is another important valuation metric). Lower tax rates also promote faster growth as everyone has a higher discretionary income.
As a business owner, you also have a big incentive to sell in a low tax environment. When you sell your business, you will incur taxes which can significantly lower your take-home cash amount after the sale of the business.
The multiple that a buyer is willing to pay for your business is very much dependent on factors that are outside your control. However, the low taxes, low-interest rates, and years of economic growth have driven multiples higher, making this an ideal time for a seller. Such an alignment of factors promoting higher valuations was last observed in 2007. You can see in the chart above that multiples have struggled over the last decade to climb back to 2007 levels. If we have another economic shock and the tides turn, you should be prepared to wait a long time before considering a sale of your business.