Unravelling transaction multiples, business valuation mysteries

By Ken Tarry, From Business in Vancouver Magazine, June 14, 2019

The last 10 years, the North American transaction market has been strong and business valuations have been rising. The result? There’s a high probability that you or someone you know has recently heard the tale of transaction multiples (those broad, all-encompassing financial metrics used to value a company).

Often, the story originates from that neighbour. You know, the one whose lawn is always perfect and who expounds knowledge in the form of useless anecdotes, with little concern for actual facts.

“Did you know the Sumerians invented beer?” he asks.

“I did not,” you respond.

“Well it’s true,” he’ll confirm. And so it goes…

At some point, the conversation might stray into the world of transactions and business valuations. After all, the number of deals in Canada topped 2,200 last year (up 34% from post-recession 2009). One major driver is the significant number of owners selling their businesses as the wave of baby boomers address succession and retirement.

“I hear Bob got 12 times,” he’ll say in a hushed tone, as if he’s just confessed to armed robbery. “Can you believe that?” At which point you can be forgiven for being skeptical.

In the world of private transactions, there is often limited information and much speculation. This is to be expected, because business valuation can be challenging and opaque – a combination of established methodology and sound judgment.

The theory is relatively straightforward: what is someone willing to pay today for a series of future cash flows? But after that, it can quickly veer into the world of discount rates, weighted average cost of capital  (WACC) and other obscure concepts.

So, it’s important not to lose sight of the big picture. Here are five valuation tips to help you maintain perspective:

1. Focus on what’s adding value (not the multiple). Recurring revenue, a diversified customer base, long-term contracts, management depth, low capital expenditures, profitability trends and barriers to entry all add value to your business. If you focus on what adds value and the process you undertake to sell, the multiple you achieve will take care of itself.

2. Every business is different. While it’s temping to apply the same valuation multiple to every business in a particular industry, it just doesn’t work that way. Other deal multiples are just a data point. Your business is different from your competitors’ (and that’s a good thing). You don’t want to be painted with the same brush.

3. Value does not equal price. Valuation is a theoretical number, while price is what two parties agree on. Specific buyer motivations, timing, the sale process undertaken, capital availability, your personal objectives, that big contract you just won; all of it has an influence on price in the moment.

4. Buyers purchase the future, not the past. While parties tend to focus on historical financial statements when negotiating price, remember: they’re only a guide. The future is what matters, and that’s what they’re buying. The more confidence and visibility you can provide into the future, the better your valuation.

5. Pay attention to working capital. It’s boring, I know, but working capital is the engine of your business. Most owners do not manage or monitor working capital as closely as they should, often with material value implications. Managing your receivables and payables more closely, for example, can extract significant value without asking anyone to write a cheque.

So, all of this to say, don’t let your neighbour drag you into the mud of multiples speculation without understanding the facts. And the next time he throws 12 times on the table? Ask him how he calculated the WACC as part of the valuation. Most likely he’ll nod slowly while moving to the other side of the lawn. •

Ken Tarry is the managing partner of Sequeira Partners. He has more than 20 years of experience advising clients in Western Canada in diversified sectors on a wide range of transactions.