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Home > Tools and Resources > Ask the Expert > How are "Multiples" Determined for Specific Industries in Business Valuation?

How are "Multiples" Determined for Specific Industries in Business Valuation?

By Richard Parker | Diomo Corporation
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Question:
I am familiar with the concept of multiples of sellers' cash flows or owners' benefits as a means to determine value. My question is: How is the multiple determined? With the scarcity of verifiable information on business sales, how does one determine an appropriate multiple for an industry, specifically, the property management industry?

Answer:
If you spend anytime looking at businesses for sale, you'll see multiples that can be "all over the place". However, when a seller has the right professional assistance (i.e. CPA, business broker) the valuations will subscribe to certain historical formulas. Unlike residential or commercial real estate where comparables rule, every business is different and so it is difficult to have any standardization that can be used without margin of error.

Keep in mind that business valuation is an art, not a science.

That being said, there are some general parameters regarding the range of multiples. Many of these evolved from the concept of what a buyer can expect as a reasonable return on their investment and the level of risk to the new owner of each potential venture.

As an example, small businesses will generally sell for 1 - 3 times the Owner Benefit number. However, this is an enormous spread. My own rule is that for any business where "out the door goes the seller, so too go the customers" should be closer to 1 multiple. Examples can be professional practices, businesses with very high customer concentration issues, distribution companies where the seller has a long-standing personal relationship with suppliers/key customers, etc.

On the other hand, businesses with solid fundamentals including good books/records, increasing revenues, a stable marketplace, no major customer concentration issues, ease of transition, growth opportunities, etc, will naturally all trade on the high side at, or even above 3 times.

A typical Property Management business will likely have components of both of the examples noted above and will likely sell near the middle. However, you certainly want to look out for customer concentration issues, contract assignability, potential properties bringing the management function in house, the bidding process to maintain/acquire accounts, etc.

Historically, Property Management businesses sell for a much higher multiple because they generally appeal to a very large buyer pool, they are considered "easier" businesses to operate, and they are pure service businesses with no inventory and can be operated with little overhead. I've seen them sell for 3 - 5 times the Owner Benefit figure but in these cases an earnout and substantial seller financing is usually involved.

Since this is very much a relationship business, you have to consider an earnout deal structure (see prior articles) to be certain that revenue is sustained and key clients remain on board or, if there is a big drop, the purchase price may be adjusted accordingly after a review period.

Although the comments herein outline an extremely wide range of potential multiples, the core strength and possible future threats will dictate a realistic figure. If you want to give yourself a frame to operate in then the more creative the deal structure (earnout, seller financing, specific contingencies materializing) the higher the multiple.

Get more expert advice in Richard Parker's How To Buy A Good Business At A Great Price - the most widely used reference resource and strategy guide for buying a business.

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About The Author
Richard Parker is the author of: How To Buy A Good Business At A Great Price, the most widely used reference resource and strategy guide for buying a business. He has purchased ten businesses in his career and has helped thousands of prospective buyers worldwide learn how to buy the right business for sale. He is also founder and President of Diomo Corporation - The Business Buyer Resource Center.

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