More About Comparables

In my last real post I talked about some of the problems with using comparables, namely that there is not enough information in most datasets to determine how comparable the data really is. It’s a bit like trying to value an orange by knowing the price of 30 small round fruits.

Comparable values often can give you a range of multiples that is so broad as to be meaningless. In a comparables report that I ran for Mfg. – Fabricated Metal Products with sales between $1,500,000 and $2,500,000 I got an average cash flow multiplier of 3.21, and the median was 3.52. “Great,” you say, “so my metal fabrication business with cash flow of $1,000,000 is worth about $3,333,000.” “Not so fast,” I reply, “the range of multiples in the report was from 0.16 to 5.27, so your business is worth between $160,000 and $5,270,000 – quite a range.”

Further complicating the use of multiples is that unlike in real estate deals where comparables are often used, in small to mid-sized business transactions the deal is seldom all cash. When a comparable is reported it may not be clear what the true value of seller provided notes, earn-outs, restricted stock, contingent payments, and so on really is.

There is, however, one big advantage to using comparables. Comparables represent real world transactions. So, if you are going to use comparables, how do you go about doing so in a way that minimizes the problems that we’ve discussed? The answer has two pieces. First, use comparables as only one method of valuing your business among several. Second, select a good source of multiples data. The best source is a business broker that can use past transactions of his own as a source of data. The broker will be aware of how the deal was structured and how similar your business is to the comparable. If you don’t have access to an experienced professional to help with the valuation, has data that is more comprehensive than most. For example, the data includes a field for the percentage of the deal paid in cash at closing. Alternatively, if you’re considering selling perhaps it makes sense to talk to a broker. You can use our website (shameless promotion here) to get up to four proposals from pre-screened business brokers. Ask them how they’ll help you determine an appropriate asking price.

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