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M&A POLL

Will Business Values Increase Over Next 12 Months?

Substantially - 10%
Moderate - 31.4%
Stable - 30%
Decrease - 24.3%
Plummet - 4.3%
The voting for this poll has ended on: 06 Mar 2012 - 21:24

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M&A Home -> EXIT STRATEGIES INDEX -> BETTER VALUATION FOR YOUR BUSINESS THROUGH HIGHER REVENUE OR HIGHER EARNINGS?

BETTER VALUATION FOR YOUR BUSINESS THROUGH HIGHER REVENUE OR HIGHER EARNINGS?

Mergers & Acquisitions – Better Valuation for your Business for Sale from Higher Revenue or Higher Earnings

When an M & A advisor, investment banker or a business valuation company determines a value for a business for sale or acquisition, they consider multiple factors.  But, the most important factor the business M & A intermediary will utilize when valuing the acquisition is the financials of the business for sale.  How do you make your financials more attractive to a potential acquirer?  Are your decisions affecting your Exit Strategy for your business?”  Most M & A advisors will tell you that it is all about profit, the more you make, the more you will get for your business for sale.  The facts do not support this myth.

A critical trade off with many product lines, customers, or strategies is the age old revenue vs. margin argument.  Is it better to start a product line which will increase revenue and have a detrimental effect on your profit margin, or is it better to take on a large customer, even though they demand a steep discount on your products?  For the purpose of this article, we will ignore the effect of this decision on the daily operation of your company, and focus solely on the effect of this decision on the value of your business as you prepare for a business sale.

The answer is clear. Revenue wins.  The effect of higher gross sales will have a greater effect as you go to sell your business, versus the detrimental effect on the value of your business which will come from a lower margin percentage.

Princeton Capital determined this by compiling information from a variety of sources, including Pratt’s Stats.  Princeton utilized the most important financial metrics, the multiple of Revenue to the Sale Price, and the multiple of Earnings to the Sale Price.  These multiples are computed by taking the sale price and dividing it by the amount of earnings or revenue.  For example, if a company sells for $10 million, and has an EBITDA of $2.5 million, that company sold for a 4x’s multiple of EBITDA or had an earnings multiple of 4.  If that same company had revenue of $12.5 million, and sold for $10 million again, the company sold for a 0.8 multiple of revenue (10 / 12.5), or had a revenue multiple of 0.8.  We aggregated information from business sales and broke the results down by a range of revenue amounts, and a range of EBITDA amounts.

The businesses sold in the lowest revenue range received a value based on a multiple of Selling Price to EBITDA (earnings multiple) of 3.81 for their businesses on average.  For the highest revenue range, the businesses were sold for a value that was equivalent to a 6.99 earnings multiple on average.  Princeton then categorized the businesses in the same revenue ranges, and determined the value they received based on a multiple of Selling Price to Revenue (revenue multiple).  The revenue multiple for the lowest range was .47, and the revenue multiple for the highest range was .55 on average.  We then took into account the decrease in profit margins as these businesses increased in revenue.  The profit margins for the businesses in the lowest range averaged 12%, and the higher range had average profits of 5%.

The results show that the increase in revenue has a much greater positive effect on the valuation of a business for sale then the negative effect from loss of profit and profit margin.  The revenue multiple increased by 83% from the lowest category to the highest.

What does this mean to my business?  When making decisions about a new product, service or growth strategy, you should value increased revenues over decreased profit margins.  For example, if your company has annual revenue of $4 million, all else being equal, according to our study your company will be valued based on a earnings multiple of 4.8 and a revenue multiple of 0.47.  Assuming your company has the average profit margin of businesses in that revenue range of 8%, your company is earning approximately $320 thousand per year.  Therefore your company is worth $1.88 million based on revenue, and $1.53 million based on your earnings, or approximately $1.7 million.

In one scenario, you can begin producing a new product or service that will help you maintain your profit margin, and increase revenue by $1 million.  Utilizing the above, your company is now valued at $2.13 million.  In the second scenario, you decided to take revenue over profit margin.  You went with a product that earned only 4% margins, but had an additional $2.0 million in revenue, making your businesses average margin 6%.  The additional revenue puts your company into the next revenue range, and you will be valued at higher multiples.  Instead of your business being worth $2.13 million, your company is now worth approximately $2.9 million, a 36% increase!

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The moral of the story is, go with revenue over margin to get a better value for your business.

We would love to hear your thoughts – please go to http://www.princetoncapitalllc.com/valuation-articles

 

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