Free Money Not So Free?

April 01, 2021

by a searcher from University of Virginia-Darden - Darden School of Business in Richmond, VA, USA

All, did multiples of purchased small businesses move up in the last year as a result of all the money printing the Fed did? I haven't noticed too much difference but wanted to get a sense of what others are seeing or know.

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Reply by a searcher
in New York, NY, USA

I feel how Sam feels — anecdotally, seems like multiples have creeped up in the last few years. I think it’s only partly due to the recent fiscal policies (e.g. getting SBA to pay 6 months of your loan payments certainly doesn’t hurt), I also think a big reason is the growing prevalence of EtA in general, thanks in part to top B-schools all pushing curricula and resources to advance EtA, and great platforms like this one that help make the information accessible. Even pandemic aside, there’s a lot of macro tailwinds behind more and more millennials (and Gen-Xers) considering EtA. Again, super anecdotal, but when I first started looking at potential small businesses to acquire just 2-3 years ago, I rarely ever “competed” with another searcher. Nowadays, it happens a lot more often. Even for non-brokered deals, I often run into a seller who’s says something like “I also talked another guy a few months ago who’s also doing what you’re doing...”. (If it’s a brokered deal, I always ask the broker at some point before the LOI “so what kind of other buyers is the owner talking to/considering?”, and the brokers usually tells me the general high-level.)

For brokered deals, I also seem to see more “sophisticated” processes recently that are starting to resemble IB-run MM processes, whereas 2-3 years ago, most of these processes seemed to be simpler (more akin to real estate brokering processes).

Again, just one person’s anecdotal two cents. Would love to hear others’ experiences.

Reply by an intermediary
from Boise State University in 800 W Main St, Boise, ID 83702, USA

While it might seem like multiples change over time, in small business sales, the data shows a different story. Multiples tend not to vary much. What changes are the earnings that are applied to the multiples. Thus the values change because earnings change. My comments are based on my observation and from the analysis by Jack Saunders, founder/owner of BIZCOMPS data base of sold businesses. In the 2020 User Guide, he states: "...over time, there is very little difference in the ratios, particularly, the more important Seller’s Discretionary Earnings to Sale Price ratio. These ratios tend to stay consistent, while the earnings they are based upon change, thus causing an ultimate variation in sale price."

Also, a company with larger SDE (Seller's Discretionary Earnings) as a percentage of revenues tends to sell at a lower multiple than a company with smaller SDE as a percentage of revenue. The reason that SDE tends to go down as company revenues increase is because generally the company must add layers of management to grow the company. As small privately-held companies grow in size, multiples will be lower even though earnings will be greater. The numerator and denominator determine a multiple. It is important to understand that a multiple is NOT a valuation indicator. It is only the result of dividing one number by the other and warrants investigation and analysis of both the numerator and denominator.

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