It’s no secret that the value of most businesses tanked during the Great Recession. Many small business owners were not able to survive, losing not only their business but in many cases, a lifetime of savings. Even those businesses that remained post-Recession tended to suffer several years of woeful Profit and Loss statements, making the business difficult if not impossible to sell.
The value of the average small business in the market is largely determined based on cash flow, measured by historical financial performance, meaning that the business could only be sold at a discounted value until its cash flow recovered. But what about cash flow multiples as a determinant of business value? If businesses are commonly valued by buyers based on some multiple of cash flow (and they are), reduced cash flow will of course suppress the value of the business. But what about the multiple applied to cash flow, does that change over time?
As a simple example, take a business that generated net cash flow of $100,000 in 2004 through 2006. If that business were valued and sold in 2007, $100,000 cash flow would seem to be a good proxy to predict future cash flow the business will generate in the future. If that same business generated $100,000 cash flow in 2013 through 2015, would it have the same value if sold in early 2016?
Data collected by Business Valuation Resources and published in its Pratt’s Stats Private Deal Update reveals that valuation multiples do change over time, and that valuation multiples have not yet recovered, at least as of the end of 2015. Applying median multiples from the Pratt’s report, a business doing less than $1 million in revenues with $100,000 cash flow would have sold for $271,000 in 2006, and just $174,000 in 2010. In 2015, that same hypothetical median business would have sold for $212,000, still down significantly from the high water mark in 2006, but substantially recovered from 2010.
At $1 million to $5 million annual revenues, a business with $500,000 cash flow sold for $1,640,000 in 2006, but just $1,260,000 at the market low in 2009. In 2015 that same hypothetical median business sold for $1,400,000, still well down from the high water mark in 2006.
The data suggests that valuation multiples have recovered since lows in 2009-2010, yet still have a way to go. Perhaps more importantly, business cash flows are proving to have recovered in large measure, and many small businesses are doing quite well in the current market.
Data used in this article is median data for all types of businesses, and business value multiples will vary significantly from one industry to another. The definition of cash flow used is “seller discretionary earnings”, which is a measure of cash flow determined by adding back certain expenses to net income, including depreciation, interest, certain non-recurring expenses, owner compensation and benefits, and discretionary expenses.
An excerpt of the data from the Pratt’s report for 3Q2016, referenced in this article, is reproduced below:
|MVIC/Seller’s Discretionary Earnings|