The Barbeque Test

I was doing some reading recently and came across a corporate development group who referred to the "barbeque test" they use when determining culture fit. Basically, they ask themselves, "Would we have these folks over to our house for burgers and a beer?"

I'd like to suggest the test works both ways, for buyers and sellers. When interviewing potential buyers, ask yourself whether you'd invite their acquisition team over for dinner. If not, it may be a good indication they won't be the best fit for your company.

Poor culture fit could threaten your company's ongoing success, affecting your ability to get paid on any alternative financing arrangements like seller financing or earn outs.

As M&A advisors, we talk about taking advantage of opportunity and being ready to sell in a "seller's market." And I do think that's good advice for any business, of any size.

Main Street businesses are more likely to sell when the market is hot. But the fact is, the value of those businesses isn't going to change much whether you sell in a down market or one trending up.

It's typically when your business value climbs above $2 million that timing starts to really matter. That's when you want to start building ongoing relationships with an exit advisor so you can keep tabs on your business value relative to current market trends.

A quick primer on multiples: When selling a business, its market value is often measured in terms of "multiples." Businesses with a valuation of $2 million or less are typically measured as a multiple of seller's discretionary earnings (SDE). A business with SDE of $500,000, for example, might sell at a 3.0 multiple for $1.5 million.

As valuations rise above $2 million, we begin using EBITDA as the basis. Multiples in the lower middle market typically start at 4.0 for the smallest businesses in this sector and can rise to eight or more for the larger, most desirable deals.

Small business multiples consistent
Main Street multiples don't shift much. If you have SDE of $250,000 or less, for example, your business will probably sell at a 2.0 multiple. That's the median reported by business brokers for the last six years.

It did climb as high as 2.3 for one year from Q2 2016 to Q1 2017, but otherwise it's held firm at 2.0.

For those of you doing the math, with $250,000 of SDE, that 0.3 increase makes a $75,000 difference in value.

As business size increases, so do multiples. If you have SDE of $350,000 to $650,000, your business will likely sell at a 3.0 multiple. In recent history, we've seen median multiples for that sector jump around a bit more, but again, never higher than 3.3.

So, for these smaller businesses, timing the market isn't going to play a huge role in your valuation.

Remember, though, that we're talking about median numbers here. These metrics are meant to help you get a sense of the market, but getting a valuation for your business is the only way to understand your company's unique value.

Your business could fall above or below the median based on any number of factors such as having a strong management team, clean and reviewed books, diverse customer base, and consistent growth trends. Also, different industries can have different multiples due to several factors.

Lower middle market multiples vary
Now, as we transition into the lower middle market, timing becomes a much bigger factor in a business's valuation. Over the last six years, we've seen median multiples for businesses with enterprise value of $5-50 million vary anywhere from 4.5 to 6.1.

Notably, these multiples correlate fairly well with seller market sentiment, as reported in the Market Pulse Survey. Specifically, we saw the lowest number of advisors reporting the market felt like a "seller's market" at the same time as multiples dropped to 4.5 in Q1 2014.

Median multiples in this sector hit a peak of 6.1 in Q1 2018 and 6.0 in Q1 2019. During those quarters, 77 percent and 81 percent of advisors, respectively, indicated this sector was experiencing a seller's market.

So, let's assume you have $4 million in EBITDA. At a 4.5 multiple, your company sells for $18 million. At a 6.0 multiple, you sell for $24 million. That's a significant difference in valuation. And because these multiples vary with market conditions, business owners in the lower middle market would do well to pay attention to market timing.

Talk to your advisors and keep a pulse on market trends. Know how much your business is worth, when multiple trends are climbing, and when advisors think they might be at the peak. Get an updated estimate of value every couple of years so you can make an informed decision about when to sell your business.