If you’re thinking about selling your online business, you have probably heard of valuation multiples. If you haven’t, you should know that they play a significant role in determining the value of your business. But how much do you know about the different factors that can change your valuation multiple, either for the worse or for the better? Informing yourself about how to improve your business’s valuation multiple is a key step in preparing for a profitable exit.

In this article, we first discuss how business valuation works before exploring 11 elements that impact your business’s valuation multiple. These include:

• Past and current growth rates
• Future growth prospects
• Prevailing market and industry trends
• The state of your accounting records
• Clear business documentation
• Single points of failure
• Legal issues
• The age of your business
• Patents
• Automated operations
• The degree of owner involvement

Related Article: What Buyers Will Want to Know About Your Business

How Business Valuation Works

Before we start exploring the individual factors that impact your valuation multiple, it is important to understand how online businesses are valued in the first place. By knowing how value is calculated, you can gain a deeper understanding of how particular characteristics influence value for better or worse.

The SDE multiple method

There are a number of different ways to value businesses, including enterprise value, book value, market capitalization, fair market value, and more. When it comes to online businesses, however, the most common valuation method is the SDE multiple method. According to the SDE multiple method, a business’s value is equal to its SDE times a multiple.

Value = SDE x the multiple.

Simple, right? Unfortunately, not really. A lot goes into calculating an accurate SDE figure and assessing a fair multiple. Even small errors can lead to significantly overvaluing or undervaluing your business.

SDE explained

SDE stands for seller’s discretionary earnings. It is a financial metric that describes the total money-generating capacity of a business, or the total benefit the business provides to the owner. To calculate SDE, start with net income and add back all allowable discretionary expenses or income. These include, but are not limited to:

• Interest
• Taxes
• Depreciation
• Amortization
• Owner’s salary
• One-time expenses

Getting your SDE right is very important. Even small deviations can have an outsized impact on your business value assessment by way of the multiple.

“The multiple is a number that captures tangible and intangible components of business value.”

Understanding valuation multiples

Two comparable companies in the same industry with identical financial metrics can still have different values. Clearly, there are a lot of factors that determine the value of a company other than the seller’s discretionary earnings. These factors are explained by the multiple.

Essentially, the multiple is a number that captures the tangible and intangible components of business value. These components are often internal qualities of the business, but they can also be external conditions such as market forces or exit timing.

Ultimately, your company is worth what the market values it at. That is, it is worth what people are willing to pay for it. When you value your company, you can calculate an exact SDE figure based on your financial data. Your exact multiple is only known after your company is sold.

However, you can (and must) estimate your valuation multiple before you list your business for sale. This can be done by closely examining your business and doing a comparable company analysis to see how it stacks up against other similar businesses.

Given the variety of factors that influence valuation multiples, it is very important to work with a qualified business Advisor, or business broker, to determine an accurate and realistic estimate.

“Ultimately, your company is worth what the market values it at. That is, it is worth what people are willing to pay for it.”

Multiples of what?

When discussing business valuations, it’s important to know that there are different types of valuation multiples. Sometimes you may see a business advertised with a 10x multiple, and others may be listed with a 2x multiple.

Often, these vast disparities in multiple values are due to the fact that different business valuation methods incorporate multiples of different financial metrics. As a result, you can’t directly compare these two business’s multiples and conclude that one is five times better than the other.

Commonly used valuation multiples include enterprise value multiples (or enterprise valuation multiples), equity multiples or equity value multiples, EBITDA multiples, revenue multiples, and more. When using the SDE multiple method to value a company, we are talking about multiples of SDE.

11 Elements That Impact Your Business’s Valuation Multiple

So, what factors impact the way you calculate valuation multiples? Below, we discuss 11 different elements that can raise or lower valuation multiples. By understanding these factors, you can take steps to optimize your business and raise your multiple before listing it for sale.

Past and current growth rates

Buying a business is an investment. As with all investments, the person making the investment is looking to achieve the best possible return on investment (ROI). With businesses, one of the best ways to achieve a great ROI is to buy a business that grows into the future.

How does a buyer know which businesses will grow into the future? One of the best predictors of future growth is past and current growth performance. Therefore, businesses with strong past and current growth trends will be more attractive to prospective buyers. The more attractive a business is, the more competition it will receive, and the higher it will be valued. This increase in value is captured by a higher multiple.

In short, strong past and current growth pushes up valuation multiples, all other things being equal.

Future growth prospects

Past and current growth trends are clearly not the only factors that influence future growth. An educated buyer will carefully examine your business to see if there are any untapped opportunities to drive future growth.

For example, perhaps your marketing strategy could be optimized. If you have gotten by on one or two marketing channels, a new owner could potentially drive significant growth by adding more channels down the road. Or there could be room to launch additional products or services, further driving growth.

The more you can identify and highlight clear opportunities for future growth, the higher your multiple will be.

“Strong past and current growth pushes up valuation multiples, all other things being equal.”

Prevailing market and industry trends

Your business doesn’t operate in a vacuum. Internal business growth trends are not the only thing that shapes your future growth prospects, and thus your multiple. The overall state of the wider economy, and your industry more specifically, has a large bearing on the potential future success of your company.

A healthy overall economy bodes well for your business, making it more valuable to potential buyers. Again, this puts upward pressure on your valuation multiple. Likewise, if your niche or industry is experiencing strong growth, buyers will be more interested in your business.

Of course, you don’t have control over these external factors. If you sell your business during a recession or when your industry is falling apart, your multiple will likely be lower (along with everybody else’s). If you have the luxury of waiting for things to turn around before selling, consider doing so. Only you can decide when is the best time for you to sell your business.

The state of your accounting records

If you were buying a business, would you prefer to purchase one with clear, orderly, and accurate accounting records or one that had poor and disorganized accounting records? If everything else was equal, how much more would you be willing to pay for the former?

Maintaining clear and orderly accounting records makes your business more attractive to prospective buyers. This, in turn, increases its value, and thus, its multiple. Before selling your business, take some time to get your accounting records in tip-top shape.

Clear business documentation

Accounting records are just one aspect (albeit an important one) of your business documentation. Again, the more orderly your documentation is, the more attractive your business will be. Before you sell, make sure you create clear documentation for all business operations, including:

• Standard operating procedures
• Supplier relationships
• Vendor or partner relationships
• Legal documentation
• Business formation documentation

While this can take some time, you will be rewarded with a higher multiple and easier selling experience.

“Buyers are generally willing to pay more for businesses with diversified and stable operations.”

Single points of failure

If any part of your business’s success relies on a single point of failure, potential buyers will be a bit wary of your business. If that point of failure fails, your business could be kaput. As a result, buyers are generally willing to pay more for businesses with diversified and stable operations.

For example, if the bulk of your revenue comes from content marketing, your business could take a major hit if your ranking suffered or Google changed its ranking formula (as they often do). To address this issue, you would need to launch additional marketing channels to diversify your marketing operations.

Before you sell your business, go through your business operations and identify which areas are vulnerable. Then, take the time to diversify your vulnerabilities in order to create a stabler and more predictable organization.

Legal issues

No business owner wants to inherit unexpected legal issues when they buy a business. Before making a buying decision, they will carefully examine your business to evaluate any potential future legal issues. If they detect any, you can expect them to lose interest or make a lower offer.

The age of your business

In general, older businesses are considered a safer bet than newer ones. Since they have a longer track record, they are perceived to be stabler and less likely to fail. Thus, older businesses often have higher multiples than younger businesses, all else being equal.

Patents

If your business is sitting on a strong patent, it could dramatically raise the value of the business by way of increasing the multiple. Recognizing the potential for strong patents to drive future revenues, smart buyers will often be willing to pay more for patent-owning businesses.

On the flip side, if your business operations are potentially trampling on someone else’s patent, it could present future risks. If a buyer recognizes this, they may be scared away or at the very least offer a lower purchase price.

Automated operations

The easier your business is to run, the more valuable it will be. Often, buyers are looking for businesses that produce strong revenues and income but require only minimal effort. The more you can automate operations and reduce owner time requirements, the larger your multiple will be.

There are several ways to do this. For starters, create clear standard operating procedures for all of your business’s operations. The more systematized your business’s tasks are, the easier it will be for a new owner to take over.

Secondly, consider hiring employees or teams to handle the day-to-day operations of your business. This will reduce the amount of time you or a new owner are required to spend managing the business. Again, a business that mostly runs itself is extremely attractive to prospective buyers.

“The easier your business is to run, the more valuable it will be.”

The degree of owner involvement

Lastly, it is important to consider how easy it would be for a new owner to step in and fill your shoes as the owner and operator. If your business relies on your image, personality, or likeness, it will be extremely difficult (or impossible) for a new owner to take the reins. Or, if your business requires an owner with a highly specialized skill set or knowledge base, it may be difficult to find someone qualified to run the business. Of course, both of these scenarios would lower your multiple and the overall value of your business.

Again, it is important to address these challenges before you decide to sell your business. Take steps to remove your image or likeness from your operations, if that is the issue. If your business requires unique skills to run, find and hire individuals with the required skills. That way, they can stay on board when you sell the business and help the new owner succeed.

Conclusion

Many factors impact the overall SDE valuation multiple that your business receives. By understanding these factors and what you can do to shape them, you can work to create a more valuable and sellable business.