While I was in New York in late November, I met with a firm in Rochester that was acquiring a business in North Carolina. In the financial advising business, we normally see that a typical income multiple used to value a business is two times revenue. Verifying this assumption is an article in Investment News, “Advisory firm values slip; big buying small,” which highlighted a 2.31 multiple firms have recently been receiving.
As I spoke to the firm in Rochester, I discovered that it had paid five times EBITDA (earnings before interest, taxes, depreciation and amortization). Since I don’t have the actual numbers, let’s look at an example. Let’s say a firm has $100 million in assets. It charges a 1% fee, so revenue is $1,000,000. EBITDA is $150,000, or 15% of sales. The firm is valued at $750,000, or five times EBITDA (which is $150,000).
Using an income multiple of 2.31, as the Investment News article suggests, results in a value of $2.31 million for our example. The difference between the value of the firm (based on the average multiple) and what was actually paid is thus $1.56 million. The variance could be attributed to many different factors, but, in this case, it was due to having poor financial reporting and procedures in place.
The firm that was purchased could have seen its valuation triple if it had better financials and operating procedures in place. While it takes work to do both, it shows the buyer that you are well organized, focused, and a good steward of the business.
Even if you are not looking to sell your business in the near term, having the process in place could save you and your employees substantial time. But, where do you start? Think about all the crucial components of your business: sales, operations, trading, transfers and billing. Once you define these areas, then you need to make checklists. Any operation that is repeated regularly and require consistency make for a good reason to create a checklist. Checklists are a simple way to ensure things are done the same way repeatedly over time. It also creates efficiencies, because employees have more time to think about creating value rather than worrying about what to do next. For a good read on how checklists can improve operations, check out Atul Gawande’s book, “The Checklist Manifesto.”
As outlined in the book, checklists have been vitally important to everyone ranging from pilots to surgeons. For instance, Chesley Sullenberger, the US Airways pilot that landed in the Hudson River and maneuvered the plane to safety, used a checklist. And, as highlighted by Gawande, surgeons improve their results by following checklists. If it can work for them, it can work for you, whether it’s to ensure that you can value your firm more appropriately or improve your customer service.
Homework: List out your action items that are done on a regular basis and are important to your customers or to your own efficiency. Then ask each person responsible for each of the items in your list to write down what they do step-by-step (a checklist!).