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What is a Multiple and How Do I Pay for a Business?

LisaRileyLisa Riley, Ph.D., CBI, CBB

Principal at LINK Business

All transactions are measured, in one way or another, by cash flow produced. This represents the return for the buyer’s investment.

Larger businesses that have more infrastructure, however, are typically measured by Earnings before Interest Expense, Taxes, Depreciations and Amortization (EBITDA).

Smaller companies are frequently measured by the cash flow available to the owners. This number is referred to as Seller’s Discretionary Earnings (SDE). SDE = EBITDA + 1 FT owner operator salary.

Owners of a closely held business typically have expenses that are discretionary and would not be typical of a more corporate-run business. Significant verifiable expenses, such as personal cell phones for owner and/or the family, personal automobile, etc., are included in SDE.

If an owner gets too aggressive, a bank will not give a borrower credit for these discretionary expenses.

Information is taken from the national IBBA and M&A Source Market Pulse Survey with Pepperdine Private Capital Markets Project and the Graziado School of Business and Management at Pepperdine University. The survey provides an understanding of the market conditions for businesses being sold in Main Street (values $0-$2MM) and the lower middle market (values $2MM -$50MM). For the full executive summary, please go to https://www.ibba.org/resource-center/industry-research/.

The Q4 2015 survey was completed by 348 business brokers and M&A advisors, representing 38 states. Half of the respondents (56%) had at least 10 years of experience in the M&A industry.

It should be no surprise that the businesses being sold for more than $5M have the highest multiples.

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