A conversation I often have with firm owners goes something like this:
Owner: My friend sold his firm for four times cash flow. That’s what mine should be worth.
Me: Great. What were the deal terms?
Owner: He didn’t say. I assume it was all cash.
Me: What type of cash flow? EBITDA, owner benefit, or net taxable income?
Owner: Isn’t cash flow just cash flow?
There are three problems with using a tale of a firm sale as a benchmark for pricing a firm.
First, the terms make or break every sale.
Did the seller receive the price in cash at closing? Or did the seller receive 20% at closing with the balance being contingent on future performance? Was the seller required to remain employed with the buyer for two or three years after the closing to get the full purchase price?
A high price that is contingent on future performance – such as achieving revenue after you no longer control the firm – isn’t a high price. It’s a calculated risk.
In that situation, I ask the owner whether she’d be happy selling for the cash portion of the price because it’s the only part that counts. Most of the time, the answer is “No.”
And if you’re thinking you “know” the firm is going to get there, remember someone else will be making all the decisions after the sale.
Next, without knowing the type of cash flow metric used to establish the price, the multiplier is meaningless.
Selling for three times EBITDA (earnings before interest taxes depreciation and amortization) is VERY different than three times owner benefit (which adds owner compensation to EBITDA). Likewise, five times net taxable income might only be two times owner benefit.
So, if the offer is x times ‘cash flow,’ the first thing to ask is what ‘cash flow’ are they talking about.
Finally, the whole premise is based on one situation. While the situation could represent the norm, with only one transaction you can’t know that it does. More data is necessary to discover where this sale fits within the universe of sale transactions.
Is the sale an outlier (either good or bad) and, if so, why? For example, the buyer might have been looking to leverage the seller’s client relationships in another practice area and thereby generate more income than the seller received. Or the seller could have had to sell for a health reason.
Instead, establishing a most probable selling price for the firm requires:
- The terms that the seller is willing to accept,
- An understanding of the financial performance of the firm to be sold, and
- Data about past closed transactions and the financial performance of those firms.
If you’re wondering what you could sell your firm for, call me at 407-649-7777. I look forward to speaking to you.
