What’s a business worth?

More company leaders in the promotional products space have been asking that question amid considerable merger and acquisition activity in the industry.

As owners and executives begin to contemplate the sale or purchase of a business, they want to know how to determine a company’s value.

M&A experts tell ASI Media that each business and particular acquisition presents unique factors that must be taken into consideration to establish value – and thus ultimately the price for which a company will sell. Accounting for these variables is essential in every potential deal.

Still, “while there can be variability depending on the industry and specific circumstances, there are some general best practices and overarching metrics that potential buyers typically consider,” says Jon Morgan, CEO of Venture Smarter, a consulting firm that advises start-ups and small businesses on scaling and growth.

What valuation metrics should buyers analyze and sellers present? Here are eight to consider.

1. Financial Performance Data: Buyers should assess the financial health of a business by reviewing total revenue, revenue growth rates, profitability, gross margin, net income, operating expenses as a percentage of revenue, cash flow and capital expenditure requirements.

The primary sources for this information would be the company’s financial statements, including profit and loss statements, tax returns and balance sheets for the previous three to five years, says Sarah Goodman, founder/managing partner of Eminence M&A Strategies, which provides guidance to business owners seeking to exit their companies. Goodman previously worked for Top 40 distributor BDA (asi/137616) in roles that included director of client services.

“Sellers should have clean financials that have preferably been prepared according to generally accepted accounting principles (GAAP),” states Brian Goodhart, director of M&A advisory services at Capstone Strategic, a Virginia-based firm that consults on acquisitions. “These financials could then be used to determine standard metrics of profitability, such as profit margin and EBITDA (earnings before interest, taxes, depreciation and amortization).”

Sellers take note: Consistency and transparency in financial reporting are crucial, Goodman says. “Discrepancies between the company’s bookkeeping records and formal tax returns can cause confusion during the sale process, possibly diminishing the perceived value of the business,” she shares.

“Prospective buyers will be interested in the company’s growth prospects, so highlighting areas with potential for future growth can enhance the business’s perceived value.” Sarah Goodman, Eminence M&A Strategies

2. Multiples of EBITDA: Keeping on the financials theme, another common way buyers value a business is through a multiple of EBITDA, explains Connor Frischmeyer, managing partner at Auxo Partners, a financial advisory firm.

The EBITDA multiple is a financial ratio based on a company’s annual EBITDA and its Enterprise Value. The ratio takes a company’s enterprise value (which represents market capitalization plus net debt) and compares it to EBITDA for a given period. The multiple can be used to assign a value to the company up for sale.

In this valuation approach, “the ‘multiple’ means that the buyer will pay the company’s EBITDA multiplied by a certain amount,” says Frischmeyer. “EBITDA multiples can vary quite a bit industry to industry and even company to company based on growth rates of the company, expected future earnings, EBITDA margins (higher is better), and a wide array of other variables.” Factors beyond the EBITDA multiple can influence valuation too.

3. Competitive Barriers: A seller can potentially increase their company’s value if the firm has established strong bulwarks that protect its business position. These can include long-term exclusive customer contracts, proprietary products, patents and protected supplier relationships. “In the promo space,” says Goodman, “establishing competitive advantages and protective barriers is crucial.”

Adds Morgan: “Sellers should highlight any intellectual property assets, patents, trademarks or unique technology that provide a competitive advantage. Metrics related to research and development (R&D) investment and innovation pipeline can also be relevant.”

4. Place in the Market: Growth rate compared to industry peers, market share, customer perception surveys and brand strength can also be assessed as part of the business valuation process. “Buyers are interested in understanding a company’s competitive advantage and market position,” says Morgan.

5. Client Roster & Retention Rates: The size, diversity and quality of a company’s customer base should be understood and evaluated as these things can affect a business’s value. “Metrics like customer acquisition cost (CAC), customer lifetime value (CLTV), churn rate and customer satisfaction can provide insights into customer loyalty and long-term revenue potential,” says Morgan.

Expanding on the point, Goodman says that a business’s reliance on a small number of customers or clients in a single industry adds risk and may lessen the value of a firm – something that needs to be considered in acquisition talks. “It exposes the company to market fluctuations and the potential loss of key clients, a risk that buyers would seek to offset with a lower purchase price,” Goodman says.

“M&A is very much a timing dance that ebbs and flows. I expect the end of 2023 to have a moderate amount of activity (in the promo industry).” Jamie Watson, Certified Marketing Consultants

6. The Potential to Grow/Scale: Not surprisingly, buyers are usually keen to understand a business’s growth prospects. Sellers may be able to increase the valuation of their business if they can demonstrate ample opportunity for expansion – and have a plan for making it happen. “Market size, addressable market share, customer acquisition potential and scalability of operations are important factors to consider,” says Morgan.

Goodman adds: “Prospective buyers will be interested in the company’s growth prospects, so highlighting areas with potential for future growth can enhance the business’s perceived value.”

Indeed, she asserts, financial projections are important. Goodman advises sellers to prepare detailed financial forecasts, ideally giving a monthly breakdown for the next two to three years, and be prepared to discuss the projections’ underlying assumptions. “Buyers will scrutinize these forecasts to understand the growth potential and profitability of the business,” she says.

7. Strength of Operations: If a seller has well-documented systems and processes and a good management team, those elements can contribute to the value of the business and should be emphasized. Conversely, would-be buyers should take note if a business lacks such processes and is highly dependent on an owner or a select few people. “A high dependency on the owner could reduce the business’s perceived value as it suggests potential disruptions to operations post-acquisition,” says Goodman.

Buyers can assess – and sellers demonstrate – operational efficiency through information like cost structure, inventory turnover (in the case of a supplier), employee productivity and production cycle times. “These provide insights into how well the business is managed and its ability to generate profits,” asserts Morgan.

8. Macroeconomic Factors: What’s the current general economic climate and how do things look going forward? In the case of a distributor, what’s the relative strength and projected future for key end-markets in which a seller’s business may have many clients? What are projected growth rates for promo and other verticals, if applicable, that a business may be active in? Answers to these questions can influence a business’s valuation.

“Sellers should include industry trends and macroeconomic factors in their presentation to buyers,” says Goodman. “Providing information on the size, growth rate and key drivers of the industry in which the business operates can help potential buyers better understand the opportunities and risks associated with the acquisition.”