SBA Business Valuation Methods and Multiples
There are a wide range of methods available to appraisers when considering the market approach for SBA business valuation engagements. The confusion can be great when one considers the sources of data are not all reported in the same manner, the applicability of comparable companies, the unknown factors not reported in the data, and the level of control indicated from each method (controlling versus minority) among other factors. However, all those factors neglect the most important question, what is the appropriate multiple?
This article will focus on the private transaction method, sometimes referred to as the direct market data method (DMDM) or the guideline merger and acquisition company method (GMAC). As you can see the confusion begins at the appropriate labeling of the method. In our reports, we refer to this method as the GMAC method. While there are numerous providers of data for use in the GMAC method, this article focuses on the application of the data found in the DealStats database. Our article will focus on small businesses, defined as businesses with less than $5 million in revenues, in conjunction with an appraisal for SBA 7(a) loan business valuations.
So why DealStats? There are various alternative sources for private transaction data available. Providers include BizComps, Institute of Business Appraisers (IBA), and Done Deals among others. However, DealStats provides the most detailed data regarding each transaction. Therefore, it allows the appraiser to have the most facts in making an informed decision as to the appropriate multiple(s) to select.
In regards to the financials of each company sold in the database, DealStats provides revenue, gross profit, seller’s discretionary earnings (SDE), EBITDA, EBIT, and Book Value. Sources such as BizComps and IBA only provide us with the target’s revenue and SDE. While valuable financial metrics, in some instances the consideration of multiples in relation to gross profit, EBITDA, and EBIT may provide more reliability.
SBA loan valuations have a tendency to be a perfect candidate for the use of this valuation approach and database. This is largely because SBA valuations are usually related to an SBA loan which is funding the acquisition of common, smaller, businesses, such as restaurants, car washes, or daycares. Since these businesses are quite common for smaller size businesses there are a lot of comparable private transactions, which have been executed and reported to DealStats. For example, as of the publication of this article, DealStats has 1,696 reported transactions for full-service restaurants. With this amount of data, one can make a reasonably informed decision as to an appropriate multiple(s) to apply to the business being valued. Overall, the database contains 35,722 transactions as of the publication of this article.
Which Multiple to Select?
In reviewing a business valuation, which uses the GMAC method, there should be sufficient support for each multiple the appraiser selects. Too often there is a tendency for an appraiser to simply select a multiple without much support behind it. The narrative of any appraisal report should provide the reader with ample rationale behind any selection which has a significant impact on the valuation conclusion.
Let’s look at a restaurant as an example. We have selected 130 comparable transactions based upon comparable revenue size and the dates upon which the reported sale took place.  Our filtered transactions provide us with a large range of multiples. We have the maximum, 75th percentile, mean, median, 25th percentile, and minimum to consider, or somewhere in between any of those points. So what is the most supportable multiple?
To understand this better, the appraiser first needs to have a deeper understanding of common industry benchmarks, if available. For restaurants, typically some common rules of thumb apply for certain expense line items as a percentage of revenue.
- Costs of Goods Sold – 26% to 36%
- Staffing – 25% for fast food and 30% to 40% for full-service 
- Rent – 6% to 10%
If the Company we are appraising falls on the low end of this range we have a restaurant that performs favorably to its peers and vice versa for a restaurant that falls on the high end of this range. Prior to even examining the reported transaction multiples, we should have an idea as to where our company falls within its industry’s performance.
Let’s consider other factors that drive the value of a restaurant, such as local demographics. The appraiser should have an idea as to the expected local population and wage growth. Once again, we should have an idea as to our company’s value prior to even reviewing these multiples.
This does not focus on all factors related to the valuation of restaurants, there are many more to consider. However, the above provides an idea as to the factors an appraiser should have already considered prior to reviewing any multiples from private transactions.
The next step in this approach would be to compare the financial performance of the company being valued (subject company) to the private transactions which have been reported. There are a few questions appraisers should be asking themselves for each of these comparability factors:
- Historical Growth Rates – How fast is the subject company growing? Has recent growth been above and beyond industry norms? Higher growth companies tend to yield higher multiples.
- Size Measures– How does the subject company rank in terms of total revenue, gross profit, SDE, EBITDA, and EBIT size? Larger companies tend to support higher multiples.
- Profit Margins – How does the subject company rank in terms of gross profit, SDE, EBITDA and EBIT margins? Going back to our restaurant example, if our subject company has a gross profit margin above the 75th percentile consideration to a multiple above the median should be given.
- Non-Recurring Events – In some instances, it could be appropriate to apply a multiple to the subject company’s projected financial performance. Consider a restaurant that experienced a decrease in revenues due to a fire on the property which resulted in a shutdown for two months. Outside the restaurant industry, consider a business that has agreed to contract with a customer which will significantly change its financial performance.
- Dispersion of Multiples– How volatile are the multiples? A simple coefficient of variation (CoV) calculation can provide the dispersion of the multiples reported. A set of multiples with a lower CoV indicates less dispersion and greater confidence in the data.
- Correlation of Multiples – In some instances, there can be correlations found in the data. For example, there is typically a strong relationship between revenue multiples and profitability. The appraiser should examine if there are any relationships of this kind in the dataset.
Only after the appraiser has considered qualitative and quantitative factors should the multiples be selected. In the valuation of a small business, the typical multiples used are revenue, gross profit, and SDE.
Which Multiple to Rely Upon
The revenue multiple is commonly used as it allows the greatest standalone comparison. As we get further down an income statement, the financials reported can be influenced by discretionary expenses that were not removed when reported to the database.
The gross profit multiple can be useful for companies selling a tangible good as there is greater confidence in the accounting for costs of goods sold, and the gross profit in these instances becomes similar to how we would view revenue. The gross profit multiple should be used in industries where it is considered a key metric. Using our restaurant example, the gross profit multiple would be a reliable indication of value.
The SDE multiple is preferable over an EBITDA multiple as it allows the data to be normalized for any differences in Officer’s Compensation. It is important to note when there is more than one officer, the EBITDA multiple may be more preferable with the caveat being this figure can be distorted from discretionary expenses as noted earlier.
The EBIT multiple may be preferable when valuing a company with heavy reinvestment (capital expenditure) requirements. However, the EBIT can be affected by accelerated tax depreciation and amortization from prior transactions. We caution the use of the EBIT multiple unless the transaction data has a large enough sample size  and a relatively low CoV.
Another reason why the DealStats database is preferable is due to the transparency of the data which allows the appraiser to adjust the sale price. For example, DealStats will report the tangible assets and liabilities which were included in the sale price. Transactions may include assets or liabilities which the appraiser must adjust out from the reported multiple.
In addition, DealStats reports transactions that have occurred on an asset and stock basis. When relying upon multiples that were derived from asset sales the appraiser should add back or deduct any of the subject company’s assets or liabilities which were not included in the sale price. For example, most reported transactions do not include accounts receivable. If the proposed buyer were to acquire accounts receivable the value of such should be added to any concluded value.
Referring back to our example, for a restaurant valuation we may consider the results for selected revenue, gross profit, and SDE multiples. However, an important question remains. Which multiple gets the highest weight? In consideration of the weighting of multiples, we note for very small companies the revenue multiple typically gets the primary weight. ,  The rationale behind this stems from the fact a buyer of a small business believes they already know how much they can reduce expenses by and subsequently improve profitability. The next commonly used multiple for businesses up to $5 million in revenue would be the SDE multiple.  As size increases, many appraisers consider the EBITDA multiple over an SDE multiple.
The market approach for SBA valuations can provide a very defensible conclusion of value when performing a business valuation. For small businesses, we especially favor the use of the transactions in the DealStats database for reasons which are highlighted in this article. In reviewing a business valuation for SBA, or any other, purposes be sure that the report has adequate support for the selection of each multiple in the valuation, and justification for each of the multiples ultimately considered.
If you have any additional questions around the market approach for SBA Business Valuations, fill in the form below and a member of our SBA Loan Valuation team will be in touch.
 There is evidence that the reported multiples do not show a significant change over time, but if there are enough comparable transactions available it could be appropriate to focus on more recent transactions in relation to the valuation date. However, time may be a more important factor in industries forecasted to decline, for example, commercial printing.
 Sometimes referred to as “prime costs”, the total costs of goods sold and labor should ideally not exceed 60%.
 Shannon Pratt, The Market Approach to Valuing Businesses, New Jersey, Wiley & Sons, 2005, p. 138.
 Shannon Pratt, The Market Approach to Valuing Businesses, New Jersey, Wiley & Sons, 2005, p. 138.