Valuing a Business Based on Its Revenue
When you need to estimate a business's value, a full-scale appraisal isn't always required. There are "rules of thumb" methods that can provide reasonable estimates, offering a useful starting point for business valuation and pricing. Valuing a business based on its revenue is a legitimate method, but it's crucial to also factor in bottom-line profit or owner discretionary earnings. In this article, we'll explore the times-revenue method of business valuation, discuss its limitations, and explain how and when it should be applied. How to Value a Business Based on Revenue Whether you are buying the business, selling it, conducting a valuation for financing, or exit planning, using revenue as the basis for valuation is a good place to start. The calculation is straightforward and simple – just multiply the businesses revenue by a suitable pricing multiple. But what multiple? And what's included in revenue? Revenue vs. Sales For most businesses, revenue and sales are the same thing. It's the total amount of money collected from customers. For some larger businesses though, there may be other income from non-operating sources like investment dividends or interest earnings. Revenue includes all sources, while sales include only operating sources. For this article's purposes, we will skip that distinction and focus on operating revenue. Valuations attempt to predict future finances by looking at past performance. With that in mind, it’s common to take an average of the past three years revenue as a basis for the calculation. What Multiple? Getting the right multiple is the tricky part of the times-revenue method. Ideally, we would have access to the sales price and financial information of similar businesses that have recently sold, but that is not usually readily available. Most sales of private businesses are transacted confidentially, so the details are not in the public domain. The next best thing is to use industry averages. The average revenue multiple of businesses sold on BizBuySell is about 0.6 – so the average business sells for around 60% of annual revenue. Going one step further, we can look at revenue multiples for distinct types of business. Restaurants, for example, sell for an average of about 0.4 times annual revenue, while breweries sell for nearly 0.7 times revenue. Some other notable disparities: Gas stations (0.46) vs. car washes (1.88) Software/app companies (1.68) vs. software service/IT (0.95) Car dealerships (0.42) vs. towing companies (0.86) Grocery stores (0.33) vs vending machine businesses (1.10) As you can see, revenue multiples can vary quite a bit between different types of businesses. For a complete list of industries and sectors, see our revenue multiple tables. Assumptions and Limitations While using revenue as a metric for valuing a business is a decent starting point, it assumes that the business is operating at the industry average profit margin, and that is a big assumption. While similar businesses may have a comparable bottom line, it's certainly not guaranteed, or even expected. Let's consider two gas stations operating on different corners of the same intersection. Both have annual sales of $1,000,000. Gas station 1 spends $1,000,000 a year on operating costs (rent, wages, fuel, etc.) and gas station 2 spends $800,000. Would you pay the same price to buy gas station 1, which will earn you $0, as one that would earn you $200,000 a year? Of course not. That's why every valuation must include an analysis of the business's bottom line. Business buyers are interested in how much a business will bring its owner after all the expenses. The result is market valuations that hinge primarily on earnings, as opposed to revenue or sales. To read more about profit-based valuation as well as other common valuation methods, see our Guide, How to Value a Business. Why Focus on Revenue? Revenue-based business valuations are a helpful tool as long as the overall valuation analysis considers net income or discretionary earnings. That said, business buyers (and as such, sellers) may lean on revenue-based valuation if they believe they have levers available to reduce expenses and improve business earnings. For example, the owner of gas station 2 above may have access to more favorable pricing on fuel and goods or may be able to renegotiate the lease terms. A business buyer may have the tools and experience needed to improve the performance of a business, and as such may be willing to pay a slight premium over an earnings-based valuation for the sales volume. Keyword, slight. Bottom-line earnings will always trump revenue when it comes to business valuation.
What’s a Buyer Broker Agreement, And What Should You Know Before Signing One?
In the past, a simple handshake could solidify a working agreement between a buyer and their real estate agent. Today, however, buyer's agents present homebuyers with a "buyer broker agreement," a document that formalizes this relationship. If you're new to home buying, the buyer-broker agreement is just one of many documents you'll encounter. For those who purchased homes before the 1990s, this document may seem unfamiliar. Let's break down its importance and the role of a buyer’s agent. The Role of a Buyer’s Agent A buyer’s agent is a real estate professional dedicated to assisting you throughout the home buying process. They have a fiduciary responsibility to ensure you understand the contract language, choose the right contingencies, and avoid being taken advantage of. They also help determine if the home is worth the asking price and assist in making offers. What is a Buyer-Broker Agreement? A buyer-broker agreement is a legally binding document that protects both the buyer and the buyer’s agent. It outlines the agent's duties, the terms of the agreement, and how the agent will be compensated. There are different types of buyer-broker agreements, each with specific terms: Exclusive Right-to-Represent Contracts: The most common type, where you agree to work exclusively with one agent for a specified period. You may be responsible for the agent's commission, although sellers often cover this. Nonexclusive Not-for-Compensation Contracts: These can be terminated at any time and allow you to work with multiple agents without owing compensation. Nonexclusive Right-to-Represent Contracts: These state that you will compensate the agent if the seller doesn't, but you can still work with other agents for properties they haven't shown you. Key Components of a Buyer-Broker Agreement Duties: Specifies the responsibilities of your agent, including showing properties, explaining documents, helping with offers, monitoring contingencies, and supporting you on closing day. Term Length: Defines how long the agreement lasts, typically six months but can vary. This is a negotiable term. Termination: Outlines how either party can terminate the agreement and any required notice or fees. Compensation: Details any retainer fees and the commission structure. The seller usually pays the agent's commission, but in some cases, you may be responsible. Representation: Clarifies the type of representation, whether designated or dual agency. Dual agency, where the agent represents both buyer and seller, is not legal in all states. Exclusivity: States whether you will work exclusively with one agent or have the flexibility to work with others. Property Description: Defines the type of property and price range you're seeking, potentially allowing you to work with another agent for different property types. Conclusion Understanding the buyer-broker agreement is crucial for a smooth home-buying experience. This document ensures that both you and your agent are clear on each other's roles and responsibilities, providing a structured framework for a successful partnership.
Do Elections Impact the Housing Market?
The 2024 Presidential election is just months away. As someone who’s thinking about potentially buying or selling a home, you’re probably curious about what effect, if any, elections have on the housing market. It’s a great question because buying or selling a home is a major decision, and it’s natural to wonder how such a major event might impact your plans. Historically, Presidential elections have only had a small, temporary impact on the housing market. Here’s the latest on exactly what’s happened to home sales, prices, and mortgage rates throughout those time periods. Home Sales During the month of November, in years when the Presidential election takes place, there’s typically a slight slowdown in home sales. As Ali Wolf, Chief Economist at Zonda, explains: “Usually, home sales are unchanged compared to a non-election year with the exception being November. In an election year, November is slower than normal.” This is mostly because some people feel uncertain and hesitant about making big decisions during such a pivotal time. However, it’s important to know this slowdown is temporary. Historically, home sales bounce back in December and continue to rise the following year. In fact, data from the Department of Housing and Urban Development (HUD) and the National Association of Realtors (NAR) shows after nine of the last 11 Presidential elections, home sales went up the next year (see graph below): The graph shows annual home sales going back to 1978. Each year with a Presidential election is noted in blue. The year immediately after each election is green if existing home sales rose that year. The two orange bars represent the only years when home sales decreased after an election. Home Prices What about home prices? Do they drop during election years? Not typically. As residential appraiser and housing analyst Ryan Lundquist puts it: “An election year doesn’t alter the price trend that is already happening in the market.” Home prices are pretty resilient. They generally rise year-over-year, regardless of elections. The latest data from NAR shows after seven of the last eight Presidential elections, home prices increased the following year (see graph below): Just like the previous graph, this shows election years in blue. The only year when prices declined after an election is in orange. That was during the housing market crash, which was far from a typical year. Today’s market is different than it was back then. All the green bars represent when prices rose the following year. So, if you're worried about your home losing value because of an election, you can rest easy knowing prices rise after most Presidential elections. Mortgage Rates Mortgage rates are important because they affect how much your monthly payment will be when you buy a home. Looking at the last 11 Presidential election years, data from Freddie Mac shows mortgage rates decreased from July to November in eight of them (see chart below): Most forecasts expect mortgage rates to ease slightly throughout the remainder of the year. If they’re right, this year will follow the trend of declining rates leading up to most previous elections. And if you’re looking to buy a home in the coming months, this could be good news, as lower rates could mean a lower monthly payment. What This Means for You So, what’s the big takeaway? While Presidential elections do have some impact on the housing market, the effects are usually small and temporary. As Lisa Sturtevant, Chief Economist at Bright MLS, says: “Historically, the housing market doesn’t tend to look very different in presidential election years compared to other years.” For most buyers and sellers, elections don’t have a major impact on their plans. Bottom Line While it’s natural to feel a bit uncertain during an election year, history shows the housing market remains strong and resilient. For help navigating the market, election year or not, let’s connect.
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