Many businesses suffered badly due to the economic restrictions and contraction of business activity related to the virus panic of 2020 and 2021.
Many businesses failed during this time or in the process of recovering failed or are now failing.
But many businesses that survived emerged from those grim days with a blockbuster year. In some cases, it was the best year ever for business, driven by pent up demand bursting forth, price inflation, and many new projects coming online. This led to higher revenues and profits.
For many business owners contemplating the sale of their businesses, this prompts the thought: “Since we just had our best year ever, this is a good time to sell.”
This thought seems very reasonable, but for many business owners selling in this situation would be a mistake.
What the Buyer Will Think
Sellers do not want to be valued based on the worst year they have ever had. Likewise, buyers are reluctant to pay a purchase price based on the strongest year the business has ever had.
Buyers tend to be skeptical. Mid-market private businesses are generally some of the riskiest investments. Buyers don’t want to pay more than is reasonable given the prospective risk and returns.
When a business has its best year ever and is looking to sell, the seller will face a trust gap with the buyer. The buyer will simply not value the business based on the best year ever if he expects weaker performance next year. He will tend to hedge his bets by considering an average of the last few years – which will include the best year, but also some years that are, by definition, “less good” than the best year.
You need to consider the buyer’s perspective and how you would reply to the following questions:
- What evidence can you show that this higher level of performance will continue?
- How can I be confident that this isn’t just a temporary ‘bump’ driven by some external factor that the business cannot control?
Millions on the Line
Your outcome will tend to be much stronger if your performance is consistent – or, even better, consistently improving.
Consider the following financial summary. While the numbers are made up, we have seen similar patterns with various client’s post-virus panic.
| 2019 | 2020 | 2021 | 2022 | 2023 | |
|---|---|---|---|---|---|
| Revenue % Growth | 9,700,000 | 6,200,000 -36.1% | 7,100,000 14.5% | 7,500,000 5.6% | 11,800,000 57.3% |
| EBITDA % Growth | 800,000 8.2% | (45,000) -0.7% | 225,000 3.2% | 950,000 12.7% | 2,240,000 19.0% |
You can see 2023 is the strongest year in this period by far. Not only is the EBITDA margin % the highest, but the revenue is highest so that margin percentage translates to a much bigger operating income.
The problem is that the buyer’s will be skeptical about the repeatability of 2023’s performance. Consider some of the averages:
- Five year, 2019-2023: $834,000
- Three year, 2021-2023: $1,138,333
- Two year, 2022-2023: $1,595,000
A 4.0 EBITDA multiple would give us the following when applied to these averages:
- Five year, 2019-2023: $3.34 million
- Three year, 2021-2023: $4.55 million
- Two year, 2022-2023: $6.38 million
You can see there are millions of dollars on the line depending on how the buyer balances risk by putting less weight on the best year.
Without a very strong argument that the most recent year is the best representative of current and future business realities, potential offers will much lower than otherwise.
Sell When You Have Several Strong Years in a Row
As you can infer from the previous illustrations, the situation improves significantly when the business has several strong years back-to-back and worse years become an increasingly distant memory.
What if our imaginary business owner waits a bit and notches another year. It doesn’t even have to another best year ever; it just has to be a strong year. Consider:
| 2019 | 2020 | 2021 | 2022 | 2023 | 2024 | |
|---|---|---|---|---|---|---|
| Revenue % Growth | 9,700,000 | 6,200,000 -36.1% | 7,100,000 14.5% | 7,500,000 5.6% | 11,800,000 57.3% | 10,400,000 -11.9% |
| EBITDA % Margin | 800,000 8.2% | (45,000) -0.7% | 225,000 3.2% | 950,000 12.7% | 2,240,000 19.0% | 1,800,000 17.3% |
Let’s imagine we rack up another strong year in 2024.
Compare the three-year averages. When the best year ever had just been completed, for 2021-2023 we had an average EBITDA of $1.14 million. At 4.0x EBITDA, that’s $4.55 million.
But with another great year for 2024, the three-year average shifts forward. We now have an average EBITDA of $1.66 million. At 4.0x EBITDA, that’s $6.65 million.
Now imagine another year. Again, it doesn’t need to be the best year ever. It can merely be roughly consistent with the previous year:
| 2019 | 2022 | 2021 | 2022 | 2023 | 2024 | 2025 | |
|---|---|---|---|---|---|---|---|
| Revenue % Growth | 9,700,000 | 6,200,000 -36.1% | 7,100,000 14.5% | 7,500,000 5.6% | 11,800,000 57.3% | 10,400,000 11.9% | 11,200,000 7.7% |
| EBITDA % Margin | 800,000 8.2% | (45,000) -0.7% | 225,000 3.2% | 950,000 12.7% | 2,240,000 19.0% | 1,800,000 17.3% | 1,900,000 17.0% |
Now if we apply a 4.0x multiple to the 2023-2025 average, we get $7.92 million.
At the risk of simplifying the issue a bit too much, think if you were in this situation.
- Would you imagine that it’s worth getting another year of strong performance to add a couple million more to the enterprise value of your business?
- What about investing two more years to add increase the value of your transaction by more than three million dollars?
You should not rush to sell your business just because you just had your best year ever.
However…
Is it Ever Possible to Sell Based on the Best Year?
In some situations, you can make a strong case to a buyer that the best year is most representative of future performance expectations.
This is often because there has been some categorical change in the business, generally related to special contracts with customers or a major evolution in business capabilities.
For example, you can imagine a company getting a big new contract to produce 20,000 widgets per year for the next five years or becoming the exclusive service provider for a major client in a key geographical area.
These cases require an especially compelling story and strong evidence of the businesses’ evolution in advance of being validated by some consistency of actual financial results over time.
Conclusion
Many business owners want to sell when they’ve had their best year ever. This is a natural instinct.
But to get the highest transaction value for a business, buyers need to be confident the future is bright. A very strong year after a few years of weaker performance years is encouraging, but it raises the concern that it’s a one-time extraordinary event.
The hardest part about selling your business is reducing the perception of risk. Without corresponding support to strengthen the future projections, having the best year ever can create a lot of perceived risk for the buyer.
The MAXIMA Group has been helping clients sell businesses for more than 27 years. We have developed a time-tested system to guide you through the process — enhancing value, increasing peace of mind, and providing a clear understanding of what motivates buyers.
Contact us today to get started.
