The mirage of company valuation multiple expansion
“Multiple expansion” is an idea around company valuation. The idea is, as a company grows from $1mm in annual revenue to $15mm then $25mm and higher, the company valuation multiple will also increase. Two common company valuation metrics are, a multiple of annual revenue and a multiple of EBITDA. I have been acquiring, divesting and valuing recurring revenue businesses in the Internet space for over 20 years. What I have experienced in the sub $25mm private M&A deal market is valuation multiple expansion is for the most part a mirage, it doesn’t exist.
There are a few reasons, but the major reason is simple. In the well populated recurring revenue based Internet service businesses such as MSPs, web hosters, some SaaS providers and the many flavors of cloud service providers …
· there are plenty of buyers with $1-3mm in cash on hand for an acquisition.
· however, there are fewer buyers with $5-10mm in cash on hand for an acquisition.
· and even fewer buyers with $25mm in cash on hand for an acquisition.
So, for a $3mm acquisition, since there are many more buyers who are bidding up the value of the deal … the highest bid ends up being close to or higher than the same revenue/EBITDA multiple as a similar $25mm deal, where there are far less bidders.
In addition, smaller $5mm deals have a very attractive quality that comparable $25mm deals don’t … and that is, the smaller acquisition is far less risky than the larger deal. A common example of this is, if a larger company wants to enter a specific geographic market, maybe expand to the other coast, they can achieve this with either a small acquisition ($5mm) or a larger one ($25mm). Buyers tend to prefer the smaller acquisition even if they have the cash on hand for the $25mm deal … and these buyers are not alone in their logic. If the acquisition strategy is anything other than to simply add scale, buyers many times tend focus on smaller deals.
In closing, when CEO/owners are talking to me about either selling or continuing to grow their companies, I tell them there are many valid reasons to continue to grow the company from a $5mm company to a $20mm company, but if one of the main reasons is multiple expansion … scratch it off the list.
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FYI, I send out a “Weekly Internet M&A Deal List”. This list contains between 30-40 deals. Each week it is sent out to 1,000s of Internet executives and financial buyers around the world. If you would like to see the latest copy, message me. If you would like to be added to the auto weekly version, you can either sign up on my web site or message me and I will add you.