Big public companies trade at a significant premium over small businesses in the same industry because investors perceive big, sophisticated companies as a safer bet than small, owner-dependent companies.
Let’s take a look at the facility services industry. Although most facility service companies are less than $1MM in annual revenue, there are many regional medium size firms and a handful of big publicly traded professional services firms. ABM Industries (NYSE:ABM) is a facility services company with a market capitalization of around $1.81 billion (stock price x number of shares = total value of ABM). ABM’s earnings before interest, taxes, depreciation and amortization (EBITDA) were about $190MM for 2014. To calculate the multiple they used to buy the stock of ABM you simply divide their stock value (market capitalization) by their EBITDA. $1.81B divided by $190MM is a multiple of about 9.53 x their annual EBITDA.
Smaller service businesses trade at much lower multiples. Typical smaller companies in the size range of $1-3 million in annual revenues will sell in the range of from 2-4 times their annual EBITDA. When we look at the average value being offered for companies in this size range, we find the average multiple is approximately of 3 times is more than three times lower than ABM.
When we isolate facility services companies with at least $3 million in revenue, the multiple being offered goes up to 4.97 times pre-tax profit, but it is still just over half of ABM’s 9.53 times.
And in case you thought this phenomenon was unique to the facility services vertical, take a look at the IT services giant Accenture (NYSE:ACN). Accenture reported pre-tax income of $5 billion in 2014 and currently has a market capitalization of more than $64 billion, meaning they are trading around 13 times pre-tax profit, which is more than double the price we see being offered to smaller facility services firms.
So how do you get a public company-like multiple for your business? One approach is to look for a strategic buyer. Unlike a financial buyer that is looking for a relatively safe return on their capital invested (which is the reason investors place a premium on big, stable companies trading on the stock market), a strategic buyer will value your company on how buying you will impact them.
Let’s imagine you have a grommet business predictably churning out $500,000 in pre-tax profit. These days, a financial buyer may pay you around 4 or 5 times earnings – in this case, roughly $2.5 million – if you can make the case your profits are likely to continue well into the future.
Now let’s imagine that a company that sells a billion dollars’ worth of widgets starts sniffing around your grommet business. They think that if they integrate your grommets into their widgets, they can sell 10 percent more widgets next year.
Therefore, your little grommet business could add 100 million dollars of revenue for the widget maker next year – and that’s just year one after the acquisition. Imagine what your business could be worth in their hands if they continued to sell more widgets each year because of the addition of your company.
The widget maker is not going to pay you $100 million for your business, but there is somewhere between the $2.5 million a financial buyer will pay and the $100 million in sales that the widget maker stands to gain next year that is both a good deal for you and for the widget maker.
Premium multiples get paid to big companies, and also to the little ones that can figure out how to make a big company even bigger. If you’d like to know how your company performs on The Sellability Score, simply complete the 13-minute questionnaire by clicking on the Sellability logo below.
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