There are several ways to grow a business. One impactful way to quickly grow and sometimes even double your book of business is to acquire another company, but as a small business owner, it can be daunting to think through how you will actually pull off the deal.
Sometimes, even when you make the smartest moves for your given situation, you may end up losing. We recently did.
Lessons Learned from Our Loss
A short backstory: Our company was in the process of acquiring another property management company of about the same size as ours. We were looking to buy their contracts as a bolt-on to our business rather than acquire their entire business name and brand. After nearly 18 months of on-and-off discussions and negotiations, the deal ultimately fell through.
As we reflect now and attempt to diagnose what went wrong and where, it’s also an opportunity to discuss some of the important elements that go into structuring a deal such as a small business acquisition.
Certainly price is a major factor and many small business owners simply can’t compete with large national companies when it comes to paying top dollar.
But there are other ways to get creative in terms of how you structure a potential deal and determine what is important to the seller. In doing so, one important factor you must consider is the business’ multiple on earnings.
Understanding Valuation and Multiple of Earnings
Before even considering a business deal, one of the first things to evaluate is its Seller’s Discretionary Earnings (SDE). SDE is an earnings metric that helps standardize (or “normalize”) a company’s earnings so potential investors can more accurately understand its available cash flow and value.
As business owners ourselves, we consider SDE and think through how much we are willing to pay for it. For the acquisition to be successful, we must be confident that our business can reproduce the current SDE and grow it.
We also must consider the multiple, which is a metric based on comparison. There are many ways multiples can be calculated, but one common way is to take the price or valuation of a company and divide it by its earnings.
Companies with high market values relative to their earning levels have high multiples, whereas a lower priced company relative to its earnings have a lower multiple. Another way to think through multiples is:
- Higher multiples are typically associated with more stable and more predictable cash flows. These businesses may be more autonomous and not require as much owner involvement.
- Lower multiples, meaning businesses that are less expensive, may be more unpredictable, less established and require more owner involvement.
All that said, multiples are a very personal business decision. For us, a lot has to do with our own comfort level with the business itself and how well we think it’s going to work for us.
When we’re valuing a property management company, we are able to calculate with just a few basic pieces of information exactly how much money those new property management contracts are going to be worth.
Given our calculations, the multiple on the seller’s earnings is almost irrelevant because we know exactly how much revenue per door we can generate once the property is set up in our system.
But we weren’t always that confident. Gaining experience as business owners and with acquisitions has helped us grow our business, and we are still learning every day.
How about you? We’d love to hear from you about your experience with entrepreneurship, acquisitions and how you balance risk with opportunity as you evaluate potential new deals.
Get in touch with us at RL Property Management to let us know what’s on your mind, and subscribe to our podcast Owner Occupied to hear more from CEO Peter Lohmann as he discusses other small business and property management topics.