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Don’t investment bankers just do multiplication? – I can do that

Thank goodness for people – they make me smile everyday.  In the context of my job it is often because they think that all I do is multiply, and didn’t we all earn that in 2nd grade?

Investment banking job description: (1) figure out cash flow of a business, (2) multiply for 4, 5, or 6, and Voilà, your business is worth the product of this multiplication. Trust me folks, it is quite a bit more complicated than that.

I do get a kick out conversations I have with business owners who, during a conversation, will ask, "What kind of multiple do those types of businesses trade for?"  Sort of like, “Hey doc, I have this lump on my side, chemo or surgery?"  Maybe the lump is a mosquito bite or maybe it's a tumor.  Gee, do you want me to give you the old "it's worth five to six  times" answer? That is the proverbial verbal vomit answer.  The real answer is always somewhere between some negative number times cash flow and some number near infinity times cash flow. 

Truth is, if I have some experience in your industry and you answer 10-ish questions for me, I can give you a ballpark number.  A problem arises if you take that ballpark number and sell your business based on it.  An even worse situation happens if you take a ballpark number from your accountant, lawyer, or the guy you share a row with in the locker room at the club, and use that to value your business. 

And yet, this is EXACTLY what happens. 

To the guy that says “businesses like mine trade for 5-6 times cash flow, and I got eight times, so I must have gotten a good deal,” my response is "maybe," and maybe the buyer pulled your pants down and is laughing all the way to the bank.  I would highly doubt that an unsolicited buyer showed up and paid you two turns more than the going rate without being involved in a competitive process.  Could happen.  Highly unlikely.

I am not saying that a seller can’t occasionally stumble on a really good offer, they can.  But even in this case, why not give your investment banker a call and ask? If it is a really, really good, "stop the presses, get a pen, and sign six copies" type offer, I will tell you that.  Does this happen often?  No.  

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