Valuations and Multiples

Often, the first and biggest question on the minds of someone contemplating a sale is “How much money am I going to make?” There’s no exact formula for this, but there are general guidelines and heuristics you can follow to come to a conclusion about the value of your company. And while there are many factors that go into a valuation of your company, the biggest are typically your financial history, your financial projects, and the multiple related to your revenue or earnings.

Preliminary financial model

To arrive at a valuation, you’ll need a comprehensive financial model. This is something your banker will create in close collaboration with you (and your CFO, if you have one), and here are some of the things it will include:

Three or four years of historic, real revenue and earnings data

A buyer is going to want to see steady (and hopefully, better-than-linear) growth, so they’ll want to see three years of historic data. They’ll look for this in aggregate, month by month, and organized by client. The more you organize yourself now, the less time you’ll spend waiting for either your banker or CPA to make sense of your mess. As our company grew I learned how to keep better financial books, but my early organization was… not great. I didn’t adopt Quickbooks in earnest in the first few years of our business, and so as our financial modeling started, I had to move information from various spreadsheets into a central place. It’s time consuming, but I found it cathartic as well: it was a good “walk down memory lane” for me to see just how much the company had grown and changed.

A projection of growth for the next two or three years

Your company valuation is going to be based on not just where you’ve been, but where you are going, and the likelihood that you’ll get there. Your financial model will include a forward-looking view of growth, likely for the next two years.

There’s a dance that plays out here between “realistic” and “optimistic.” You want to present a very positive view of ability for growth, because it’s attractive to a buyer and because it will increase the valuation of your company. But you’ll be held to the numbers you are presenting, and it’s very likely that a portion of the money you will earn from the sale will be tied to your achieving those projections.

A buyer will be looking not just for growth, but also relative predictability. Where possible, you’ll see your financial model morph and shift to become less lumpy and more consistent. This, again, is a dance: will you actually be able to deliver on a model that has that type of uniformity?

Cost of sale (including real salaries and supporting salaries for projected growth), and expenses

Your historic and future-casting forecast will also include your expenses, with a particular lens on salaries. In a service business, the majority of our expenses are in our people (and the building they sit in), and if you project growth in the future, you’ll need to propose realistic growth in your headcount expenses, too.

Part of these costs will also come from unexpected places. Gavin described unexpected overhead—“internal taxes”—that they weren’t expecting pre-sale, but that suddenly had a material impact on their numbers. These are points to probe on during negotiation, and to get in writing. What fees or expenses are shared across an organization? How much are they? And when, and how much, will they change in the future?

I’ve also found that salary expectations can vary tremendously in different industries. We’ll hear later from Crystal Rutland who explains how, when she sold Particle Design to Wind River, she had to make a concerted effort at the board level to pay her employees what she forecasted.

Add backs

An “add back” is a strange element in a financial model that is used to improve the way your historic earnings look. These are one-time expenses that are, theoretically, anomalous; these are costs that are removed from your revenue (making your earnings look higher), because the acquiring company won’t ever have to incur them again.

For example, if you held a large event like a conference and spent $100,000 on it, and that conference will never happen again—it was a one-time activity—you can deduct that from your expenses in the year in which it was held.

This is a lever that gives you a little more control over how your company is perceived, and a little more finesse over showing a consistent, non-lumpy burn rate. But these add backs have to be real, and too many of them set off alarm bells with buyers.

A set of assumptions that support your projection

If you’ve steadily improved your revenue by 15% year-over-year, it will seem highly unrealistic to suddenly project continual 40% growth post-acquisition, and a buyer will look for a narrative of your assumptions to explain that growth. Are you going to change your marketing strategy? How do you know it will work? Have you been turning away work, but now you feel you’ll be able to handle that growth? Can you show examples? These assumptions may be listed in a separate document; more importantly, you’ll need to be able to speak to them confidently and consistently in-person, and show real examples to support your expectations.

One big assumption you may make is that you’ll be leveraging the buyer’s sales team or pipeline to achieve new revenue targets. If that’s the case, it’s important to understand, in detail (and captured in writing) how that will work, what will be made available to you, and a realistic view of what upside that might bring. As you’ll see in our next interview, Christian Barnard ran head first into competing sales approaches post-acquisition, and so any assumption of co-selling in support of higher revenue went out the window.

Notes to explain revenue recognition methods

Gavin described encountering a new accounting format that changed the way revenue was recognized, and that meant that he didn’t hit his numbers: revenue he expected to get in a current year would actually be recognized in the subsequent year. Having supportive notes on your current profitability approach will help bring these differences to light during negotiations, rather than after it’s too late.

These are common recognition methods:

  • Revenue is considered “earned” when money is received in the bank. This is not a great approach, because all of that money is at risk and is a liability, and your banker will have you change this (and that may be a pain, historically, because you’ll have to revise all of the historic recognition in the model).
  • Revenue is considered “earned” when the work is done. This form of accrual implies that you are tracking what “done” means. If your work is deliverable based, that’s fairly easy: done means that the artifact (the comp, wireframes, powerpoint, product design) has been handed off to the client. If your work is billed hourly, done means when the hours have been burned.

But in both cases, you’ll need to be prepared to substantiate your method during diligence: you’ll need to show contracts with deliverables and dates assigned that match with invoices, or utilization reports that show hours worked per project. In many small companies, it’s common that designers work on multiple projects at once. Real time tracking, through an automated tool, will make it much easier to show revenue was recognized as described.

  • Revenue is considered “earned” when the work is done and the money is in the bank. This method of cash accounting is theoretically the easiest to prove, but gets messy for work in progress, or clients who are consistently delinquent in their payment.

Whatever the method, be prepared to talk about it with confidence, and to show examples that support how it’s been applied consistently.

Valuation: The Big Number

Now that you have a pretty strong idea of your finances, and a good prediction of where they’re going, you can arrive at a valuation: the Big Number. It’s this number from which you negotiate; once the number is established, it’s very difficult to change it in your favor (although, as you’ll see in some of our stories, it’s very easy for the potential purchaser to change it in their favor). The way the number is calculated can seem complicated, and while there are guidelines and heuristics for it, there’s a lot that’s very subjective and open to interpretation. But the biggest factors will be your revenue, your earnings, your contracts and your employees, with the largest weight on the finances. And the biggest lever will be on the “multiple.”

Notes to explain client consolidation and anomalies

It’s fairly common for a small services company to rely on one or two key anchor clients. For example, you’ll later read that Max Burton, who sold his company to Fjord, worked very closely with Carnival Cruise Line and it was his major account. This speaks to the strong relationships you form during your work, which is great—but it presents a risk to a prospective buyer: what if that client goes away? If you can show a pathway to growth of alternative clients, or broad penetration in that anchor client’s organization (working with multiple business units and stakeholders), it will help minimize fear of this consolidation.

An additional red flag for a buyer will be seeing an anomalous project value. If you consistently sign projects that are $100,000, and then have a single project that you signed for $500,000, you’ll be asked to explain the unique nature of the program.


The result of all of the financial modeling is to arrive at real revenue and EBITDA numbers, but these numbers don’t translate directly to the value of your company; instead, they act as one of the key baselines upon which you can negotiate. To get to the financial value based strictly on your financials, your banker will identify a multiplier against your numbers. And ideally, your multiple is high and positive, although a negative multiple is sometimes applied for a company that’s lacking leverage or that looks like it’s in poor shape.

What to expect

A simple example shows the power of the multiple. If your revenue was one million dollars, a 1x multiple values your company at a million dollars. 2x indicates a value of two million, and so-on.

You’ve probably heard of massive valuations of internet startups. These valuations are often based on multiples of 5x for slow growth startups, 10x for a mid-growth company, and even 20x for startups growing like unicorns. But typically, service companies like design consultancies are valued anywhere from 1x to 3x revenue. The reason for the lower valuation is because of the constraints on scaling; theoretically, a product company can scale their revenue at a much higher (and even exponential) rate than their expenses, while a service business runs into a linear relationship between revenue and salaries.

1x and 3x revenue is still quite broad, and this is your room for negotiation. Often, the figure that’s selected is based on comparable companies that have sold recently: their size, their revenue, their location, and the type of work they do. The rub here is that those figures aren’t always publicly shared, and so you’ll lean heavily on your banker to provide the initial number.

Sometimes, multiples are based on earnings instead of revenue, and these multiples may be 6x or 7x. Theoretically, a valuation based on revenue indicates that the company is able to sell work and less emphasis is placed on margins; this might be a strategic acquisition, where the operational efficiency is less important than a strong brand and reputation.

You will be held to this later!

The biggest takeaway of the financial modeling and multiple conversation is that this valuation number acts as a definitive flagpole that is really hard to move later. When you’re working on these financial issues, it’s very early in your sale and it’s easy to gloss over just how binding and lasting this calculation is in the process. But once a financial model is presented to a prospective buyer, and once your banker has a good view of how you’ll be valued, it’s unlikely you can walk it back. Take your time to get this right, even if it means slowing down the momentum of the sale, and curbing your enthusiasm.