In all my years as an M&A advisor, I have never…. Let me repeat that, I have never, ever seen an industry so littered with rules of thumb than I have since I began working in the pest control industry. Pest control companies sell for: “One times sales”… “dollar for dollar on revenue”… “1x recurring sales… etc.”
Everyone you talk to knows exactly how pest control companies are valued and everyone has a very simple solution to your valuation issues and concerns – a simple rule of thumb. Buyers and sellers who rely on this nonsense generally get what they deserve, they overpay for a target or sell their pest control business for much less than they should have.
So where do rules of thumb come from? The most common rule of thumb that you’ll hear in the pest control industry is “one times sales.” For example, if a pest control company does $1 million per year in revenue, then it should sell for $1 million, or so the story goes. This rule of thumb is distilled from purchase price multiples (the market approach to valuation) which over time tend to surface as rules of thumb. It’s simplistic, easy to remember, and convinces just about every pest control operator that he knows the value of his business… of course until the offers come in. The reality is, not much of anything sells for a multiple of sales. The sales multiple (calculated as the aggregate purchase price / revenue) is not a transaction multiple, but rather a derivative multiple calculated after the fact.
Consider the following example for second. Suppose Rentokil acquires a business doing $10 million in sales. I can guarantee you that Rentokil is not basing its purchase price on a multiple of sales, it is basing its purchase price on projected returns on invested capital, which is based upon the expectation of future cash flow. If Rentokil ends up purchasing the company for $10 million, surely the market will say that Rentokil purchased the company for 1x sales (100% of sales).
However, we can just as easily say that Rentokil purchased the company for 2x the cost of goods sold, 64,000x the number of trucks, or 923x the number of flowers on the company’s property. A purchase price can be expressed as a multiple of just about anything, and sales, being “top-line” is very easy for people to understand, but it is not sales that sophisticated investors are looking at, they are basing purchase price on the expectation of future cash flow.
Sales multiples are calculated after the fact by the publicly available information on the deal. For example, if a company doing $5 million in sales was sold for $4.5 million, it is very easy to say that the company sold for 90% of sales, or $0.90 per dollar of revenue. But I can tell you with absolute certainty that these sales multiples did not drive the deal, they were calculated after the fact. The fact that the company sold for 90% of sales is certainly a true statement, but it is math applied after the deal had been done, it did not drive the deal.
If pest control companies really sell for a multiple of sales, then wouldn’t it be the brilliant pest control operator who goes out and undercuts every one of his competitors on price and locks in long-term recurring contracts at break-even, and then turns around and sells the company for 100% of sales? That doesn’t work, clearly, because pest control companies are not priced on the basis of sales multiples, nor are they bought and sold on the basis of recurring revenue multiples.
One could clearly argue that sales multiples in the pest control industry have become somewhat of a self-fulfilling prophecy. They began as a derivative multiple, and then so many buyers and sellers have begun to rely on them that they are now driving deals. Perhaps, to a certain extent, at the lower end of the market, revenue multiples do drive deals, but there are very important reasons not to rely on sales multiples whether you are a buying or selling a pest control company.
Relying on sales multiples is a great way for sellers to leave money on the table, or buyers to over-pay for businesses. If you want to accept pest control revenue multiples as transaction drivers, then you must accept that all pest control companies are created equal below the revenue line. They all must have the same growth rates, same levels of profitability, same depth of management, service mix, return on assets (ROA), etc. If you believe this, then go on using sales multiples, but if you do not, throw that rule of thumb in the trash where it belongs.
I can tell you, from the hundreds of pest control valuations and M&A engagements that we have been involved with around the globe, no two pest control companies are the same below the revenue line, and in fact, you would be surprised at the differences you will find in profitability, service mix, and ROA in such a competitive and fragmented industry.