Rules of Thumb Will Cost You Millions: Why ROT Is Garbage
Discover why industry multiples and comparable sales destroy business value and what financial professionals actually use to determine what buyers will pay for your company.
That “4x EBITDA” rule you heard at a conference? It’s killing your exit strategy. Rules of thumb (ROT) are vile deceivers used by people too lazy to value businesses properly. They overvalue troubled companies and undervalue performers like yours. Here’s what premium purchasers actually use to determine price.
10 KEY TAKEAWAYS - VALUATION SHORTCUTS
ROT stands for exactly what it sounds like: Rules Of Thumb are deceivers with no place in serious business valuation.
Industry multiples are outcomes, not inputs: That “5x EBITDA” number came from somewhere specific, not universal truth.
Comparables hide critical differences: Even identical revenue businesses can have vastly different value propositions.
Premium purchasers hire bean counters: Young financial professionals determine your price, not industry veterans who understand your craft.
They’re buying a system, not widgets: Purchasers want corporate business systems that convert revenue to income independently.
Public company data is managed: Transaction terms are often structured to meet market expectations, not reflect true economics.
Small businesses aren’t comparable to public companies: The dynamics, reporting requirements, and deal structures are fundamentally different.
ROT typically overvalue troubled companies: Generic shortcuts miss the specific risks that destroy value.
Calculated multiples require due diligence: Proper valuation considers your specific financials, risks, competitive position, and growth potential.
Your business is special, but differently: Being unique only adds value if differences can be systematized, documented, and transferred.
📚 READING PREREQUISITES
Each post in this series builds upon the technical groundwork laid in earlier entries. The content is designed to progress in depth and complexity, making prior understanding essential for full comprehension. Key valuation concepts, models, and metrics are intentionally revisited and reinforced across multiple posts to ensure retention and clarity. Repetition and redundancy are used deliberately, not as filler, but to demonstrate how these foundational ideas interconnect and remain central to every subsequent analysis.
Recommended Prior Reading:
Understanding EBITDA and Financial Metrics
The Four Pillars of Business Risk
Why Founder Dependency Destroys Value
The Uncomfortable Truth About How Your Business Gets Valued
You’ve spent years mastering your industry. You know your customers, your products, your margins. You’ve heard that businesses in your sector sell for “X times revenue” or “Y times EBITDA” and you’ve calculated what that means for your exit.
Here’s the problem: you’re using tools designed for amateurs in a professional game.
Rules of Thumb (ROT) are exactly what the acronym suggests. They’re shortcuts used by people who don’t know how to value businesses or are too lazy to do the work properly. Think about what a rule of thumb actually is: a rough measure, an approximation, a guess dressed up in the clothes of wisdom.
The etymology is uncertain, but if I had my way, you’d be hit with a stick every time you used one.
Why ROT Fails Small Business Owners
ROT don’t consider any specifics of your business that may add or detract from value. Your business is special and particular. A ROT is generic without analysis.
Here’s what ROT typically do:
Overvalue troubled companies by ignoring specific risk factors
Undervalue performing companies by missing unique value drivers
Create unrealistic price expectations for both vendors and purchasers
Replace thoughtful analysis with lazy industry averages
Hide the actual work required to determine true business value
The critical distinction you must understand: there’s a massive difference between a multiplier calculated from hard due diligence work and the assumption that same number applies to everyone.
“4x EBITDA” calculated for your specific business after thorough analysis? That’s legitimate valuation work.
“The rule of thumb for small business valuation is 4x EBITDA”? That’s professional malpractice.
The Comparable Transaction Trap
Comparables aren’t quite as evil as ROT, but they’re still dangerous when misused. In real estate appraisal, comparables work beautifully because houses are relatively homogeneous. Three-bedroom, two-bath homes in the same neighborhood built in the same year are genuinely comparable.
Your business? Not so much.
Comparables give you market state information, which matters. Alternative investments are always considered by investors. They look at the market to compare risk between your company and other opportunities. That’s useful context.
What comparables cannot give you:
Specific deal terms and conditions
Identity and motivations of sellers and buyers
Hidden contingencies or earnout structures
Working capital adjustments
Non-compete agreements
Employment contracts for key personnel
Actual risk profiles of supposedly “similar” businesses
The $26 Million Deal That Wasn’t
A public company negotiated a subsidiary spinoff for $16 million. Market expectations were $26 million. The CEO and CFO had to manage public expectations while closing a deal on actual merits.
The purchaser suggested the public company put $2 million in capital expenditures and $8 million cash into the company before closing. Deal closed at $26 million.
Everyone was happy. But the public market data was completely skewed. The deal terms weren’t normal or typical for the market.
This is why you can never assume you’ll get the same deal as the last guy. Sometimes you may not even want it. Even public market transactions with full disclosure require deep analysis to understand true comparability.
What Premium Purchasers Actually Care About
If you want your business to sell for millions, you’ll sell to purchasers who have millions. Does this make sense?
You’d be surprised how many business owners understand everything about their customers (demographics, price points, buying behavior) but never profile potential purchasers of their company.
Have you identified the best purchaser for your business who will pay the most cash for it? Are you building a company they would actually buy?
People with millions hire people like me to commence due diligence. Therefore, you must understand the approach financial professionals take to determine corporate value.
The Bean Counter Reality
Since most business professionals in this industry are lawyers, accountants, appraisers, and valuators, their determination of value depends on the finance theory to which they adhere.
You can say this is nonsense. But the financial professionals have the money, and this is what they do.
You can sell your business to Billy, Bob, or Joe down the street. But if you want to cash out huge, you’ll be talking to a guy like me.
Like it or not, this is your reality. The sooner you accept that some young bean counter knowing little about your business or industry will determine the price paid for your business, the sooner you’ll be on the path to corporate value maximization.
The axiom “the customer is always right” applies here. The bean counter is your customer.
The System Buyers Actually Want
Here’s the news flash: premium purchasers are not buying your widgets or digits. They’re buying a corporate business system that converts revenue to income.
They would rather buy it than build it. Your job is to give them a reason to overpay.
What makes a system worth buying:
Operations that function without founder involvement
Documented processes that transfer to new ownership
Predictable cash flow generation from systematic activity
Risk profiles that professional valuators can quantify
Growth potential that doesn’t depend on irreplaceable talent
This is why we start with rules of thumb and comparables but quickly leave to find greater relevance and reliability in analysis. Generic shortcuts can’t capture what makes your specific business valuable to specific buyers.
Moving Beyond Amateur Valuation
The path to maximizing your business value requires abandoning shortcuts and understanding what drives professional valuation:
Replace ROT with systematic risk reduction. Every risk you eliminate increases your multiple exponentially more than revenue growth.
Use comparables as market context, not as pricing tools. They tell you what’s happening in your sector, not what your business is worth.
Build for the bean counter. Structure your business to meet professional valuation standards rather than hoping buyers will see past amateur presentation.
Focus on transferability. Every system, process, and relationship must be documented and transferable to create value a purchaser will pay for.
The business owners who understand this build companies worth millions. Those who rely on industry multiples and rules of thumb build jobs worth nothing.
Which are you building?
💡 KEY TAKEAWAYS
Remember These Core Principles:
Abandon rules of thumb immediately: They’re amateur tools that destroy professional valuation opportunities and create unrealistic expectations.
Comparables provide context, not pricing: Use them to understand market conditions, never as substitutes for proper due diligence and analysis.
Bean counters control your exit: Young financial professionals will determine your price using systematic methods, not industry experience.
Build systems, not jobs: Premium purchasers buy corporate business systems that convert revenue to income without founder dependency.
Professional valuation requires work: Proper multiples come from thorough analysis of your specific risks, financials, and transferable value.
❓ FREQUENTLY ASKED QUESTIONS
Q: If industry multiples don’t work, how should I estimate my business value?
A: Start with systematic risk assessment across the four pillars (customer concentration, key person dependency, revenue reliability, operational ambiguity). Reduce risks systematically while documenting all processes. Professional valuation requires understanding your specific risk profile, not applying generic industry averages.
Q: Can’t I just use the multiple from a recent sale in my industry?
A: You can use it as rough context, but that multiple reflected specific conditions of that business and transaction. Deal terms, buyer motivations, hidden contingencies, and risk profiles all vary dramatically. Never assume you’ll achieve the same multiple without understanding why that specific number emerged.
Q: Why do financial professionals get to determine my business value when they don’t understand my industry?
A: Because they have the money and expertise in valuation methodology. They’ve analyzed hundreds of businesses and know what creates transferable value versus founder-dependent operations. Your industry expertise matters, but only if you can systematize it into transferable processes.
Q: What’s the difference between a legitimate multiple and a rule of thumb?
A: A legitimate multiple results from thorough due diligence analyzing your specific business: financials, risks, competitive position, growth potential, transferability. A rule of thumb is a generic industry average that considers none of your business’s actual characteristics.
Q: Should I completely ignore what other businesses in my sector sold for?
A: No, use comparable sales as market context to understand broader trends and investor appetite. Just don’t use them as pricing tools or assume your business will achieve similar results without proper analysis.
🎯 READY TO BUILD A BUSINESS WORTH BUYING?
Understanding why rules of thumb fail is just the first step toward professional valuation.
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📖 RELATED READING
Continue Your Learning:
Harvard Business Review: The Real Cost of Not Knowing What Your Business Is Worth: Explores why business owners consistently overvalue companies and miss exit opportunities.
McKinsey & Company: Small Business Valuation Best Practices: Professional standards for determining enterprise value in middle-market companies.
Journal of Business Valuation: Rules of Thumb in Business Appraisal: Academic analysis of why industry multiples fail to capture business-specific value drivers.
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👤 ABOUT THE AUTHOR
Sean Cavanagh, BAS, CPA, CA, CF, CBV
With over three decades negotiating business sales and conducting valuations, Sean delivers unvarnished truth about business exits. Starting at Deloitte and Canada Revenue Agency, he now advises business owners through his M&A practice. YBAWS! reflects his frustration with owners who consistently overvalue their companies.
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📚 DO YOUR OWN RESEARCH
The concepts discussed in this article are grounded in professional standards and industry best practices. For deeper understanding, consult these authoritative sources:
Business Valuation Standards:
American Institute of Certified Public Accountants (AICPA) - Statement on Standards for Valuation Services No. 1 (SSVS 1)
American Society of Appraisers (ASA) - Business Valuation Standards
International Valuation Standards Council (IVSC) - International Valuation Standards
M&A Analysis:
PwC Global M&A Industry Trends Report
Sherman, A.J. (2018) Mergers and Acquisitions from A to Z, AMACOM
Howson, P. (2017) Due Diligence: The Critical Stage in Mergers and Acquisitions, Gower Publishing
IMPORTANT DISCLAIMERS
Educational Content Only: This material provides general educational information about business valuation concepts. It does not constitute professional advice for your specific situation.
Consult Qualified Professionals: Business valuation, M&A strategy, and exit planning require professional guidance from qualified advisors including business valuators (CBV, ASA, CFA), M&A attorneys, and tax professionals familiar with your jurisdiction.
Fictional Case Studies: All examples and case studies are fictional composites created for educational purposes from collective industry experience. Any resemblance to actual businesses or transactions is coincidental.
No Liability: Neither the author nor YBAWS! accepts liability for decisions or actions based on this content. This material supplements but never replaces proper professional consultation and judgment.
Canadian Focus: Tax and regulatory references primarily reflect Canadian law and practice. Consult qualified advisors in your jurisdiction for applicable rules.
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