Why is EBITDA important to Business Valuation?
For middle-market business owners looking to execute an M&A transaction, the first question that needs to be answered is: What is your business worth? Knowing the range of value of your business valuation is key to negotiations around valuation and structure. So how should you proceed?
There are several methods for assessing company value, including the discounted cash flow model, public market comparisons, and many other methods that hinge on asset values. However, the model that is perhaps the most used is called the multiple of EBITDA calculation.
What is the EBITDA multiple calculation?
EBITDA stands for Earnings Before Interest Taxes Depreciation and Amortization. In order to get the right EBITDA calculation, begin by assessing the company’s pre-tax net income. After that, add back interest expense, depreciation, and amortization for an initial EBITDA figure. One final step is to adjust EBITDA for any costs that will not continue under new ownership and/or any expense line items that need to be normalized. These could include non-business-related travel, car expenses, excess salaries or rent, and so on.
After reaching this EBITDA number, it is then multiplied to configure the final value. This multiple can vary, due to business size and other factors, but for mid-size businesses … the larger the EBITDA, the higher the multiple that can be achieved. Higher multiples are usually applied to businesses with higher margins, or businesses in a niche market that have a strong record of success. Lower multiples are usually given to commodity-typed businesses, or to those who operate in industries that are more capital-intensive. Generally, it’s also worth noting that larger businesses tend to get higher multiples than smaller businesses.
Should I use the EBITDA multiple calculation for my business?
Yes. Overall, the EBITDA multiple calculation gives buyers a good idea of performance comparisons within an industry. It provides a strong idea of operating profitability, since it eliminates costs outside of that area such as interest and taxes, as well as non-cash charges like depreciation and amortization. Additionally, in the event that the acquisition requires financing, the EBITDA provides an idea of the company’s financial health regarding any interest or debt payments.
On the other hand, while EBITDA is sometimes used interchangeably with cash flow, it does not include factors such as debt payments, cash for increasing working capital, or continued capital expenditures. As a result, some debate the clarity of EBITDA as a comprehensive measure. Still, even taking into account the skeptics, there’s no denying that it is the most used by buyers to value businesses and it is a key calculation for those in the middle market looking to sell.
How do I estimate my EBITDA multiple?
There are different average multiples for every industry, so be sure to compare against other similar businesses. For example, if you know that others in your industry have sold for six or seven times EBITDA, it’s safe to estimate that the same multiple will be applied to your company. In the same situation, it’s unlikely to assume your business will sell for a multiple of 10 unless it includes a significant detail. Keep in mind that the multiple also hinges on your being able to manage the process effectively, preparing your business, and following the appropriate measures.
How do I prepare my business for the best value?
As previously noted, the multiple assigned to any business also hinges on their efficacy and efficiency in preparing the business for sale. To prepare, there are several areas to dive into: keep fastidious financial records, ensure that all legal battles have been concluded, diversify the customer base, report any and all revenue, get rid of non-business expenses, analyze products and services, and look for a higher margin business. And most important of all: Hire trusted management in the event that you plan to leave after the sale. It’s one of the most overlooked but most important ways to increase the value of your business.
For buyers, it’s attractive to see a business that can change leadership, and they will pay even more for a company with a proven infrastructure and management team that can continue after purchase. Continuity is key, and so is knowing that a company’s success doesn’t hinge on one person’s leadership but rather on a system that has already been put in place.
How do I get started?
Email us to touch base. We will sign an NDA for you up-front and will work with you at no cost to Recast back to EBITDA for your company on a multi-year basis. This will help us both talk through your Range of Value and the process to get from where you are at to where you want to go. If there is something actionable at that point, we can discuss what an Engagement may look like.