Today's blog is by Mark Blackton with Molliter Advisory regarding Earnings Multiples and problems associated with them.
Clients and potential clients ask, “What EBITDA1 multiples are being paid for a company in my industry,” or they state, “I am going to work until the EBITDA in my company is Y, and then it will be worth Z”.
This is where we must explain that: Yes, multiples are discussed to value of companies within industries, not all companies within an industry trade at the same multiple. The problem with multiples is that sellers often use them to anticipate a high or industry level multiple without knowing how or if it’s practical to interpret their company’s value through that common industry lens. The problem is further extenuated as industries and the market tend to emphasize high multiple transactions.
For small-to-medium sized companies, items that can enhance a company’s value, and ultimately the multiple received, are components that provide assurance that a buyer will succeed with the company platform in place. Significant among these are:
- earnings track record
- management systems
- customers (including underlying contracts)
A company with consistent up-trending earnings will trade at a premium to those with volatile earnings, even if the good years outweigh the bad. Earnings volatility can lead to a 30% discount to companies demonstrating smooth earning patterns.
Key employees confident that their interests are aligned with a successful transition will lend value. Buyer’s want some assurance that flight risk is not a liability to recouping investment.
Management systems and processes that allow for autonomy are critical to the value of your business. Avoid looking like a “life-style business” or one where the “secret sauce” is locked up in the owner’s experience.
When equipment plays a major role in earnings, as with trucking or manufacturing, make sure quality, uniformity, look-and-feel, reflect the same kind of premium you want of your overall company. Avoid appearances where your tangible assets can be thought of as disposable commodities. Equipment can be old, but being able to demonstrate proper maintenance along with paint and decals will go a long way.
Diverse customer bases always reduce risk and help deliver consistent revenues to new owners. Strive to deliver as broad a base as possible. Automobile manufacturers have a naturally occurring diversity of consumers, makers of rockets, less so. If your business has a narrow channel, carefully consider the importance of contracts that allow for transferability to a new owner. It is much easier to ask for that language now than under circumstances where it becomes a sale contingency.
A buyer is valuing the business on how much money can be made in the future utilizing the business. A multiple of past performance may be one indicator, but there are many ways to value a business, for example, discounted future cash flow. If the platform does not provide confidence that the future will be successful the value will be discounted and result in lower multiples.
Therefore, the discussion of multiples is a great way to simplify the comparison of deals, not the valuation method utilized in most cases. The good news is that the higher the quality of the items that drive value, the higher multiple a business can command at the closing table.
1 “EBITDA is net income with interest, taxes, depreciation and amortization added back to it. EBITDA is a utilized as a proxy for cash generated. EBITDA is often used to analyze and compare profitability between companies and industries because it eliminates the effects of financing and accounting decisions.”
Molliter Advisory, LLC, is a boutique mergers and acquisitions firm that works with small-to-medium sized companies to value, market, negotiate and bring to close the transactions of their clients. Their deal sizes range from $500K to $20 million. Check out their website at http://molliteradvisory.com/.