11/09/2022
In Valuing Your Company, EBITDA Only Tells Part Of The Story : Sharon Heaton is the CEO of sbLiftOff, a lower middle-market M&A advisory firm that serves GovCon companies and founder-led businesses.
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As an advisor to lower middle-market business owners, I am frequently asked: “How much is my company actually worth?” Every owner sees tremendous value in the business they have built and hopes the market will support their view. But as we know, value always lies in the eye of the beholder, which is why we often see a disconnect between sellers and buyers during the mergers and acquisitions process. Agreeing on the value of a company—and its likely value in the future—is almost always a negotiation. And it’s one that can be more challenging when the markets are volatile and interest rates are rising.
There is a lot at stake for a business owner who has spent the greater part of their adult life building a company, and rightfully so. If they enter the market with a company valuation that exceeds current industry benchmarks, buyers may not be willing to engage in a discussion, limiting the owner’s opportunity to transition the business. If the company valuation is too low, a business owner could attract multiple buyers, but may walk away with significantly less than the business is worth.
One of the most common occurrences in this business is that owners don’t fully understand all the elements of the valuation equation. They know revenues and earnings before interest, taxes, depreciation and amortization (EBITDA) are critical—but what additional value can be assigned to the reputation of the company, the strength of the leadership team and the quality of its customers? These intangible assets are harder to value, but buyers look closely at these attributes. Sometimes it’s the intangibles that give a prospective buyer the added comfort that there will be business continuity after the owner departs and that the business’s future growth potential is strong.
Luckily for business owners, valuation is not unchartered territory. Thousands of companies are bought and sold every year, and while no two companies are alike and no two deals are the same, business owners can follow some simple guideposts to develop an initial valuation of their business.
• Adjusting the EBITDA. It’s important to get the clearest possible picture of the company. This means adjusting the EBITDA to account for expenses outside the normal course of business that the new owner would not incur. Personal and nonessential expenses should be removed from the equation. For example, expenses associated with non-business travel personal cars or other personal expenses should not be included, as they are non-recurring.
• Basic valuation is EBITDA times a “multiple.” Let’s assume your company has an EBITDA of $5 million a year. If the multiple is 3, the valuation is $15 million (i.e., 5 x 3 = 15). If the multiple is 6, the valuation is $30 million (i.e., 5 x 6 = 30). So, determining the appropriate multiple is critical.
• Different industries have different multiples. You probably would not be surprised to learn that a software company is likely to have a high multiple. You might be surprised, however, that a highly skilled law firm would have a low multiple. To determine the appropriate multiple for your business, start by researching multiples for your industry.
• Within an industry, no two companies are alike. Let’s assume that two different companies manufacture widgets and that the multiple for widget manufacturers is generally 5. But one of these companies has 30% margins, and the other company is barely breaking even. Should those two companies have the same multiple? Of course not!
• Why the “intangibles” matter. The intangible assets discussed above are factored into a company’s valuation because they can determine the multiple used. If the company’s management team (outside of ownership) is strong, its reputation is stellar and its customer base is recurring, the multiple will be higher than for a company lacking those characteristics. A range of other variables—including whether revenues are subscription-based or project-based—can also affect the multiple.
• Larger companies are valued higher than smaller companies. While seemingly unfair, smaller companies tend to sell at lower multiples than bigger companies. An IT managed service provider with $3 million in EBITDA will
