M&A Insights – Mark Young, Managing Partner, CKS Advisors
Welcome to the November 2023 edition of M&A Insights. Our goal at CKS Advisors is to help you stay up-to-date on the Merger and Acquisitions climate.
This edition is the second in a two-part series on valuing a business for the purpose of a sale. As we discussed last month, buyers commonly value businesses by determining a company’s cash flow (EBITDA) and applying a multiple to that cash flow to arrive at the company’s enterprise value (i.e. purchase price).
Last month, we discussed in detail EBITDA and the importance of adjusted EBITDA in valuing a business. Click here to read Part 1.
This month, we will discuss EBITDA multiples in relation to calculating a company’s enterprise value and more specifically, the factors that influence the multiple a buyer may use to value a business.
What is an EBITDA Multiple and How is it Determined by A Buyer in Order to Value A Business?
EBITDA multiples are a valuation metric widely accepted in the finance community as a barometer to compare one company to another and ultimately aid in determining the enterprise value of a company. Buyers will assign a multiple to a company based on a number of factors that are discussed in detail below. The multiple chosen by the buyer is then used to multiply the company’s adjusted EBITDA, to arrive at the enterprise value.
Adjusted EBITDA x Multiple = Enterprise Value (Purchase Price)
Example: $4,000,000 x 5 = $20,000,000
How Does a Buyer Determine the Multiple They Are Willing to Pay for A Company?
We tell our Clients the multiple a buyer is willing to pay will depend on many factors- too numerous to list in their entirety for the purposes of this article. To add to the complexity of answering this question, each buyer is likely to rank and weigh these factors differently based on their experiences. The old saying, “beauty is in the eye of the beholder” is alive and well in determining a multiple.
With that said, in general, the following are several of the factors that tend to be more commonly applied:
- Industry Characteristics: Logically, fast growing industries elicit more interest, thus more value. Industries that are not cyclical and/or are recession resistant will also enjoy greater multiples.
- EBITDA Size: Greater cash flow demands higher multiples.
- Growth Rates: Companies experiencing above average consistent growth command greater multiples.
- Profit Margins: Relatively high margins are indicative of companies that have some sort of competitive advantage, upon which buyers place a premium.
- Type of Revenue: Buyers prefer recurring and reliable revenue streams (vs. project based).
- Customer Mix: Buyers place a greater value on companies that don’t have any customer concentration issues and have strong, longstanding relationships with customers.
- Strength/Depth of Management Team: Companies that have matured past the heavy reliance on the entrepreneurial talent of its CEO/Owner are assigned a higher value.
- Scalability: Professionalized companies with streamlined operations and effective processes afford a buyer the ability to support growth which warrants a premium.
- Growth Opportunities: Whether it be a business in a fragmented industry allowing for roll-up opportunities or a situation where there are untapped markets or product/service offerings. Buyers like logical growth paths.
Again, while this is not an exhaustive list of factors influencing the multiple a buyer chooses to apply to a company, they are the most common.
What Should You Do Now?
As you can see, there is an art and science component to valuing a business. Talk to your professionals, particularly an investment banker, who can assist you in determining your company’s enterprise value. We are available to answer any questions.
This concludes our 2 part discussion on valuating a business for a sale transaction- we hope it has been informative for you.
If you would like to learn more about the M&A market or are ready to take the next step to explore your options, we would be glad to meet. Please contact me at 602-501-4414 or myoung@cksadvisors.com.
