Building Blocks for an EBITDA Multiple & How to Enhance Yours Prior to Sale

Jul 24, 2018

A common methodology for valuing a privately held company is to calculate the EBITDA (Earnings before Interest, Taxes, Depreciation, & Amortization) and multiply the figure by a number appropriate for the company’s industry, location, and the risk associated with continued successful operation of the business through a transition of ownership.  This number is commonly referred to as an EBITDA multiple.  The ability to correctly determine an EBITDA multiple requires a deep base of knowledge and years of relevant experience.  EBITDA multiple determination is a very subjective science where ten knowledgeable, experienced parties have a probability of coming up with different specific figures within a likely range of approximately one whole number.  Determination of the EBITDA multiple provides a road to establishing a potential business purchase and sale value that will ultimately need to be justified by the parties, their merger & acquisitions intermediaries, and the accounting professionals in the deal if a transaction is to be completed.  The true value of a business is not subjective, it is the value a willing buyer & seller will agree to with equal motivation in an arm’s length transaction.

Acknowledging that there is not one correct answer when valuing a business or establishing an EBITDA multiple, as the president & CEO of the Pacific Northwest’s oldest business brokerage firm and a recognized expert on the valuation of privately held companies & family owned businesses by the Small Business Administration (SBA), business appraisal community, the accounting and legal professions, and banking community, I thought I would take this opportunity to provide education regarding the six primary components that go into determining an EBITDA multiple. The stronger the assessment of a business in each of these areas the higher the overall EBITDA multiple will be for a specific company.

The first primary element to assess in determining an EBITDA multiple is the company’s competitive position in its marketplace.  Is it stable, gaining or losing market share?  Is it competing on price or quality, knowledge, and customer service?  The stronger a company’s competitive position in the marketplace the higher the multiple.  For this reason, it is always a stronger position to sell (Higher EBITDA Multiple) when things are going well for a company rather than when the business is experiencing turbulence in its marketing strategies, operations, or personnel.

The second component in determining an EBITDA multiple is an assessment of the industry of the subject business.   This is not a component an individual business can control or influence.  However, higher business values are always achieved in transactions in industries that are thriving than in ones that are stagnant or in decline.

The third element to assess in determining an EBITDA multiple is the revenue & profit trends for the subject business.  Customers vote in the business world with their dollars.  The more votes a business receives, the higher the business value.  I often use the analogy of a marathon race when discussing how to maximize value when selling a privately held company or family business.  It is in a business owner’s “best interest” to sprint the last couple of miles (months) of their ownership doing what they can to increase revenues and mitigate expenses.

The fourth component to assess in determining an EBITDA multiple is the clarity of the financial records of the business and the operational infrastructure in place.  Financial records of a business in a sale need to pass scrutiny traditionally by a buyer, their accounting professionals, and a bank and/or investors.  The better the financial records are the higher the EBITDA multiple and value of the business.  It is in your best interest to detail your car before selling it.  It is equally true it is in your best interest to provide clear & accurate financials to potential buyers when selling a business. Operational systems like employee manuals, SOP’s, and sales training programs also enhance multiples and the value of privately held companies.

The fifth element to assess in building a composite EBITDA multiple for valuation of a privately held company or family business is the risk associated with a change of ownership.   Companies with strong middle management and employees have higher EBITDA multiples and values than companies where the owner is the dominant hub for executive decisions, sales, and/or production.  A business owner who has built an employee team that can run the business in their absence will also be able to transition out of the company quicker after the sale is completed.  Reoccurring revenue and/or long term customer relationships also mitigate buyer risk enhancing EBITDA multiples and business valuations.

The final major element to be assessed by a mergers & acquisitions intermediary in determining an appropriate EBITDA multiple to value a business is the most subjective element, the desirability of the business in the marketplace.  The assessment of this element requires a professional that is actively engaged in the relevant mergers & acquisitions marketplace.  The desirability of businesses can range significantly based on industries and geographic locations with a resultant impact on EBITDA multiples and business valuations.  Universal & national EBITDA multiples are convenient to employ, but inherently flawed.  Business valuation like real estate valuation is a venue where local knowledge & experience are king.   A new construction, four-bedroom, three-bathroom 2500 square foot house in Seattle metropolitan area will sell for a different value than one in Spokane, Washington based on market conditions. The same is true for an aerospace industry manufacturing company supplying products to Boeing with identical gross revenue in Everett, Washington versus one in North Charleston, South Carolina when market demand, relevant state & municipal taxes, employee labor rates, and occupancy costs are taking into consideration.   It is always prudent to engage a business broker with experience selling companies in the relevant geographic location and industry if transaction goals include a timely sale of the business at the maximum possible market value.

An assessment of the six primary components of an EBITDA multiple completed a composite multiple can be built.  IBA, as the premier business brokerage firm in the Pacific Northwest and the proud facilitator of over 4000 transactions since 1975, generates EBITDA multiples in .25 increments for its clients in an effort to provide as accurate an assessment of the business value as possible before taking a privately held company or family owned business to market.  Our business valuation knowledge is consistently confirmed by the marketplace with an overwhelming majority of the businesses we represent for sale selling within 10% of their asking price.

If you own a business in the Pacific Northwest, are interested in selling in the next three to twelve months, and would like to know how to value a business or what your business is worth, we would welcome the opportunity to talk or meet with you.

IBA, the Pacific Northwest’s premier business brokerage firm since 1975, is available as an information resource to the media, business brokerage, and mergers & acquisitions community on subjects relevant to the purchase & sale of privately held companies and family owned businesses.  IBA is recognized as one of the best business brokerage firms in the nation based on its long track record of successfully negotiating “win-win” business sale transactions in environments of full disclosure employing “best practices”.