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  • Business Valuation Using an EBITDA Multiple

    Aug 20, 2019

    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, unique characteristics, and the desirability of the business to potential buyers in the marketplace.  The figure used for this multiplication calculation is commonly referred to as an EBITDA multiple.  The ability to correctly determine an EBITDA multiple requires a comprehensive foundation of knowledge and years of relevant experience.  Business valuation is a very subjective science where twenty parties completing the same project have a probability of coming up with different specific figures for company value within a wide range.  The advantages of having an experienced, knowledgeable business broker value a business versus an accountant or business appraiser are that they will often do it for free as a method of providing introductory exposure to their knowledge & ability and that they are accountable for delivering the number in the marketplace.  Accountants & appraisers valuing businesses often lack “field” knowledge to incorporate into their assessment that can only be obtained through active facilitation of mergers & acquisitions transactions. Determination of an EBITDA multiple provides a pathway to establishing a potential business purchase and sale value that will ultimately need to be justified by the parties, their merger & acquisitions intermediaries, their accounting professionals, and/or business appraisers involved in the deal.  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 IBA, 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, real estate community, and the banks financing business acquisitions in the Pacific Northwest, 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 ability to assess each of these areas by the party valuing the business the more accurate the EBITDA multiple will be for determining the estimated market value of 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, quality, knowledge, and/or 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 revenues, client retention, 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.  Assessment of an industry in a specific state or region enhances the accuracy of this multiple component.  For example, IBA is recognized as one of the premier business brokerage firms in the Pacific Northwest related to facilitating the sale of construction industry companies.  The construction industry is presently robust in the Pacific Northwest.  An assessment of this industry based on what is occurring in the Midwest or nationally, would currently result in an under valuation of this component of an EBITDA multiple for a Pacific Northwest company.

    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 & profits and mitigate expenses.  A proper assessment of this element should include both analysis of 2019 vs. 2018 performance year-to-date and a running twelve-month time period analysis.  December 31 is an arbitrary cut-off date for financial documentation.  An assessment of financial performance based on 2018 figures currently has seven months of dust sitting on the documentation.  Would you value a publicly traded stock today based on its market value on December 31, 2018? The answer is no.  The same holds true for a privately held company.  Business valuation should reflect current financial performance and projections for the next quarter and/or year.

    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 business plans, employee manuals, SOP’s, a current technology website, marketing & advertising plans, 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, long term customer relationships, and occupancy stability also mitigate buyer risk enhancing EBITDA multiples and business valuations.

    The final major element to be assessed 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 Redmond, Washington will sell for a different value than one in Redmond, Oregon based on market conditions. The same is true for a technology industry company based in South Lake Union in Seattle, Washington versus one in San Jose, California when market demand, relevant state & municipal taxes, employee labor rates, and occupancy costs are taken 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. We also cannot recall a time when one of our business valuations did not pass scrutiny of a third-party business appraiser as part of a SBA loan process.

    If you own a business in the Pacific Northwest, are interested in selling in the second half of 2019 or 2020, and would like to know how to value a business or what your business is worth, we would welcome the opportunity to provide an overview of our client services.  100% of IBA’s fees, including business evaluations, for sell side clients are paid upon completion of the transaction.

    It should be noted that IBA’s complimentary, business evaluations serve two purposes for our firm.  Client facing, they allow our professionals to provide business owners with an introduction to our market leading knowledge, experience, and professional skill set without any obligation by the seller to engage IBA for representation services.  On IBA’s side, they allow our professionals, who work on a performance based compensation model, to assess if the business sale project is one they are interested in taking on as an intermediary, if the business owner is realistic about their company’s market value, and if the entrepreneur will be a good collaborative partner to work with during the sale process.   IBA as one of the most selective business brokerage firms in the region traditionally represents 1 of 3 companies where it provides a professional opinion of market value to ownership.

    IBA, the Pacific Northwest’s premier business brokerage firm since 1975, is available as an information resource to the media, business brokerage, mergers & acquisitions, and real estate communities 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”.

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