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  • The Use of an EBITDA Multiple in Business Valuation

    Apr 26, 2016

    One of the most common methods for valuing a privately held company or family owned business is to determine the EBITDA (Earnings before Income Tax, Depreciation, and Amortization) and multiply it by a figure (multiple) appropriate for the size of the company, industry, and estimated risk associated with the acquisition. This figure or multiple is the reciprocal number of the percentage return deemed appropriate for the investment opportunity associated with a potential acquisition of the company. For example, a multiple figure of five would be employed for business valuation for a company where a 20% return on investment was desired by the buyer given the associated risk. Conveyed, an alternative way a five multiple would indicate an ability to pay back the investment in five years, if 100% of the profit was applied to repaying the cost of acquisition.

    Many business brokerage firms use guide books and outside resources to determine the multiple to use in business valuation when evaluating a company as a potential representation project. These resources can be beneficial in valuing a business and allow sales people with many business brokerage companies who lack accounting & finance knowledge to roughly value businesses. IBA is unique in the business brokerage industry because its professional team possesses internally the knowledge & experience to build a multiple from its basic components when valuing a business for a client. This knowledge & experience is based on IBA’s successful completion of over 4000 transactions involving the sale of privately held companies & family owned businesses since 1975 in the Pacific Northwest states of Washington, Oregon, Alaska, and Idaho and a staff of professionals with educational knowledge ranging from JD to DVM to a spectrum of business degrees from respected institutions.

    The multiples constructed for IBA’s clients in the valuation of their privately held companies have six different components. The components are risk, industry growth, company growth, competition, financial records & infrastructure, and desirability. The component of Risk assesses the risk associated with the change of ownership. Industry growth evaluates general trends in the company’s industry. Company growth evaluates the company’s individual performance in its industry. Competition assesses the competitive landscape for the company. Financial records & infrastructure assesses the clarity of the information available for evaluation by a buyer, their professional advisers, and/or a party financing a portion of the transaction. Desirability evaluates the anticipated market reaction to the company in the marketplace. Each of these components evaluates an important, but distinct element of the company and how the market will likely react to the opportunity in terms of demand & valuation. The evaluation of each of these components requires knowledge & experience and is the definition of subjective science. IBA professionals evaluate each component in ¼ point gradations resulting in multiples in our valuations that are rounded to the hundredth point. The result of this detailed analysis is thought through price recommendations that can be justified on multiple levels to potential buyers evaluating the businesses represented for sale by IBA as acquisition opportunities. The ability to justify a price to a buyer, their CPA, and/or a bank is critical to successful achievement of the business sale process. A business broker who does not personally perform an evaluation or who cannot articulate the thought behind a business valuation offers a lower caliber of service to their clients than one who possesses that skill set.
    The best evidence that a mergers & acquisitions firm has their hand on the pulse of the marketplace they serve is a track record of completed transactions in a timely manner in close proximity to the asking price the business was brought to market. I have seen studies that indicate that 15% of businesses listed for sale sell. This figure likely is depressed by inclusion of a large number of small & young businesses that were not successful. I cannot speak to what other firms do for their clients, but IBA annually sells in excess of 80% of the projects it takes on as a selective, seller representation firm with an overwhelming majority of them selling within 10% of the price they were first brought on the market.

    IBA, the Pacific Northwest’s premier business brokerage firm since 1975, is available as an information resource to the media and the mergers & acquisitions community on confidentiality and any other subjects relevant to the purchase & sale of a business.

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