Here, I spend 5 minutes detailing how buyers and investors assess the value of your firm.
The firm’s EBITDA provides the basis for calculating how quickly the sale price might be recouped by the buyer. This is used because it is seen as a more reliable estimate of the real profits generated by the firm because it excludes things (i.e. the ‘ITDA’) that vary depending on country, financing structure, or investment decisions.
The projected growth of EBITDA promises to shorten the expected recoup period, but if perceptions differ between the buyer and the seller then earn-out targets are a good way of settling the disagreement! Buyers ideally want sustained, growing revenues for at least three years, and projections of the same for a subsequent 3 years. A minimum of 20% EDITDA and 20% growth for the previous three years is the basis for a good price.
Buyers and investors typically value a firm at between 5-12 x EBITDA. And it is usually worth focusing as much on the multiple as the profit. In a well run firm increasing EBITDA by 5% is usually harder and less effective for the value than increasing the multiple by 1x.
Beware of average multiples as a way to value your firm!
Twice in the last month I’ve seen some very dodge valuations (one from a broker, and one from an insurance company) that used an ‘industry average multiple’ to value a firm.
EVEN if you use this as a baseline which is adjusted for growth, client risk, founder risk, and IP (like this beauty https://lnkd.in/giZwBdVn) the valuation can be up to 50% out.
Why?
- You only really know the exact value of your firm when the earn-out is over. This can be 3-4 years after the deal is done.
- Industry averages are a nonsense. Bigger firms tend to drive a higher multiple and the sub-sector within each industry is crucial (for example, the consulting industry average is 8, but if you are a 500 person AI-consulting firm, your multiple might be 15; if you are a 15 person HR consultancy firm, your multiple might be 4).
- It depends who else is on the market when you decide to sell. More supply = lower prices (Economics 101).
- For strategic buyers, your value is very much dependent on your fir and synergy with their existing services (and culture). If the Porgy to your Bess is not buying, then your value is likely to be lower.
- The macro economic situation (take now for example!), the availability of capital, the cost of debt and inflation all have an impact on the projected future returns of your firm, and thus its value.
- The sales process. A bad choice of broker (e.g. one that is doing their favourite buyer a favour), poor negotiation tactics, or the business development effort of the firm dipping during the sale can not only decrease the firm’s value, but also scupper the whole deal.
- Dodgy banks & brokers: there is a well-known phenomenon among estate agents that a higher valuation tends to win the seller’s contract. The same is somewhat true of companies. A broker/bank which says ‘I’m sure we can get you a multiple of 20’ is likely to win more business than one which gives you a realistic valuation.
- Luck: when I do a valuation/due diligence, I ask 300 questions of the leadership, undertake a review of key documentation, interview the senior team, do a detailed competitor analysis, review recent deals of similar firms, and look to see which companies might fit best with the seller. Despite this, it is still rare to get the valuation spot on.
- There are 6 other ways to value a firm other than the multiple route. The multiple is the favoured one in the consulting industry but many buyers use several different methods to produce their ideal buy price range.
So, seller beware! Find the right broker, don’t listen to inflated valuation figures, hope for the best and expect the worst.
