Valuation Multiples: Meaningful or Murky?
We’ve heard so many stories over the years from owners and executives who have called their friend in banking and found that their company’s valuation multiple should be “8 times EBITDA”, and then called their accountant to hear that it might go “as low as 6 times EBITDA” in the industry. This game of phoning an informed friend may at first sound helpful to the individual gaining data points, but to us, this information on its own can be quite murky or even useless if the context of the multiple is within M&A deals.
This problem requires reasonable attention to deal structure. What if your informed friend pulled down data on a set of deals in your industry and the result included half as stock transactions and the other half as asset transactions? On the asset side – meaning the deals were transacting in specific assets of the target companies rather than its stock – you might look at asset transactions in the same industry and find several different structures. Hypothetically, among 10 asset transactions, you might get 7 where only the fixed assets, trade name and goodwill have been sold; 2 where inventory, receivables, fixed assets, trade name, customer list and goodwill were sold; and 1 where cash, receivables, fixed assets, goodwill and accounts payable (a liability!) were sold.
If you’re lost so far, here’s a practical example: in valuing a real estate services business recently, one method of valuation was showing a value of $8.8 million, while a second method using a market multiple of about 4 times EBIT was coming up to $6.3 million. Needless to say, if the valuation really was almost 30% lower, this would be a seriously meaningful impact to the clients exploring the value of their company. Puzzled at first, a careful look at deal structure revealed that the median market multiple was almost unanimously among deals which excluded all of the working capital of the business. Controlling for this structural nuance, the two different methods of valuing the company were actually within just a few percentage points, rather the massively divergent observation at the start.
Here’s another example, via a hypothetical scenario based in years of practice: you’re selling a company and your buyer is willing to pay you 10 times EBITDA – perhaps a modest premium over prevailing market multiples – but only 25% will be paid immediately, another 25% is seller financed and paid over 3 years, and the final 50% is a contingency based on ambitious targets set for 3 years out. We ask rhetorically, is 10x still 10x?
For about as many times as we’ve looked into the going market multiple to apply to any particular company, we’ve also had to consider how deal structure (e.g., asset vs. stock, which assets, how the deal gets paid out, etc.) impacts our understanding of the multiple and overall deal valuation.