Whenever a business is being bought or sold, the question of worth and reasonable price become important points of discussion. There are many articles and books that have been written on business valuation that describe time-tested techniques to arrive at an accurate figure.
If you have a reasonable set of financials and have the ability to evaluate the current state of the company, you can derive a valuation.
We like to focus on being a strategic buyer. We believe we can incorporate and/or integrate the purchased company into our existing business and make the whole combination better than its individual pieces.
Understanding the benefits of the integration process helps you to establish valuation. There is another important reason for someone who intends to sell their business to have a better understanding of valuation.
When an analysis of known valuation metrics of the business is conducted, it can provide valuable data to that company for how to improve its future valuation.
The EBITDA multiple method is a commonly used way of valuing a business by multiplying earnings before interest, taxes, depreciation and amortization by a factor that both the buyer and the seller believe is reasonable.
For the purposes of this article, we have not detailed the terms that make up the EBITDA acronym, but detail on these terms can be found easily in multiple texts on finance and accounting.
The factor to multiply EBITDA by is not as difficult to develop as you may think. Several acquisition consultants have developed routines and track all acquisitions by market type and will then publish a range for the current period of time. This, of course, serves as a starting point and then you need to apply your experience and due diligence results. Revenue growth, market share, customer perception and many other criteria will cause you to adjust the EBITDA multiple.
We tend to utilize an average EBITDA — generally an average of the last five years — rather than using just the current year. Many times a seller will want to use their adjusted or projected EBITDA to offset what they consider expenses that are out of the ordinary or anticipated growth in revenue. This is just a normal negotiating tactic.
The EBITDA multiple method is a great place to start when determining business valuation, but depending on your sophistication and complexity, discounted cash flow may be a better alternative. The biggest weakness of this method is its historical performance basis.
The future may, in fact, be much different in regards to revenue growth or capital requirements. Whatever valuation method you choose, our experience has taught us there is no substitute for extensive, rigorous due diligence on the business being acquired. ●
Matthew P. Figgie is chairman and Rick Solon is president and CEO at Clark-Reliance.