If you are a business owner, I’m sure you are familiar with EBITDA (Earnings Before Interest, Taxes, Depreciation and Amortization). This is considered the traditional valuation method that measures a company’s historical cash flow generation. Usually a multiple (depending on the type of company) of this number is used to value a company – anywhere from 3x to 12x in the Microsoft technology space, unless of course you have your own IP then valuations can be as high as 21x.
And size matters: If you are over $25M in revenue, anticipate higher multiples in the 10x – 15x range – this higher range is attributed to businesses with strong recurring revenue and those with their own IP. That said, this multiple-based calculation is not necessarily reflective of the potential total value of one’s business, and on many occasions the final transaction value exceeds any standard valuation as the buyer views the ultimate value to be in the future potential of the company and not the historical past. We have all witnessed purchases in the last couple of years that are out of the normal range.
As I outlined earlier, while it is the typical gold standard, not every transaction is valued based on EBITDA.
In both of my transactions I calculated a number that was considered an “adjusted” EBITDA. Adjusted EBITDA is revised to exclude the effects of mainly non-recurring items of revenue or gain, and expense or loss. It can also include items that are directly related to the owners running the business. Examples of adjusted EBITDA items are as follows:
Add backs to your EBITDA number: (increases your value)
- Excessive owner salary: Owners earning far above the industry norm;
- Owner Bonuses: Amounts per rata beyond what other employees are receiving;
- Profit Sharing: Distributions not reinvested back into the business.
- Automobiles/Housing: While completely legal, the buyer would likely not embrace moving forward
- Insurance (i.e owner’s health, auto, life, key man, disability)
- Owner Travel: If excessive between locations
- Legal Expenses: Perhaps due to a one-time lawsuit.
- Intercompany expenses: One holding Company paying the other for a variety of reasons
- Extraordinary losses: Such as unusual customer bankruptcy.
Subtracts to your EBITDA number: (decreases your value)
- Less than normal owner salary – the add-back might be the difference on what you are earning and what your replacement might cost.
- Not have adequate benefits in place for your company – this is usually not the case, but those will be reviewed in detail.
- Owner leaves but has also been a key player in sales – the salary of a sales person may be a subtracted based on the need to hire a replacement.
- Extraordinary gain – i.e. one-time sale of IP that will never happen again.
I was personally aware of a few of these items from my first transaction, but my broker and CFO identified additional items that materially increased the value of the company. And as much as I wanted my broker to give me a value for my company in advance, it was IT ExhangeNet’s approach to never to take a company to market with a preconceived price tag because it provides a ceiling and encourages bargain hunting. Instead they let the market determine the value of my company. This approach I felt gave us the greatest valuation for our company (combined with multiple buyers who had an interest in acquiring us).