1. Despite all the naysayers on the usefulness of EBITDA as a valuation tool, most small and medium sized companies in almost all industries today are valued as a Multiple of Normalized EBITDA or Earnings before Interest, taxes and depreciation. We use EBITDA rather than simple Earnings before taxes because buyers want to factor out debt and depreciation charges to get to a cash flow number. Normalizing EBITDA refers to the process of adjusting EBITDA for any material, non-recurring revenue or expense items and any abnormal “Owner’s Take.” In determining price, buyers will pay more attention to past EBITDA numbers than the future.
2. One calculates Enterprise Value (EV) by settling on a suitable “multiple” of EBITDA to determine a company’s worth. Generally small companies trade for three to five times EBITDA. Larger public companies can trade for multiples of anywhere from eight to 15 times. Besides the size of the company, this multiple can be affected by the following: Is the company growing? Are the margins in the company attractive? How much recurring monthly revenue does the company have? Does the company have a unique value proposition that will protect it from competitors? Is the company’s revenue spread over a large number of customers? In the integration and fire companies I have sold in the last year, the multiple have varied from 4.5 to 6.5.
3. As mentioned above, Enterprise Value is what you get when you multiply EBITDA times a suitable multiple. But here’s the thing: Enterprise Value = Working Capital + Fixed Assets + any Intangibles. When you sell a business valued this way, the buyer expects to get a reasonable amount of working capital plus all the fixed assets required to run the business for the price. Some of my clients have suggested to me after I quote them a ball park valuation figure, in addition they should get the value from their balance sheet on top of the Enterprise Value. Not going to happen.
4. Alarm companies, companies where the bulk of the value is in the recurring monthly revenue, can also be valued using a multiple of EBITDA but for simplicity’s sake buyers tend to revert to a Multiple of Recurring Monthly Revenue (RMR). Some owners of alarm accounts think all alarm accounts bases will sell to anybody for 36X RMR. Not true. A large batch of high margin, low attrition accounts all on signed contracts and on a call forward line may sell to a strategic buyer like a bigger alarm company for 36 times but the buyer has to be able to buy the base without any other expenses and get the seller’s telephone number in the deal for future referrals.
5. You might think that all buyers will end up with the same Enterprise Value when looking at a target company. After all, how much can EBITDA and the multiple vary? Well the answer is quite a lot depending on the buyer. A strategic buyer — someone from the same industry that is “rolling up” companies — may well get the opportunity to take more efficiencies post closing than a financial buyer who basically has to leave the existing organization and cost structure in place post closing. Being able to reduce costs produces a higher normalized EBITDA number and therefore a higher potential purchase price. Valuations can depend on who the buyer is. Strategic buyers generally pay higher prices than financial buyers.
6. Selling any business, no matter how small, takes time. Most security businesses I have been involved in take anywhere from six to 12 months to sell or longer. Fire and integration businesses take longer than alarm companies. Security businesses in big cities usually sell faster than those in the hinterland. Deals where the buyer uses financing usually take longer than when the buyer has the capital. Share deals generally take longer than asset deals. Over-riding all these points is another rule: the longer it takes to close a deal, the greater the chance of the deal not closing.
7. A good time to sell your business is when:
- Economic times are good and valuations of public and private companies are high.
- Your company is doing well and growing. You have two years of solid numbers to show.
- There are lots of buyers in the marketplace. Interest rates are low.
This story appeared in the January/February 2019 edition of SP&T News Magazine.