In this environment of abundant capital, merger and acquisition (M&A) valuations and transaction volumes are rising to historically high levels. Fueled by ample supply of low cost debt and rising real estate values, EBITDA multiples are commonly reaching 10x and higher. It’s a seller’s market, which can be a bad thing for buyers, intermediaries, and ironically sometimes also the seller, in terms of getting a deal done.
With historically high valuations, the frothiness of the market drives biases and misconceptions among some business owners. Owners who are operators first and foremost have limited knowledge of how the capital markets work. They make hasty, not very thoughtful comparisons based on what they read in the business press or what they hear from their peers.
Make the right comparisons when determining valuation
“My brother-in-law just sold his company at 12x EBTIDA. My company is bigger, better, leaner, [fill in the blank here]. Therefore, my company should sell for at least 12x or more,” a business owner may justify.
But what if the other company had real estate as part of the deal? Or no stale inventory? Or was purchased by a strategic, not financial, buyer? There can be many considerations that drive different multiples—even among similar companies in the same industry. These can be somewhat nuanced and beyond the owner’s initial awareness.
To make matters worse, a frugal owner may be opposed to paying for professional advice on such nuanced considerations— or even the tax implications of the transaction. This can create difficult obstacles for M&A professionals to overcome, even for those seeking to represent the owners’ best interests.
Assess the available options
Deal makers have many tools to address the gap between owner expectations and buyer perspectives. This can include: carve-outs, spin-offs, ESOPs, earn outs, seller notes, convertible debt and other structured debt instruments. However, not all of these tools are viable options in every case. There’s also the issue of an owner balking at related-fees.
One way to solve for a valuation gap could be to “reframe the game” in the owner’s mind. It doesn’t help anyone if the owner is fixated on some arbitrary multiple of EBITDA for which there is no detailed basis. Ask the owner, are you more interested in a high multiple or a high valuation?
At the end of the day, you don’t take your EBITDA multiple to the bank. You take dollars—after tax dollars—to the bank.
Consider an alternative approach
When owners try to solve for a specific multiple of EBITDA, they are solving the wrong problem. That’s a problem they really do not control and is decided in an arena in which they have very limited experience. Owners are better served by trying to solve for a specific level of EBITDA, something which they have a great deal more control over in an arena where they have vast experience.
Many owners are surprised to discover untapped EBITDA margin opportunities in some pretty unremarkable places. Indirect expense categories with relatively low levels of expenditure often have another 10 or 20 percent improvement potential. Telecom, packaging, waste hauling… typically, these categories get looked at once every year or two, maybe some get RFP’d. But changes in the company’s business, or changes in their suppliers’ business, can create opportunities for additional refinement. There may not be significant opportunity in any one expense line, but across multiple expense areas, it can add up viable annual EBITDA contributions. This can help fund the cash to pay the professional advisory fees of all the intermediaries involved.
This may seem like a lot of work, and it can be without outside assistance. But in many cases it is a more realistic course of action than trying to dictate a particular EBITDA multiple to the capital markets.