All about Multiples

September 30th, 2013

What every Staffing firm owner should know!

I sold my business for a Ten Multiple

Don’t you just love to hear this boast, as we have heard this bold statement at least a dozen times. Before we can draw any value conclusions we may want to ask a multiple of what or when this occurred?

The Metric depends on the type of Company

For publicly owned companies, the most noted multiple is that of after-tax net income and it often applied to projected income over the next twelve months. For early-stage companies, it could often be a multiple of revenues primarily for two reasons; they are often:

a) Not profitable at this stage but are expected to be in the future once their product or service is proven out or,

b) They are in high growth mode, and profit levels are depressed as a result of higher than long-term average spending on R & D and product/service marketing.

For established private companies, like most staffing firms, the most commonly used valuation metric is a multiple of trailingtwelve monthAdjusted EBITDA  for profitable firms.

EBITDA

Stands for earnings, before interest, taxes, depreciation and amortization, if any;andit therefore allows for a fair comparison between companies because it negates the following four effects on profitability:

1. The effect of having different asset bases by cancelling depreciation;

2. The effect due to different takeover histories by cancelling amortization often stemming from goodwill;

3. The effect due to different tax structures; and lastly

4. The effect of different capital structures by cancelling interest costs.

Adjustments are often thought of containing fluff used to boost profitability, so be sure you can verify and justify all items that you are proposing to add back.

 

The Time Frame Matters

The period the multiple applies to is also important. While Valuation is conceptually a forward-looking principle and publicly owned firms will often present their earnings on the next 12 months performance; for most privately owned companies the time frame is generally the Trailing Twelve Months (TTM) performance as a result of the difficulty in predicting what the next 12 months of earnings may be.

Other Considerations in determing Value

A. Did the buyer assume any of the seller’s debt?

B. Were their working capital adjustments made?

C. Over what time frame was the purchase price paid?

D. Sellers seeking 100% cash on closing will take deep discounts if they can even find a buyer.

E. Are payments set or contingent on performance?

F. Are there claw back features if the business becomes less profitable?

G. Are their enhanced payments for superior performance?

All of these questions will impact valuation and the amount the seller receives over time.

So, the next time someone tells you they sold for a ten multiple, focus more on the total value that was received, since we can’t spend a multiple, we can only spend the cash in our pockets. A multiple is just one-way to express value however as we can see from the questions above, what is counted in a multiple can vary a great deal due to the circumstances of both the buyer and seller.

When we actually probed one very proud seller about his ten multiple that he kept bragging about, we learned that his multiplier was all of $1,500 dollars of adjusted EBITDA, so his ten multiple was real; however it amounted to all of a $15,000 purchase price. So focus on the dollars you will end up with and try not to get hung up on the multiple, after all it is only a number without context unless you have a more complete picture of the transaction.

This posting contains substantial contributions from an article by Derek van der Plaat.

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