April 6, 2020 HMA Website

Understanding Multiples

What is a Multiple anyway?  This term is most often the focus of a business owner either looking to acquire or sell a business.  It’s so common of a term that most people don’t step back and ask the fundamental questions, specifically what’s a Multiple and how is it determined?

It’s important to note at the beginning that a Multiple is great for speculative conversation as it’s a way to broadly categorize and benchmark value.  However, each business is as individual as snowflakes with their own unique characteristics.

What does “Multiple” Mean?

A Multiple is the number of times a key metric, most often associated with a company’s normalized earnings or adjusted Earnings Before Interest, Taxes, Depreciation, and Amortization (EBITDA) is “multiplied” in order to assess the company’s market price. When the values of similar business types in the same basic industries are analyzed and averaged, then it’s possible to gain a general sense of market prices of similar businesses within a given business industry.

For example, within your specific industry, if your type of business sells for a 5 to 7 times Multiple on adjusted EBITDA then it’s possible to arrive at an estimate of the market price of your business.  In this example, if your company generates $2M in adjusted EBIDTA, then the generalized market price would be $10M to $14M should you decide to market and sell the business.

Of course, these are highly generalized statements of market price and often do not reflect certain unique attributes of your business that may make the business more or less valuable to a potential acquirer.

Adjusted versus Unadjusted EBITDA

In order to compare apples to apples, it’s important to address how adjusted EBITDA is defined within any discussion of Multiples.  Adjusted EBITDA also accounts for the addback or deduction of certain non-operating, non-recurring type of expenses.  The concept behind adjusted EBITDA is to get to a figure that represents the true and ongoing earnings the acquirer is likely to realize based upon sound financial reporting.

For example, depending on how an item is accounted for with respect to financial reporting (such as whether an item is expensed or capitalized), a one-time, extraordinary expense like the costs of implementing a new ERP system might be considered an “addback” to adjusted EBITDA as the implementation costs are not likely to reoccur within the ongoing operation of the business.  Other examples, especially relevant in closely held or family businesses would be above-market salaries, perks paid to the owner, and expenses that are unrelated to the business operations. Understanding the factors that make up adjusted EBITDA is critical to determine an “accurate and reasonable” base in which to apply the Multiple.

Factors Impacting Multiples

Multiples on EBITDA can vary greatly.  A well run, positively trending, less risky, more easily transferrable business will attract a greater pool of acquirers and therefore drive the Multiple, and hence market price higher.

Below are factors that are often known to drive higher Multiples, when compared to similar businesses in the same sector.

  • Higher growth rate
  • Higher gross margin
  • Higher revenue
  • Customer Composition
    • Long term customers with lower churn rate
    • Broad customer base (Low customer concentration)
  • Business Types
    • Distribution/retail/collision as compared to basic manufacturing
    • Public companies with more favorable funding options
  • Competitive Advantage
    • Unique services, products, and technologies
    • Defensible, marketable intellectual property
  • Financial Reporting
    • Use of GAAP reporting
    • The availability of 3rd party audited financial statements
  • Experienced management team with established leadership

There are many macro forces such as industry outlook, impact of technology, and outside economic conditions that also may come into play when assessing market price.

Industry specific M&A specialists like Hart Marx Advisors can provide an analysis that will blend all the critical factors together to determine a Multiple range for your specific business.  A plan can then be developed to maximize the business in terms of overall acquisition attractiveness in order to achieve the highest market price and simultaneously increase the likelihood of closing a transaction.