LuM&A - The Art of Bright M&A | Part 4 - So, What’s in The Multiple?
LUM&A IS A 4-PART SERIES WHERE WE SHARE OUR EXPERIENCES OF THE KEY ISSUES OWNERS FACE WHEN CONSIDERING SELLING THEIR BUSINESSES.
IN PART 1, WE HAVE EXAMINED THE OPTIMAL TIMING FOR A SALE
IN PART 2, WE HAVE DESCRIBED HOW TO OPTIMIZE VALUE
IN PART 3, WE HAVE EXPLORED WHAT TO EXPECT WHEN EXPECTING AN OFFER
IN PART 4, WE IDENTIFY THE KEY METRICS THAT DETERMINE VALUATION MULTIPLES
PART 4: SO, WHAT’S IN THE MULTIPLE?
When selling your business, you can generally expect the offered price to be a multiple of EBITDA. In our previous post What to Expect When Expecting an Offer we have analysed different applicable EBITDA adjustments. In this last part of the series, we identify the starting point and the different factors the multiple takes into account.
While the best starting point, normalized multiples, at which comparable publicly listed companies are trading, cannot be used off-the-shelf to value your business. The inherent differences between private and publicly listed companies, and for which a discount is applied include:
1- LIQUIDITY
The liquidity discount is unavoidable and can range from 15% to 50% depending on risks specific to your business. This reflects the discount the buyer would have to offer if he were pressed to re-sell the business right after having purchased it. Listed companies see their shares change hands in the space of minutes with liquidity measured as the spread between bid and ask prices.
2- QUALITY AND AVAILABILITY OF INFORMATION
The discount applied will depend on the quality of the information you make available to the buyer. The reason for it is to mitigate any risks related to the non-disclosure of information that could affect the value of the company post-acquisition. Publicly listed companies on the other hand, are regulated and required to periodically file their earnings and disclose any material information as it comes to light.
3- OPERATING HISTORYListed companies typically have a longer track record than private ones, track record being requisite to the listing of their shares. The discount here will depend on the longevity of your operating history and the sustainability and robustness of earnings.
4- SIZEThe discount will reflect your business’s ability to weather business cycles and can be mitigated with a range of value drivers that we have covered in LUM&A Part 2 Optimizing Value.
5- ADJUSTING FOR THE GROWTH PROFILEThe average market multiple will typically comprise a cross section of comparable company multiples which will have been adjusted for growth. The buyer will then apply a premium to reflect the growth profile of the business. We have illustrated below what an EBITDA multiple would imply in terms of payback period given the expected average EBITDA growth.
LuM&A - part 4 graph1
6- LAST FISCAL YEAR, TRAILING AND FORWARD MULTIPLES
Buyers will usually want to base their valuation on the last fiscal year results, as these numbers will have been audited and comparable to prior years. However, using the same last-fiscal-year multiple for two similar companies, with the same growth profile, but with different fiscal year dates, will penalize the one whose fiscal year-end is further away from the transaction date. For example, if the transaction is taking place in January for two similar companies that generate the same EBITDA growing at 7% per quarter but one has a fiscal year that ends in December and the other in June they will have different results and values:
LuM&A - part 4 graph2
Forward multiples on forward earnings are seldom used in M&A transactions as it is difficult to project and reward for income under a potentially new leadership. The purpose of projecting pro forma earnings in such transactions is to determine the potential growth profile of the company and embed it in the proposed multiple.We usually recommend using last twelve months (trailing) EBITDA and growth adjusted multiples as a basis for valuation. An interim audit report may be required to satisfy the buyer, but it is well worth given the multiplier effect the difference in earnings would have on the price.
7- REVENUE MULTIPLES
Revenue metrics are usually used as size indicators rather than for valuation purposes as they do not reflect any of the business’ operating characteristics such as efficiency, productivity, management quality etc.[/vc_column_text][vc_column_text]We will be following up on the series with a quarterly Lumina Private Company Valuation Index that will track multiples private companies are trading at, so stay tuned for more!
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By Jessica Estefane, CFA
Director | Lumina AdvisersJessica has been working with the firm for the last 3 years playing an integral role in closing a number of deals in the Education, Healthcare and Food and Beverage sectors, before joining full-time in October 2016. Jessica continues to play a vital role on all key mandates in the Transaction Advisory and Funding Solutions divisions.
Jessica is an experienced transaction advisory professional with 10 years of experience in the UAE. A former sell side Equity Research analyst with SHUAA Capital, Jessica ranked among the top analysts in the Middle East region for equity research in the telecommunication, energy and utilities sectors for four consecutive years by Euromoney Middle East until 2012.