Last time, we went through the nitty-gritty work of calculating your company’s Adjusted EBITDA. The fun part is now to apply a multiple to that EBITDA to determine your company’s value.
If calculating Adjusted EBITDA is a generally objective process, EBITDA multiples are a much more subjective process. In other words, the multiple is in the eye of beholder, as a certain company earnings stream may be valued differently by different buyers.
While multiples can vary subjectively across buyers, and each multiple is both industry and company dependent, telling you that the multiple “generally depends” isn’t very helpful to you – so let’s talk about some general ranges. The primary driver of multiple is typically size. Putting venture capital, bleeding-edge tech companies aside (i.e. if you own the next Facebook this will not be relevant for you), smaller companies trade at lower multiples than larger companies. This is because larger size generally correlates with “staying power” and thus stability (as we discuss below), and thus a more valuable cash flow stream.
With respect to small private companies, I believe that size dictates the multiple of the company more than any other one factor, and thus is a good place to start. For a services, distribution or light manufacturing company, at $1M of EBITDA or less, the owner can likely expect a 3.0x – 4.0x multiple or thereabouts. When that same company grows larger to $3-12 million of annual Adjusted EBITDA, that same company can expect a mid-high single digit multiple in the 5.0x – 8.0x range, and when the Adjusted EBITDA jumps to $15M or above, that same company can expect a 9.0 – 12.0x multiple. Said differently, size matters.
But in addition to size of the company, there are 3 other industry and company dependent factors that dictate EBITDA multiple:
- Capital Intensity.The more capital equipment or investment in inventory you need to make in your business, the lower the multiple will be – all else equal. While EBITDA is the commonly accepted proxy for normalized cash earnings, things like required capital expenditures (i.e. buying equipment) is a drain on cash earnings, and lower true cash earnings means a lower multiple assigned to that EBITDA. So a $5 million EBITDA manufacturing business with $1 million of annual capital expenditures required is going to fetch a lower multiple on that $5 million EBITDA amount then is the $5 million EBITDA services business with $0 capital expenditure requirements.
- The higher the historical and/or projected growth of an industry or specific business, the higher the multiple. The logic here is intuitive – you would pay more for an earnings stream that is growing faster than one that is staying flat, or declining. A $5 million EBITDA software company growing at 20% per year historically, and is projected to grow 20% to $6M EBITDA next year is worth more than a flat $5 million EBITDA distribution business
- Just as important as the growth profile of the company is the stability of its financial performance. Buyer investment themes like seeking companies with ‘recurring revenue,’ ‘repeat customers,’ or ‘predictable cash flows’ all are aiming to identify stability. In my mind, this single aspect determines an EBITDA multiple more than any other. Buyers want to buy a business that delivers a “guaranteed” reliable, stable, predictable cash flow. Customer repeatability, and consistent margins are the key drivers of consistent margins. Most importantly, buyers can convince themselves of future growth without historical growth, and they can convince themselves they can be more efficient with capital spending than historical – but they can rarely convince themselves that volatile cash flows will become stable. Thus, stability is key, and the more stable the year-to-year performance, the higher the multiple assigned to that EBITDA stream.
Stability, growth and capital intensity are the primary reasons that software companies are worth higher multiples than a “job shop” manufacturing company. Software companies can scale (i.e. grow) easy with no capital investment (thus low capital intensity), they generally embed themselves into their customer’s business operations and thus have customer repeatability and stable performance, and software generally is considered a growth sector. So low capital intensity, high stability, and high growth. Conversely, a machine shop has to continually buy equipment to grow, and thus is capital intensive in its operations, U.S. domestic metalworking manufacturing is not generally considered a growth sector, and a CNC ‘job shop’ tends to experience inconsistent customer repeatability and volatile year-to-year financial performance. Obviously, the software EBITDA stream, even if the same size as the CNC machine shop, warrants a much higher multiple.
Now that we’ve discussed how to calculate Adjusted EBITDA and where to start in finding a multiple – let us do the work for you! Head here, fill out as much information as you can, and we’ll give it some thought and send you back something that will hopefully be helpful in valuing your company.