EBITDA Multiples represent the most common method used by corporate finance advisors, Private Equity and corporate acquirers for valuing businesses. The acronym specifically relates to Earnings Before Interest, Tax, Depreciation and Amortisation. As a profit figure it is therefore independent of these features – independent of tax, independent of artificial accounting policies that relate to the balance sheet and independent of how the business is funded. It therefore represents the clearest proxy for ‘operating cash-flow’ available for various parties to consider.
At this point it is important to note that Public Company valuations tend to relate to the P/E Ratio which is generally for the benefit of external shareholders and as such relates to post-tax earnings rather than pre-tax.
Example of EBITDA Multiples in use
Imagine a business turning over £10m, making a reported profit of say £500,000 under private ownership. The starting point is to add-back all owners drawings, including any benefits that may stem from simply being a business owner – salary, pension contributions, benefits (cars, additional offices etc) – say £250,000. Also add back any additional ‘exceptional’ costs from within the year that would not be expected to recur under new ownership – say £250,000. The figure is then reduced by the commercial rate payable to an employed manager replacing the outgoing owners (eg £100,000), this gives an ‘adjusted net profit figure’. A multiple is then applied and the total Enterprise Value is the resulting figure, in this case £7.2m. However as a purchaser will reduce the value by any outstanding debt within the business and in our example we have a Term Loan of £600,000, the final Equity Value using EBITDA multiples approach is £6.6m.
EBITDA Multiples approach to valuation
An interesting anecdote is that if you take all private company transactions over the past 20 years with available data, the range of EBITDA multiples has averaged somewhere between 4 & 8.
Comments regarding the ‘EBITDA Multiples’ approach
The primary benefit of this approach is that it is simple. As a method for comparing offers, it provides a framework upon which both sides can agree the raw data and agree the method. What remains to negotiate is the multiple chosen by the buyer.
A note of caution when comparing EBITDA Multiples – Publically quoted multiples often cite the reported net profit figure and can rely on previous years numbers as these are all that the journalist could find at the time. Taking our previous example if you were to reverse engineer the multiple based upon the reoprted profit of £500,000, the result would be 13.2 – partial information can undermine the usefulness of EBITDA multiples.