Small business owners are often obsessed with how much their business will bring in when sold. While the multiple is important – a company sold at 9 times EBITDA is worth 50 percent more than when sold at 6 times multiple – that focus may be misplaced.
That’s because the multiple of EBITDA, defined as earnings before interest, taxes and depreciation, at which the company is being sold is frankly beyond their direct control. The market determines the multiple through the sales process orchestrated by the seller’s investment bank or financial advisor, which ideally involves multiple potential buyers.
What is under the control of the business owner is EBITDA and the steps taken to maximize it. Improving EBITDA helps sellers maximize the profit they will make.
EBITDA, not net income, is the most important metric for valuing private companies
First some background. EBITDA, not net income, is the most important metric for valuing private companies. Looking at companies without the impact of “ITDA” – interest payments, a function of the company’s debts; taxeswhich vary based on the jurisdictions where the business is located and generates revenue; depreciation, which is usually more for manufacturers, less for those with few physical assets; And depreciationtypically larger for companies that have made serial acquisitions – helps normalize value across industries and capital structures.
If you’re thinking about selling a business, try this: Put yourself in the shoes of a buyer and consider these steps that directly affect EBITDA and leave a business with a better financial return:
· Reduce personal expenses that go through the income statement. It pays to divert the business from financing home repairs or keeping your kids on the P&L. If you don’t, your buyer will.
· Provide audited financial records. Small business audits are inexpensive. You will realize multiples of the $10,000 or so you spend on the buyer’s diminished interest.
· Discuss bonus compensation in advance. Small businesses often use large post-EBITDA bonuses to reward key executives and return capital to family members. If future management fees and family payments will not flow through the income statement, discuss them before the sale.
· Eliminate perks. Mid-market owners can tie their business finances to the boats, cars, private jets, and country club memberships. But realize that once these benefits are increased on the buyer’s multiple, they will have a disproportionate negative impact on the company’s perceived value.
· Document one-time expenses. Things happen in the life of any small business, so document mishaps, losses, and higher discretionary expenses to ensure the company gets credit for EBITDA that will prove more robust than otherwise.
These suggestions are true regardless of the type of sale you’re considering: ESOP, M&A, or IPO.
Consider our advice to the owner of several related companies incorporated as separate companies with different names and different financial statements. The owner engaged us to sell the combined entity, but no historical financial information existed before that. Consequently, he had three strikes against him. Uniform financial statements would be a lot of work for a buyer to make. The individual companies raised suspicions about the integrity of the whole. And each entity had different add-backs, such as personal expenses and extra fees.
We advised him to invest in a “Quality of Earnings” report prepared by a reputable firm, which enabled him to present potential buyers with clean, coherent, and well-researched financial statements that portrayed the company as the attractive investment opportunity it really was. The owner made a successful exit with an exponential payback of the cost of the earnings quality report.
A powerful advantage comes from taking steps to maximize EBITDA before the sales process begins. It is the psychological lift that these actions provide the buyer. Just as creating and mowing your yard exudes neatness and upkeep, making a potential buyer positively inclined to pay your asking price, a potential buyer will be more interested in acquiring your business if his or her due diligence report on the quality of earnings raises few red flags. .
In reality, these proactive steps are the only factor impacting your company’s superior is under your control. So improve your company’s “curb” before you start the sales process. You benefit from the high-quality EBITDA and present your business in the most attractive light – and that will maximize its multiple.
