Valuation of a private business
Valuing a private business · Acquisition Entrepreneur Blueprint
Private businesses are generally valued as a multiple of adjusted EBITDA. The range of observed multiples is wide, but the factors that determine a business's position within it are largely identifiable.
Valuation ranges by size
Businesses with EBITDA below $1 million typically transact at 2.5x to 4.0x. Those with EBITDA of $1 million to $3 million transact at 4.0x to 6.0x, and those with $3 million to $10 million at 5.0x to 8.0x. Above that level, institutional buyers participate and multiples increase further.
The size premium has an economic basis. Larger businesses are less dependent on a single individual, have greater management depth, have access to lower-cost debt and attract a larger pool of potential buyers. Each of these characteristics supports a higher multiple.
Determinants of position within the range
Factors supporting a higher multiple: recurring revenue, a diversified customer base, retention of management, documented systems, growth, a defensible market position, reliable financial records and an active buyer market in the sector.
Factors supporting a lower multiple: owner dependence, customer concentration, declining revenue, undocumented systems, unreliable records, pending litigation, deferred capital expenditure and limited buyer interest in the sector.
Owner dependence is the largest single discount and is the factor most frequently underestimated by first-time acquirers. Where the owner holds the customer relationships, prepares the estimates and is the only person able to price work, the acquirer is purchasing a customer list and physical assets rather than a self-sustaining business.
Debt service capacity
The acquirer should determine the maximum price by reference to the debt the business can service.
At adjusted EBITDA of $1.5 million, a multiple of 5.0x implies a price of $7.5 million. If financed with $3.5 million of senior debt, a $1.5 million seller note and $2.5 million of equity, annual debt service on $5 million at 7% over seven years is approximately $900,000. Against EBITDA of $1.5 million, less $200,000 of maintenance capital expenditure and taxes, debt service coverage is narrow and leaves little capacity to absorb a decline in earnings.
At 4.0x, the price is $6 million, annual debt service falls to approximately $700,000, and coverage is comfortably adequate. The difference between the two multiples determines whether the business can withstand an adverse year.
Maximum and appropriate price
A competitive process may raise the price to the point at which the transaction is only marginally viable. The acquirer should determine a walk-away price before becoming committed to the transaction, and should adhere to it.
First-time acquirers frequently overpay because, having searched for an extended period, they are reluctant to recommence the search. The cost of recommencing is real, but it is smaller than the cost of an over-leveraged acquisition.
Work it through
1 exercise · nothing is recordedDebt service capacity and the walk-away multiple
Determine the maximum price by reference to the debt the business can service. As the purchase multiple increases, coverage declines; the multiple at which coverage becomes inadequate defines the walk-away price.
Adjust a value to see the result.
Work this through
Value a target identified in your search: normalised EBITDA, an appropriate multiple with a written justification of its position within the range, and the resulting price.
Calculate debt service coverage at that price, and determine the multiple at which coverage becomes inadequate. Record that multiple as your walk-away price before negotiations begin.
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