Business valuations using EBITDA (Earnings Before Interest, Tax, Depreciation & Amortisation) is a widely used profit related valuation method.
When EBITDA is employed in valuing a business, it needs to be “adjusted” which should include any “add-backs” as part of the “normalising adjustments” which will typically take into account of items such as:
- Below fair market rates for sales, purchases or expenses
- Owners salary or bonuses that are not at a fair market rate
- Repairs and maintenance charges that should have been capitalised (eg improvements)
- Non-recurring expenditure, including but not limited to professional and legal fees, patent & trademark fees, donations, employee bonuses etc
- Stock levels that are too high for one reason or another
EBITDA Multiples
A multiple is then applied to the “Adjusted EBITDA” figure, which will determine the Valuation for the business (or amount of Return) if the shares are then sold. The EBITDA multiple in the valuation process is often based on an industry based average, calculated on a sample of transactional values and multiples of similar sized businesses sold. The multiplier figure for SME company valuations, is usually between 3 and 5, sometimes higher eg 7 or 8 or higher still when a “special purchaser” is involved in buying the business, ie a purchase for strategic reasons; the actual multiplier taking into account risk factors, business environment, market potential etc.
Risk Factors that affect Value
We all know that “the higher risk, the greater the return” but when it comes to business value, those risk areas need to be reflected the other way around as generally, “the lower the risk, the higher the value” and therefore, the Valuer will take into account the “risk factors” which will determine the multiplier. The following factors reduce perceived risk and enhance value:
| Positive Factor | Impact on Valuation |
|---|---|
| Strong, independent management team | Higher multiple |
| Low reliance on owner | Lower risk |
| Blue-chip or diversified customer base | Stability |
| No single customer >10% of revenue | Risk mitigation |
| Repeat or contracted business | Predictability |
| Contracts with suppliers/customers | Continuity |
| Operates in a niche or growing market | Growth potential |
| Difficult to replicate (IP, know-how, barriers) | Competitive edge |
| Minimal direct competition | Market strength |
| Good industry reputation | Intangible value |
| Consistent revenue/profit growth | Sustainability |
| Recognised accreditations, management systems | Operational maturity |
When evaluating the value of a business, it is important to understand what “adjustments” have been made (or not been made) and what multiplier has been used. These must be seen to be fair and reasonable, otherwise a false impression of value could easily be made.
For further information on EBITDA Valuations, please CLICK HERE.
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