Multiple of EBITDA
You have received an offer for your business based on a multiple of EBITDA. What is EBITDA and are you sure the multiple is right?
WHAT IS EBITDA?
EBITDA stands for “Earnings Before Interest, Tax, Depreciation, & Amortization.
WHY DO WE USE IT?
It is a quick way to show a company’s earnings before the influence of accounting and financial deductions.
WHAT IS A MULTIPLE OF EBITDA?
Simply, the multiple is the number of times you multiply EBITDA to determine the price of the company.
HOW DO WE DETERMINE THE MULTIPLE?
The multiple is somewhat subjective; however, it does have an impact, and therefore, understanding its effects may help you gain better insight into the buyer’s position. A multiple is the inverse of the rate of return an investor/buyer is seeking to receive. For example; (100% divided by 5 = 20%) or (100% divided by 10 = 10%). A buyer will seek a higher return for businesses that is determined to have more risk, such as, customer concentration, or a lack of recurring revenue.
HOW DOES A MULTIPLE IMPACT THE BUYER’S ABILITY TO PAY MORE?
Buyers will often negotiate based on their ability to finance the transaction. In the current financial environment, it is reasonable to assume that a bank is only willing to finance between 3-5 times EBITDA, with 5 times EBITDA being rare. Therefore, the gap must be filled by either or a combination of subordinated debt, such as a vendor take back, mezzanine financing, or equity.
Therefore, you need to ask yourself, is the buyer pushing back on valuation because of concerns around risk or inability to get financing.
If you want to understand how the multiple is impacting the buyer’s ability to finance your transaction? Download this template.