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Calculating acquisition multiples
FRED HAGEMAN
Fred Hageman is a partner in the mergers & acquisitions consulting firm of Hageman, Stansberry & Associates (HS&A). HS&A specializes in the rental industry. More information on HS&A can be found on the Web site at www.rentaladvisors.com. He may be reached at (530) 672-1885 or by e-mail at fjhageman@aol.com. 04/01/2006
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“What are acquisition multiples today?” is a question that my partner, Gary Stansberry, and I are asked several times a week — every week. From independent multi-location regional equipment companies to single-location general rental centers to “mom-and-pop” party rental businesses, this is a top-of-mind question for many rental company owners.
There is one thing you can count on — there isn’t an easy, clear or “cookie-cutter” answer to the question. Each company is valued differently. Even two companies that appear to be very alike on the surface could have very different valuations. There are several valuation methods or “multiples” to consider that relate to different measurements and there are different and wide ranges of multiples based on varying criteria.
With more acquisition activity than usual in the rental industry over the past year, many rental store owners are curious about what valuations are attached to businesses like theirs. But each business is unique with different positives and negatives that an acquirer will focus on. Acquirers today are very methodical. They are looking for businesses that fit their strategy and they struggle with valuing an enterprise because of the number of angles to analyze.
In general, people want to know what multiples are being paid on earnings before interest, taxes, depreciation and amortization (EBITDA).
A business valuation, however, is a culmination of a myriad of factors and is based on several valuation methods, not just one relating to EBITDA or cash flow.
Those factors include the size of the operation, geographic location and competition, equipment and revenue mix, fair market value of the rental fleet, facilities, leases, employees, growth potential, revenue and profit trends over several years, recurring and non-recurring revenue, legal structure of the enterprise, synergies that can be realized by an acquirer and much more.
We have developed several proprietary rental industry valuation models with each model acting as a “limiting factor” to one another. That means no one single valuation model or method is the best. Each valuation model and criterion matter, and have to be in proper relation to the others to accurately value a rental business.
Each buyer and seller of a business would like to choose a favorite valuation method and sell or buy at the price based on that favorite method, but that would be wrong. A multiple of four times EBITDA, for example, might look good to a buyer, but what if the company assets are old and have little net book value? What if the lease of the building is overvalued or expires in a short period of time? What about revenues in relation to true asset value and EBITDA? Are revenues inflated from a non-recurring business? After answering these questions, four times EBITDA might not look like a good deal.
When a publicly traded company is involved in an acquisition and purchase price is disclosed, the
determination of the “multiple” paid by an acquirer isn’t always what it might appear to be, either. For example, if real estate is included in the transaction, the property would not be part of the “enterprise value” of a company, but may be included as part of the purchase price. This example would inflate what the multiple appears to be whether it relates to EBITDA, revenue or something else.
If there is an “earn-out” agreement, the purchase price might never be realized — it could be significantly lower or even higher than what the purchase and sale documents say. The multiple paid can only be determined when the purchase price is completed at the end of such an arrangement.
EBITDA, too, can mean different things to different parties in a transaction. A buyer could “add back” certain synergies that will be realized immediately after the acquisition, thereby lowering the multiple paid in the buyer’s calculation so that the “pro forma” EBITDA would be much higher for the buyer than the seller. A multiple paid on stated EBITDA, on the other hand, could make the purchase price appear to be substantially higher than it is. When a seller legitimately “adds back” his personal or non-recurring expenses that have run through his income statement, the multiple paid appears lower, too, in what is called “adjusted” EBITDA.
The multiple paid on adjusted EBITDA is then lower than what it is on stated EBITDA.
We have seen transactions where the price paid to a seller appears to be lower than what it might have been, but additional considerations are paid in other ways such as consulting agreements or increased facility rent that doesn’t show up in the purchase price and reflects a lower multiple on the surface.
Conversely, a higher price might be paid, but it includes future services to be provided by a seller that have no value attached. This could alter the true multiple paid for a business. There are many ways to interpret numbers and multiples are easily skewed one way or another.
So, what multiples are being paid today? It’s all over the place. It could be as low as three times EBITDA or as high as 5.5 times EBITDA, and that could be adjusted or stated EBITDA.
An agreement is not all about the price. Structure of the deal is of utmost importance, too. If the structure of the deal isn’t right, the price might not matter, no matter how good the deal looks at first glance. Time value of money also needs to be calculated properly to get a decent handle on the metrics of a deal.
Those who have sold their businesses realize the difficulty and time involved. There are hundreds of steps to be taken by all parties in order to consummate the acquisition of a company with valuation being of
utmost importance.
What we can say is that fair multiples are being paid in today’s market. It may be a bit more of a seller’s market now than in the past, but no acquirer is going to pay an unreasonable multiple for a business. The deal has to make sound business sense and turn into a moneymaker for the buyer at some point in time. Bankruptcies occur when unreasonable multiples are paid for the wrong reasons.
Selling a business is complex. Once a deal is complete, it is complete. There is no going back, so you want to make sure all bases are covered and that the deal is valued fairly, negotiated thoroughly and structured properly. One misstep out of the hundreds of steps it takes to complete a deal can cost you dearly. Ultimately, it is what goes into the bank account that matters, not just the multiple paid.
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