M&A 101: Demystifying Business Valuation — A Brief Overview
Hey there, fellow M&A enthusiasts! 👋🏻 Today, we’re diving into the intriguing realm of business valuation. While I won’t be dropping a step-by-step guide on how to precisely value a business, I’m here to offer you some essential pointers to help you navigate this complex terrain.
📈 Let’s begin by taking a closer look at the industry in which the business operates. It’s important to ask some key questions: How well is the industry currently performing? What is its Compound Annual Growth Rate (CAGR)? Are there any notable trends shaping its landscape? Is it a thriving sector, or is it facing a decline? Equally important is assessing whether the business enjoys consistent and recurring revenue streams. If it’s part of a vibrant, growth-oriented industry, its valuation may shine brighter compared to those in less promising sectors.
👩🏻💼 Now, let’s delve into what your trusted analysts, bankers, or advisors will require when evaluating a business. By the book, they will be interested in the P&Ls from the past three years, the most recent BS, and the somewhat elusive ‘add-backs.’ So, before venturing into the world of business valuation, ensure your financial records are meticulously organized.
➕ You might be wondering, what exactly are these ‘add-backs’? Well, they become pertinent when dealing with the acquisition of a small or medium-sized business. Add-backs essentially refer to those occasional, non-recurring expenses — be they personal or one-time expenditures — that should be factored back in to arrive at the true, adjusted EBITDA. In simpler terms, EBITDA is akin to Operational Income, just a step higher in the P&L statement.
💰 The purpose of determining this adjusted EBITDA is to apply a multiple (EV/EBITDAx) for the purpose of calculating a business’s valuation. However, it’s imperative to exercise caution: not all sources providing these multiples can be trusted blindly, as they often lean towards either excessive optimism or undue pessimism.
🏢 Drawing from my experiences during graduate school and past internships, I’ve found that the most reliable method is to establish a multiple by comparing your target business with similar companies in the same industry. Yet, if you find yourself pressed for time or seeking a quick ballpark figure, MergerMarket can be a helpful resource. This platform allows you to search by geography and sector, offering a ‘medium’ multiple, which tends to be a more pragmatic indicator, as the average multiple is often on the optimistic side.
📖 Naturally, there are numerous other factors to consider in the realm of business valuation, but a comprehensive exploration of these would warrant a book, not an article! So, for the time being, keep these essentials in mind: gather the financial data from the last three years, compile a list of add-backs for adjusted EBITDA, and determine your EV/EBITDA multiple — whether calculated independently or sourced from a dependable platform like MergerMarket.
Until our next encounter, may your valuations be sharp, and may your investments always yield promising returns! 💸
