By Linda Rose, founder, RoseASP, recently sold to ESW Capital (IT ExchangeNet facilitated transaction)
Part III - Adjusted EBITDA
This is my last post of this series. Hopefully you have had the opportunity to read my earlier articles highlighting the recent sale of my Dynamics business. If not, the links can be found here: Why Now / The Timing of the Deal / Valuations.
If you are a business owner, I'm sure you are familiar with EBITDA (Earning Before Interest, Taxes, Depreciation, and Amortization). This is considered the traditional valuation method that measures a company's historical cash flow generation. Usually a multiple (depending on the type of company) of this number is used to value a company - anywhere from 3x to 12x in the Microsoft Dynamics space - not the 21x I heard Microsoft tell 0365 Partners last year at WPC.
And size matters: If you are over $25 million in revenue, anticipate higher multiples in the 10x-15x range. This higher range is attributed to businesses with strong recurring revenue (read: SaaS companies) and those with their own IP. That said, this multiple-based calculation is not necessarily reflective of the potential total value of one's business, and on many occasions, the final transaction value exceeds any standard valuation as the buyer views the ultimate value to be in the future potential of the company and not the historical past. We have all witnessed purchases in the last couple years that are out of the normal range.
As I outlined in an earlier post. while it is the typical gold standard, not every transaction is valued based on EBITDA.
In both of my transactions, I calculated a number that was considered "adjusted" EBITDA. Adjusted EBITDA is revised to exclude the effects of mainly non-recurring items of revenue or gain, and expense or loss. It can also include items that are directly related to the owners running the business. Adjusted EBITDA items are as follows:
Add backs to your EBITDA number: (increases your value)
- Excessive Owner Salary: Owners earning far above the industry norm
- Owner Bonuses: Amounts per rata beyond what other employees are receiving
- Profit Sharing: Distributions not reinvested back into the business
- Automobiles/Housing: While completely legal, the buyer would likely not embrace moving forward
- Insurance: Owner's health, auto, life, key man, disability, etc
- Owner Travel: If excessive between locations
- Legal Expenses: Perhaps due to a one-time lawsuit
- Intercompany Expenses: One holding company paying the other for a variety of reasons
- Extraordinary Losses: Such as unusual customer bankruptcy
Subtracts to your EBITDA number: (decreases your value)
- Less than normal owner salary - the add back might be the difference on what you are earning and what your replacement might cost
- Not having adequate benefits in place for your company - usually not the case, but those will be reviewed in detail
- Owner leaves but has also been a key player in sales - the salary of a salesperson may be subtracted based on the need to hire a replacement
- Extraordinary gain - for example, a one-time sale of IP that will never happen again
I was personally aware of a few of these items from my first transaction, but the team at IT ExchangeNet helped me discover additional items that materially increased the value of my company. And as much as I wanted them to give me a value for my company in advance, it was IT ExchangeNet's approach to never take a company to market with a preconceived price tag because it provides a ceiling and encourages bargain hunting. Instead, they let the market determine the value of my company - also knowing that I didn't need to sell. The combination of the two provided for a sale price that I ultimately found appealing.
If you are interested in learning more, have been contemplating a sale, or just want to understand the process, join me on June 28th (re-scheduled from June 21st) for a webinar where I will join Tim Mueller of IT ExchangeNet for a more in-depth conversation on the process.
Registration links TBA
And of course, confidentiality by all participants will be maintained!