According to data in a Wall Street Journal article, “Private-Equity Firms Forced to Evolve” (January 6, 2012), in 2011 private-equity firms used capital structures for acquisitions with far less debt than in 2010: from roughly 58% debt to a little under 49%. The surprise, though, was that despite using less financial leverage and the country still being in a very anemic recovery, private-equity firms, on average, paid a higher multiple of EBITDA for businesses than in 2009 or 2010. While the average EBITDA multiplier paid for businesses isn’t as high as in 2007 or 2008, it is higher than from 2000 to 2006.
So what was the average price in terms of an EBITDA multiplier that private-equity firms paid for businesses in 2011? Just under 9x EBITDA.
Before assuming that this is the price you will achieve for your business if selling or what you should pay for a business if you are a buyer, there are a few things to keep in mind:
1. If you are reading this blog it is likely that you are either looking to buy or you own a small to lower mid-market company. Most of my seller clients have less than $3 million in EBITDA, and the majority have less than $1 million in EBITDA. Very few private-equity firms will consider a business with less than $1 million in EBITDA, and most are looking for significantly larger businesses to acquire. Small firms, in general, are perceived to be riskier and less attractive than larger companies, so many buyers will discount price when considering a small business.
2. I find that many business buyers and sellers confuse Seller Discretionary Earnings with EBITDA. Seller Discretionary Earnings will be a larger number than EBITDA, since it is comprised of EBITDA plus the expensed compensation and benefits of a single owner. Particularly on small businesses, the mistake of confusing the two can dramatically distort estimates of value. So, even if you perceive that the EBITDA multiplier that private equity groups have paid on average for a business, make sure that you are truly using EBITDA as the financial measurement, not Seller Discretionary Earnings. For example, if a business owner is either not not paying herself a salary or is paying herself a salary that is significantly below market for her management labor, then without making an adjustment, EBITDA will be overstated for estimating value.
3. Business value is unique to an individual business according to its risk factors, profitability, competitive environment, opportunities for growth, etc. so while it is nice to look at trends with average multipliers paid, it is not overly meaningful in determining what a particular business should be worth. When Codiligent business brokers assists buyers and sellers, one of the roles it plays in the process is to fully analyze the business taking into consideration both quantitative and qualitative information to estimate value based on the unique characteristics of the business.
For buyers, the increase in multipliers paid by private-equity firms may indicate greater competition for businesses, which may mean not only that higher prices may be required than during the recession, but also that buyers who want to complete a deal may have to act more quickly to avoid losing out to a competitor for the target business.
