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When an EBITDA Valuation Multiple Doesn’t Work

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Many business owner’s when they want to sell their business, often read about an EBITDA (earnings before interest, taxes, depreciation and amortization) valuation multiples. But when they’re questioned further, what they really mean is they want to sell for a higher EBITDA valuation multiple than discussed in the industry journals. Here, I will identify occurrences when traditional industry EBITDA valuation multiples fall short in determining the “invested capital” value of a business.

During Aggressive Growth

The first occurrence is when a company that is growing its sales rapidly. If you analyze how this growth is occurring, you often find that they’re investing allot of cash from daily operations back into the business. This may be in the form of research and development, hiring sales people, marketing campaigns, and systems upgrades, etc. Compare this to a business in the same industry niche that is satisfied to maintain status quo and not investing in growth, but rather merely increasing their EBITDA. The EBITDA performance for the latter company is going to be far better than the aggressive growth company.

From an EBITDA valuation perspective, the aggressive growth company will actually be punished for a behavior that a future buyer will benefit from. You are actually lowering your EBITDA in order to achieve higher future sales and profits.

What Earnings Stream Works Better?

Business appraisers will often use an earnings stream that doesn’t affect the daily operations for businesses growing at high rates. Net cash flow is used, as this selected earnings stream takes into account the capital spending to support high sales growth rates. Many businesses are cyclical in nature. These cycles may exhibit annual variability in capital spending.

Rarely do businesses incur a consistent level of capital expenditures each year. It is more common for a business to incur large capital expenditures for a brief period as it builds, acquires additional manufacturing or warehouse capacity, improves information technology systems, acquires other businesses or updates its current facilities. After a period of overinvestment, the business may have excess capacity that will take years to utilize. This often leads to a subsequent period of underinvestment while the business grows, in part, through the use of its excess capacity. An example is most businesses are impacted by technological advances. These advances, while costly at times, may lead to lower capital expenditures in the future.

How can American Business Appraisers Help?

Every individual situation is different and not everyone requires our certified appraisal services and sometimes just talking with one of our appraisers is all that may be necessary. With our initial consultation, there is no cost or obligation to you. We promise you two things; first, to invest a reasonable amount of time to gain an understanding of your specific requirements, and second, our communication will be kept confidential.

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