How to Maximize Business Value: Focus on Increasing EBITDA and not the Multiple

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Business owners and their advisers sometimes fixate on the multiples, usually of EBITDA, obtained in transactions.  Normally, these are transactions involving other businesses and other owners.  To maximize business value, however, that focus is misplaced.  The reason is simple:

All that any business owner can hope to achieve in a sale is the maximum multiple of EBITDA available in the marketplace for his or her business at the time it is offered for sale.

Worry About the EBITDA Multiple?

The maximum multiple (or, in reality, range of multiples) at a point in time is a function of numerous factors including:

  • Conditions in the stock market
  • The level of interest rates and the availability of financing
  • Conditions in the relevant economic markets (national, regional, local…)
  • Industry conditions
  • Current interest of competing strategic buyers in similar businesses
  • Availability of investment funds in private equity funds focused on similar businesses
  • When irrational buyers abound
  • The level of earnings and conditions in the business being sold

Except for the last item in the list above, factors influencing the level of multiples available in the market at a point in time are outside the influence of a company’s owners and management.

Assume for this discussion (and simplicity) that the target range of multiples for a particular business at a point in time is from 6x EBITDA to the maximum of 8x EBITDA.  This range is set.

Focus on EBITDA?

Company owners and managers should focus on building the level, sustainability, and expected growth of their earnings to maximize the value of their businesses.  The basic idea is to have the company in a good or optimal position at all times so that at the time a sale is initiated, earnings are optimal and the outlook for earnings is favorable.

There are many more ongoing opportunities to work on increasing EBITDA for any company than there are for increasing the multiple.  Rather than worrying about his or her EBITDA multiple, the business owner (or director) could work on (or cause others to work on) one or more of the following:

  • Work on increasing revenue  
    • Increase sales of existing products or services to existing customers
    • Sell existing products or services to new customers in new markets
    • Create new products to sell to existing customers (and new customers)
    • Omit lines of products or services that are losing money
    • Expand productive selling locations
    • Increase sales force if appropriate
    • Add new locations
    • Acquisitions that fit and do not increase risk materially
  • Improve cost of sales or cost of goods sold
    • Work on improving pricing on purchases
    • Enhance the product creation processes
    • Work or invest to increase productivity of the label
    • Invest appropriately to increase manufacturing or distribution efficiencies
    • Consolidate facilities
    • Reorganize management
    • Fix any deferred maintenance or investment issues
  • Improve operating expenses (absolutely or relatively)
    • Lower personnel costs if possible, or
    • Lower personnel costs per unit/product/service
    • Work to reduce occupancy costs
    • Eliminate known redundant expenses
    • Develop and implement new ideas for selling and marketing
    • Reorganize management
    • Increase productive use of the internet and social media
    • Enhance technology to improve efficiencies
    • Work on systems to better organize efforts
    • Make solid investments in research and development
  • Other ideas to consider
    • Work on diversifying customer base to reduce risk
    • Diversify products/services to reduce risk
    • Diversify suppliers to reduce risk
    • Work on obvious “window-dressing” to enhance the appearance of facilities for employees, visitors, and prospective buyers

While all this work is going on to increase EBITDA, or to increase the EBITDA margin with growing sales, it can also be helpful to rationalize a company’s balance sheet.  We can talk about that on another day.

Wrapping Up

My father gave me some excellent advice as a young man when I’d say “I wish” about something.  He’d say, “Chris, wish in one hand and work with the other one and see which hand gives you the best results.”  It taught me to quit wishing for good things, like good EBITDA multiples.

The key to obtaining the best price for your company—or your clients’ companies—is to work on the businesses over time to increase earnings, or EBITDA, rather than worrying about what multiple might be available in the marketplace.  Once a business is on the market, it is too late to work on it.  We began by saying:

All that any business owner can hope to achieve in a sale is the maximum multiple of EBITDA available in the marketplace for his or her business at the time it is offered for sale.

We end by saying further:

To achieve the maximum multiple of EBITDA available in the marketplace for a business at a point in time, the best strategy is to have been working to enhance EBITDA before that time.

While the following comment in this post has nothing to do with EBITDA, my new book, Buy-Sell Agreements: A Handbook for Attorneys, will help preserve, position, and transfer ownership of businesses.  While written for the attorneys who must draft buy-sell agreements, the book will be valuable for business appraisers, business owners, accountants, financial planners, and other advisers to businesses.

Send me an email to receive notification of its availability, hopefully near the end of the first quarter.

mercerc@mercercapital.com

And please call with any questions about the applicability of the ideas in this post to the value of your clients’ businesses or if you are a business owner or director, to the value of your business.

901-685-2120

Be well,

Chris

Please note: I reserve the right to delete comments that are offensive or off-topic.

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2 thoughts on “How to Maximize Business Value: Focus on Increasing EBITDA and not the Multiple

  1. Perfectly crafted and delivered advice for business owners and advisors. Owners have the most control on the numerator of the “value equation”…so efforts should be applied accordingly, as suggested in this article, to position the company for an improved transaction result. (Create more cash flow today and a better outcome tomorrow!)

    Risk mitigation, which affects the denominator, can be carefully be combined, as noted, with these plans and actions. Recognizing that this factor is ultimately determined by the buyer, based on their analysis of the business and markets, and not by the seller.

  2. In the context of valuing larger enterprises–say, those with revenues north of $25 million–I think a focus on increasing EBITDA, rather than on increasing the EBITDA multiple, is spot-on. However, most of us in the valuation community, esp. those of us who live in non-metropolitan areas, don’t have a lot of opportunities to value companies of that size.

    In valuing SMEs–which I will arbitrarily define as companies with annual revenues < $10 million–the fastest way to increase value is to reduce risk. And, since risk comes in two flavors–systematic (the risk common to all enterprises – the risk-free rate + the equity risk premium) and unsystematic (the risk risk unique to a particular enterprise)–the easiest way to increase value is to reduce unsystematic risk (USR). The linchpin of my 2010 book, 'Value Maps' (http://bit.ly/ValueMaps), is the 'tri-level unsystematic risk framework. It separates USR into macroenvironmental risk (6 forces), industry/strategic group risk (6 factors), and company (5 factors).

    With a singular focus on the company's five factors–Strategy, People, Architecture, Routines, Culture (SPARC)–a savvy appraiser can identify doable, sensible, and inexpensive ways to reduce USR. Here is more about the SPARC Framwork:

    1. Strategy – As Michael Porter noted, there are just two ways to compete: on cost or on differentiation. Since there can be only one low-cost producer in a competitive domain, the default choice for an SME's competitive strategy is some form of differentiation. The beauty of such a strategy is that its potential sources are many. The challenge for an SME is to come with a one or more sources of differentiation (a) that mesh with one another, (b) that cannot be easily replicated by competitors, and (c) that customers are willing to pay more for. For knowledgeable strategist, (a) and (b) are not difficult. The challenge is (c). The best way to ensure that (c) is workable it to survey customers using a survey design that embeds either multiple regression analysis or factor analysis. Valuation professionals who understand those two designs well enough to incorporate them into a survey of customers are not standing on every street corner.

    2. People – It is axiomatic that the skills required to run a $10MM enterprise successfully are markedly different from those required to run a $2MM company. That is because the economics of success are hugely different at those two levels. Therefore, savvy companies that grow their revenues must 'grow their people,' too. That is best done through an implicit contract between company and employees whereby the company commits to doing everything it can to avoid layoffs, in return for which employees agree to take steps to upgrade their skills and knowledge and/or retrain (if necessary).

    3. Architecture – This refers to the design of the organization in terms of its structure, its incentives, its internal structure, and its alignment with its external environment. Companies that fail to do that are called 'misfits'. They consistently under-perform their peers and, at some point–without deep-pocketed investors who are willing to pore good money after bad–either shut down or are acquired at bargain-basement prices.

    4. Routines – These are the everyday internal processes that enable a company to function. Most owners of growing SMEs are to busy revisit, or don't know the importance of, the need to change how key processes are accomplished at higher levels of revenue. Instead, they 'throw people' at congested processes in hopes that more people will reduce congestion. It seldom does. The metric that identifies this problem is annual revenues per full-time equivalent employee (FTEE). Comparing that with figure with the ones from a company's competitors will tell owners whether they are overstaffed (which, in my experience, most high-growth companies usually are). Instead of more people, such companies need to overhaul and redesign key processes. Importantly, that includes selecting and seating a 'Council of Advisers' (not to be confused with a Board of Directors) comprising individuals with successful experience growing companies and with expertise that the company needs (esp. HR, IT, and marketing).

    5. Culture – As noted on p. 197 of my book, 'Value Maps,' "A firm's culture is an expression of its shared values, beliefs, and acceptable behaviors. We subscribe to the notion of T3 (the '3' is a superscript, but this format doesn't allow it): Truth + Transparency = Trust. Trust really is 'the coin of the realm.' That can be a problem in companies run by conflict-avoiders. How can that happen? In my experience, it happens most often with descendants of a company's founder. Conflict-avoiders are only as good as their most recent conversation. Example: many years our consultancy had a client run by an industrial-strength conflict-avoider. Organizational life was chaotic b/c there was almost no trust among members. To prove my point to two key senior executives, I invited them and the conflict-avoiding third-generation owner to lunch one day. Before meeting at a restaurant, I took the two non-owners aside and said that (a) the owner should place his order first, and (b) no matter what the second guy ordered, the remaining two of us would order the same entree as the second guy. I then said, "I'll bet each of you 20 bucks that [the owner] will change his mind and get what we get." Almost in unison, they said, "You're on!" Long story short: we did, and he did.