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Two Similar Companies ~ Big Difference in Value

Consider two different companies in virtually the same industry. Both companies have an EBITDA of $6 million – but, they have very different valuations. One is valued at five times EBITDA, pricing it at $30 million. The other is valued at seven times EBITDA, making it $42 million. What’s the difference?

One can look at the usual checklist for the answer, such as:

  • The Market
  • Management/Employees
  • Uniqueness/Proprietary
  • Systems/Controls
  • Revenue Size
  • Profitability
  • Regional/Global Distribution
  • Capital Equipment Requirements
  • Intangibles (brand/patents/etc.)
  • Growth Rate

There is the key, at the very end of the checklist – the growth rate. This value driver is a major consideration when buyers are considering value. For example, the seven times EBITDA company has a growth rate of 50 percent, while the five times EBITDA company has a growth rate of only 12 percent. In order to arrive at the real growth story, some important questions need to be answered. For example:

  • Are the company’s projections believable?
  • Where is the growth coming from?
  • What services/products are creating the growth?
  • Where are the customers coming from to support the projected growth – and why?
  • Are there long-term contracts in place?
  • How reliable are the contracts/orders?

The difference in value usually lies somewhere in the company’s growth rate!

© Copyright 2015 Business Brokerage Press, Inc.

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Three Basic Factors of Earnings

Two businesses for sale could report the same numeric value for “earnings” and yet be far from equal. Three factors of earnings are listed below that tell more about the earnings than just the number.

1. Quality of earnings
Quality of earnings measures whether the earnings are padded with a lot of “add backs” or one-time events, such as a sale of real estate, resulting in an earnings figure which does not accurately reflect the true earning power of the company’s operations. It is not unusual for companies to have “some” non-recurring expenses every year, whether for a new roof on the plant, a hefty lawsuit, a write-down of inventory, etc. Beware of the business appraiser that restructures the earnings without “any” allowances for extraordinary items.

2. Sustainability of earnings after the acquisition
The key question a buyer often considers is whether he or she is acquiring a company at the apex of its business cycle or if the earnings will continue to grow at the previous rate.

3. Verification of information
The concern for the buyer is whether the information is accurate, timely, and relatively unbiased. Has the company allowed for possible product returns or allowed for uncollectable receivables? Is the seller above-board, or are there skeletons in the closet?