“The best place for a picnic is a little farther on.”
That’s an expression my mom used to use when I wouldn’t settle for my perfectly good current situation, and pushed for something just around the corner.
That same expression might apply to company owners who want “just a little more” EBITDA before they take their company to market, even though the current value would be perfectly good, if not exactly what they imagined.
Commonly, when a seller looks at their EBITDA, and our investment banking team explains the multiple of EBITDA that could be achieved in a sale—say it’s 6X—many sellers will say, “OK, great. I want to drive the EBITDA up another $1 million and get an additional $6 million in enterprise value when I’m acquired.” Let’s look at the practical implications of that.
Say you’re operating at a 10% EBITDA margin, with $50 million in sales. At 6X and $5 million in EBITDA, your enterprise acquisition value is $30 million. If you want $36 million, you need $1 million in additional EBITDA. To attain that, you’d have to book $10 million in increased sales (assuming your GPM and OPEX remain constant as a percentage of sales). That’s a 20% sales revenue increase; a tall task in any market.
Increasing sales by $10 million is the hardest way to attain a higher acquisition value. Here are some other approaches:
Crank up your gross profit margins. This approach is two-fold, and it’s the easiest and quickest way to juice the EBITDA line. The steps are: 1. Raising prices. But this risks customer volatility, and you may be top-of-market already. 2. Onboarding higher-margin product lines, e.g. windows, doors, millwork, or specialty finish lines. These items are often sold at two or three times the GPMs of commodity lumber or drywall.
Crank up your EBITDA percentage. From the example above, let’s leave the sales at a “steady state”—$50 million—and improve the EBITDA percentage by 20%. Admittedly, this is more difficult than raising GPMs, but consider the effect of increasing your EBITDA percentage from 10% to 12%. This exercise requires sweeping through the OPEX line items and reducing expenses, without reducing the value to your customers. That said, the math here is very rewarding: Every dollar lopped off OPEX is a dollar-for-dollar increase in EBITDA. Although OPEX line items include fixed expenses (rent, fuel, utilities), you may discover some “Easter eggs” in there, like ineffective marketing, non-essential travel, event sponsorships, family expenses, or family employees. (Right now, a few readers are saying, “John, that’s genius. I can finally justify firing my son-in-law!”)
Credits to EBITDA. Consult with your investment banker to see if there are valid credits to EBITDA, which are shown in an Adjusted EBITDA figure. Credits to EBITDA are a non-GAAP consideration, but Adjusted EBITDA is common in M&A value formulas, and part of every one of our deals. The credits are closely examined, from pricing to due diligence, so be realistic as to what’s acceptable. These credits typically fall into these buckets: family expenses that won’t continue under new ownership; compensation for non-essential employees; compensation normalization down to “fair and customary” levels for seller-owners who become employees after the acquisition; cash paid for recent non-capitalized business expenses. In a 6X deal, every $1,000 “adjusted” is worth $6,000 in increased purchase price.
Multiple rise with performance. Finally, note that as your EBITDA and EBITDA percentage rise, your acquisition multiple may rise. You’re worth more to an acquirer if your GPMs are maximized, your pricing is right-sized, your EBITDA percentage is above average, and your EBITDA dollars are strong. A company with a 10% EBITDA margin and $50 million in sales might achieve 6X in an acquisition, but a 12% EBITDA company might achieve a lift from 6X to 6.2X, or even much higher, depending on product mix. With a $6 million EBITDA basis, 6X of a $6 million EBITDA is $36 million in acquisition value, but 6.2X is $37.2 million. As the old song goes, “Nice work if you can get it. And you can get it if you try.”
