This is the first installment in a three-part series Rock Fusco & Connelly, LLC will be publishing on using M&A transactions to maximize and grow your company’s value. This first part will help you understand a simplified valuation methodology (earnings before interest, taxes, depreciation, and amortization (or, “EBITDA”)), and how to increase EBITDA and its multiplier. The second and third installments, which will follow in the weeks to come, will address how to compare rates of return from M&A deals with internal rates of return, and how much diligence may be performed before closing an M&A transaction.
What is EBITDA?
EBITDA is a component of an extremely common methodology for valuing private companies. EBITDA is a preferred financial benchmark as it reflects a company’s operating profit excluding non-cash expenses. When EBITDA is multiplied by a specific multiplier, the product is the company’s cash/debt-free enterprise value.
To increase the value of your company, you can either increase its EBITDA or the EBITDA multiple. Or, for those who are truly ambitious, you can do both.
Increasing EBITDA
If your company acquires another with a positive EBITDA, the EBITDA of your company of your company also increases. In addition, you can also increase your company’s EBITDA by acquiring a seller with a negative EBITDA so long as it can be transformed into a positive EBITDA due to synergies with your business. You should constantly be constantly evaluating the rate of return expected from various acquisition targets as well as pursuing a transaction compared to investing that money in internal growth. More will be written about comparing rates of return from M&A deals with internal rates of return in the second installment of this series.
Increasing the EBITDA Multiple
Many factors going into the EBITDA multiple, including company size; sophistication; market position; barriers to entry; macroeconomic trends; management team; financial reporting; customer concentration; growth trajectory; or capital expenditure needs.
After acquisition, your company may be worth more than the sum total of the seller and buyer. For example, say your company has an EBITDA of $5mm with a six-times multiple for a total valuation of $30mm. You acquire a company with an EBITDA of $2mm with a multiple of five times, which costs $10mm. The total value of your company after acquisition may be more than the sum of the two valuations ($40mm). In fact, the EBITDA of your company is now $7mm. Assuming it stayed at a six-times multiple, the value would now be $42mm, with a gain of $2mm of arbitrage. If the EBITDA multiple increased as a result of the transaction, which they often do, the arbitrage would be even higher.
For help with all your M&A and corporate securities needs, please reach out to the attorneys at Rock Fusco & Connelly, LLC.