One of the questions we are asked most frequently is how to value a business. Especially in the media:tech sector, the question often comes in the form of ‘revenue multiples or EBITDA multiples?’
Although all the textbooks on valuation go in to exhaustive detail on sum of the parts approaches and the way to calculate the multiple to within two decimal places, it is in practice a lot less mechanistic than this implies.
Start with EBITDA
In general in the mid-market, people start with multiples of EBITDA because EBITDA is a good proxy for operational cash flow, and isn’t distorted by policies (such as depreciation) which can vary dramatically between companies.
In industries where there’s a lot of capital expenditure required, acquirers might apply a multiple of EBITDA less capex, but this tends not to apply in media:tech.
More relevant here is that, for fast-growing but loss-making/breakeven businesses, there might not be any EBITDA – and an acquirer may have to work with revenue multiples because that’s all there is.
Other acquirers focus on different line-items, such as profit after tax – particularly relevant for listed acquirers as this is a key metric for their shareholders (it’s the top half of earnings per share). But revenue and EBITDA remain the most common.
Revenue Multiples vs. EBITDA Multiples
There is a perception that a revenue multiple implies a higher valuation than an EBITDA multiple, but this isn’t necessarily the case.
Frequently, it’s just an artefact of a company’s margins. For example, if an acquirer values at £24m a technology platform doing EBITDA of £3m on revenues of £6m, this implies 4.0x revenue but only 8.0x EBITDA – the former sounds pretty good, the latter might seem disappointing for a scalable technology platform – but the headline valuation is the same.
Multiple of What?
The key question is actually to which figure the multiple should be applied – historic, current, or forecast?
With typical media:tech growth trajectories, current or run-rate performance will be higher than historic, and forecast higher still. The higher the figure, the lower the implied multiple for any given valuation.
In general, you want your acquirer focused on current year or run-rate performance. If you have enough visibility to support it, it is worth trying to focus attention on the forecast for the next year; the closer you are to the start of the next financial year, the easier this will be (because the risk for an acquirer is lower).
Art not Science
In practice, most acquirers start with what they consider to be recent relevant comparable transactions (either their own acquisitions or those for which data is publicly available), use these as a benchmark and work from there.
There will be a consideration of what is ‘required’ to win the deal in the competitive context of the process, balanced by a fear of over-paying, and a preliminary assessment of synergy benefits which might help a VP of Corporate Development to demonstrate to his Board that what looks like 10.0x EBITDA is really only 9.0x because there are immediate cost savings which add up to 1.0x, and so on.
And then there is the growth opportunity.
The two fundamental factors which drive exceptional valuations for our clients are:
- What an acquirer believes he or she can do with the business, and the revenue opportunity in particular; and
- The degree of competitive tension in the process.
The growth opportunity is what an acquirer is buying in to – what can they do with the business that you couldn’t do on your own? Articulating this growth story powerfully and persuasively (and differently for each potential acquirer) is an essential part of a good corporate finance adviser’s role.
More importantly, it is where an acquirer capable of propelling a great business into exponential growth – the Googles, Apples and Facebooks – by leveraging their unique routes to market, can afford to pay apparently stratospheric values for young but unique tech businesses.
The degree of competitive tension your adviser generates in a properly-run process is the way you get them to share those upside benefits with you, and to pay for them today.