What a seller takes home after the sale is more important than the price the company sells for, writes columnist Steven Abbate:
After years of hearing that companies can’t be valued by the gallon, owners are beginning to grasp the idea that companies are valued based on return on investment, usually in the form of a multiple of EBITDA (Earnings Before Interest, Taxes, Depreciation and Amortization). AKA: cash flow or operating income.
The valuation buzz at propane industry events is that companies are selling for 10 times EBITDA, or “10 X EBITDA.” We have it on good authority that values have reached that high, but to understand what that means, you need to know which form of EBITDA is being used. There are three basic forms.
The first is the seller’s EBITDA, which comes from financial statements or income statements. Some adjustments are made for additional owner compensation. The second is the adjusted EBITDA, which takes the financials and normalizes earnings by adjusting for items such as weather, related party rent, owner and family compensation, expensed items that should have been capitalized, onetime expenses and other items which would typically not occur under new ownership. Adjusted EBITDA is the basis for business valuations and the most commonly used of the three. The last EBITDA is the buyer’s EBITDA. It is calculated using the adjusted EBITDA, then projecting the buyer’s results. A buyer may have operating synergies which would allow them to reduce expenses.
As an example, a company may sell for $5 million with an owner (seller’s) EBITDA of $500,000. The owner perceives this as selling for 10X. When going through the income statement, the buyer has reduced operating expenses items such as owner’s vehicle expenses, non-working family salaries, owner medical insurance, payroll taxes, 401K contributions and professional fees for owners such as owner tax preparation. The owner may also own the property and be charging themselves above market rent for tax purposes. Those items would all be adjusted, and the adjusted EBITDA may now be $750,000. This would be 6.6 X EBITDA for a $5 million purchase price. In addition, the buyer projects that they can increase margin per gallon, consolidate a few positions over time, lower the insurance cost, bank fees, and advertising expense and use technology such as tank monitors to operate more efficiently. This now brings the buyer’s projected EBITDA up to $900,000. The buyer is now paying 5.5 X EBITDA based on their projections.
While EBITDA is a key measurement for valuing a company, there are many other details to consider. Does the company have real estate and does that include a bulk storage facility? How old are the vehicles and will the buyer need to make further investments in vehicles and other capital expenditures? Is there a large percentage of company tank ownership? Those details influence “X”— the multiplier. For example, suppose there are two companies with identical EBITDA. Company A has trucks whose average age is six years, a modern office, three 30,000-gallon propane tanks, and 90% company tank ownership. Company B has trucks whose average age is 15 years, no owned real estate and 25% company tank ownership. In this example, Company A will sell at a higher multiple of EBITDA.
Another major factor is size of company. The larger the EBITDA, the larger the multiple. A company with an adjusted EBITDA of $100,000 will sell at a substantially lower multiple than one with a $3 million EBITDA. There are many other considerations, such as exposure to natural gas conversions, competition, and union employees to name a few. A seller must also consider how a company is presented to potential buyers. A professionally presented company using a highly confidential managed process always brings a higher selling price with substantial tax benefits. What a seller takes home after the sale is more important than the purchase price.
Yes, 10 X EBITDA sounds like a great valuation, but as they say, the devil is in the details.