Last week I received two phone calls asking for my opinion on valuation multiples. This is a very common question from agency owners. Owners who are considering a sale are concerned about any trend in agency multiples. Owners who are considering an Internal Perpetuation are also concerned because they want to know how much they might be forfeiting by selling internally. Everyone who is left wants to know in order to determine the value of their greatest asset.
Multiple of What?
If I asked 100 agency owners how their company is valued, 50 would respond that their agency is valued on a multiple of revenue. They heard about the agency just like theirs that sold for 3 times revenue. This logic ignores a lot of valuable facts. I wouldn’t plan my retirement based on this valuation unless someone took a much deeper look at your agency.
The other 50 owners would tell you that their company would be valued based on a multiple of profits. However, they would have difficulty defining how profits are calculated. The answer is that every informed buyer would value an agency based on a multiple of EBITDA, which is defined as Earnings Before Interest Taxes Depreciation and Amortization. Simply stated, it is the projected cash flow of the agency.
Who Do You Believe?
You just can’t determine an agency’s value by answering a few questions. Here are a few examples of problems you might encounter. Assume your agency has $4.0 million in revenue and $1.0 million of EBITDA. For simplicity purposes, let’s assume an EBITDA multiple of 8.0. This would result in a valuation of $8.0 million. Sounds good from an EBITDA multiple basis. Why is the 2.0 times revenue so low? In this case, the 25% profit margin should be improved before the agency is valued. However, beware of this common situation:
Buyers will want to incorporate a series of “Charges” against the EBITDA. Assume those Charges amount to $120,000. All of a sudden, your $1.0 million in EBITDA gets reduced to $880,000. Based on an 8.0 multiple, the value of the agency is now $7,040,000. This harmless looking Charge just reduced the value of the agency by $960,000. The true multiple ending up being 7.04 based on the original $1.0 of agency EBITDA.
If You Can’t Believe Buyers, Can You Believe Consultants?
I’m embarrassed to say that you can’t. Both of my calls this week had also talked to an advisory firm other than Sukay & Associates. There is no truth in advertising in this business. If it sounds too good to be true, it probably isn’t true. We have experienced advisors who simply mislead owners in order to get a prospect to talk with a buyer. Others play with the facts.
Most deals include an Earnout component. Earnouts are based on an increase in EBITDA over some pre-determined period. These Earnouts are at risk and should not factor into the current multiple calculation. If your advisor includes the Earnout in their valuation projection, find a new advisor.
Can I believe my friends that have sold their agencies?
Unfortunately, the answer to this question is no. The problem is that the terms of the deals can get complicated and many of your friends may not totally understand them. The other reason is that they might want you to believe they got a better deal then they did. The only way to know the real multiple that they received is to know all the terms of the deal.
Current State of Multiples
Since we tend to represent the Seller, we are pleased to report that multiples have hit new highs. A lack of Sellers coupled with the influx of new aggressive buyers have pushed multiples higher. Where do we expect multiples to be for the rest of 2015? We believe multiples will stay high for most of 2015. Many deals seem to get done in the last half of the year. As a result, we would expect the multiples to level off or slightly decline in the second half of 2015.
If you talk to a Buyer or another advisor, we would be happy to speak with you and give you our honest opinion of the current market.
