Question :
My business have been valued at 3.5 times EBIT. In light of massive losses In March, April, May and most likely June, can these losses be ‘normalised’ i.e removed in a a valuation? Or is that just a discussion to be had with a purchaser. Also, for a service based business being bought my another service business, what is the spectrum or cash vs workout that is considered normal?

Question submitted 11/05/20 @ 02:38pm
Industry: Funding & Finance
  • To whom it may concern,

    If your business bounces back to pre-covid numbers within the next couple of months, it would absolutely be fair to keep the initial valuation. The key to any business valuation is future maintainable earnings (hence this is why normalisations occur); if covid19 has caused a structural changes and you are unlikely to recover back to your pre-covid trading obviously this will have a negative affect on your valuation.

    I run a company that provides business valuations and I’m more than happy to give you free advice in this regard; my email is chris.small@abcbusiness.co.nz

    It would be a discussion for a prospective purchaser, but, assuming that you can demonstrate ongoing quality of earnings post COVID-19, it would be appropriate to make a normalisation adjustment for the losses in the months heavily impacted by the closure. A multiple based valuation (in fact any valuation) is about estimating future earnings rather than past. I think the question about cash vs workout is probably too broad to answer here depends on the size, industry etc, and also the specific circumstances that suit the vendor and purchaser.

    Hi there,
    This is a particularly tricky one given the current circumstances. Valuation is an “art not a science” at the best of times and each transaction will always have unique characteristics depending on the situation, business being sold and the purchaser.
    I would say that both multiple and future maintainable earnings (FME) will be re-litigated in the current environment… and is more about the future projected earnings rather than past earnings and your ability to clearly demonstrate the believability of going from substantial losses over covid-19 into profit at L2, L1 and the next few years ahead in times of negative GDP, and lowered incomes globally.
    It may well be that any purchaser will significantly discount the multiple (and earnings) to reflect increased risk and uncertainty and it may well be better to delay a sale if the discount is too steep and some ‘new normal’ returns.
    Other things that may impact the equity value is increased debt loading and changes to normal working capital levels.
    In terms of cash v workout, I’d approach this based on what are the unique factors the purchaser needs to ensure the business transitions well (especially in this environment)… are you a “key person” risk and your time is valuable to transition customers/suppliers under new ownership, do you need to show the purchaser how the business runs (if a small business or buyer is small), or is there a steep sales/profit forecast increase, in which an earnout might be a better mechanism to reduce downside risk for the buyer, but preserve upside value for you… There are many ways to get value for the seller, either a retainer, earnout or performance incentive if you stay in the role for a longer period…
    Hope that helps.

    In a pre-COVID-19 world we would say that 3-5x EBITDA would be a ‘normal’ valuation range for services businesses, with 3-4x being ‘typical’. My firm has completed a range of services business M&A transactions. Re normalisation – I would show the business pre-COVID [what was a standard level of revenues and earnings (EBIT or EBITDA)] and then outline the impact so far and into the future. We are seeing M&A transactions happening in the current environment – but the impacts on valuations and timings are still playing out [too early to give a definitive view on where they’re landing]. The answer to your question directly is – it will be a discussion with the potential purchaser. Re deal structures – it really can depend. The potential acquirer will want to ensure that the management/leadership of the acquired company is incentivised to make the deal work. A ‘typical’ structure [but there is a wide range of variables here] could be: 1/ a third of the purchase as cash up-front, 2/ a third of the purchase as equity in the acquiring entity, and 3/ an element of earn-out based on the future performance [a third or more or less]. Obviously you want the most cash as possible – but you will likely have to accept some other components. Two other points to look out for. First – there will be a working capital calculation in the deal. Get professional advice around the calculation of that. Second – the acquirer will likely want you to stay in the business for a period. Less than 12 months is short and rare, 12-24 months is typical and more than 24 months is long [try to avoid]. Mark Clare, Clare Capital

    Hi Mark,
    In my view 1/3rd left as equity is not typical in my experience and is not a great outcome for the vendor… but of course this depends on the transaction arrangement and business concerned (tech business perhaps). A clean deal is best if price can be preserved as there is nothing worse being the previous owner, having no real say or control and watching changes being made to what you had built, let alone being left with a minority shareholding with no real exit option other than the purchaser you just sold it to and they call the shots on value going forward unless another buyer if found… or there is a pre-agreed exit arrangement or a put option at an agreed multiple at best.

    We often do see an equity component – primarily because services businesses don’t have great margins, and therefore a lack of cash to complete [cash-only] M&A deals… I agree with your comments that cash is better – and I state that in my answer. The reality is, we see, that private services businesses often have a lack of M&A options – and those that exist often mean taking some equity. With all of these things – it depends, and ultimately comes down to a negotiation.

    Hi, it is reasonable to expect that the covid months will be normalised however depending on the sector you operate in, your future earnings multiple could be under significant pressure. For example, food manufacturing companies may see an uplift in multiples whereas a hospitality business will likely see the opposite.

    Many factors come into play when determining value also, it’s impossible to give a solid opinion without knowing more about your business.

    Happy to answer in more detail if you would like.


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