This video originally ran in January 2012.
Narrator: Trying to sell or purchase a business can be a difficult, cumbersome and often complex process. In the fourth installment of a short series on the merger and acquisition industry, host Renate Mueller, the President of Renate M. Mueller Consultants Inc., explains the criteria used to place a value on a business.
Renate Mueller: Well, the standard model that is used by accountants and professionals in determining values is EBITDA: Earnings Before Interest Tax Depreciation and Amortization. And to put it into a simpler term, it is the free cash flow that is available to pay off the debt of an acquisition. So, let me give you an example. If the EBITDA, which is the free cash flow of the business, is $400,000, and the purchaser is willing to pay five times EBITDA, then you’d be looking at a purchase price of $2 Million.
The five times multiple represents what the purchaser would expect to earn over a period of time in order to pay off the $2 Million debt. If we now move forward and say okay, the purchaser is willing to pay a multiple of six times EBITDA, we take the $400,000 cash flow, the purchaser in that case is willing to pay six times, which is $2.4 Million. How we can convert that back to the benefit of a vendor is let’s take that business and say alright, if they have the opportunity to grow their business by another $100,000 by EBITDA cash flow, and they can bring their business up from $400,000 EBITDA to $500,000 EBITDA, and the market place for the purchaser is five to six times multiple, then that vendor could, realistically, get between another five to six hundred thousand dollars in selling price.
When we start off building a model of EBITDA cash flow for a purchaser, we also look at the vendor should consider that as well. How much better can I make the bottom line of my business so I can enhance it and sell it at a higher price. So that’s the model of EBITDA and how it affects either party.
Other titles in this series: