Alternatives to EBITDA Multiples
On a regular basis, we seem to be
driven to want to know the current Earnings before interest, taxes, depreciation and amortization (EBITDA) “multiples” that apply to businesses
in various sectors. We strive to find comparables that we can use to provide a
prospective seller with an expectation range of price that he or she can
anticipate for the sale of the business that they have worked a lifetime to
create. We want them to believe that we will be able to find the right buyer,
at the optimum price and that they will not be made to look foolish in the eyes
of their peers... who are always parlaying the latest Industry scuttlebutt as
to what Joe got for his business and why they think they deserve more. I would
like to visit several aspects of price as there is much analysis to insure the
The first aspect to address when speaking to our potential sellers is the tax liability that is being created when the business is sold. If he or she sells assets, they will likely have recaptured depreciation – which is ordinary income. It can be taxed as high as 53% when combining various state and federal taxes. The allocation of purchase price could assist them here. If the purchase price allocation were to set out only the depreciated value for assets that they have taken depreciation, the seller may not have to endure the ordinary tax rate on recapture. This is highly unlikely, as the purchaser wishes to take the tax shelter on those assets acquired in the future. So, the current market value will likely be reflected in the allocation.
If the seller sells the shares of his firm, they can be assured of only paying the capital gains tax. This is a distinct tax benefit and will result in a materially larger after tax proceeds for the seller.
One must consider the advantage of using 1042 Election for the proceeds which will defer all taxes. This is the methodology, wherein you use an ESOP as the acquirer and as a result any and all proceeds that are reinvested in an eligible investment. The proceeds carry the old tax basis and are tax deferred. What an incredible win for the seller in that his net proceeds will likely have grown by 30% or more now that there is not a tax bite. Talk about blowing the EBITDA multiples!
Further consideration should be focused on dividing the sale into real estate and operating assets by using a 1031 Election. Exchanging the real estate for a like property, the seller can defer any recapture of depreciation and capital gains tax as they take this basis to the new property. The purchase price may be funneled into the real estate perhaps through the purchaser paying down or paying off mortgages, etc. on the real estate. A significant portion of the purchase price may now be tax deferred.
Conversely, one must be careful if acting for the seller that any employment agreements that are taken as a portion of the purchase price. Employment income is at the ordinary rate (as opposed to capital gain rate generally half that of ordinary). If we are acting as a buyers’ agent, we would certainly encourage as much of the purchase price in the form of employment agreements as all of this consideration is tax deductible. So, in effect it is almost halved as to net after tax cost. In this instance, we can also pay a very hefty EBITDA multiple (if that is important to the seller) as that portion of the purchase price that is allocated to the employment agreement is tax benefited by at least 30%.
Another significant contributing factor to the EBITDA multiple that can be achieved for a seller is the historical Compounded Annual Growth Rate (CAGR). Revenue, earnings, market share, etc. represent a significant value indicator that allows a purchaser to pay at the top of the range if for example, a 15% CAGR has been achieved over the past three to five years and the marketplace appears to accommodate that continued growth. Compare that against an entity that has demonstrated a 3 to 4% CAGR. Historical growth is a huge factor in determining value. However, it is really the purchaser’s belief that that growth rate can be sustained that truly drives the premium multiple. If the industry is growing, it is merely a matter of stepping on to that moving train and participating in the growth. If the industry is flat or contracting, then all growth has to come from taking business away from the competition...a much more challenging task. So the position of the business in the industry and the growth of the industry has a huge impact on the multiple that can be achieved.