Broker using projected earnings for valuation

searcher profile

June 12, 2024

by a searcher from Duke University - The Fuqua School of Business in Atlanta, GA, USA

I'm currently evaluating a deal where SDE grew by 84% in###-###-#### I've based my valuation on 4 year average SDE, which provided a much lower value than what the seller is asking. The broker told me the asking price is based on a 4 year average SDE that includes 3 prior years and projected SDE for this year, which is 7% higher than###-###-#### I am not yet convinced the 2023 pop in earnings is sustainable, so including a projection based on this number seems pretty optimistic.

Am I off base thinking that using projected earnings is too aggressive, especially when the projection is based on 1 year where earnings jumped so significantly. Is this just a normal practice brokers use to juice EV?

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commentor profile
Reply by a lender
from University of Missouri in St. Louis, MO, USA
4 years is a long time, especially if Covid had an impact in revenue in###-###-#### I would focus more heavily in FYE22, FYE23 and the interim, assuming they are a calendar year end. Most banks will heavily weigh their decision on those time frames. The easiest way to mitigate this issue is with a contingent seller note. I don't know the numbers but if the delta between their expectations and your price is $1 million, then make the $1 million payable through performance metrics. If growth is sustained they get their payout. If not it goes away.

As an aside, outside of a contractual obligation, I would never recommend buying a business based on projections unless you are putting the risk on the seller that the company reverts to their past performance.
commentor profile
Reply by an intermediary
from Harvard University in San Diego, CA, USA
Everybody perceives value differently. If you don't believe the pop in revenue is sustainable, then put together an offer based on what you think will take place. Dig in with the seller (not the broker) and ask a lot of questions to determine why they think the numbers are sustainable. With 6 months of earnings in the books, its not a big leap to see why they are trying to use it to increase the valuation.

I think the big question is which year should be dropped from the valuation. Are you comfortable dropping the SDE figures from 4 years ago and just doing a 3 year average? That might get you closer to their number but at the end of the day you need to offer only what YOU believe the business is worth.
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