Thoughts on multiple and whether NWC should be included
October 25, 2023
by a searcher in Petaluma, CA, USA
This is a gifts and home business. Discretionary purchase. I'm valuing it at 3.3x EBITDA and expecting that 2024 will be 10% down on 2023, with growth returning in 2025 in response to increased sales effort and product launches.
Questions:
1. Is 3.3x fair/rich/lowball?
2. I'm asking for normalized NWC to be included at that multiple. Seller claims that the business has carried too much inventory but I have verified that it needs to carry what it has done historically because of various supply chain constraints
3. How would you calculate NWC? I'm asking for Average(AR - AP + Inventory)
2019 2020 2021 2022 TTM Sept
Revenue 7.7 5.5 6.6 6.2 5.9
GP 4.4 3.5 3.9 3.7 3.7
GP% 57.53% 63.46% 58.96% 58.97% 62.62%
Expenses 3.7 2.7 2.5 2.4 2.5
Expenses % 48.24% 50.44% 38.69% 38.56% 43.48%
EBITDA 0.7 0.7 1.3 1.3 1.1
EBITDA % 9.63% 13.43% 20.20% 20.64% 19.08%
AR Dec 0.4 0.39 0.35 0.31 0.4 AP Dec -0.2 -0.2 -###-###-#### -0.16 Inventory Dec###-###-#### 2.0 1.7 2.5 2.5
from University of Tennessee in Nashville, TN, USA
Most business valuation methods are focused on revenues, expenses, and the resulting profit. These are income statement-driven methods. NWC is a formulated output of balance sheet accounts. Without assets and their corresponding liabilities, the business could not generate income nor the income-generated expenses. This entanglement is why there is so much disagreement on what is (and what is not) included in an offer.
NWC is important for the Buyer to be able to run the business without disrupting operating cash flows. Many Buyers calculate an average of historical NWC and pay for it in addition to the acquisition price of the business. Others negotiate it inclusive of their offer. Many times, there is a post-close true-up that the Buyer must provide to the Seller in order to account for miscalculations or unforeseen changes. Because there is no single way to account for NWC, the Buyer and the Seller must both concur on its value and inclusivity.
Answers to your questions:
1. There is no singular value to be assigned to a business at any singular point in time. The same business has multiple value points based on the perspective of the evaluator. There are industry multiple ranges that should be researched to support a market approach to your valuation should you need it. Each investor assigns their own multiple based on their investment criteria, which may or may not be within the range of industry transaction multiples or other investors' discount rates.
2. A NWC Target amount should be discussed and agreed to between the Buyer and the Seller. If the Buyer is paying for NWC separately, a higher NWC Target is beneficial to avoid having to pay the Seller for an unexpected overage at close and/or at true-up. On the flip side, the Seller will receive less if there is a shortfall. In all instances of agreement, Accounts Receivable need to be realistically collectible, Inventory needs to be fairly market-valued, and Accounts Payable need to be properly identified and accounted.
3. There is no single way to calculate NWC and is a topic that has norms but not absolutes. Generally, NWC is calculated as AR + Inventory + specified Other Assets (if applicable) - Accounts Payable - specified Other Liabilities (if applicable), exclusive of debt and debt-like instruments. Some Buyers buy all or a portion of the Seller's cash or claim cash as part of immediately payable liabilities (i.e., accrued payroll). In both circumstances, the NWC calculation may or may not be altered to reflect the adjustments.
from Boise State University in 800 W Main St, Boise, ID 83702, USA
And here is an article about SDE vs EBITDA multiples that may be of interest: https://www.bizbuysell.com/learning-center/article/cash-flow-sde-ebitda-what-business-buyers-should-use-to-decide-what-to-pay/
Remember a multiple is a result of one number being divided by another. A good way to determine whether or not the price makes sense is to do a buyer's sanity test with a reasonable amount down, and the balance financed at the market rate. Then see what the multiple is.