Typical purchase multiples in search funds
December 31, 2019
by a searcher from Carnegie Mellon University - Tepper School of Business in Boston, MA, USA
I know it all depends on the specific industry and deal at hand, but I'm curious to get this group's view on average/median purchase multiples for searchers.
I started off reading the HBR guide to buying a small business and they are pretty strong on the 3x-5x EBITDA multiple range, with an average of ~4x for deals completed by searchers.
https://hbr.org/product/hbr-guide-to-buying-a-small-business/14156E-KND-ENG
I then read the Stanford 2018 Search Fund study (which appears to be more rooted in data, or at least they present the data) and they show a median multiple that hovers around###-###-#### 0x over the years.
https://www.gsb.stanford.edu/gsb-cmis/gsb-cmis-download-auth/469696
Is this just a difference in the self-funded model versus the traditional search fund model versus where the former is targeting smaller businesses and therefore smaller multiples? Or something else that I'm missing?
from The University of Chicago in Chicago, IL, USA
Here are few comments;
1) In many databases, std. deviation on EBITDA multiples across all industries and across all sizes is very large. If mean is 5, std. devaition is 2, meaning 2/3 of the transactions are between 3 and 7.
2) What do you get for the price? Is WC included? What is WC (don't fall for accounting WC definition, that can kill you in M&A)? Once you define WC, what is Target WC included in price? What is DFCF balance sheet?
3) Multiples depend on whether you are doing an Asset purchase or a Stock purchase, S Corp. or C Corp.
4) Value is a function of cash flow, not of earnings or EBITDA. EBITDA is a starting point, not the end.
5) Overvaluation does not kill the deal, Over-leverage (inability to service debt) does. Where is debt amortization period in determining multiple? Does any MBA school address that? No. Why? Because corporate finance theories assume ECM.
6) Multiple depends on many quantitative factors, and qualitative factors (which impacts probability of forecast)
7) Do not use WACC as a discount rate and do not use Gordon Growth Model. They assume that debt principal does not have to be repaid. Download a free spreadsheet from www.AltBV.com.
8) Multiple do not grow on tree; it is PV of future cash flow divided by EBITDA.
9) Run (or develop) a financial model of PL, BS, CF and IRR. Do sensitivity analysis.
10) Debt/Equity ratio: High equity lowers IRR, High debt creates debt-service problem. There is an optimal capital structure that achieves both objectives.
11) Simple math: EBITDA 100. P=500. E=100, D=400. g=0. CapX=0, Transaction = Asset. You will need constant P+I amortization if 100% of debt is 5 yr term debt. After 5 years, equity IRR >30%. Is that Bad?
12) In above example, if Transaction = Stock, you will not be able to service the debt. If C Corp., IRR will drop to 20% range.
13) I hope you see my points. This is an elite group. You should be able to lift yourself out of arbitrary game. of picking multiples.. You will wind up buying a bad business at low multiple, or not buying a good one b/c someone told you not to pay a higher multiple.
14) All of above, and more, is built into an interactive financial model that I developed (www.BVXpress.com) b/c I could not let my 100% commission based M&A practice depend on random pick of multiples. It derives multiples.
from University of Colorado at Boulder in Horsham, PA, USA
Size
To give you an idea, for middle market private equity, average multiple of EBITDA has now exceeded 2007 levels and is approaching 11x. For lower middle market deals, it is around 8-8.5x. For traditional search funds i.e. microcap companies ($1-5M EBITDA), it was 6.3x, say 5-7x, in the last Stanford study, but it's higher now. For self-funded deals (the Harvard model), it's lower but those multiples have also gone up. This is of course intuitive since larger businesses are more stable, have stronger brands, better middle level management etc.
Growth
Whether with public equities or private acquisitions, growth is a big factor. Faster growing companies will have higher multiples. SaaS companies, which usually have 30-40% growth (plus satisfy the quality of earnings below), get 6-9x and sometimes are even priced on ARRs.
Quality of revenues and earnings
This is a broad area that includes things like what % of revenues are recurring or at least repeat, how cyclical is the business, what is EBITDA to FCF conversion etc. You pay up for quality as you'd expect.
Hope this is helpful.