What is included in the multiple?
November 15, 2022
by a searcher from University of Washington in Redmond, WA, USA
I am considering buying a light manufacturing business that is positioned as priced at 4X the weighted trailing six years of EBITDA plus the value of inventory plus working capital. The three most recent years are weighted at 75% and the 3 years prior weighted at 25%. Are working capital and the value of inventory normally included as part of the 4X multiple consideration? If they are, can someone point me at documentation I can use as backup for that position as I'm going to need to have a conversation with the seller. I appreciate the brain trust!
from Wake Forest University in Winston-Salem, NC, USA
While there is no question that a buyer needs working capital on day 1, it turns out that only a minority of transactions in the <$5 million size include working capital in the purchase. The IBBA/M&A Source posts quarterly data that show the % of transactions that include working capital vs. exclude it. In summary, looking at the average for the last four quarters for deal sizes in the $500k-$1M range only 21% included working capital, $1-$2M only 25%, $2-$5M only 36%, but in the $5-$50M 67% included working capital.. In the cases where it is not part of the purchase, it is usually provided by the acquisition lender in the form of a permanent working capital loan and possibly also a line of credit (this is usually right on their term sheet next to the acquisition loan).
It's important for buyers and sellers to know what perspective along the working capital continuum the company was valued and then offered at. That continuum being: (1) base company value + (2) other assets/liabilities (such as deferred revenues, customer deposits, payroll/vacation/bonus accruals, etc.) + (3) inventory + (4) AR/AP + (5) other = (6) aggregate company value. Most transactions that buyers see on sites like BizBuySell or Axial are going to be a combination of 1+2+3, and exclude 4+5. In these transactions the buyer does not acquire or pay for the net value of AR/AP, instead, the seller keeps them and the buyer takes out a working capital loan along with the acquisition loan to cover future working capital (this is how many SBA loans are structured). Occasionally, the buyer will want the AR/AP for customer experience reasons and will buy the net AR/AP dollar for dollar or close thereto. The key is to make sure that when using a valuation multiple to come up with the asking/offer price the comparables used are in sync with assets/liabilities being offered/requested. Each database handles the working capital differently, so the user has to know the inventory and net working capital rules before applying them to a transaction -- just like it would be a significant mistake to apply a multiple of SDE to EBITDA, it would be a significant mistake to use a multiple that excluded working capital and then use value derived from that multiple to represent a price that included it. In short, here is how each of the major comps databases handles inventory and working capital: -BizComps: specifically excludes inventory and AR/AP (you are getting values 1+2 (if entered)). -PeerComps: includes normal inventory, excludes AR/AP and other working capital. You are getting value 1+2+3. -DealStats (fka Pratt's Stats): Can include or exclude net working capital - this varies greatly by industry and data set pulled. The user must look at the asset allocation detail for the comps being used in order to determine where on the working capital continuum those particular comps are located and thus appropriately sync the derived value to the appropriate level of net working capital included.
from Texas A&M University in Dallas, TX, USA