Navigating the intricate methodology of business valuations can be daunting, especially in the ever-evolving healthcare M&A landscape. At M&A Healthcare Advisors, we understand the importance of simplifying complex valuation concepts to empower business owners to make informed decisions about the future of their businesses. Picture this: You've poured your heart and soul into building your business and are now at the point of considering selling all or part of it. Now how do you gauge its true value in the market?
In this article, we will explore one of the most common forms of valuation methodologies, the EBITDA Multiple. We will break down how EBITDA Multiples are used in M&A transactions, examples of common ranges in lower-middle market healthcare M&A, and what factors buyers consider when proposing an EBITDA multiple in an offer. (You can read more about the basics of EBITDA and it's relationship to valuation here).
What is an EBITDA Multiple?
An EBITDA multiple is a financial metric used in business valuations and investment analysis, representing the ratio of a company's Enterprise Value (EV), which is the sum of equity value plus debt minus cash, to its EBITDA.
Enterprise Value (EV) calculation.[1]
- Enterprise Value (EV) = Shareholders Equity Value* + Debt – Cash
Enterprise Value is considered the Price. In the market, buyers will make an offer, identifying this price. From the seller’s perspective, the “full” price includes your short and long Debt. This makes sense because you will pay off all your liabilities at close. At the same time, you will keep your keep your Cash or Cash equivalents[2], which are held in the company accounts.
If you have the EV, then the EBITDA Multiple is easy to solve:
- EBITDA Multiple = EV ÷ EBITDA
EBITDA, like Equity Value, is not agreed to until a thorough due diligence of the company is conducted. Sellers and buyers will enter into an LOI with an agreed EBITDA value, but this could differ after a financial analysis or Quality of Earnings (QoE) is performed.
Another way to look at an EBITDA multiple is to multiply it by the EBITDA, which gives the enterprise value (EV). The purpose of an EBITDA multiple is to provide a business owner with a sense of perceived value from the buyer’s market research and thorough analysis of the target business.
We also like to think of this EBITDA multiple in relation to time in number of years. For instance, if your EBITDA multiple is 6, then it will take 6 years at your current EBITDA value to earn the money you could receive now (your EV) in a successful transaction. Factors such as inflation, and the time decay of money , should be taken into account.
What Factors Determine an EBITDA Multiple?
First and foremost, there is no standardized formula to determine the EBITDA multiple at which a company will trade in a successful transaction. Multiples are based on several factors, including market comparables (sometimes referred to as "transaction comps") and historical company performance. They are ultimately dictated by an investors' (or buyers’) perceptions of the company's current and future performance. After thorough analysis and assessment, a prospective investor proposes their statement of perceived value in the form of a Letter of Intent (LOI), which has a clear statement of value ascribed to the business and is most often based on a multiple of EBITDA.
While there is no way to predict the exact multiple, there are ways to better anticipate the range of multiples that will be received prior to officially entering the market to field offers.
One of the primary methods for determining an anticipated EBITDA multiple, and subsequently the anticipated Enterprise Value in the current market, is through analyzing recent transactions within the same industry segment to determine comps and provide an anticipated value. Transaction multiples are calculated by dividing the transaction value (the purchase price) by the target company's EBITDA. By examining a sample of recent M&A deals, analysts can identify the range of EBITDA multiples paid by acquirers for similar companies. This analysis helps determine the prevailing market multiples and assess the target company's relative value to the acquirer. After calculating the multiples for each, comparable analysts can compute median or mean multiples to derive a healthcare segment specific EBITDA multiple. This industry multiple serves as a benchmark for the anticipated value of the target company.
We should note that while in theory this practice is fairly straightforward, the majority of lower-middle market transactions are private, and therefore comparable transactional data is largely unavailable to the public. This is where the involvement of an M&A Advisor can be beneficial to a prospective seller, in their ability to triangulate the anticipated value of a business through utilizing their internal transactional data and resources, market relationships, generating multiple offers and ultimately lean on previous experience in a target segment. Ultimately, the truest form of determining the valuation range of a business is to go to market, field offers, and determine the perceived value based interested investors.
Market conditions and investor sentiment also play a significant role in determining an EBITDA multiple. During periods of economic growth, lower cost of capital, and market consolidations, EBITDA multiples tend to be higher as investors are willing to pay more for growth opportunities. Conversely, during economic downturns or periods of uncertainty, heightened regulations, and higher cost of capital, EBITDA multiples may contract as investors become less active. In times of economic uncertainty, financial investors may focus more on managing and growing their portfolios, organically. Factors like interest rates, industry trends, regulatory changes, and geopolitical events can influence market conditions and, consequently, EBITDA multiples. While there remains constant fluctuation in the larger economy, as we have seen over the last decade, healthcare has remained a worthy investment despite times of economic hardship and there has always been a market for quality healthcare assets. The US population is aging and not particularly healthy. The people need quality healthcare, regardless of the state of the economy.
What is a Good EBITDA Multiple?
No hard and fast rule defines a "good" EBITDA multiple. Generally, a reasonable EBITDA multiple aligns with the height of an industry sector’s average, reflects the company's profitability and growth potential, and provides enough incentive for an operator to sell (instead of holding onto the company and generating the proposed EV over X amount of years). Within the lower middle market, EBITDA multiples from successful transactions can range from low single digits up through the low double digits (ex: 4x – 10x+).
However, while the multiple range we provided is generally applicable within healthcare, EBITDA multiples can vary significantly between healthcare segments due to the diverse range of companies and sub-sectors within the industry, as well as the size of the target company within a specific segment. For example, Private Equity has traditionally defined a platform acquisition as a business that is generating over $5 million of EBITDA and can operate as a standalone investment, meaning there is no need for the investors to already have an existing healthcare holding company or portfolio to “add-on” the target acquisition (we should note, that Private Equity has lowered their ‘platform’ EBITDA threshold over the years and will look as low as $3 million of EBITDA within specific segments). Typically, companies that are of a ‘platform’ scale, warrant higher multiples -- often times in the mid to high singles or even double digits for particular segments due to the scale, growth opportunities, and proven track record of the business.
Conversely, businesses that fall beneath the threshold of a ‘platform’ acquisition EBITDA range, are traditionally defined as ‘bolt-on’ or ‘add-on’ acquisitions. These are targets that would be acquired for the purpose of bolting-on to an existing healthcare platform, in order to benefit from operational synergies between the existing companies and to increase the patient count, market share, and number of caregivers or employees. ‘Bolt-ons’, traditionally, warrant a lower multiple than a platform acquisitions.
Regarding varying ranges between specific healthcare segments, factors such as market conditions, patient demand, payor rates, and unique service programs can create higher investor demand, resulting more competitive (or higher) EBITDA multiples presented in offers. For example, if an Autism Services business and a Private Duty Home Care business both had an identical EBITDA, they will warrant different ranges in presented EBITDA multiples due to the heightened demand from investors within Autism Services compared to the Private Duty Home Care segment.
“No hard and fast rule defines a "good" EBITDA multiple. Generally, a reasonable EBITDA multiple aligns with the height of an industry sector’s average, reflects the company's profitability and growth potential, and provides enough incentive for an operator to sell (instead of holding onto the company and generating the proposed EV over X amount of years). Within the lower middle market, EBITDA multiples from successful transactions can range from low single digits up through the low double digits (ex: 4x – 10x+).”
What are EBITDA Multiples from the Buyer's Perspective?
Buyers have several things to consider when determining a reasonable EBITDA multiple to include in their offer for a particular company.
First, an investor researches industry benchmarks to understand the typical EBITDA multiples for comparable companies within the same healthcare segment, which provides context for evaluating a company's multiple. Assessing a company's historical EBITDA, overall performance, and how it has evolved over time can provide insights into market perceptions and trends. Comparing current average multiples to historical averages or trends within the industry can help gauge whether the current valuation aligns with historical norms.
Since companies with solid growth prospects often command higher EBITDA multiples, investors are willing to pay a premium for future earnings potential. Profitable companies with healthy margins typically command higher EBITDA multiples, reflecting their ability to generate strong cash flows. Analyzing metrics such as operating margins, net income, and return on invested capital (ROIC) can provide insights into a company's profitability and its impact on the EBITDA multiple.
Buyers also place an emphasis on factors such as revenue growth rates, market share expansion, quality and tenure of staff (including management), product innovation, and strategic initiatives when determining prospective value of a target company. In the case of Private Equity, synergies with their existing portfolio may give reason for an increase in proposed multiple.
Other primary factors buyers consider in their assessments:
- Size of the Target Acquisition – The scale of the target acquisition and if the buyer is approaching it as a ‘platform’ investment or a ‘bolt-on’ investment, will impact the proposed EBITDA multiple.
- Effect on Market Share – Often times, capturing market share can be a primary motivation of a buyer, and if an opportunity exists to capture a new geography or further strengthen their service within an existing geography, a buyer will often increase their proposed multiple compared to the average.
- Quality of Contracts – The rarity, value, and standing of existing contracts (whether with referral sources, regional or national payors, or to provide unique services or medications) can impact proposed multiples.
- Capability of Management and Transitioning Ownership – For private equity buyers, particularly purchasing a larger ‘platform’ company, the management team is vital. The company leadership may be considered ‘operating partners’ by the investors and have a portion of the equity, which will be cashed out at the subsequent exit.
- Personnel, Patients, and Payors – The caliber of caregivers and management personnel, the lifespan and/or concentration of patients, and quality of payors can all have an impact on proposed multiples.
- Market Conditions - Including interest rates, economic growth, industry trends, and investor sentiment, can influence EBITDA multiples. During periods of economic expansion and bullish sentiment, EBITDA multiples may be higher, while they may contract during economic downturns or periods of uncertainty.
- Recent Comps - Analyzing recent merger and acquisition transactions within the industry can provide benchmarks for assessing the reasonableness of an EBITDA multiple. Comparing the target company's EBITDA multiple to multiples paid in recent comparable transactions can help validate a proposed valuation.
- Other Unique Factors - Such as market position, competitive advantages, management quality, operational efficiency, and regulatory risks can influence a company's EBITDA multiple.
Evaluating how these factors differentiate the company from its peers and impact its future growth prospects can provide insights to the buyer on how to craft a competitive offer without over or underpaying for the opportunity.
What's an Example of an EBITDA Multiple Valuation?
Assume a company has $20,000,000 in revenue and $15,000,000 in Cost of Goods Sold (COGS) for a total gross profit of $5,000,000. Selling, general, and administrative (SG&A) expenses are $1,600,000, and depreciation is $300,000. These amounts are deducted to yield $3,100,000 operating profit or EBIT.
The depreciation of $300,000 is added back to get a $3,400,000 EBITDA.
Adjustments are added to the EBITDA figure. Assume the owner's salary is adjusted by $100,000 to reflect fair market compensation. Personal expenses of $30,000 and facility rent of $50,000 are additional adjustments for a total of $180,000.
The adjusted EBITDA is now $3,400,000 plus $180,000 or $3,580,000.
If an EBITDA multiple of 6.0 is presented by a prospective buyer, the proposed Enterprise Value is $3,580,000 x 6.0 or $21,480,000.
Expert Advice and Professional Service Equals Success
When considering whether to sell your healthcare company, the anticipated sale price is one of many critical factors to consider. Valuation of a healthcare business involves a comprehensive analysis of industry dynamics, market conditions, recent transaction data, and company-specific factors. But at the end of the day, your business is worth what an investor is willing to pay for it and one of the primary metrics of valuation used within lower-middle market M&A is an ascribed multiple based on EBITDA.
At M&A Healthcare Advisors, we can assist with preparing your company for sale, including determining your current EBITDA to better gauge anticipated value in the market. Conducting thorough analysis with the assistance of an experienced CPA, who in turn can assist in presenting an accurate and reliable EBITDA to the identified buyer community, can significantly improve your ability to achieve a successful exit at the height of the market. Presenting reliable data during the marketing process is the first step in building trust and increasing the probability of reaching a successful outcome.
Contact M&A Healthcare Advisors for expert assistance in determining when you are ready to exit your business or bring on an equity partner to grow it to the next phase.
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[1] This is the fundamental definition of EV from the perspective of you Balance Sheet. However, in an M&A process the buyer will determine what they are willing to pay for the Equity Value. It is not a variable you can identify internally.
[2] In the event that Working Capital is not part of the buyer’s proposed deal terms, the negotiation of receivables can be incorporated.