How To Value Your Business Using Ebitda Multiple


Supposing you own a business that you have nurtured for years and finally now decided it was time to sell it or have some other people invest in it. How would you value the investment and at what price should people pay for it? This question will be easy to answer if your company was listed on some stock exchange as that represents a ready market that determines the value of your company from day to day. But if your company is a small business that is privately owned then estimating its Value can be quite onerous for obvious reasons. If it is just a start up, then it even can be more complicated and subjective.

For example, you may place a price to your company that is highly over valued and hence unrealistic. You may also place a price that well under values your business making your business appear cheap. This is a challenge small businesses face as they strive to get an idea of what their company’s fair value is. There are many tools that one can use to value a business but one which is very common with private and small business is using the Earnings Before Interest Tax and Depreciation (EBITDA) Multiple. To get what this mean I will use this illustration;

Example;

Joytech is a small time web based company that provides a platform for Social Networking for salsa dancers in Nigeria. It has over 1m members with about half of them active at any point in time. Currently, the company has invested a sum of N10m as start up cost over time. N2m was used to acquire computers, servers and other IT equipments, N500 used for Rent of Office Space, N1m used for advertising and publicity, N500,000 used for furniture and Equipment and N500,000 for a generator set. They also have 2 cars which they acquired for N1m each. They have also spent N2m in salaries and other operational cost since inception 3 years ago. They have a N2m cash balance. The company has projected that the business can generate a revenue of N10m annually from ads that will be displayed on their website. They expect this to grow to N15m, N20m, N25m and N30m in the second, third, fourth and fifth year respectively. Expenses is also projected to be around N4m, N6m, N8m, N10m, and N12m for the five years. Depreciation cost, which is the cost of their assets over the next five years will also average N1m yearly for the next five years. The company does not intend to pay tax at currently has a tax holiday from the government. They currently do not earn any revenue and do not have debts.

Joytech projects that to earn the above revenue, they will need a cash injection of about N20m to pay which will be used to acquire servers, more computers, marketing and publicity, software development, experienced programmers etc. This investment is believed will help them grow their user base to 3m in 24 months. They have now been approached by a group of Venture Capitalist (VC) who have indicated interest in providing the funds. However, the VC believe they should own 70% of the business since their N20m is twice the amount already invested by Joytech. What is the likely value of the business?

Valuing Joytech

EBITDA simply represents the cash that a business is able to generate. It does not take into account depreciation, tax, interest to debt holders if any and any amortizations. It basically accounts for the ability of the business to generate cash which can be used to pay debt providers (if any), taxes and off course dividends to equity holders. So for Joytech its Ebitda for the five years will be;

Year 1 – N10m – N4m = N6m

Year 2 – N15m-N6m   = N9m

Year 3 – N20m – N8m = N12m

Year 4 – N25m – N10m = N15m

Year 5 – N30m – N12m = N18m

The average of the five years gives you an EBITDA of N12m. The high point is N18m and low N6m. Joytech believes that businesses like theirs are usually able to generate return on investment (yield) of 20%(Note: The lower your yield the higher the higher your multiple and thus the higher the Enterprise Value). This means the businesses has a investment multiple of 5  (100/20) and thus pay back investors in 5 years. The formular for calculating the enterprise value of the businesses using Ebitda multiple is EV = Ebitda X Multiple. Now if we multiply the average Ebitda of N12m by 5 (multiple) we value the business at N60m. If we use the low N6m we value the business at N30m. And of we use the high of N18m we have a value of N90m. The average of the 3 is N46m. Deciding which figure to stick to will depend on the following;

At N60m

If the VC firm injects N20m then they only get 33% of the business

At N30m

If the VC invest N20m they get 67% of the businesses and get controlling shares

At N90m

With N20m investment, the VC firm only gets 22% of your business (equity)

At the average of N46m

The VC gets 43% of the business if they only invest N20m

Finally

The above illustration gives you an idea into how your business will be valued and can be a useful tool if  you are negotiating. But remember, VC firms usually invest in a company at start up stages because they believe that the huge risk taken then will be offset by the upside they get when they sell their stake when the business starts to make profit. Based on that they try to ensure that their investment gets them as much equity stake as possible (as the more equity they have the more they can get as cash when they sell). You also have to remember that most Start Ups actually do not earn any revenue and only rely on good business models that can show the potential to make money.

Another popular method used in valuing the equity of private businesses is the Discounted Cash Flow (DCF). However, this is not as simple as the Ebitda Multiple and requires a lot more assumptions in determining price.

So, whenever you get approached by a potential investor, you may want explore methods other than a simple asset valuation is determining the price for your business.

Note: The above is a simple illustration. Estimating the EBITDA of your business and the expected yield may involve a lot more rigorous analysis, possibly by a Corporate Finance Personnel.

 

What others say about : How To Value Your Business Using Ebitda Multiple..


824838725

Interesting article however I think you made a mistake in equating ROI with the earning multiple.

523112814

Hi Arinze, its actually Investment Multiple and not Earnings. Using Ebitda, we are dealing with returns that are accruable to both Shareholders and Debt providers. So ROI is correct in this instance.

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