M&A Multiples. Where are they heading?

M&A Multiples. Where are they heading?

If you are looking to buy an IT Services firm or sell your firm, the number probably most on your mind at the start of the process is the multiple. We hear it all the time as we begin to talk with buyers and sellers. What’s the multiple they ask? What is your client looking to spend to buy my business? They then do a quick calculation to determine if the price seems right, attractive, and worthy of a conversation.

We answer wisely with a general observation about the current market, and the range of multiples that the market has been valuing companies. What we’re seeing at the start of 2014 is that the range of multiples has been moving up. It was only a few years ago when we told prospective buyers and sellers to expect multiples in the range of 4-6 times trailing 12 month earnings. Today we are looking at multiples in the range of 6-7 times 12 month trailing earnings, quite a jump.

We’re now also telling clients that it is not unusual to expect a multiple of 10. It’s a hard conversation to have with companies looking to acquire firms commanding that multiple, but as with most things in life, quality comes with a price. And quality companies get that way because they have done all the right things. So what are a few of the right things that quality companies have, and that any company looking to be acquired should strive to achieve?

It helps of course, right off the bat, to be in the right segment of the industry. The right segments now are practices like Business Intelligence, Mobility, Big Data, Telephony, Business Process Management, Security, and Compliance. It then helps that you have:

  • Double-digit annual growth in both revenue and profit.
  • Healthy balance sheet with strong retained earnings and minimal debt.
  • Strong backlog of work and orders
  • Clearly differentiated offering, ideally positioned as No. 1 or No. 2 in the market you serve.
  • Recurring or subscription revenue of at least 30 percent of total revenue. More is better.
  • Continuous stream of one new breakthrough expansion strategy per year. Maybe it’s an expansion into a new geography. Or getting into a new service line. Or a new delivery system. Some vitality.

If you’re in the M&A market as buyer, and the valuations you are prepared to pay are in the sub 6-7 times 12 month trailing earnings, then you are probably a financial buyer, and not a strategic buyer. Be wary.